July 25, 2014

Too Tangential

In its recent Chadbourne decision, the U.S. Supreme Court held that to be "in connection with" the purchase or sale of a security, an alleged securities fraud must involve "victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintaned an ownership interest in financial instruments that fall within the relevant statutory definition." Whether that requirement is met, of course, depends heavily on the particular facts at issue.

In Hidalgo-Velez v. San Juan Asset Management, Inc., 2014 WL 3360698 (1st Cir. July 9, 2014) the court addressed whether SLUSA preemption, which applies only to cases involving the purchase or sale of securities traded on a national exchange ("covered securities"), could be invoked if the plaintiffs were investors in a fund that promised to invest at least 75% of its assets "in certain specialized notes offering exposure to North American and European bond indices." As a threshold matter, the fund shares were not covered securities. The court found, however, that "the analysis does not invariably end there." To the extent that "the primary intent or effect of purchasing an uncovered security is to take an ownership interest in a covered security," the "in connection with" requirement could still be met.

The court held that in analyzing this issue, the "relevant questions include (but are not limited to) what the fund represents its primary purpose to be in soliciting investors and whether covered securities predominate in the promised mix of investments." In the instant case, it was clear the fund was marketed "principally as a vehicle for exposure to uncovered securities" (i.e., the specialized notes). Accordingly, the "in connection with" requirement was not met and SLUSA preemption did not apply.

Holding: Judgment of dismissal vacated, reversal of order denying remand, and remittal of case with instructions to return it to state court.

Quote of note: "As pleaded, the plaintiffs' case depends on averments that, in substance, the defendants made misrepresentations about uncovered securities (namely, those investments that were supposed to satisfy the 75% promise); that the plaintiffs purchased uncovered securities (shares in the Fund) based on those misrepresentations; and that their primary purpose in doing so was to acquire an interest in uncovered securities. Seen in this light, the connection between the misrepresentations alleged and any covered securities in the Fund's portfolio is too tangential to justify bringing the SLUSA into play."

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July 18, 2014

Doubling Down

In Spitzberg v. Houston American Energy Corp., 2014 WL 3442515 (5th Cir. July 15, 2014), the Fifth Circuit reversed the dismissal of a securities class action based on alleged false statements concerning oil and gas reserves. The decision contains a few interesting holdings.

(1) Scienter - The district court found, among other things, that the company's decision to spend $5 million on more testing of one of its wells "would not make sense" if the defendants had believed that no oil or gas would be found. The Fifth Circuit noted, however, that this testing took place after the company had been "heavily criticized" for making optimistic statements regarding its reserves. Accordingly, it was just as plausible that the defendants "may have felt the need to substantiate the allegedly irresponsible statements they had made previously."

(2) Loss Causation - The district court held that the complaint "warranted dismissal because it did not allege specifically whether the alleged misstatements or omissions were the actual cause of [the plaintiffs'] economic loss as opposed to other explanations, e.g., changed economic circumstances or investor expectations or industry-specific facts." The Fifth Circuit disagreed with this pleading standard. Instead, the court concluded that "the PSLRA does not obligate a plaintiff to deny affirmatively that other facts affected the stock price in order to defeat a motion to dismiss."

(3) Forward-looking Statements - The Fifth Circuit joined "the First Circuit, Third Circuit, and Seventh Circuit in concluding that a mixed present/future statement is not entitled to the [PSLRA safe harbor for forward-looking statements] with respect to the part of the statement that refers to the present." In particular, while the company's statements concerning the commercial productability of its wells were forward-looking, to the extent that its statements about "reserves" communicated information on past testing of the wells, those statements were actionable.

Holding: Reversed and remanded for further proceedings.

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June 23, 2014

Halliburton Decided

The U.S. Supreme Court has issued a decision in the Halliburton case holding that defendants can rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence of a lack of stock price impact. It is a 9-0 decision authored by Chief Justice Roberts, although Justice Thomas (joined by Justices Alito and Scalia) concurred only in the judgment. As discussed in a February 2010 post on this blog, Halliburton has a long history that now includes two Supreme Court decisions on class certification issues. A summary of the earlier Supreme Court decision can be found here.

Under the fraud-on-the-market presumption, reliance by investors on a misrepresentation is presumed if the misrepresentation is material and the company's shares were traded on an efficient market that would have incorporated the information into the stock price. The fraud-on-the-market presumption is crucial to pursuing a securities fraud case as a class action – without it, the proposed class of investors would have to provide actual proof of its common reliance on the alleged misrepresentation, a daunting task for classes that can include thousands of investors.

The fraud-on-the-market presumption, however, is not part of the federal securities laws. It was judicially created by the Supreme Court in a 1988 decision (Basic v. Levinson). In Halliburton, the Court agreed to revisit that decision, but ultimately decided that there was an insufficient "special justification" for overturning its own precedent.

The Court rejected the following key arguments. First, Halliburton argued that the fraud-on-the-market presumption was no longer tenable because (a) there is substantial empirical evidence that capital markets are not fundamentally efficient, and (b) investors do not always invest in reliance on the integrity of a stock's price. The Court found, however, that the Basic decision was not undermined by either of these arguments because it was based "on the fairly modest premise that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices." Accordingly, "[d]ebates about the precise degree to which stock prices accurately reflect public information are . . . largely beside the point" and it is sufficient that most investors do rely, either directly or indirectly, on the accuracy of stock prices.

Second, Halliburton argued that the fraud-on-the-market presumption could not be reconciled with more recent Court decisions making it clear that plaintiffs must prove that their proposed class meets all of the certification requirements imposed by the Federal Rules of Civil Procedure. The Court disagreed, noting that plaintiffs who invoke the fraud-on-the-market presumption must still prove certain prerequisites for that presumption - publicity, market efficiency, and market timing - before class certification.

Finally, Halliburton argued that the fraud-on-the-market presumption, by facilitating securities class actions, "allow[s] plaintiffs to extort large settlements from defendants from meritless claims; punish innocent shareholders, who end up having to pay settlements and judgments; impose excessive costs on businesses; and consume a disproportionately large share of judicial resources." The Court found that these "concerns are more appropriately addressed to Congress, which has in fact responded, to some extent, to many of the issues raised by Halliburton and its amici." Moreover, the fact that Congress "may overturn or modify any aspect of our interpretations of the reliance requirement, including the Basic presumption itself" supports the notion that the principle of stare decisis should be applied to the Basic decision.

Although the Court was unwilling to overturn Basic, it did agree with Halliburton that defendants should be able to rebut the fraud-on-the-market presumption with evidence that the alleged misrepresentation did not actually affect the stock price. Notably, price impact evidence is already used at the class certification stage "for the purpose of countering a plaintiff's showing of market efficiency" by establishing that the stock price did not react to publicly reported events. If it can be used to rebut this prerequisite for the fraud-on-the-market presumption (which is nothing more than "an indirect showing of price impact"), the Court found that it also should be available to directly rebut the presumption as to the specific misrepresentation.

Holding: Vacated judgment and remanded for further proceedings consistent with opinion.

Notes on the Decision:

(1) There are two concurrences, which go in radically opposite directions. A concurrence authored by Justice Ginsburg (joined by Justices Breyer and Sotomayor) simply states that she joins the opinion because she understands that it "should impose no heavy toll on securities-fraud plaintiffs with tenable claims." In contrast, Justice Thomas (joined by Justices Scalia and Alito) concurs only in the judgment and forcefully argues that the Basic decision should be overturned, noting that "[t]ime and experience have pointed up the error of that decision, making it all too clear that the Court's attempt to revise securities law to fit the alleged new realities of financial markets should have been left to Congress."

(2) Missing from the fray is Justice Kennedy, who joined Justice Thomas' dissent in the recent Amgen decision. In that dissent, Justice Thomas expressed skepticism about the continued vitality of the fraud-on-the-market presumption. A number of commentators therefore assumed that Justice Kennedy was interested in overturning the Basic decision. Apparently not.

Disclosure: The author of The 10b-5 Daily submitted an amicus brief on behalf of the Washington Legal Foundation in support of petitioner. The amicus brief primarily argued that the Court should permit defendants to rebut the fraud-on-the-market presumption with price impact evidence.

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May 20, 2014

Specious Logic

In 2003, America Online (AOL) investors brought a securities class action alleging that Credit Suisse First Boston (CSFB) fraudulently withheld relevant information from the market in its reporting on the AOL-Time Warner merger. After many years of litigation, the D. of Mass. granted summary judgment to CSFB, finding that the plaintiffs had failed to raise a triable issue of fact as to loss causation.

The key basis for the district court's decision was its rejection of the plaintiffs' expert study. In particular, the district court found that the study improperly (a) cherry-picked days with unusual stock price volatility, (b) overused dummy variables to make it appear that AOL's stock price was particularly volatile on the days CSFB issued its reports, (c) attributed "volatility in AOL's stock price to the reports of defendants analysts when, at the time of the inflation or deflation, an efficient market would have already priced in the reports," and (d) failed to conduct "an intra-day trading analysis for each event day with confounding information (which is, to say, nearly all of them) in order to provide the jury with some basis for discerning the cause of the stock price fluctuation."

On appeal, the First Circuit affirmed the exclusion of the expert testimony and the grant of summary judgment. See Bricklayers and Trowel Trades Int'l Pension Fund v. Credit Suisse Securities (USA) LLC, 2014 WL 1910961 (1st Cir. May 14, 2014). The appellate court disagreed that the expert's use of dummy variables was "inconsistent with the methodology or goals of a regression analysis" and concluded that it was a "dispute that should be resolved by the jury." However, the other three deficiencies identified by the district court were "more than sufficient" to find that the district court had not abused its discretion.

The plaintiffs argued that affirming the district court's decision was inappropriate because it was uncontested that 5 of the event days identified by the expert as having "statistically significant abnormal returns" (out of a total of 57 days) "did not suffer from any methodological infirmities." While the appellate court conceded that it could be an abuse of discretion to reject "mostly salvageable expert testimony for narrow flaws," in this case it "confront[ed] the reverse situation - pervasive problems with [the expert's] event study that, allegedly, still leave a few dates unaffected." Under these circumstances, the district court properly treated the entire event study as inadmissible.

Holding: Affirming exclusion of expert testimony and grant of summary judgment to defendants.

Quote of note: "Requiring judges to sort through all inadmissible testimony in order to save the remaining portions, however small, would effectively shift the burden of proof and reward experts who fill their testimony with as much borderline material as possible. We decline to overturn the district court's ruling on this specious logic."

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May 9, 2014

Keeping It Domestic

In its Morrison decision, the U.S. Supreme Court held that Section 10(b) (the primary federal anti-securities fraud statute) only provides a private cause of action for claims based on "[1] transactions in securities listed on domestic exchanges, and [2] domestic transactions in other securities." A number of subsequent lower court decisions have explored the scope of those two categories, with most of the decisions taking the view that they should be strictly construed to limit Section 10(b) claims to transactions that take place within the United States.

In the UBS securities litigation, for example, 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. 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.

On appeal, in a case of first impression at the appellate level, the Second Circuit has affirmed that decision. In City of Pontiac Policeman's and Firemen's Retirement System v. UBS AG, 2014 WL 1778041 (2d Cir. May 6, 2014), the court found that the plaintiffs' listing theory "is irreconciliable with Morrison read as a whole," in which the court "makes clear that the focus of both prongs was domestic transactions of any kind, with the domestic listing acting as a proxy for a domestic transaction." In addition, the Second Circuit test for whether a transaction is domestic is if "the parties incur irrevocable liability to carry our the transaction within the United States or when title is passed the United States." The fact that the purchaser is a U.S. entity or placed the order in the U.S. does not establish that it has met this test.

Holding: Dismissal of "foreign-cubed" and "foreign-squared" claims affirmed.

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March 28, 2014

Shielding From Suspicion

The U.S. Court of Appeals for the Fourth Circuit has issued an opinion - Yates v. Municipal Mortgage & Equity, LLC, 2014 WL 890018 (4th Cir. March 7, 2014) - that clarifies the court's position on several securities fraud issues.

(1) Core operations (scienter) - Core operations is a scienter theory that infers that facts critical to a business's 'core operations' or an important transaction are known to the company's key officers. Exactly how and to what extent the theory can be invoked to satisfy a plaintiff's burden to plead a strong inference of scienter has been the subject of some judicial debate. In Yates, the Fourth Circuit held that "such allegations are relevant to the court's holistic analysis of scienter," but without other allegations "establishing the defendant's actual exposure to the . . . problem, the complaint falls short of the PSLRA's particularity requirement."

(2) Rule 10b5-1 trading plans - Two of the individual defendants sold shares pursuant to non-discretionary Rule 10b5-1 trading plans. The court found that the use of these plans "further weakens any inference of fraudulent purpose" caused by the sales, but also noted that because one of the plans was instituted during the class period, it did "less to shield [that defendant] from suspicion."

(3) Statute of repose for Section 11 claims - The case included Section 11 claims based on an alleged misrepresentation in a registration statement that was declared effective on January 14, 2005. The plaintiffs argued that their Section 11 claims were not barred by the applicable 3-year statute of repose - despite being brought on February 1, 2008 - because the actual offering did not commence until two weeks after the effective date. The court adopted what it described as the majority position: "Section 11 is violated when a registration statement containing misleading information becomes effective." The fact that the plaintiffs "did not know that the registration statement was effective as of January 14 is of no consequence for statute of repose purposes."

Holding: Dismissal affirmed.

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March 13, 2014

Back To The Well

Securities litigation? Check. Then you are well on your way to getting your cert petition granted by the U.S. Supreme Court. After agreeing just last week to hear Omnicare and resolve a circuit split over the pleading of false opinions in Section 11 claims, the Court has come back this week with yet another grant of cert in a securities case.

Public Employees' Retirement System of Mississippi v. IndyMac MBS, Inc. presents the question of whether the filing of a securities class action tolls the applicable statute of repose for individual class members. The Second Circuit found that the statute of repose cannot be tolled because it "create[s] a substantive right in those protected to be free from liability after a legislatively-determined period of time" and "[p]ermitting a plaintiff to file a complaint or intervene after the repose period . . . has run would therefore necessarily enlarge or modify a substantive right and violate the Rules Enabling Act." The Court will hear the case next term.

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March 6, 2014

Halliburton Argued

On Wednesday, the U.S. Supreme Court heard oral argument in the Halliburton v. Erica P. John Fund case, which brings into question the continued viability of the fraud-on-the-market presumption of reliance. The fraud-on-the-market presumption is crucial to pursuing a securities fraud case as a class action – without it, the proposed class of investors would have to provide actual proof of its common reliance on the alleged misrepresentation, a daunting task for classes that can include thousands of investors.

Much of the pre-argument commentary had focused on Chief Justice Roberts as the possible "swing vote" that could create a majority in favor of eliminating the fraud-on-the-market presumption (which was judicially created by a 1988 Supreme Court decision). Based on the questioning at the hearing, however, The 10b-5 Daily's prediction that Halliburton would be unable to find five justices who are willing to go that far seems more accurate. Indeed, to the extent that the Court is willing to change the current regime, it now appears that they are more likely to embrace the intermediate step of requiring evidence of price impact before a class can be certified (because price impact is a prerequisite of the fraud-on-the-market presumption).

Why read the tea leaves this way? A few highlights:

(1) Petitioner (Halliburton) started off arguing that the fraud-on-the-market presumption should be overruled because at least three things have changed since it was implemented: (a) the Court has consistently construed the private right of action for securities fraud narrowly, (b) the Court has issued decisions making it clear that class-wide issues should be addressed at the class certification stage, and (c) the economic premise that "investors rely in common on the integrity of the market price" is no longer accurate (assuming it ever was). In response, Justice Kagan noted that Petitioner apparently agreed "that market prices generally do respond to new material information," so in any particular case there will have to be a fact-specific inquiry into "whether there's an exception to this general rule." Petitioner responded that "if the Court were inclined to keep the presumption in some sense, it should at least place the burden on the plaintiff to establish that the misrepresentation actually distorted the market price, or to give defendants the full right of rebuttal at the class certification stage to establish the price was not impacted."

(2) Once the discussion turned to the use of price impact evidence, much of the rest of the hearing focused on that issue. Most notably, Justice Kennedy asked Petitioner to address whether a possible solution to the economic issues it had raised was to require plaintiffs to demonstrate - via an event study at class certification - that the alleged misrepresentation had impacted the market price. Petitioner readily agreed that it made "sense to focus like a laser on the only relevant question, whether the misrepresentation distorted the market price." In response to questions from Chief Justice Roberts and Justice Alito, Petitioner also argued that the cost of these event studies would not be significant because "plaintiffs are commonly using event studies right now as part of their [overall] market efficiency showing" at class certification and that event studies are "very effective" at determining a misrepresentation's price effect.

(3) Respondent (investors) and the government also were asked to address the use of price impact evidence at the class certification stage. In response to questioning from Justice Sotomayor and Justice Kennedy, Respondent argued that in a case alleging multiple misrepresentations, conducting event studies would be "very complicated" and "very expensive," and, moreover, "the idea that there are not significant merits filters that prevent cases from going to trial is simply wrong, both at the pleading stage and at the summary judgment stage." In contrast, however, the government readily conceded that if the Court were to require proof of price impact at the class certification stage, it "would be a net gain to plaintiffs, because plaintiffs already have to prove price impact at the end of the day."

Disclosure: The author of The 10b-5 Daily submitted an amicus brief on behalf of the Washington Legal Foundation in support of petitioner.

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March 4, 2014

Chadbourne Decided (And Section 11 Is On Deck)

On the eve of the Halliburton oral argument, there have been two other developments in the U.S. Supreme Court related to securities litigation.

(1) Last week, in the Chadbourne & Parke LLP v. Troice case, the Court held that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) does not preclude state-law class actions unless the alleged misrepresentation "is material to a decision by one or more individuals (other than the fraudster) to buy or sell a 'covered security.'" The Court went on to find that the state-law class action against the defendants should be allowed to proceed because the alleged ponzi scheme, in which high-interest certificates of deposit (not covered securities) were sold to investors who were falsely told that the proceeds would be invested in liquid securities (at least some of which would be covered securities), did not satisfy this test.

The 7-2 decision authored by Justice Breyer provides an interpretation of the phrase "in connection with the purchase or sale" of a security that is contained both in SLUSA and Section 10(b) of the Securities Exchange Act (the primary statutory basis for federal securities fraud claims). The Court presents the following key arguments in support of its interpretation. First, SLUSA's language suggests that the requisite connection to the purchase or sale must "matter" and "[i]f the only party who decides to buy or sell a covered security as a result of a lie is the liar, that is not a connection that matters." Second, "every securities case in which this Court has found a fraud to be 'in connection with' a purchase or sale of a security has involved victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition." Finally, the Court's reading of SLUSA is consistent with the Securities Exchange Act and the Securities Act because "[n]othing in [those] statutes suggests their object is to protect persons whose connection with the statutorily defined securities is more remote than words such as 'buy,' 'sell,' and the like, indicate."

On its surface, of course, the decision is a victory for the plaintiffs' bar because it narrows the scope of SLUSA preemption. But the split within the Court - Justices Kennedy and Alito filed a vigorous dissent arguing that the new test is inconsistent with the Court's prior "broad construction" of the "in connection with" language - may be the result of two different forces at play. While the Court's test narrows the scope of SLUSA preemption, it also appears to narrow the overall scope of Section 10(b), limiting how far the plaintiffs' bar (and the SEC) can push the definition of a "securities fraud." This result sheds some light on why, for example, Justice Thomas joins the majority in a short, separate concurrence that applauds the application of "a limiting principle to the phrase 'in connection with'" - an outcome that no doubt appealed to a justice who has been in dissent in previous cases that arguably espoused a broader view of "in connection with" (e.g., O'Hagan).

(2) Apparently anxious to continue to delve into securities litigation issues, the Court also granted cert on Monday in the Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund case, which will be heard next term. At issue is the scope of Section 11 of the Securities Act, which provides a private remedy for a purchaser of securities issued under a registration statement filed with the SEC if the registration statement contains a material misstatement or omission.

The Court will consider the pleading standard for an allegedly false or misleading opinion (as opposed to statement of fact). While the Second, Third, and Ninth Circuits have held that under Section 11 a plaintiff must allege that the statement was both objectively and subjectively false - requiring allegations that the speaker's actual opinion was different from the one expressed - in Omnicare the Sixth Circuit held that if a defendant "discloses information that includes a material misstatement [even if it is an opinion], that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity." Stay tuned.

Posted by Lyle Roberts at 10:23 PM | TrackBack

January 10, 2014

Halliburton Briefing (Petitioners)

The Halliburton case in the U.S. Supreme Court is moving quickly, with oral argument scheduled for March 5, 2014. At issue, at least potentially, is the continued viability of the fraud-on-the-market presumption of reliance. The presumption was judicially created by the Court and is routinely invoked in securities class actions to justify the grant of class certification.

The merits brief for the petitioners (Halliburton and its CEO) and the supporting amicus briefs have been filed with the Court. A listing of the briefs can be found here. The author of The 10b-5 Daily - Lyle Roberts of Cooley LLP - assisted the Washington Legal Foundation (WLF) with the filing of an amicus brief that focuses on the second question presented: Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.

The WLF brief argues that price impact is not dispositive as to either materiality or loss causation for all class members and, as a result, allowing a price impact rebuttal at the class certification stage does not run afoul of the Court's Amgen decision. In addition, the brief points out that allowing a price impact rebuttal would harmonize the Court’s approach to affirmative misstatement and omissions cases and would better protect the rights of individual investors who can demonstrate actual reliance. The WLF brief is available on the Foundation's website.

Posted by Lyle Roberts at 9:34 PM | TrackBack

November 15, 2013

Supreme Court Grants Cert In Halliburton Case

The U.S. Supreme Court has granted certiorari in Halliburton v. Erica P. John Fund, setting up what could be the most important securities litigation decision in the last twenty-five years. At issue is the continued validity of the fraud-on-the market-theory, whereby reliance by investors on a misstatement is presumed if the company's shares were traded on an efficient market that would have incorporated the information into the stock price. The presumption is routinely invoked in securities class actions to justify the grant of class certification.

In its petition, Halliburton presented the following two questions:

1. Whether this Court should overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory.

2. Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.

In granting review, the Court did not limit its consideration to either question. As a result, SCOTUSBlog notes that the Court presumably "at least will consider the broader plea to cast aside the prior ruling."

The case will be argued early next year. Reuters and Bloomberg have coverage of the cert grant. For more on the underlying case and the cert petition, see this recent blog post.

Quote of note (Bloomberg): "Four justices -- Antonin Scalia, Clarence Thomas, Anthony Kennedy and Samuel Alito -- suggested in a ruling in February that they might jettison the 'Basic presumption,' as it has become known. The outcome of the case may be in the hands of Chief Justice John Roberts, who usually joins that group in ideologically divisive cases."

Posted by Lyle Roberts at 11:54 PM | TrackBack

October 25, 2013

Challenging The Fraud-On-The-Market Theory

Pursuant to the fraud-on-the-market theory, reliance by investors on a misstatement is presumed if the company's shares were traded on an efficient market that would have incorporated the information into the stock price. The presumption was judicially-created by the U.S. Supreme Court and is routinely invoked in securities class actions to justify the grant of class certification. In the Court's recent Amgen decision, however, four justices expressed concerns about the fraud-on-the-market theory's continuing validity. In particular, the Amgen dissent noted that the Court is not well-equipped to apply economic concepts and there is some disagreement about how market efficiency works. Given that invitation, it was only a matter of time before a securities class action defendant asked the Court to reconsider its current position.

Erica P. John Fund v. Halliburton, a securities class action that has been pending in the N.D. of Texas since 2002, has already been the subject of a Supreme Court decision relating to the fraud-on-the-market theory. In 2011, the Court held that loss causation is not a precondition for invoking the fraud-on-the-market presumption and, therefore, is not necessary to establish that reliance is capable of resolution on a common, classwide basis. On remand, the defendants pursued a related issue. Halliburton argued that it should be allowed to rebut the fraud-on-the-market presumption by establishing that the alleged misstatements did not have a stock price impact. The district court found that price impact evidence did not bear on the critical inquiry of whether common issues predominated under FRCP 23(b)(3) and certified the class. The Fifth Circuit subsequently affirmed, finding that although price impact evidence certainly could be used at trial to refute the presumption of reliance, it was not appropriate to consider this evidence at class certification.

Halliburton is once again seeking certiorari in the Supreme Court, but now it is going after an even bigger prize. In addition to arguing that the Fifth Circuit should have allowed the defendants to rebut the presumption by presenting price impact evidence, Halliburton asserts that the Court should overrule or substantially modify the fraud-on-the-market theory. It takes four justices to grant cert - will the Amgen group decide that the Halliburton case is the right vehicle through which to consider this question? A handful of amici have urged them to do so, including the U.S. Chamber of Commerce, and the issue has caught the attention of the legal press. Stay tuned.

Posted by Lyle Roberts at 10:36 PM | TrackBack

October 11, 2013

Chadbourne Argued

On Monday, the U.S. Supreme Court heard oral argument in three related cases - Chadbourne & Parke v. Samuel Troice, No. 12-79; Willis of Colorado v. Troice, No. 12-86; and Proskauer Rose v. Troice, No. 12-88 - raising the issue of the scope of the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"). SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities ("covered securities").

Observers who were hoping for a lot of discussion about the meaning and import of SLUSA, however, were sorely dissapointed. Instead, oral argument focused on an issue that the Court has considered before: exactly what fact patterns does "in connection with the purchase or sale" (which is taken from Section 10(b) of the Securities Exchange Act of 1934) cover? The three cases related to the Stanford ponzi scheme, in which high-interest certificates of deposit (not covered securities) were sold to investors who were falsely told that the proceeds would be invested in liquid securities (at least some of which would be covered securities).

The justices appeared to struggle with idea that a false statement concerning whether securities have been purchased can satisfy the "in connection with" requirement. Almost immediately, Chief Justice Roberts asked counsel for the petitioners "if I'm trying to get a home loan and they ask you what assets you have and I list a couple of stocks and, in fact, it's fraudulent, I don't own them, that's a covered transaction, that's a 10(b)(5) violation?" When counsel responded that the scenario would appear to be missing any representation about a purchase or sale, Justice Kagan argued that the problem is "In all of our cases, there's been something to say when somebody can ask the question: How has this affected a potential purchaser or seller in the market for the relevant securities? And here there's nothing to say." For his part, Justice Scalia appeared willing to go even further, noting that the "purpose of the securities laws was to protect the purchasers and sellers of the covered securities. There is no purchaser [] or seller of a covered security involved here." Ultimately, counsel for the petitioners argued that the "in connection with" standard is satisfied "when there is a misrepresentation and a false promise to purchase covered securities for the benefit of the plaintiffs."

The government argued in favor of the petitioners' position, but also ran into stiff questioning, When the government suggested that Justice Kagan's "market effect" test was satisfied because the Stanford scheme would make investors less likely to trust the financial markets, Justice Kennedy responded that this argument was the equivalent of saying "if you went to church and heard a sermon that there are lots of people that are evil, maybe then you wouldn't invest."

Counsel for the respondents argued that the alleged scheme did not involve purchasing covered securities for the benefit of the plaintiffs. The seller of the C.D.'s "was only buying [covered securities] for itself. It did not pledge to sell the assets. It did not give the plaintiffs any interest in them." Moreover, what the Court's precedents "have said over and over and over and what has been the dividing line that has prevented 10(b)(5) from swallowing all fraud is these are misrepresentations that affect the regulated market negatively. This fraud did not do that."

The New York Times and Reuters have coverage of the oral argument.

Posted by Lyle Roberts at 11:36 PM | TrackBack

September 13, 2013

Leading Off

Securities litigation is at the top of the Supreme Court's docket this fall. On October 7, the first day of the term, the Court will hear three cases - Chadbourne & Parke v. Troice, Proskauer Rose v. Troice, and Willis v. Troice - that have been consolidated for one hour of argument. The topic is the scope of the Securities Litigation Uniform Standards Act ("SLUSA").

SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In the three related cases, the Fifth Circuit held that the "best articulation of the 'coincide' requirement" is that the fraud allegations must be "more than tangentially related to (real or purported) transactions in covered securities." The Fifth Circuit then concluded that the relationship between the alleged fraud, which centered around the sale of certificates of deposit, and any transactions in covered securities was too attenuated to trigger SLUSA preclusion. The defendants successfully moved for certification on the grounds that the Fifth Circuit's "more than tangentially related" standard was in conflict with the standards articulated by other circuits.

The ABA Preview of Supreme Court Cases has all of the briefs, which include amicus briefs from the United States (petitioners), DRI - the Voice of the Defense Bar (petitioners), Occupy the SEC (respondents), and Sixteen Law Professors (respondents). A preview article in The National Law Journal (Sept. 4 issue - subscrip. req'd) focuses on the perceived threat to law firms and other third parties arising from the Fifth Circuit's decision to allow the state law claims to proceed.

Interestingly, both sides will be represented by prominent Supreme Court advocates: former solicitor general Paul Clement for the defendants (petitioners) and Tom Goldstein for the plaintiffs (respondents).

Posted by Lyle Roberts at 11:46 PM | TrackBack

June 28, 2013

A Problem For Congress

The federal securities laws have statutes of repose (suit barred after a fixed number of years from the time the defendant acts in some way) and statutes of limitations (establishing a time limit for a suit based on the date when the claim accrued). There is a significant district court split, however, over whether the existence of a class action tolls the statute of repose for a federal securities claim.

Under what is known as American Pipe tolling, "the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action." American Pipe & Construction Co. v. Utah, 414 U.S. 538, 554 (1974). The Supreme Court found that its rule was “consistent both with the procedures of [Federal Rule of Civil Procedure] 23 and with the proper function of limitations statutes.” Id. at 555. In a later case, however, the Supreme Court also found that federal statutes of repose are not subject to equitable tolling. Lampf, Pleva, Lipkind, Prupis & Pettigrow v. Gilbertson, 501 U.S. 350, 364 (1991). In attempting to reconcile these two cases, the majority of lower courts have concluded that American Pipe tolling applies to the statute of repose for federal securities claims because it is based on FRCP 23 and, therefore, is a type of legal (as opposed to equitable) tolling. Other recent decisions, however, have concluded that because FRCP 23 does not expressly create a class action tolling rule, American Pipe tolling is best understood as a judicially-created rule based on equitable considerations and, as a result, cannot extend a statute of repose.

In Police and Fire Retirement System of City of Detroit v. IndyMac MBS, Inc., 2013 WL 3214588 (2d Cir. June 27, 2013), the Second Circuit has resolved the split by holding that the statue of repose cannot be tolled even if the American Pipe tolling rule is "legal." The court noted that statutes of repose "create a substantive right in those protected to be free from liability after a legislatively-determined period of time." Meanwhile, FRCP 23 is a product of the Rules Enabling Act, which specifically states that the rules it authorizes "shall not abridge, enlarge or modify any substantive right." Accordingly, the court held, "[p]ermitting a plaintiff to file a complaint or intervene after the repose period . . . has run would therefore necessarily enlarge or modify a substantive right and violate the Rules Enabling Act."

Holding: Affirming denial of motions to intervene.

Quote of note: "We are cautioned by some of the proposed intervenors that a failure to extend American Pipe tolling to the statute of repose in Section 13 could burden the courts and disrupt the functioning of class action litigation. We are not persuaded. Given the sophisticated, well-counseled litigants involved in securities fraud class actions, it is not apparent that such adverse consequences will inevitably follow our holding. But even if the decision causes some such problem, it is a problem that only Congress can address; judges may not deploy equity to avert the negative effects of statutes of repose."

Posted by Lyle Roberts at 9:07 PM | TrackBack

May 31, 2013

Something Systemic

In Massachusetts Retirement Systems v. CVS Caremark Corp., 2013 WL 2278599 (1st Cir. May 24, 2013), the plaintiffs asserted that the company had failed to disclose integration problems following a merger. The district court dismissed on loss causation grounds, holding that the complaint did not plausibly allege that the company's statements prior to the stock price decline, which related to lost contracts, revealed the supposed fraud. On appeal, the First Circuit provided guidance on how to evaluate loss causation.

(1) "Mirror-image" disclosure not required - The court found that "a corrective disclosure need not be a 'mirror-image' disclosure - a direct admission that a previous statement is untrue." Although the company did not attribute its lost contracts to integration issues, the company's statements "plausibly revealed to the market that CVS Caremark had problems with service and the integration of its systems." In particular, the court noted that the strongly negative analyst and stock price reaction "likely reflected an understanding that something systemic had gone wrong."

(2) Lost contracts v. reason for lost contracts - The defendants argued that CVS Caremark's loss of certain clients "was public knowledge" well before the disclosures that led to the stock price decline. The court agreed that the market knew about the lost contracts, but concluded that the core allegation in the complaint was that the disclosures revealed "for the first time the real reason for the loss: the failed integration of CVS and Caremark" and "this new information could plausibly have caused [the plaintiffs] losses."

(3) Use of analyst reports - To support their assertions about the "meaning" of the company's disclosures, the plaintiffs relied heavily on analyst reports. The court held that "[w]hen a plaintiff alleges corrective disclosures that are not straightforward admissions of a defendant's previous misrepresentations, it is appropriate to look for indications of the market's contemporaneous response to those statements." In this case, the analyst reports plausibly reflected an understanding that "the merger had failed to produce any value for CVS Caremark" and the reports "should have been considered in deciding the motion to dismiss."

Holding: Dismissal vacated and case remanded for further proceedings.

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May 24, 2013

Reading the Tea Leaves

Section 11 of the '33 Act creates liability for material misrepresentations in a registration statement. According to the Second Circuit (Fait) and Ninth Circuit (Rubke), however, if the alleged misrepresentation is an opinion, the plaintiff must establish that the opinion was both objectively false and disbelieved by the defendant at the time it was made. In effect, these rulings convert a Section 11 claim based on an opinion from a strict liability (the company) or negligence (the individual defendants) standard to a knowing falsity standard.

The Omnicare securities litigation has generated a number of decisions discussing the pleading standards for Section 11 claims. After the district court dismissed the case, the Sixth Circuit reversed as to the Section 11 claim, finding that the district court had erred by requiring the plaintiffs to plead loss causation. The plaintiffs initially pursued a writ of certiorari on the issue of whether Section 11 claims can be subject to the heightened pleading standard of FRCP 9(b), but then, after the U.S. Supreme Court asked for the government's view of the cert request, withdrew their petition and went back to the district court. The district court then dismissed the Section 11 claim again, finding that the alleged misrepresentations were opinions and the plaintiffs had failed to sufficiently plead the defendants' knowledge of falsity.

In Indiana State District Council of Laborers v. Omincare, Inc., 2013 WL 2248970 (6th Cir. May 23, 2013), the court examined the "knowing falsity" rule for opinions. The court found that while it "makes sense that a defendant cannot be liable for a fraudulent misstatement or omission under Section 10(b) and Rule 10b-5 if he did not know the statement was false at the time it was made" that logic does not extend to strict liability claims. Under Section 11, if a defendant "discloses information that includes a material misstatement, that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity." Nor was the court persuaded by the reasoning of the Second and Ninth Circuits, which had relied on the Supreme Court's decision in the Virginia Bankshares case interpreting a non-strict-liability securities statute. According to the court, "it would be unwise for this Court to add an element to Section 11 claims based on little more than a tea-leaf reading in a Section 14(a) case."

Holding: Dismissal reversed in part and affirmed in part.

Posted by Lyle Roberts at 8:09 PM | TrackBack

May 17, 2013

Shrug, Concur, and Move On

In a famous market manipulation that lead to multiple criminal convictions, the A.R. Baron brokerage engaged in a pump-and-dump scheme to induce customers to purchase the securities of small companies at artificially inflated prices. Among many others, investors sued an individual whose acts allegedly facilitated Baron's frauds in violation of Section 10(b). The district court dismissed the Section 10(b) claim.

On appeal, the Second Circuit addressed this dismissal (Fezzani v. Bear Stearns & Co., Inc., 2013 WL 1876534 (2d Cir. May 7, 2013) (Lohier, J. dissenting). The court found that manipulation violates Section 10(b) "when an artificial or phony price of a security is communicated to persons who, in reliance upon a misrepresentation that the price was set by market forces, purchase the securities." The Supreme Court, in its decisions in Stoneridge and Janus, has held that in a Section 10(b) claim involving a misrepresentation there can only be primary liability for entities or individuals who actually communicated the misrepresentation to the injured investors. Applying that principle in the instant case, the court found that because there was no allegation that the individual defendant actually communicated the artificial price information to the investors (as opposed to assisting Baron in its fraud), there could be no Section 10(b) primary liability.

In a vigorous dissent, however, one of the panel members challenged whether Stoneridge and Janus are applicable in a case alleging market manipulation. The dissent noted that a "market manipulation claim permits the plaintiff to plead that it relied on an assumption of an efficient market free of manipulation, whereas a misrepresentation claim requires the plaintiff to allege reliance upon a misrepresentation or omission." As a result, a plaintiff alleging market manipulation is entitled to use a fraud-on-the-market theory to establish reliance (i.e., the defendant engaged in a transaction that sent a fale pricing signal to the market, which was then communicated by the market to the investor). Accordingly, the dissent concluded, the fact that the individual defendant was a key participant in the transactions that sent a false pricing signal was sufficient to establish Section 10(b) primary liability.

Holding: Dismissal affirmed.

Quote of note (dissent): "I fear that every market manipulator . . . will be cheered by the extra shelter for stock manipulation under the federal securities laws that the majority opinion unnecessarily provides them. If I thought that Stoneridge or Janus required that result, I would shrug, concur, and move on. Because I conclude that neither case forecloses the federal claim of market manipulation against Dweck, I respectfully dissent."

Posted by Lyle Roberts at 8:58 PM | TrackBack

May 10, 2013

What Next?

Based on the Supreme Court's recent decisions, a plaintiff is not required to prove the existence of loss causation (Halliburton) or materiality (Amgen) to certify an investor class. In the Halliburton case, however, the defendants pursued a related issue on remand. Halliburton argued that it should be allowed to rebut the fraud-on-the-market presumption of reliance by establishing that the alleged misrepresentations did not have a stock price impact. The district court found that price impact evidence did not bear on the critical inquiry of whether common issues predominated under FRCP 23(b)(3) and certified the class. Halliburton appealed.

In Erica P. John Fund, Inc. v. Halliburton Company, 2013 WL 1809760 (5th Cir. April 30, 2013), the Fifth Circuit found that "Halliburton's price impact evidence potentially demonstrates that despite the presence of the necessary conditions for market price incorporation of fraudulent information (fraud-on-the-market reliance), no such incorporation occurred in fact." Although this evidence certainly could be used at trial to refute the presumption of reliance, the court questioned whether it was appropriate to consider it at class certification.

Under Amgen, the court held, price impact evidence should not be considered if it is "common to the class" and if there is no risk "that a later failure of proof on the common question of price impact will result in individual questions predominating." The court found that both criteria were met and the district court did not err in declining to consider Halliburton's price impact evidence. First, "price impact is ordinarily established by expert evaluation of a stock's market price following a specific event and it inherently applies to everyone in the class." Second, although defeating the presumption of reliance would presumably still leave open the possibility of individual claims, "[i]f Halliburton were to successfully show that the price did not drop when the truth was revealed, then no plaintiff could establish loss causation." Accordingly, the claims of all individual plaintiffs would fail.

Holding: Affirming grant of class certification.

Addition: As detailed in a February 2010 post, the Halliburton case has a remarkable procedural history that now includes a Supreme Court decision and two Fifth Circuit decisions on class certification. What next?

Posted by Lyle Roberts at 6:47 PM | TrackBack

April 5, 2013

The Sun May Not Rise Tomorrow

The Boeing securities class action related to its development of its 787-8 Dreamliner plane continues to provide some drama. In 2011, as noted on this blog, the district court granted the company's motion to dismiss (on a motion for reconsideration) after it was determined that a key confidential witness denied being the source of the allegations attributed to him in the complaint, denied having worked for Boeing, and claimed to have never met plaintiffs' counsel until his deposition. The plaintiffs appealed this decision to the U.S. Court of Appeals for the Seventh Circuit.

In City of Livonia Employees' Retirement System and Local 295/Local 851, IBT v. Boeing Company, 2013 WL 1197791 (7th Cir. March 26, 2013), the court affirmed the dismissal based on the complaint's failure to establish a strong inference of scienter. The opinion, authored by Judge Posner, contains some interesting commentary.

(1) Motive - The plaintiffs alleged Boeing had failed to disclose in a timely manner that the Dreamliner's first test flight would be cancelled. The court noted that the law does not require the disclosure of the mere risk of failure. Indeed, "[n]o prediction - even a prediction that the sun will rise tomorrow - has a 100 percent probability of being correct . . . If a mistaken prediction is deemed a fraud, there will be few predictions, including ones that are well-grounded, as no one wants to be held hostage to an unknown future." Moreover, it was unclear what motive Boeing would have had to put off the announcement, with the court wryly concluding that the main effect would be to "undermine Boeing's credibility with its customers and expose the company to a multi-hundred million dollar lawsuit for securities fraud."

(2) Confidential Witness - The court found that the recantation of the key confidential witness was fatal to the plaintiffs' claims, because his supposed evidence provided the only basis for concluding that the company knew (at an earlier date) that the first flight test would be cancelled. Moreover, the confidential witness would no longer be useful because "[e]ither he had told the investigator the same thing he said in his deposition, which would be of no help to the plaintiffs and would expose the investigator as a liar, or he had had made the opposite assertions on the two occasions, in which event he was the liar, which wouldn't help the plaintiffs either."

(3) Sanctions - The defendants had cross-appealed for sanctions. The court strongly suggested that sanctions were appropriate in the case, noting that the plaintiffs' lawyers "failure to inquire further [about the supposed evidence from the confidential witness] puts one in mind of ostrich tactics - of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing." Nevertheless, the court remanded the case to the lower court to determine whether sanctions should be imposed.

Holding: Dismissal affirmed, but case remanded for consideration of whether to impose Rule 11 sanctions.

Posted by Lyle Roberts at 12:26 PM | TrackBack

March 8, 2013

The Bitter With The Sweet

The Eleventh Circuit has issued an opinion that provides some clear exposition on the issue of loss causation. In Meyer v. Greene, 2013 WL 656500 (11th Cir. Feb. 25, 2013), the court considered whether the plaintiffs had adequately plead loss causation in a securities class action brought against St. Joe Company (a Florida real estate development corporation). The two key disclosures cited by the plaintiffs were (1) a presentation by a prominent short seller, and (2) the company's announcement of an SEC investigation. The district court found that neither disclosure revealed to the market the supposed falsity of the company's prior statements and dismissed the complaint.

On appeal, the Eleventh Circuit examined the two key disclosures:

(1) Short Seller Presentation - The court found that the presentation was based (by its own admission) on "publicly available sources." As a result, it did not provide any new facts to the market that could act as a corrective disclosure. Indeed, the plaintiffs "cannot contend that the market is efficient for purposes of reliance and then cast the theory aside when it no longer suits their needs for purposes of loss causation." Having conceded that the market was efficient and St. Joe's stock price reflected all public information, the plaintiffs "must take the bitter with the sweet."

Nor could the plaintiffs claim that that the presentation qualified as a corrective disclosure because it provided "expert analysis of the source material." The court held that "the mere repackaging of already-public information by an analyst or short-seller is simply insufficient" because "the only thing actually disclosed to the market when the opinion is released is the opinion itself, and such opinion, standing alone, cannot reveal to the market the falsity of a company's prior factual representations."

(2) SEC Investigation - Although the company's disclosure of an SEC investigation lead to a decline in its stock price, the court noted that "the SEC never issued any finding of wrongdoing or in any way indicated that the Company had violated the federal securities laws." Under these circumstances, an "investigation can be seen to portend an added risk of future corrective action" but it does not mean that SEC investigations "in and of themselves, reveal[] to the market that a company's previous statements were false or fraudulent."

Holding: Dismissal affirmed.

Quote of Note: "Put another way, though Sec. 10(b) is designed to protect against fraud, it is not a prophylaxis against the normal risks attendant to speculation and investment in the financial markets, and loss causation therefore ensures that private securities actions remain a scalpel for defending against the former, while not becoming a meat axe exploited to achieve the latter."

Posted by Lyle Roberts at 8:55 PM | TrackBack

February 28, 2013

Amgen Decided

The U.S. Supreme Court has issued a decision in the Amgen case holding that proof of materiality is not a prerequisite to certification of a securities fraud class action. It is a 6-3 decision authored by Justice Ginsburg, with dissents from Justice Thomas (main) and Justice Scalia.

Under the fraud-on-the-market presumption, reliance by investors on a misrepresentation is presumed if the misrepresentation is material and the company's shares were traded on an efficient market that would have incorporated the information into the stock price. At issue in Amgen was whether a class action plaintiff, to take advantage of this presumption for purposes of class certification, is required to prove that the misrepresentation was material. As foreshadowed by the oral argument, the key issue for the Court was whether the fact that materiality is both a predicate for the use of the fraud-on-the-market presumption and a substantive element of the securities fraud claim means that it should be treated differently than the other fraud-on-the-market predicates (market efficiency, misrepresentation was public, transaction took place between time when misrepresentation was made and truth was revealed).

The majority opinion held that proof of materiality is not needed to ensure, as required by FRCP 23(b), that the questions of law or fact common to the class will predominate over any questions affecting only individual members. First, materiality is determined using an objective test and is therefore a common question as to every class member. Second, if the plaintiff were unable to establish materiality at summary judgment or trial, that failure would end the case for every class member leaving no individual reliance questions. This result is in contrast to the other fraud-on-the-market predicates - e.g., market efficiency - where a failure to prove that the market was efficient would still leave an individual plaintiff capable of establishing reliance by other means and proceeding with his case. The Court also rejected the notion that policy considerations militated in favor of requiring precertification proof of materiality. Notably, the Court found that Congress had previously "rejected calls to undo the fraud-on-the-market presumption of classwide reliance" and had not decreed "that securities-fraud plaintiffs prove each element of their claim before obtaining class certification."

The main dissent presented a starkly different view of the importance of addressing materiality at the class certification stage. According to the dissent, "nothing in logic or precedent justifies ignoring at certification whether reliance is susceptible to Rule 23(b)(3) classwide proof simply because one predicate of reliance - materiality - will be resolved, if at all, much later in the litigation on an independent merits element." Indeed, a recent Court decision (Wal-Mart) "expressly held that a court at certification may inquire into questions that also have later relevance on the merits." The judicial history of the fraud-on-the-market presumption also shows that materiality "has been the driving force behind the theory from the outset" and "further supports the need to prove materiality at the time the fraud-on-the-market theory is invoked."

Holding: Judgment of Ninth Circuit upholding grant of class certification affirmed.

Notes on the Decision:

(1) The decision does not "revisit" the fraud-on-the-market presumption. That said, it would appear that at least four justices have some concerns about its continuing validity. The dissent notes that the Court is not well-equipped to apply economic concepts and there is some disagreement about how market efficiency works. In a separate concurrence, Justice Alito references that part of the dissent and suggests reconsideration could be appropriate because the presumption "may rest on a faulty economic premise."

(2) The majority's eagerness to establish there can be no individual questions of reliance if a class action plaintiff fails to prove materiality leads to some interesting language. Notably, the Court states that "there can be no actionable reliance, individually or collectively, on immaterial information." The Court also concludes that an individual's reliance on immaterial information would be "objectively unreasonable." In the context of the entire opinion, it is not clear whether the Court is suggesting that (a) any class member's claim will fail in the absence of materiality (therefore rendering the question of reliance moot), or (b) materiality is a necessary predicate for a finding of reliance under any circumstances. There is no doubt that there is close relationship between the concepts of materiality and reliance, but for an individual investor the reliance question is typically whether he actually saw the misrepresentation and acted upon it (i.e., transaction causation), with materiality as a separate inquiry.

Posted by Lyle Roberts at 1:15 PM | TrackBack

January 22, 2013

SLUSA Accepted

Just because the government says a case is not a good cert candidate, does not mean the U.S. Supreme Court will agree. On Friday, in a somewhat surprising decision, the Court granted cert in three related cases that raise an issue about the scope of the Securities Litigation Uniform Standards Act ("SLUSA").

SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In the three related cases, the Fifth Circuit held that the "best articulation of the 'coincide' requirement" is that the fraud allegations must be "more than tangentially related to (real or purported) transactions in covered securities." The Fifth Circuit then concluded that the relationship between the alleged fraud, which centered around the sale of certificates of deposit, and any transactions in covered securities was too attenuated to trigger SLUSA preclusion. The defendants moved for certification on the grounds that the Fifth Circuit's "more than tangentially related" standard was in conflict with the standards articulated by other circuits.

The government, at the invitation of the Court, filed an amicus brief arguing that cert should not be granted because (a) the circuit standards are substantially similar and (b) the unusual fact pattern in the cases would render any holding that SLUSA applies (or does not apply) of little assistance to lower courts in future cases. But the Court evidently did not find the government's arguments persuasive.

The official question presented is: Whether SLUSA precludes a state-law class action alleging a scheme of fraud that involves misrepresentations about transactions In SLUSA-covered securities. Bloomberg and the Associated Press have coverage of the Court's decision.

Posted by Lyle Roberts at 8:25 PM | TrackBack

December 21, 2012

SLUSA Denied?

Back in October, this blog speculated that the Supreme Court might grant cert in three related cases that raised an issue related to the Securities Litigation Uniform Standards Act ("SLUSA"). The Court had asked for the government to weigh in on the cert petition, which can be an indicator that the Court is inclined to take the case. The government has finally expressed its view and it is a frustrating one for the defendants: the lower court's decision was wrong, but the Court should not grant cert.

SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In the three related cases, the Fifth Circuit held that the "best articulation of the 'coincide' requirement" is that the fraud allegations must be "more than tangentially related to (real or purported) transactions in covered securities." The Fifth Circuit concluded that the relationship between the alleged fraud, which centered around the sale of certificates of deposit, and any transactions in covered securities was too attenuated to trigger SLUSA preclusion. The defendants moved for certification on the grounds that the Fifth Circuit's "more than tangentially related" standard was in conflict with the standards articulated by other circuits.

In its amicus brief, the government concluded that the Fifth Circuit had reached the wrong result because "the purported existence of covered securities transactions was far from 'tangential' to the fraudulent scheme and the misrepresentations that supported it." Nevertheless, it urged the Court to deny cert for two reasons. First, the Fifth Circuit's "more than tangentially related" standard is substantially similar to those used by other circuits and any variation in word choice "does not mean that the courts of appeals have applied substantively different understandings of the “in connection with” requirement." Second, the unusual fact pattern in these cases would render any holding that SLUSA applies (or does not apply) of little assistance to lower courts in future cases.

Does this mean that the Supreme Court will deny cert? More likely than not, but stay tuned.

Posted by Lyle Roberts at 9:23 PM | TrackBack

November 5, 2012

Amgen Argued

Oral argument took place in the Amgen case in the U.S. Supreme Court this morning. The case involves the issue of whether, to obtain class certification, a plaintiff must prove that an alleged misstatement was material and therefore can support a fraud-on-the-market presumption (reliance by investors on the misstatement is presumed if the misstatement is material and the company's shares were traded on an efficient market that would have incorporated the information into the stock price).

The argument focused heavily on whether it was appropriate to decide the issue of materiality at the class certification stage given that it is both a predicate for the use of the fraud-on-the-market presumption and a substantive element of the securities fraud claim.

A few highlights:

(1) The parties agreed that materiality was a "common issue" for all the class members, but not on whether that fact should preclude it being examined at the class certification stage of the case. Petitioner (Amgen) had some difficulty persuading the Court that a distinction could be drawn between determining materiality at the class certification stage for purposes of the fraud-on-the-market presumption and determining materiality on the merits. A few justices pressed whether it was Petitioner's position, as Justice Kagan put it, "that a judge who has just ruled that a statement is immaterial is going to keep the case in his court litigated by an individual plaintiff, even though he's just ruled that the statement is immaterial?" Petitioner insisted that this was possible, because the judge would not be able to resolve disputed facts at the summary judgment stage of a case brought by an individual plaintiff. Justice Breyer questioned whether this established too much, because why not "try out everything [at class certification], because we could always think of a few examples where, despite the fact that, you know, it's only a common issue 99 percent of the time, we can dream up a situtation where it's not a common issue."

(2) More broadly, Petitioner argued that the purpose of FRCP 23 "is for a court to determine whether all of the preconditions for forcing everyone into a class action are present before you certify." Because materiality is "an essential predicate of the fraud-on-the-market theory" and that theory is necessary to certify a securities fraud class, it follows that the court must determine the existence of materiality at class certification.

(3) In turn, Respondent (investors) was asked numerous questions about why the Court should draw a distinction between market efficiency (another predicate for the fraud-on-the-market presumption that can be rebutted at the class certification stage) and materiality. Justice Scalia noted that market efficiency also is a common issue that, if decided by the judge at class certification, might preclude individual investors from bringing a suit because they could not say "that's why I got cheated, because the market reflected this false statement and I paid more money for the stock than I should have." Respondent - with some assistance from Justice Breyer - argued that the difference was that market efficiency is merely a "gate-keeping function[] to determine whether or not the answer for indirect reliance on the market is a common question," while materiality is a traditional element of a fraud.

(4) For its part, the government argued in support of Respondent, stating that "materiality in a fraud-on-the-market case serves two purposes . . . . And what Petitioners would have this Court do is isolate the two inquiries when they're really the same question." Justice Scalia's response: "If you have the same question, then maybe we shouldn't have this fraud-on-the-market theory . . . . So maybe we should overrule Basic [the Supreme Court case endorsing the fraud-on-the-market presumption] because it was certainly based upon a theory that simply collapses once you remove the materiality element."

All of the briefs and other background materials can be found here. Reuters has an article on the argument.

Posted by Lyle Roberts at 9:25 PM | TrackBack

November 2, 2012

Amgen Preview

On Monday, the Supreme Court will hear oral argument in the Amgen case. The official questions presented are:

1. Whether, in a misrepresentation case under SEC Rule 10b-5, the district court must require proof of materiality before certifying a plaintiff class based on the fraud-on-the-market theory.

2. Whether, in such a case, the district court must allow the defendant to present evidence rebutting the applicability of the fraud-on-the-market theory before certifying a plaintiff class based on that theory.

The court will be addressing a circuit split on these issues. Three circuit courts (Second, Fifth and, to a lesser extent, the Third) previously have held that materiality is a required part of the fraud-on-the-market analysis when evaluating whether a class should be certified. The Ninth Circuit joined a decision from the Seventh Circuit, however, in rejecting that position and holding that materiality is a merits question that does not affect whether class certification is appropriate.

Scotusblog has links to all of the relevant background materials, including the merits and amicus briefs, and an argument preview. Thomson Reuters and Forbes also have columns on the case.

Posted by Lyle Roberts at 9:56 PM | TrackBack

October 5, 2012

SLUSA Is On Deck

As the U.S. Supreme Court begins its October term, a securities litigator's thoughts turn to what cases the court might take next. A leading indicator (although far from a guarantee) is a cert petition where the Court asks the government to provide its input. On Monday, the Court made this request in three related cases arising out of an alleged Ponzi scheme.

The Securities Litigation Uniform Standards Act ("SLUSA") precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In determining what is meant by "in connection with," the Supreme Court has held that it is sufficient that the alleged misrepresentation "coincide" with a covered securities transaction. The circuit courts have had difficulty, however, in expanding upon this requirement to form a consistent standard (see, e.g., decisions from the Second Circuit, Sixth Circuit, and Seventh Circuit).

In the Ponzi scheme cases, the Fifth Circuit held that the "best articulation of the 'coincide' requirement" is that the fraud allegations must be "more than tangentially related to (real or purported) transactions in covered securities." The court concluded that the relationship between the alleged Ponzi scheme, which centered around the sale of certificates of deposit, and any transactions in covered securities was too attenuated to trigger SLUSA preclusion.

Will the Supreme Court revisit SLUSA? Stay tuned.

Addition: Bloomberg has an article on the Supreme Court's request.

Posted by Lyle Roberts at 8:06 PM | TrackBack

September 7, 2012

Competing Methodologies

Determining whether a pharmaceutical company has made a false statement about a clinical trial can raise technical issues. In In re Rigel Pharmaceuticals, Inc. Sec. Litig., 2012 WL 3858112 (9th Cir. Sept. 6, 2012), the plaintiffs alleged that the company misstated the results of a clinical trial for a drug designed to treat rheumatoid arthritis. The district court found that the plaintiffs "had failed to adequately plead a false statement regarding efficacy [of the drug] because disagreements over statistical methodology and study design are insufficient to allege a materially false statement."

On appeal, the Ninth Circuit agreed with that analysis. The court found that the plaintiffs were really "alleging that Defendants should have used different statistical methodologies, not that Defendants misrepresented the results they obtained from the methodologies they employed." Even if another statistical methodology would have been better or more accurate, accepting the plaintiffs' argument "would suggest that a company should announce statistical results that are obtained using a statistical methodology that is adopted after the study data is made available to the researchers and that is different from the methodology used as part of the clinical trial." Any company that took this approach "could raise concerns regarding reliability, biased scientific methods, or even fraud."

Holding: Dismissal affirmed (both on falsity and scienter grounds).

Addition: The Recorder has an article on the decision.

Posted by Lyle Roberts at 9:01 PM | TrackBack

August 3, 2012

Offsetting Gains and Attributing Losses

What evidence is necessary to establish loss causation and economic damages? Two recent circuit court decisions address this issue, albeit at different stages of a securities fraud case.

(1) In Aciticon AG v. China North East Petroleum Holdings, Ltd., 2012 WL 3104589 (2d Cir. Aug. 1, 2012), the lower court dismissed the case based on the plaintiffs' failure to adequately plead economic damages. Within a couple of months after the "final allegedly corrective disclosure" was made, the company's stock price rose above the lead plaintiff's average purchase price. The lower court held that a "plaintiff who foregoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure."

On appeal, the Second Circuit rejected this economic-loss rule as "inconsistent with the traditional out-of-pocket measure of damages, which calculates economic loss based on the value of the time of the security at the time that the fraud became known." The court noted that "a share of stock that has regained its value after a period of decline is not functionally equivalent to an inflated share that has never lost value." To hold otherwise, would allow defendants to improperly "offset gains that that plaintiff recovers after the fraud becomes known against losses caused by the revelation of the fraud if the stock recovers value for completely unrelated reasons." Accordingly, the court held, "the [stock price] recovery does not negate the inference that [the lead plaintiff] has suffered an economic loss."

Holding: Dismissal reversed and case remanded.

(2) In Hubbard v. BankAtlantic Bancorp, Inc., 2012 WL 2985112 (11th Cir. July 23, 2012), the plaintiffs alleged that BankAtlantic fraudulently concealed the poor credit quality of its commercial real estate portfolio. The plaintiff’s only evidence of loss causation was the testimony of its expert. After a trial, the court granted judgment as a matter of law to the defendants based on the plaintiffs' failure to establish loss causation.

On appeal, the Eleventh Circuit agreed with the lower court (albeit on a slightly different basis). The court found that a plaintiff must "offer evidence sufficient to allow the jury to separate portions of the price decline attributable to causes unrelated to the fraud, leaving only the part of the price decline attributed to the dissipation of the fraud-induced inflation." The study conducted by the plaintiffs’ expert was supposed to isolate which part of the stock price drop was caused by the materialization of the risk concealed by BankAtlantic. But it failed to adequately take into account that BankAtlantic’s assets were concentrated in loans tied to Florida real estate. The court noted that there was a general downturn in the Florida real estate market at the relevant time, which may have been a substantial cause of the stock price drop. Because the plaintiffs' evidence failed to exclude this possibility, the court affirmed the lower court's decision.

Holding: Judgment affirmed.

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July 20, 2012

When Working Hard Is Not Enough

The U.S. Court of Appeals for the Second Circuit has reversed a summary judgment grant in favor of Grant Thornton (outside auditor) in a securities class action related to the collapse of Winstar Communications. The case was originally filed in 2001 and, due to intervening settlements, Grant Thornton is the sole remaining defendant. The district court found that Grant Thornton had engaged in "dubious accounting practices" and had "failed to uncover the accounting fraud" being perpetrated by Winstar. Nevertheless, the district court concluded that there was no genuine issue of material fact as to whether Grant Thornton had acted intentionally or recklessly (i.e., with scienter) in issuing its unqualified audit opinion for FY1999.

The Second Circuit disagreed. In Gould v. Winstar Communications, Inc., 2012 WL 2924254 (2d Cir. July 19, 2012), the court held that at least some evidence existed to support the plaintiffs' assertion "that in the course of its audit GT learned of and advised against the use of indisputably deceptive accounting schemes, but eventually acquiesced in the schemes by issuing an unqualified audit opinion." While the district court had placed "particular emphasis on the magnitude of GT's audit work, both in time spent and documents reviewed" in granting summary judgment, the court noted that "[t]he number of hours spent on an audit cannot, standing alone, immunize an accountant from charges it has violated the securities laws." In regard to two other issues raised on appeal - reliance by certain plaintiffs who brought a Section 18 claim and loss causation - the court found that there was sufficient evidence to allow a jury to reasonably infer that those elements were satisfied.

Holding: Grant of summary judgment vacated and case remanded.

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July 13, 2012

Single Central Risk

The U.S. Court of Appeals for the First Circuit has issued a short, interesting decision discussing the "holistic" evaluation of scienter allegations. In In re Boston Scientific Corp. Sec. Litig., 2012 WL 2849660 (1st Cir. July 12, 2012), the company allegedly failed to disclose that it had fired ten sales personnel, who ended up going to a competitor and taking business with them. The district court found it was a material omission, but dismissed the claim based on the plaintiffs' failure to adequately plead a strong inference of scienter (i.e., fraudulent intent).

On appeal, the plaintiffs argued that the district court had failed to consider their scienter allegations holistically, as required by the Supreme Court in its Tellabs decision. The First Circuit noted that it was true that "allegations that are individually insufficient can sometimes combine together to make the necessary showing." In the instant case, however, "a single central risk existed - that sales personnel might leave and perhaps take some of their business with them." While that risk became greater over time, to the point where the district court decided that failure to disclose it was a material omission, the potential lost business was "extremely modest in relation to revenues." Accordingly, the court held that there was no basis for concluding that the defendants "were dishonest or at least reckless in failing to mention" something so marginally material.

Holding: Dismissal affirmed.

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June 22, 2012

Something More

Rules 10b-5(a) and (c) establish securities fraud liability for deceptive devices, schemes, and acts. One issue courts have considered is whether "scheme liability" requires a defendant to have engaged in fraudulent conduct beyond the making of material misrepresentations or omissions (which is specifically prohibited by Rule 10b-5(b)).

In Public Pension Group v. KV Pharmaceutical Co., 2012 WL 1970226 (8th Cir. June 4, 2012), the court found that the only non-conclusory "scheme liability" allegations were based on the defendants' supposed knowledge of misstatements concerning the company's FDA compliance and earnings. The court held that these allegations were deficient, "join[ing] the Second and Ninth Circuits in recognizing a scheme liability claim must be based on conduct beyond misrepresentations or omissions actionable under Rule 10b-5(b)."

Holding: Dismissal affirmed in part and reversed in part.

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June 15, 2012

Supreme Court To Address Fraud-On-The-Market Theory

A key development this week was the Supreme Court's decision to hear the Amgen Inc. v. Connecticut Retirement Plans and Trust Funds case on appeal from the Ninth Circuit. Pursuant to the fraud-on-the-market theory, reliance by investors on a misstatement is presumed if the company's shares were traded on an efficient market that would have incorporated the information into the stock price. The fraud-on-the-market presumption is routinely invoked in securities class actions to justify the grant of class certification because it removes the potential need for individual evaluations of reliance.

At issue in the Amgen case is a circuit split over whether a plaintiff must prove that the misstatement was material to invoke the fraud-on-the-market theory in support of class certification. Three circuit courts (Second, Fifth and, to a lesser extent, the Third) previously have held that this is a required part of the fraud-on-the-market analysis when evaluating whether a class should be certified. The Ninth Circuit joined a decision from the Seventh Circuit, however, in rejecting that position. The court held that materiality is a merits question that does not affect whether class certification is appropriate.

The Amgen case picks up threads from two other recent Supreme Court decisions. In Matrixx, the Court addressed the issue of materiality, but only in the context of what must be plead to survive a motion to dismiss. Meanwhile, in Halliburton, the Court found that a plaintiff does not have to prove loss causation to invoke the fraud-on-the-market presumption, but left open the question of whether the plaintiff must demonstrate that the misstatement had a stock "price impact" (which is often used as a proxy for determining whether the misstatement was material). As a practical matter, if the Court were to find that lower courts should be evaluating whether the misstatement was material in determining whether to grant class certification, it obviously would reinvigorate class certification as a meaningful hurdle in prosecuting securities class actions.

Scotusblog has all of the relevant links, including to the amicus briefs filed in conjunction with the cert petition. The case will be heard next term.

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June 1, 2012

Appellate Roundup

The Second Circuit and Seventh Circuit have issued recent notable decisions.

(1) Item 303(a) of Regulation S-K requires issuers to disclose known trends or uncertainties "reasonably likely" to have a material effect on operations, capital, and liquidity. While it has been referred to as the "sleeping tiger" of securities litigation, it may soon be the star of the circus. In Panther Partners Inc. v. Ikanos Communications, Inc., 2012 WL 1889622 (2nd Cir. May 25, 2012), the Second Circuit added to its Item 303(a) jurisprudence, finding that the plaintiffs had plausibly alleged that the company, at the time of its securities offering, "was aware of the 'uncertainty' that it might have to accept returns of a substantial volume, if not all, of the chips it had delivered to its major customers."

Holding: Denial of leave to file an amended complaint (based on futility) reversed.

(2) He's back and so soon! Following up on last month's decision, Judge Easterbrook of the Seventh Circuit has authored another securities litigation opinion. In Plumbers and Pipefitters Local Union 719 Pension Fund v. Zimmer Holdings, Inc., 2012 WL 1813700 (7th Cir. May 21, 2012) (Easterbrook, J.), the court addressed whether the plaintiffs had adequately plead scienter (i.e., fraudulent intent) in a case alleging that the company downplayed the significance of product problems. Among other things, the plaintiffs pointed to the CEO's failure, in response to a question posed during an analyst call, to reveal that the company had received verbal notice from an FDA inspector of "significant objectionable conditions" at one of its plants. The court concluded that the CEO's answer was technically accurate and the "worst one could say about [the] answer is that it was evasive, which is short of fraudulent."

Holding: Dismissal affirmed.

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May 18, 2012

Balancing Act

There is rarely a dull moment when Judge Frank Easterbrook writes a securities litigation opinion. In Fulton County Employees Retirement System v. MGIC Investment Corp., 675 F.3d 1047 (7th Cir. April 12, 2012) (Easterbrook, J.) the court addressed a credit crisis case in which a mortgage loan insurer allegedly made misstatements about the liquidity of an affiliated company. The decision includes a few interesting holdings.

(1) MGIC stated in a press release that the affiliated company (in which MGIC held a 46% interest) had "substantial liquidity," but eleven days later announced that its investment in the affiliated company was "materially impaired." The court concluded that the liquidity statement was inactionable both because it was true when made and because the press release contained specific warnings about the liquidity risk at the affiliated company.

(2) Moreover, the court noted that the events that led to the material impairment of the investment were known to the market. To the extent that the "whole world knew that firms that had issued, packaged, or insured subprime loans were in distress," MGIC was in no better position to foresee what would happen to its investment than anyone else.

(3) The plaintiffs also alleged that certain statements made by officers of the affiliated company during MGIC's earnings call were fraudulent. The court held that (a) MGIC's ownership interest in the affiliated company was insufficient to establish that it "controlled" the affiliate (especially given that another company also had a 46% stake) for purposes of control person liability, and (b) pursuant to the recent Janus decision, MGIC could not be held liable as a "maker" of the affiliated company's statements and had no duty to correct them.

Holding: Dismissal affirmed.

Quote of Note: "The press release went on to detail problems that MGIC was encountering, including the liquidity risk at [the affiliated company]. The goal of this paragraph was to let investors know about the trouble without painting too gloomy a picture. A balancing act of that nature cannot sensibly be described as fraud."

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May 11, 2012

Public Red Flags

The efficient market hypothesis can be a double-edged sword for plaintiffs. While it is necessary to support a presumption of reliance in securities class actions, it also makes courts skeptical of any theory of fraud that is based on the corporate defendant failing to inform the market about the impact of known events.

In City of Omaha, Nebraska Civilian Employees' Retirement System v. CBS Corp., 2012 WL 1624022 (2d Cir. May 10, 2012), the plaintiffs alleged that CBS should have performed an impairment test on its goodwill and disclosed the results several months before it actually did so in October 2008. The Second Circuit affirmed the dismissal of the case on two grounds.

First, the court held, based on on its prior Fait decision, that estimates of goodwill are statements of opinion. The plaintiffs' failure to allege "that defendants did not believe in their statements of opinion regarding CBS's goodwill at the time they made them" was fatal to their securities fraud claims.

Second, the court found that "all of the information alleged to constitute 'red flags' calling for interim impairment testing . . . were matters of public knowledge." Given the efficiency of the market for CBS stock, the price therefore "would at all pertinent times have reflected the need for, if any, or culpable failure to undertake, if any, interim impairment testing." Under these circumstances, the complaint did not allege in a plausible fashion that "the market price of CBS stock was inflated by a fraud" and that the plaintiffs relied upon that fraudulently inflated price.

Holding: Dismissal affirmed.

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April 6, 2012

Appellate Roundup

(1) The Securities Litigation Uniform Standards Act ("SLUSA") precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In determining what is meant by "in connection with," the Supreme Court has held that it is sufficient that the alleged misrepresentation "coincide" with a covered securities transaction. The circuit courts have had difficulty, however, in expanding upon this requirement to form a consistent standard (see, e.g., decisions from the Second Circuit, Sixth Circuit, and Seventh Circuit). In Roland v. Green, 2012 WL 898557 (5th Cir. March 19, 2012), the U.S. Court of Appeals for the Fifth Circuit waded into this jurisprudence in a set of cases arising from an alleged Ponzi scheme. After a lengthy analysis of the legal and policy considerations, the court held that the "best articulation of the 'coincide' requirement" is that the fraud allegations must be "more than tangentially related to (real or purported) transactions in covered securities." In the instant cases, the court found that the relationship between the alleged fraud, which centered around the sale of certificates of deposit, and any transactions in covered securities was too attenuated to trigger SLUSA preclusion.

(2) Under the federal securities laws, investors cannot bring "holders" claims alleging that deceit caused them to hold their shares, which they would have sold had they known the truth. These claims are permitted, however, under the laws of many states. In Anderson v. Aon Corp., 2012 WL 1034539 (7th Cir. March 29, 2012) (Easterbrook, J.), the plaintiff brought a holders claim under California law. The U.S. Court of Appeals for the Seventh Circuit found that it was impossible for a retail investor in a security traded on an efficient market to ever establish that the company's failure to disclose information led to any damages. Once the information was disclosed, "the price of [the company's] stock would have fallen before [the plaintiff] could have sold." As a result, the "fraud (if there was one) just delayed the inevitable and affected which investors bore the loss." Without being able to demonstrate that he could have shifted his loss to a different investor had the company disclosed the information earlier, the plaintiff could not establish causation.

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March 2, 2012

What Is Your Domestic Status?

In its Morrison decision, the Supreme Court limited the scope of Section 10(b) claims to "transactions in securities listed on our domestic exchanges, and domestic transactions in other securities." While determining whether a security is listed on a domestic exchange is a relatively straightforward question (although some plaintiffs have unsuccessfully attempted to complicate it), the Court offered little guidance on what constitutes a "domestic transaction."

The Second Circuit has tried to provide some clarity. In Absolute Activist Value Master Fund Ltd. v. Ficeto, 2012 WL 661771 (2d Cir. March 1, 2012), the court evaluated "whether foreign funds' purchases and sales of securities issued by U.S. companies brokered through a U.S. broker-dealer constitute 'domestic transactions.'" The court concluded that there are two related tests for determining domesticity.

As a threshold matter, the court noted that the purchase or sale of a security normally takes place when the parties become bound to effectuate the transaction. The court held that the same test can be used to determine the locus of the purchase or sale. Based on this reasoning, "it is sufficient for a plaintiff to allege facts leading to the plausible inference that the parties incurred irrevocable liability within the United States: that is, that the purchaser incurred irrevocable liability within the United States to take and pay for a security, or that the seller incurred irrevocable liability within the United States to deliver a security." Alternatively, a "sale" is defined as a transfer of title and it also is sufficient for a plaintiff to adequately allege that title was transferred within the United States.

In the instant case, the plaintiffs merely had alleged that the transactions took place within the United States. The court found that more factual allegations related to irrevocable liability and/or transfer of title were necessary and could include "facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money." Because the complaint had been filed pre-Morrison, and based on the plaintiffs' representations that they could provide such factual allegations if required, the court granted them leave to amend.

Holding: Dismissal affirmed in part and reversed in part.

Quote of note: "[R]ather than looking to the identity of the parties, the type of security at issue, or whether each individual defendant engaged in conduct within the United States, we hold that a securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States."

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December 15, 2011

Momentary Forgetfulness

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 fertile ground for litigation more than 13 years after the legislation's adoption. A persistent issue is to what extent a plaintiff can disclaim that his case is based on an alleged misrepresentation, even if the nature of the case suggests otherwise, and thereby avoid SLUSA preclusion.

In Brown v. Calamos, 2011 WL 5505375 (7th Cir. Nov. 10, 2011), the U.S. Court of Appeals for the Seventh Circuit reviewed a SLUSA dismissal in a case about a fund's issuance of "auction market preferred stock." Although it was a "suit for breach of fiduciary obligation and not securities fraud," the complaint included allegations that the fund had falsely stated the term of the security "was perpetual" and omitted to disclose a material conflict of interest. Judge Posner found that SLUSA preclusion was appropriate under either (a) the Sixth Circuit's "literalist approach," because the complaint could be interpreted as alleging a misrepresentation; or (b) the Third Circuit's "looser approach," because the allegations of the complaint made "it likely that an issue of fraud will arise in the course of the litigation."

Holding: Dismissal affirmed.

Quote of note: "[I]t can be argued that a dismissal with prejudice is too severe a sanction for what might be an irrelevancy added to the complaint out of an anxious desire to leave no stone unturned - a desire that had induced momentary forgetfulness of SLUSA. But a lawyer who files a securities suit should know about SLUSA and ought to be able to control the impulse to embellish his securities suit with a charge of fraud."

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November 28, 2011

We're All In This Together

What must a plaintiff do to invoke the fraud-on-the-market theory (pursuant to which reliance by investors on a misrepresentation is presumed if the company's shares were traded on an efficient market) in support of class certification? According to the U.S. Court of Appeals for the Ninth Circuit, nothing more than show (a) the security was traded on an efficient market, and (b) the alleged misrepresentations were public.

In Connecticut Retirement Plans and Trust Funds v. Amgen, Inc., 2011 WL 5341285 (9th Cir. Nov. 8, 2011), the court addressed whether a plaintiff also must prove that the alleged misrepresentations were material. Three circuit courts (Second, Fifth, and, to a lesser extent, Third) previously have held that this is a required part of the fraud-on-the-market analysis when evaluating whether a class should be certified. The Ninth Circuit joined a recent decision from the Seventh Circuit, however, in rejecting that position. The court held that materiality is a merits question that does not affect whether class certification is appropriate.

Holding: Affirming grant of class certification.

Quote of note: "If the misrepresentations turn out to be material, then the fraud-on-the-market presumption makes the reliance issue common to the class, and class treatment is appropriate. If the misrepresentations turn out to be immaterial, then every plaintiff's claim fails on the merits (materiality being a standalone merits element), and there would be no need for a trial on each plaintiff's individual reliance. Either way, the plaintiffs' claims stand or fall together - the critical question in the Rule 23 inquiry."

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October 7, 2011

Repeating Falsehoods

Is it necessary for the alleged false statements to have artificially inflated the company's stock price to establish loss causation? The Eleventh Circuit recently considered this question in a case where the plaintiffs' expert found that the company's stock price was artificially inflated both before and during the class period by the same amount. The district court granted summary judgment for the defendants, concluding that because the stock price inflation predated the class period, the alleged false statements made during the class period could not have caused the inflation or any subsequent losses.

On appeal - FindWhat Investor Group v. FindWhat.com, 2011 WL 4506180 (11th Cir. Sept. 30, 2011) - the Eleventh Circuit disagreed. The court concluded that false statements "that prevent a stock price from falling can cause harm by prolonging the period during which the stock is traded at inflated prices." Accordingly, "defendants can be liable for knowingly and intentionally causing a stock price to remain inflated by preventing preexisting inflation from dissipating from the stock price."

Holding: Vacating dismissal of claims based on failure to establish loss causation (but affirming the dismissal of certain other claims)

Quote of note: "Defendants whose fraud prevents preexisting inflation in a stock price from dissipating are just as liable as defendants whose fraud introduces inflation into the stock price in the first instance. We decline to erect a per se rule that, once a market is already misinformed about a particular truth, corporations are free to knowingly and intentionally reinforce material misconceptions by repeating falsehoods with impunity."

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September 9, 2011

Pulling the Rug Out

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."

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August 26, 2011

A Matter of Opinion

Are financial estimates like goodwill and loan loss reserves statements of fact or opinion? The answer is significant, especially for claims brought under Section 11 and Section 12 of the '33 Act based on alleged misrepresentations in a registration statement. If these financial estimates are statements of fact, then a plaintiff is only required to establish that they were objectively false. If these financial estimates are statements of opinion, then a plaintiff must establish that they were objectively false and disbelieved by the defendant at the time they were made. In effect, it converts the cause of action from one based on strict liability (the company) or negligence (the individual defendants), to one based on knowing falsity.

In Fait v. Regions Financing Trust, No. 10-2311-cv (2d Cir. August 23, 2011), the plaintiffs alleged that despite adverse trends in the mortgage and housing markets, particularly in areas where the mortgage loans issued by a company previously acquired by Regions were concentrated, Regions failed to write down goodwill and to sufficiently increase its loan loss reserves. The lower court held that these financial estimates were matters of opinion and dismissed the Section 11 and Section 12 claims brought by purchasers of Region's trust preferred securities.

On appeal, the Second Circuit affirmed the lower court's ruling. Estimating goodwill "depend[s] on management’s determination of the 'fair value' of the assets acquired and liabilities assumed, which are not matters of objective fact." Similarly, loss reserves "reflect management’s opinion or judgment about what, if any, portion of amounts due on the loans ultimately might not be collectible." As a result, plaintiffs were required to plausibly allege that defendants did not believe their statements regarding goodwill and loan loss reserves at the time they made them. In the absence of these allegations, the plaintiffs' claims were subject to dismissal.

Holding: Dismissal affirmed.

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July 22, 2011

Janus Interpreted

The Janus decision holds that for purposes of primary securities fraud liability under Section 10(b) and Rule 10b-5, the "maker" of a statement is the person or entity with "ultimate authority" over the statement. Practicioners have begun to debate over the significance of that holding, including in two recent New York Law Journal columns.

(1) In "Janus Capital and Underwriter Liability Under Section 10(b) and Rule 10b-5" (July 12 - subscrip. req'd), the authors note that pre-Janus there were conflicting lower court decisions over whether underwriters could have primary liability for misstatements in offering documents. The Janus decision, however, "undercut[s] any private right of action as against underwriters" because "the ultimate decision as to whether an offering will proceed, whether to disseminate an offering document, and what the offering document will say rest with the issuer."

(2) In "U.S. Supreme Court and Securities Litigation" (July 21 - regist. req'd), Professor John Coffee argues that the "ultimate authority" standard may not be as sweeping as it seems. The Janus decision also notes that "in the ordinary case, attribution within a statement or implicit from surrounding circumstances is strong evidence that a statement is made by, and only by, the party to whom it is attributed." According to Coffee, this language suggests that "implicit attribution" is sufficient to find someone has primary liability for a false statement. Relying on this part of Janus creates another conundrum, however, because it "suggest[s] that the attributed statement creates liability 'only' for the person quoted and not the issuer that may knowingly incorporate his false statement."

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July 8, 2011

As Little As Possible

A couple of interesting recent decisions:

(1) Tolling - Courts are split on the issue of whether the commencement of a class action suspends the applicable statute of repose (as opposed to statute of limitations) as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action. In the recent Footbridge decision from the S.D.N.Y., the court concluded that the statute of repose cannot be extended by the commencement of a class action. (A fuller explanation of the decision and its ramifications can be found here.) That position is proving popular in the S.D.N.Y.

The court in In re IndyMac Mortgage-Backed Sec. Litig., 2011 WL 2462999 (S.D.N.Y. June 21, 2011) considered whether a class member who had filed one of the original complaints could intervene in the consolidated class action. The class member wanted to bring claims related to an offering in which the lead plaintiff had not participated. The court denied the motion. Once the class member had allowed his original complaint to be consolidated he was no longer a plaintiff and, under the Footbridge analysis, the claims were now barred by the relevant statute of repose.

(2) Duty to Disclose - What triggers a corporation's duty to disclose? In Minneapolis Firefighters' Relief Association v. MEMC Electronic Materials, Inc., 2011 WL 2417073 (8th Cir. June 17, 2011), MEMC did not disclose production problems at two of its plants for over a month, even though it had a history of providing investors with timely updates about production disruptions. Plaintiffs argued that MEMC had a duty to disclose the problems when they occured based on its prior "pattern" of disclosures. The Eighth Circuit disagreed, noting that it was "unable to find any legal authority directly supporting [plaintiffs'] pattern theory" and adopting the theory "could encourage companies to disclose as little as possible."

Posted by Lyle Roberts at 5:35 PM | TrackBack

June 24, 2011

Janus Applied

The Janus opinion, which holds that primary liability for securities fraud is limited to the person or entity with ultimate authority over the alleged false statements, has had its first impact. Earlier this week, the U.S. Supreme Court denied cert in a case alleging that a law firm and one of its former partners were liable for false statements made by Refco in its public filings. The Second Circuit had dismissed the claims, finding that under its "bright line" test the attorneys could not be liable because they were not identified to investors as the makers of the statements. In the wake of Janus, the Court left the Second Circuit's decision undisturbed. Law360 has an article on the cert denial.

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June 13, 2011

Janus Decided

In the Janus Capital Group v. First Derivative Traders case, the U.S. Supreme Court has held that for purposes of primary liability under Rule 10b-5, the "maker" of a statement is the person or entity with ultimate authority over the statement. The 5-4 decision authored by Justice Thomas rejects the government's proposed "creation" test, which would have extended primary liability to a person who provides false or misleading information that another person puts into a statement. Justice Breyer penned a vigorous dissent.

Oral argument does not always point the way to the ultimate decision in a case. Here, however, the justices split along the same lines, and for the same reasons, as publicly discussed back in December. At issue in Janus was whether a fund's investment advisor had "made" the alleged misstatements in the prospectuses issued by the fund. The Court concluded that "the maker of a statement is the entity with authority over the content of the statement and whether and how to communicate it." Because the fund (and not its investment advisor, which was a separate corporate entity) possessed the "ultimate authority" to determine what would go into its prospectuses, it was the "maker" of the alleged misstatements.

Although the Court recognized that an investment advisor acts as the manager of a fund and exercises significant influence over the contents of any prospectus, it concluded that "[a]ny reapportionment of liability in the securities industry in light of the close relationship between investment advisers and mutual funds is properly the responsibility of Congress and not the courts." Moreover, the Court found that its bright-line definition of "maker" was consistent with its past rejections of secondary liability in private securities fraud suits.

Holding: Judgment reversed.

Quote of note: "[T]he maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. Without control, a person or entity can merely suggest what to say, not 'make' a statement in its own right. One who prepares or publishes a statement on behalf of another is not its maker. And in the ordinary case, attribution within a statement or implicit from surrounding circumstances is strong evidence that a statement was made by—and only by—the party to whom it is attributed. This rule might best be exemplified by the relationship between a speechwriter and a speaker. Even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit—or blame—for what is ultimately said."

Notes on the Decision:

(1) In dissent, Justice Breyer argues that the "English language does not impose upon the word 'make' boundaries of the kind the majority finds determinative." It is more reasonable to conclude that several different individuals or entities can "'make' a statement that each has a hand in producing." Here, according to the dissent, the "special relationships" alleged between the fund, its investment advisor, and the prospectus statements "warrant the conclusion that [the investment advisor] did 'make' those statements."

(2) The Court is notably silent on the exact scope of its decision. Is it limited to cases involving separate corporate entities or does it also extend to disputes over who, within a corporation, can be said to have "made" an alleged misstatement? The dissent appears to suggest that it covers both situations, noting (as part of its criticism of the decision) that "[e]very day, hosts of corporate officials make statements with content that more senior officials or the board of directors have 'ultimate authority' to control."

(3) One of the key issues at the oral argument was whether a limited interpretation of "make a statement" would allow a corporate entity to avoid liability by duping another corporate entity into making misstatements. A possible solution is the application of Section 20(b) of the Exchange Act, which makes it unlawful for a person to effect a securities fraud through another person. The Court declined to address the issue (see Note 10), but will we now see an increase in Section 20(b) claims as plaintiffs attempt to limit the impact of the decision?

Posted by Lyle Roberts at 11:40 PM | TrackBack

June 6, 2011

Halliburton Decided

As predicted, the U.S. Supreme Court has issued a narrow decision in the Halliburton case rejecting the Fifth Circuit's requirement that securities fraud plaintiffs must prove loss causation to obtain class certification. The unanimous (and short) opinion authored by Chief Justice Roberts holds that loss causation is not a precondition for invoking the fraud-on-the-market presumption of reliance and, therefore, is not necessary to establish that reliance is capable of resolution on a common, classwide basis.

While the Court endorsed the majority position adopted by the Second Circuit, Third Circuit, and Seventh Circuit, it focused entirely on the nature of the fraud-on-the-market presumption and did not address the scope of Federal Rule of Civil Procedure 23 (governing class certification). Moreover, the Court gave short shrift to the defendants' argument that although the Fifth Circuit specifically said "loss causation," it really was imposing a "price impact" test designed to determine whether the alleged misrepresentation had affected the company's stock price in the first place. The Court noted that "loss causation is a familiar and distinct concept in securities law; it is not price impact" and declined to do anything other than take the Fifth Circuit "at its word."

Holding: Judgment vacated and remanded to district court for further proceedings consistent with opinion.

Quote of note: "According to the Court of Appeals, however, an inability to prove loss causation would prevent a plaintiff from invoking the rebuttable presumption of reliance. Such a rule contravenes Basic’s fundamental premise—that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction. The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory. Loss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory."

Posted by Lyle Roberts at 11:38 PM | TrackBack

May 27, 2011

Forest For The Trees

In its Tellabs and Matrixx decisions, the Supreme Court emphasized that whether a plaintiff has adequately plead a strong inference of scienter is subject to a holistic review (i.e., the allegations in the complaint must be considered in their entirety). This approach conflicts with the more traditional judicial approach of reviewing each scienter allegation separately and then coming to an overall conclusion as to whether the plaintiff has met its pleading burden.

In Frank v. Dana Corp., 2011 WL 2020717 (6th Cir. May 25, 2011), the court addressed this issue and held that in light of the Supreme Court's decisions it must adopt a new, more efficient approach to evaluating scienter allegations. Exactly how efficient, however, may have come as a surprise to the parties. In just one page of analysis, the court concluded that in light of such factors as overall industry problems, rising prices for a key commodity, and the quick collapse of the company, it was "difficult to grasp the thought that [the defendants] really had no idea that Dana was on the road to bankruptcy." Accordingly, the court found that the plaintiffs had adequately plead a strong inference of scienter because "the inference that [the defendants] recklessly disregarded the falsity of their extremely optimistic statements is at least as compelling to us as their excuse of failed accounting systems."

Holding: Dismissal reversed. (The 10b-5 Daily has previously posted about an earlier, related appellate decision in the case.)

Quote of note: "[In Matrixx] the Court provided for us a post-Tellabs example of how to consider scienter pleadings 'holistically' in section 10(b) cases. Writing for the Court, Justice Sotomayor expertly addressed the allegations collectively, did so quickly, and, importantly, did not parse out the allegations for individual analysis. This is the only appropriate approach following Tellabs’s mandate to review scienter pleadings based on the collective view of the facts, not the facts individually. Our former method of reviewing each allegation individually before reviewing them holistically risks losing the forest for the trees. Furthermore, after Tellabs, conducting an individual review of myriad allegations is an unnecessary inefficiency."

Posted by Lyle Roberts at 9:03 PM | TrackBack

May 13, 2011

Top Rated

Mortgage pass-through certificates entitle the investor to distributions from underlying pools of mortgages. A key aspect of these securities are the credit ratings given to them by the ratings agencies. In In re Lehman Brothers Mortgage-Backed Securities Litigation, 2011 WL 1778726 (2d Cir. May 11, 2010), the court considered whether these ratings agencies, by allegedly helping to "determine the composition of loan pools, the certificates' structures, and the amount and kinds of credit enhancement of particular tranches" could be liable under Section 11 of the '33 Act for misstatements in the certificates' offering documents.

The plaintiffs' argued that the ratings agencies activities made them "underwriters" of the securities and therefore subject to Section 11 liability. The court disagreed, finding that "to qualify as an underwriter under the participation prongs of the statutory definition, a person must participate, directly or indirectly, in purchasing securities from an issuer with a view to distribution, in offering or selling securities for an issuer in connection with a distribution, or in the underwriting of such an offering." The fact that the ratings agencies played a role in "structuring or creating" the securities was insufficient to find that they acted as underwriters. Nor had the plaintiffs adequately alleged that the ratings agencies controlled the primary violators. The court found that "allegations of advice, feedback, and guidance fail to raise a reasonable inference that the Ratings Agencies had the power to direct, rather than merely inform, the banks' ultimate structuring decisions."

Holding: Dismissal of claims against ratings agencies affirmed.

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May 6, 2011

When A Plan Comes Together

Can a corporate 401(k) profit-sharing plan claim a share of the settlement proceeds from a securities class action brought against the company? In In re Motorola Securities Litigation, 2011 WL 1662838 (7th Cir. May 4, 2011) the court held that Motorola's plan, despite being a purchaser of Motorola common shares during the relevant period, could not participate in the settlement because it was an "affiliate" of the issuer.

The Motorola 401(k) Profit-Sharing Plan (the "Plan") is "a participant-directed, defined-contribution retirement plan established for the benefit of current and former Motorola employees." The Plan was controlled by a committee appointed by Motorola's board. One of the plan's investment options was a fund that allowed participants to acquire beneficial ownership of Motorola common stock.

In 2007, a securities class action brought against Motorola was settled for $190 million. (The 10b-5 Daily also has posted about the lead plaintiff and motion to dismiss decisions in the case.) The settlement specifically excluded any "affiliate" of Motorola from making a claim. The Plan filed a claim with the claims administrator for the benefit of its participants, which the district court eventually rejected.

On appeal, the Seventh Circuit found that the district court's rejection of the Plan's claim was correct. The key issue was whether, pursuant to the securities-law meaning of "affiliate," the Plan was controlled by or under common control with Motorola. Motorola's board appointed the Plan committee, which in turn had managerial control over the Plan's policies and operations. The court held that "[t]his degree of control is sufficient to make the Plan an affiliate of Motorola, and as an affiliate of Motorola, the Plan is specifically excluded from the class."

Holding: Order disallowing the Plan's claim to a share of the Motorola settlement proceeds affirmed.

Posted by Lyle Roberts at 11:30 PM | TrackBack

April 29, 2011

Halliburton Argued

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).

Posted by Lyle Roberts at 5:21 PM | TrackBack

April 22, 2011

Roving Scienter

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.

Posted by Lyle Roberts at 8:59 PM | TrackBack

April 8, 2011

Picking Sides

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.

Posted by Lyle Roberts at 11:27 PM | TrackBack

March 22, 2011

Matrixx Decided

In the Matrixx Initiatives v. Siracusano case, the U.S. Supreme Court has held that the plaintiffs were not required, in a case alleging that Matrixx failed to disclose reports of a possible link between its leading drug product and the loss of smell, to plead that these reports were statistically significant. The unanimous decision authored by Justice Sotomayor rejects the use of statistical significance as a "bright-line rule" for the assessment of materiality in this type of case.

The core of the defendants' argument was that in the absence of statistical significance, adverse event reports suggesting that a drug has caused a loss of smell do not "reflect a scientifically reliable basis for inferring a potential causal link" that would be material to a reasonable investor. The Court declined to hold, however, that "statistical significance is the only reliable indication of causation." For example, the FDA relies on a wide range of evidence of causation and "sometimes acts on the basis of evidence that suggests, but does not prove, causation." If "medical professionals and regulators act on the basis of evidence that is not statistically significant, it stands to reason that in certain cases reasonable investors would as well."

Having rejected the proposed bright line rule, the Court found that the complaint adequately alleged "Matrixx received information that plausibly indicated a reliable causal link" between the drug and the loss of smell. The information included the adverse event reports and studies suggesting a causal link. In turn, investors would have viewed this information as material because it suggested there was "a significant risk to the commercial viability of Matrixx's leading product," especially because the risk associated with the drug (possible loss of smell) substantially outweighed the benefit of using the drug (alleviate cold symptoms). The omitted material information rendered Matrixx's statement that its "revenues were going to rise 50 and then 80 percent" misleading.

Holding: Reversal of dismissal affirmed (the court also found that the plaintiffs had adequately plead scienter).

Notes on the Decision:

(1) The decision is quite narrow. Perhaps most importantly, the Court did not offer any redefinition of the Basic materiality standard (so the forests are safe). Nor did the Court make any broad pronouncements on the appropriateness of evaluating materiality at the motion to dismiss stage of a case.

(2) In line with its Tellabs decision on the issue of pleading scienter, the Court emphasized a holistic approach to evaluating the plaintiffs' materiality allegations (e.g., "Viewing the allegations of the complaint as a whole . . .").

Posted by Lyle Roberts at 10:48 PM | TrackBack

March 11, 2011

Monday Madness

Two interesting decisions from this past Monday.

(1) Just when it looked like the U.S. Supreme Court would never again reject a securities litigation cert petition, it turned down the Apollo Group case. The Ninth Circuit's decision exacerbated a circuit split and presented an important loss causation issue. So why didn't the Court grant cert? Perhaps securities litigation fatigue has set in.

Quote of note (Jones Day memo): "The five circuits that have addressed the timing of the loss are divided. The Second and Third Circuits have held that a securities-fraud plaintiff must demonstrate that the market immediately reacted to the corrective disclosure. Conversely, the Fifth, Sixth, and Ninth Circuits have held that the price decline may occur weeks or even months after the initial corrective disclosure. By denying certiorari in Apollo Group, the Supreme Court left this split unresolved."

(2) Yet another cautionary tale about the use of confidential witnesses in securities class actions was issued by a court in the N.D. of Illinois. In City of Livonia Employees' Retirement System v. Boeing Co., Civil Action No. 09 C 7143 (N.D. Ill. March 7, 2011), the court granted Boeing's motions to dismiss for failure to state a claim and fraud on the court. In their second amended complaint, the plaintiffs had added allegations providing details about a confidential witness and the basis for this witness' supposed knowledge of Boeing's misconduct. The court expressly relied on these new allegations in finding that the plaintiffs had adequately plead scienter. After discovery began, however, it turned out that the confidential witness denied being the source of the allegations in the complaint, denied having worked for Boeing, and claimed to have never met plaintiffs' counsel until his deposition. The court was not amused.

Quote of note: "If these facts were disclosed while the dismissal motions were pending, the court would not have concluded that the confidential source allegations were reliable, much less cogent and compelling. The second amended complaint would have been dismissed, possibly with prejudice, as insufficient under the PSLRA. It matters not whether, as plaintiffs argue, [the confidential witness] told their investigators the truth, but he is lying now for ulterior motives. The reality is that the informational basis for [the confidential witness allegations] is at best unreliable and at worst fraudulent, whether it is [the confidential witness] or plaintiffs' investigators who are lying."

Posted by Lyle Roberts at 11:44 PM | TrackBack

January 10, 2011

Matrixx Argued

Oral argument took place in the Matrixx case this morning. The case addresses the issue of materiality, in particular whether adverse event reports (i.e., reports by users of a drug that they experienced an adverse event after using the drug) are material information even if they are not statistically significant. Also, there was a lot of talk about Satan. Seriously.

A few highlights (based on the transcript):

(1) Petitioner (Matrixx) argued that the key issue is whether the plaintiff has plead facts from which "you can draw a reliable inference that the product is the cause" of the adverse events. In the case of adverse event reports, that reliable inference exists if the adverse event reports are statistically significant. The justices were aggressively skeptical of that position right from the outset. First, a number of justices (Sotomayor, Kennedy, Ginsburg, Scalia, Roberts) wondered if the real issue is whether the company knew about information that could affect its stock price, even if that information was not credible. Second, Justices Kagan and Breyer disagreed that a reasonable investor would only want to know about adverse effects that were statistically significant. As Justice Breyer put it - "look, Albert Einstein had the theory of relativity without any empirical evidence . . . So I can't see how we can say this statistical evidence always works or always doesn't work."

(2) Respondent (investors) had a somewhat easier time, with Justice Breyer even inviting counsel to draft a disclosure rule for drug companies. Counsel responded that he would start with the "total mix of information" test for materiality and "where there is credible medical professionals describing the harms based on credible scientific theories to back up the link, a very serious health effect risk for products with many substitutes, and the effect in on a predominant line, then the company ought to disclose that information."

(3) The argument took a bit of a turn for Respondent, however, when counsel stated that even irrational information - such as a group of people believing that a product "has some link to satanic influences" - might need to be disclosed. Chief Justice Roberts wondered how companies could determine what should be disclosed under that standard and asked if it would matter whether the "product has particular satanic susceptibility"? In response to Respondent's argument that the scienter requirement might limit a company's liability for failing to disclose material, yet irrational, information, Justice Scalia noted that there was no difference between scienter and materiality in that "scienter is withholding something that is material that is known to be material and once . . . Satan is material, if the company thinks Satan is involved here, it has to put it in its report."

All of the briefs and other background materials can be found here. Bloomberg and the Washington Post have coverage of the argument.

Disclosure: The author of The 10b-5 Daily submitted an amicus brief on behalf SIFMA and the U.S. Chamber of Commerce in support of petitioner.

Posted by Lyle Roberts at 11:33 PM | TrackBack

January 7, 2011

Supreme Court To Address Class Certification Requirements

The U.S. Supreme Court continues to take an interest in securities litigation cases. Earlier today, the Court granted cert in the Erica P. John Fund, Inc. v. Halliburton Co. case.

In Halliburton, the Fifth Circuit declined to certify a class because the plaintiffs had failed to adequately demonstrate loss causation. At issue on appeal is whether the Fifth Circuit's requirement that plaintiffs establish loss causation at class certification by a preponderance of admissible evidence (but without the benefit of merits discovery) exceeds what is required by Federal Rule of Civil Procedure 23.

The Court asked for the government's views on the case. In a brief filed early last month, the government urged the Court to take the case and overturn the Fifth Circuit's decision. Among other things, the government noted that the Seventh Circuit has expressly rejected the Fifth Circuit's approach.

As always, SCOTUSblog has all of the relevant background materials.

Posted by Lyle Roberts at 6:32 PM | TrackBack

December 23, 2010

Is It Time To Revisit Loss Causation?

The Apollo Group securities class action has turned out to be far more interesting than anyone could have predicted. The case is based on the company's alleged failure to disclose the existence of a government report finding that its wholly-owned subsidiary, the University of Phoenix, had violated Department of Education regulations.

After a jury trial, the plaintiffs won a $277.5 million verdict. The trial court, however, held that the plaintiffs had failed to prove loss causation and overturned the verdict. In its decision, the court found that the two analyst reports relied upon by the plaintiffs as "corrective disclosures" that led to a stock price decline "did not provide any new, fraud-revealing analysis." Instead, the reports merely repeated information about the government report already known to the market or provided information about the University of Phoenix that was factually wrong (and therefore could not have been corrective).

The plaintiffs appealed to the Ninth Circuit and, in a summary, unpublished opinion, the appellate court held that "the jury could have reasonably found that the [analyst] reports following various newspaper articles were corrective disclosures providing additional or more authoritative fraud-related information that deflated the stock price."

So it is on to the Supreme Court, where the question will be whether the justices are ready to revisit the issue of loss causation a mere five years after their Dura decision. Commentators are making a strong argument that the court should grant cert. The Ninth Circuit's decision appears to suggest that the efficient market hypothesis, which forms the basis for the presumption of reliance in securities class actions, somehow does not really apply when examining loss causation. In other words, the market rapidly absorbs information for the purpose of allowing investors to argue that they relied on false information incorporated into the stock price, but once that information is disclosed, these same investors can argue that it was only when the media or analysts more widely broadcast the information that their loss occurred.

In a recent New York Law Journal column (Dec. 8 edition - subscrip. req'd), the authors discuss the case and the related circuit splits over the necessary timing and nature of a "corrective disclosure." SCOTUSblog has the cert petition and other pertinent information here. According to the docket, a number of amicus briefs have already been filed (e.g., a brief from the National Association of Manufacturers supporting the granting of the cert petition).

Posted by Lyle Roberts at 6:53 PM | TrackBack

December 7, 2010

Janus Argued

Oral argument in the Janus case took place this morning. The early verdict is that the U.S. Supreme Court may be headed toward a split decision on whether the investment manager of a fund can be subject to primary liability for securities fraud based on alleged misstatements in the fund's prospectuses.

A few highlights (based on the transcript):

(1) Petitioner (Janus) conceded that its in-house counsel had drafted the prospectuses on behalf of the fund, but argued that the fund was governed by its trustees who were responsible for the contents and issuance of the prospectuses. The court spent a considerable amount of time exploring the nature of the relationship between an investment advisor and a fund. In particular, various members of the court (J. Breyer, J. Kennedy, J. Sotomayor) probed as to whether an investment advisor should be viewed as the equivalent of a corporate manager who can be held liable for the corporation's misstatements.

(2) Justice Sotomayor and Justice Ginsburg both suggested that under Petitioner's theory, a corporate entity could avoid liability by duping another corporate entity into making the misstatements. Petitioner responded that a "dupe case" is addressed in Section 20(b) of the Exchange Act ("the ventriloquist dummy statute"), which makes it unlawful for a person to effect a securities fraud through another person.

(3) Respondent (investors) argued that the Court should adopt the SEC's interpretation of what it means to "make" a statement, i.e., "to create or compose or to accept as one's own." Justice Scalia was skeptical, suggesting that if Respondent was "talking about making heaven and earth, yes, that means to create, but if you're talking about making a representation, that means presenting the representation to someone, not drafting it for someone else to make."

(4) As to whether an investment advisor was the equivalent of a corporate manager, despite the fact that it is an independent entity, Respondent asserted that "contractually outsourc[ing] the management function should not alleviate the securities fraud that is alleged here." Moreover, the investment advisor had "substantive control over the content of the message" and, therefore, was not a mere aider and abettor. In response, Justice Kagan questioned the relevance of "control" given that Respondent had not brought its case under Section 20 of the Exchange Act and presumably could not have done so because of the nature of the relationship between a fund and its investment advisor.

All of the briefs and other background materials can be found here. Bloomberg and Dow Jones have coverage of the argument.

Posted by Lyle Roberts at 10:58 PM | TrackBack

December 3, 2010

More Than An Earnings Miss

Can a plaintiff adequately allege or prove loss causation by pointing to a corrective disclosure that reveals the company's financial results and condition, even if the disclosure does not directly reveal any alleged misrepresentations? Courts have been reluctant to apply this "true financial condition theory," especially at the proof stage of a case. The U.S. Court of Appeals for the Ninth Circuit is the latest court to find that an earnings miss, or similar adverse financial result, is by itself insufficient to establish loss causation.

In In re Oracle Corp. Sec. Litig., 2010 WL 4608794 (9th Cir. Nov. 16, 2010), the Ninth Circuit reviewed a grant of summary judgment for the defendants. The district court held that plaintiffs failed to identify sufficient evidence as to loss causation for their non-forecasting claims. In particular, plaintiffs relied on an earning miss rather than any actual disclosure about defects in a key product.

On appeal, the Ninth Circuit agreed that the "overwhelming evidence produced during discovery indicates the market understood Oracle's earnings miss to be a result of several deals lost in the final weeks of the quarter," not "that customers did not buy [the product] as a result of defects." The fact that two analyst reports questioned this explanation for the earnings miss could not overcome the "market's consensus." Moreover, Oracle continued to sell large amounts of the product during the following quarter, suggesting that there was no public knowledge of the supposedly concealed defects.

Holding: Grant of summary judgment affirmed.

Quote of note: "Plaintiffs take issue with our opinion in Metzler. Specifically, they assert that they should be able to prove loss causation by showing that the market reacted to the purported 'impact' of the alleged fraudthe earnings missrather than to the fraudulent acts themselves. We reject that assertion. Loss causation requires more than an earnings miss."

Posted by Lyle Roberts at 7:24 PM | TrackBack

November 5, 2010

Only As Good As Its Giver

There is a circuit split on the issue of primary vs. aiding-and-abetting liability. Under the "bright line" test adopted by the Second Circuit, primary liability for securities fraud (as opposed to aiding-and-abetting liability, which is not available in private actions) only exists if the alleged misstatement is attributable on its face to the defendant.

Other circuit courts, however, have applied a more relaxed standard. The Fourth Circuit has found that it is sufficient for a plaintiff to adequately allege that (a) the defendant "participated" in the making of the misstatement, and (b) "interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributable to the defendant." Earlier this year, the Supreme Court granted cert in that case - Janus Capital Group v. First Derivative Traders - and presumably will resolve the circuit split.

In the interim, the Fifth Circuit has issued a decision expressly agreeing with the Second Circuit and adopting the "bright line" test. In Affco Investments 2001 LLC v. Proskauer Rose, L.L.P., 2010 WL 4226685 (5th Cir. Oct. 27, 2010), the court considered whether a law firm could have primary liability based on its provision of tax opinions that were alleged to be part of a fraudulent scheme. The company that promoted the scheme informed investors that "several major national law firms" had vetted the investments. Although plaintiffs claimed to have relied on the tax opinions, the court found that they failed to allege "that they ever saw or heard any Proskauer work product before making their decision, nor do they explicitly allege that the promoters identified Proskauer as one of the 'major national law firms.'" Accordingly, the plaintiffs "failed to show reliance on Proskauer" and the law firm could not be a primary violator.

Holding: Dismissal affirmed.

Quote of note: "Knowing the identity of the speaker is essential to show reliance because a word of assurance is only as good as its giver. Clients engage 'name-brand' law firms at premium prices because of the security that comes from the general reputations of such firms for giving sound advice, or for winning trials. Specific attribution to a reputable source also induces reliance because of the ability to hold such a party responsible should things go awry."

Posted by Lyle Roberts at 9:26 PM | TrackBack

October 15, 2010

On The Stingy Side

In the Adelphia securities class action, a law firm that did not act as lead counsel in the case moved for a third (about $17 million) of the aggregate fee award. The law firm argued that it had provided "an independent and substantial benefit" for the class by initiating and preserving the Section 11 and Section 12 claims that ultimately were asserted against two of Adelphia's underwriters. The district court found no evidence, however, "that the use of those statutes, or their use against [the two underwriters], represents ground-breaking legal or factual analysis." The law firm was awarded the amount that had been allocated by lead counsel - $155,610, or the time the law firm had invested in the case, at its normal hourly rates, up to the appointment of lead plaintiffs and counsel. The law firm appealed the decision.

In Victor v. Argent Classic Convertible Arbitrage Fund L.P., 2010 WL 4008744 (2d Cir. Oct. 14, 2010), the Second Circuit considered whether the district court had abused its discretion in failing to increase the law firm's allocation. The court noted that securities class actions "are often an entrepreneurial exercise in which multiple attorneys file complaints" and it is "common practice for lead counsel to borrow legal principles from the complaints filed to the appointment of lead counsel." While work completed by non-lead counsel can confer substantial benefits upon the class, as it did in this case, a district court has "wide discretion" in determining whether the awarded fee is reasonable. The law firm was requesting a fee amounting to $45,000 an hour. The court found that it was "well within the District Court's discretion to determine that a fee application containing a lodestar multiplier of 110 is, prima facie, 'simply not reasonable.'"

Holding: Affirmed.

Quote of note: "Although [lead counsel] were no doubt on the stingy side when it came to compensating their brethern, we have not been convinced that the District Court abused its discretion in approving class counsel's allocation."

Posted by Lyle Roberts at 10:16 PM | TrackBack

October 8, 2010

Where To Next

As the U.S. Supreme Court begins its October term, a securities litigator's fancy naturally turns to what cases the court might take next. A leading indicator is cert petitions where the Court has asked the government to provide its input. On Monday, the Court made this request in two separate cases: Halliburton (5th Cir.) and Omnicare (6th Cir.).

(1) The question presented in Halliburton is to what extent plaintiffs must demonstrate the existence of loss causation as part of the class certification process. The 10b-5 Daily's summary of the 5th Circuit's decision can be found here. SCOTUSblog has all of the cert petition materials.

(2) The question presented in Omnicare is whether the heightened pleading standard of FRCP 9(b) should be applied to '33 Act claims (i.e., strict liability/negligence claims based on misstatements in a prospectus or registration statement) that "sound in fraud." The 10b-5 Daily's summary of the Sixth Circuit's decision can be found here. SCOTUSblog has all of the cert petition materials.

Stay tuned for the governments' responses.

Disclosure: The author of The 10b-5 Daily's firm - Dewey & LeBoeuf - represents Omnicare in this case.

Posted by Lyle Roberts at 11:25 PM | TrackBack

October 1, 2010

Line Drawing

It has been several years since the Second Circuit has addressed the scope of the bespeaks caution doctrine. The bespeaks caution doctrine holds that a "forward-looking statement accompanied by sufficient cautionary language is not actionable because no reasonable investor could have found the statement materially misleading." In Iowa Public Employees' Retirement System v. MF Global, Ltd., 2010 WL 3547602 (2d Cir. Sept. 14, 2010), the Second Circuit found that the district court had failed to properly sever the forward-looking and non-forward-looking aspects of the alleged misstatements. Accordingly, the case was remanded for further analysis.

Quote of note: "A forward-looking statement (accompanied by cautionary language) expresses the issuer's inherently contingent prediction of risk or future cash flow; a non-forward-looking statement provides an ascertainable or verifiable basis for the investor to make his own prediction. The line can be hard to draw, and we do not now undertake to draw one. However, a statement specifying the risk of default is distinct from a statement of present or historical financial instability, even though they both bear upon the same risk. And a statement of confidence in a firm's operations may be forward-looking - and thus insulated by the bespeaks-caution doctrine - even while statements or omissions as to the operations in place (and present intentions as to future operations) are not."

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September 3, 2010

Impounding Information

There was an interesting appellate decision last month in one of the few securities class actions to be tried to a verdict.

In 2005, Thane International won a bench trail in a case concerning the company's 2002 acquisition of Reliant Interactive Media. A class of Reliant investors brought Securities Act claims seeking recission of the merger. In particular, they alleged that Thane's pre-merger prospectus contained misrepresentations because it implied that Thane shares would list on the Nasdaq National Market. The company actually commenced trading on the OTCBB.

The Ninth Circuit subsequently found that the district court had erred in holding that the prospectus did not contain material misrepresentations, but remanded so that the district court could address the issue of loss causation. On remand, the district court granted judgment for Thane because the company's stock price did not decline below the merger price until nineteen days after trading began on the OTCBB. The plaintiffs appealed again.

In Miller v. Thane Int'l, Inc., 2010 WL 3081488 (9th Cir. Aug. 9, 2010), the court found that "stock price evidence may be used in loss causation assessment" even if the market for the stock was inefficient. In the instant case, Thane's expert demonstrated that that the company's "stock price could and did impound [i.e., absorb] information about Thane during this nineteen-day period, including the listing on the OTCBB." Accordingly, the court declined to find that the district court erred in holding that the misrepresentations did not cause any loss.

Holding: Judgment affirmed.

Quote of note: "[T]he materiality inquiry concerns whether a 'reasonable investor' would consider a particular misstatement important. It is hypothetical and objective. By contrast, the loss causation inquiry assesses whether a particular misstatement actually resulted in loss. It is historical and context-dependent."

Thanks to John Letteri for sending in the decision.

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August 27, 2010

Fated To Lose

He's back. Judge Easterbrook has authored a new securities litigation decision for the U.S. Court of Appeals for the Seventh Circuit and, as always, it is interesting and contentious.

In Schleicher v. Wendt, 2010 WL 3271964 (7th Cir. Aug. 20, 2010), the court considered to what extent plaintiffs must establish the existence of loss causation before a class can be certified. Defendants argued, based in part on Fifth Circuit precedent (Oscar Private Equity), that the plaintiffs needed to demonstrate that the alleged false statements materially affected the company's stock price and therefore caused some loss. The court disagreed and held that when and to what extent the alleged false statements affected the stock price are "merits questions" that cannot be resolved as part of the class certification process. Moreover, the Fifth Circuit's approach would "make certification impossible in many securities suits, because when true and false statements are made together it is often impossible to disentangle the [price] effects with any confidence."

Holding: Certification of class affirmed.

Quote of note: "Unlike the fifth circuit, we do not understand Basic to license each court of appeals to set up its own criteria for certification of securities class actions or to 'tighten' Rule 23's requirements. Rule 23 allows certification of classes that are fated to lose as well as classes that are sure to win. To the extent it holds that class certification is proper only after the representative plaintiffs establish by a preponderance of the evidence everything necessary to prevail, Oscar Private Equity contradicts the decision, made in 1966, to separate class certification from the decision on the merits."

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August 20, 2010

Appellate Roundup

A trio of notable appellate decisions have been issued in the last ten days.

(1) In In re Mercury Interactive Corp. Sec. Litig., 2010 WL 3239460 (9th Cir. Aug. 18, 2010), the court addressed the common settlement practice of requiring attorneys' fees objections to be filed prior to the filing of the actual fees motion and supporting papers. The court found that "the practice borders on a denial of due process because it deprives objecting class members of a full and fair opportunity to contest class counsel's fee motion." Accordingly, courts must set a schedule that allows objections to made after the class has an adequate opportunity to review its counsel's fees motion.

(2) In Malack v. BDO Seidman, 2010 WL 3211088 (3rd Cir. Aug. 16, 2010), the court considered the validity of the fraud-created-the-market theory. Under this theory, a presumption of reliance is established if "the defendants conspired to bring to market securities that were not entitled to be marketed." The plaintiff must allege both that the existence of the security in the marketplace resulted from the successful perpetration of a fraud on the investment community and that he purchased in reliance on the market. In a long and thorough opinion, the court declined to endorse the theory, finding that common sense and a lack of empirical support "calls for rejecting the proposition that a security's availability on the market is an indication of its genuineness and is worthy of an investor's reliance."

(3) In In re Aetna, Inc. Sec. Litig., 2010 WL 3156560 (3rd Cir. Aug. 11, 2010), the court found that the PSLRA's safe harbor for forward-looking statements mandated the dismissal of the case. In particular, the statements were accompanied by meaningful cautionary language and were too vague to be material to investors. The 10b-5 Daily's summary of the lower court decision can be found here.

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July 23, 2010

Artful Pleading

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. A key issue is to what extent a plaintiff can plead around the preclusive effect of the statute.

In Romano v. Kazacos, 2010 WL 2574143 (2d Cir. June 29, 2010), the Second Circuit considered a pair of state law class actions alleging that Morgan Stanley gave inappropriate retirement advice, which led the plaintiffs to retire early, place their lump sum retirement benefits with Morgan Stanley for investment, and subsequently suffer investment losses. The district court found that SLUSA preempted both actions and dismissed them.

On appeal, the Second Circuit made two key findings.

First, the court held that although a plaintiff is normally the master of his complaint, he "cannot avoid removal by declining to plead 'necessary federal questions.'" Based on this "artful pleading" rule, in a SLUSA case courts can look beyond the face of the complaint to determine whether the plaintiff has "allege[d] securities fraud in connection with the purchase or sale of securities."

Second, SLUSA's "in connection" requirement must be given a broad construction. In the cases at issue, the plaintiffs "in essence, assert that defendants fraudulently induced them to invest in securities with the expectation of achieving future returns that were not realized." Even though the plaintiffs "did not invest in any covered securities for up to eighteen months" after receiving the relevant retirement advice, the court concluded this time lapse was "not determinative here because . . . 'this was a string of events that were all intertwined.'" In sum, the court held that "[b]ecause both the misconduct complained of, and the harm incurred, rests on and arises from securities transactions, SLUSA applies."

Holding: Dismissal based on SLUSA preclusion affirmed.

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July 16, 2010

The Reversal, The Affirmance, and The Remand

The U.S. Court of Appeals for the Ninth Circuit has been busy over the past few weeks.

(1) In the Apollo Group case, the court reinstated the $277.5 million verdict obtained by the company's investors. The trial court, in a post-verdict decision, had found that the investors failed to prove loss causation. In particular, the court concluded that the two analyst reports relied upon by the plaintiffs as "corrective disclosures" that led to a stock price decline "did not provide any new, fraud-revealing analysis." Although The 10b-5 Daily suggested that the trial court's decision could lead to an interesting appeal, the actual opinion is quite anticlimactic. In an unpublished memorandum, the court simply held that "the jury could have reasonably found that the [analyst] reports following various newspaper articles were corrective disclosures providing additional or more authoritative fraud-related information that deflated the stock price." The D&O Diary has extensive coverage, including a guest commentary.

(2) In In re Cutera Sec. Litig., 2010 WL 2595281 (9th Cir. June 30, 2010), the court joined all of the other circuits that have considered the issue (Fifth, Sixth, and Eleventh) in finding that the PSLRA's safe harbor for forward-looking statements "is written in the disjunctive as to each subpart." As a result, the "defendant's state of mind is not relevant" in determining whether a forward-looking statement is protected from liability because it is accompanied by "sufficient cautionary language." Over the years, The 10b-5 Daily has posted frequently on this issue (most recently here).

(3) Many commentators believed that the U.S. Supreme Court would grant cert in the Trainer Wortham case to address the running of the statute of limitations for securities fraud. As it turned out, the Court took the Merck case instead and issued a decision earlier this year. The Court then remanded the Trainer Wortham case for reconsideration. Back in the Ninth Circuit, in Betz v. Trainer Wortham & Co., Inc., 2010 WL 2674442 (9th Cir. July 7, 2010), the court has decided that it would be better for the district court to consider the statute of limitations issue in the first (or, more accurately, second) instance.

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July 1, 2010

Supreme Court To Address Primary Liability

In what is shaping up to be a blockbuster term for securities litigation cases, the U.S. Supreme Court will address the issue of primary liability.

On Monday, the Court granted cert (over the objection of the government) in the Janus Capital Group v. First Derivative Traders case. In Janus, the Fourth Circuit found that to establish primary liability it is sufficient for a plaintiff to adequately allege (a) the defendant "participated" in the making of a false statement, and (b) "interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributable to the defendant." The defendants argued in their cert peition, apparently with some success, that both prongs of this holding created or exacerbated circuit splits.

SCOTUSBlog has links to the cert petition papers. The official "questions presented" can be found here.

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June 25, 2010

NAB Decided

In the Morrison v. National Australia Bank ("NAB") case, the U.S. Supreme Court has held that Section 10(b) of the Exchange Act applies only to transactions in securities listed on U.S. exchanges and to U.S. transactions in other securities. The 8-0 decision (Justice Sotomayor did not participate) authored by Justice Scalia thus rejects the use of the conduct/effects test to determine the extraterritorial application of the U.S. anti-fraud securities laws.

In NAB, the court considered a so-called "foreign-cubed" securities case - i.e., a securities class action brought against a foreign issuer by foreign investors who purchased their securities on a foreign exchange. The Second Circuit applied its existing "conduct test" for determining the extraterritorial application of Section 10(b) and held that the plaintiffs needed to adequately allege that "activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused losses to investors abroad." The court found that this test was not met in NAB because the locus of the fraudulent activity, including the issuance of the false statements, was in Australia.

On appeal, the Supreme Court reached the same result, but took a notably different approach.

First, the Court found (contrary to the Second Circuit and other lower federal courts) that the extraterritorial application of Section 10(b) does not "raise a question of subject-matter jurisdiction." Instead, it is an issue of "what conduct Section 10(b) prohibits, which is a merits question."

Second, it is a longstanding principle that Congressional legislation, "unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States." The fact that the "Exchange Act is silent as to the extraterritorial application of Section 10(b)" does not give courts license to speculate as to what Congress would have wanted. In the absence of any "affirmative indication" that Section 10(b) applies extraterritorially, the Court concluded "that it does not."

Finally, the Court addressed the plaintiffs' contention that even if Section 10(b) does not apply extraterritorially, there was sufficient deceptive conduct in the U.S. to make it a "domestic" case. Although the Court agreed that applying the presumption against extraterritorial application may require analysis, the presumption "would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case." The Court found that the focus should be on the location of the securities transaction, not "the place where the deception originated." Accordingly, it is "only transactions in securities listed on our domestic exchanges, and domestic transactions in other securities, to which Section 10(b) applies."

Holding: Affirmed.

Notes on the Decision

(1) Although technically a unanimous decision, the concurrence written by Justice Stevens (and joined by Justice Ginsburg) effectively acted as a dissent. The justices urged affirmance on the grounds set forth in the Second Circuit's opinion.

(2) The Court's bright-line rule would appear easy to apply. One can envision fact patterns, however, that might make it difficult to assess whether a securities transaction is "domestic" (i.e., has taken place within the United States).

(3) While the decision does not discuss whether it applies to the SEC, there is no principled reason why the Court's construction of Section 10(b) would not extend beyond private plaintiffs. Congress has been considering a codification of the extraterritorial application of Section 10(b). By indirectly limiting the scope of the SEC's authority, the Court may have improved the prospects for such legislation.

(4) The Court showed some sympathy for the argument that the extraterritorial application of Section 10(b) will encourage suits of questionable merit and compromise the ability of foreign countries to regulate their own securities markets. To wit: "While there is no reason to believe that the United States has become the Barbary Coast for those perpetrating frauds on foreign securities markets, some fear that it has become the Shangri-La of class action litigation for lawyers representing those allegedly cheated in foreign securities markets."

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June 15, 2010

Supreme Court To Address Materiality

The U.S. Supreme Court is going to address the issue of materiality in securities fraud cases, albeit in the limited context of actions based on a drug company's nondisclosure of "adverse event" reports.

Yesterday, the Court granted cert in the Matrixx Initiatives, Inc. v. Siracusano (9th Circuit) case. In Matrixx, the Ninth Circuit found that a drug company can be liable for failing to disclose adverse event reports (i.e., reports by users of a drug that they experienced an adverse event after using the drug) even if those reports were not statistically significant. The First, Second, and Third Circuits, however, have held that statistical significance is required to make the nondisclosure of the reports material. The Court will resolve the circuit split.

SCOTUSBlog has links to the cert petition papers. Although the question presented is narrow, the case may have wider ramifications if the Court offers guidance on its general materiality standard. Matrixx will be heard in the October term.

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May 21, 2010

Thorny Issues

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."

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May 7, 2010

Rejecting Creationism

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.

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April 28, 2010

Merck Decided

In the Merck case, a unanimous U.S. Supreme Court (with two concurrences) has found that the investors' securities fraud claims are not barred by the statute of limitations. In making that determination, however, the Court has significantly changed the relevant legal landscape.

The statute of limitations for private federal securities fraud claims provides that a case "may be brought not later than the earlier of (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation." Under the "discovery" clause, courts frequently have found that the statute of limitations begins to run once a plaintiff is on "inquiry notice" of the possibility (or probability) that a fraud has occurred. At issue in the Merck case was whether, as held by the Third Circuit, a plaintiff needs evidence of scienter (i.e., fraudulent intent) before inquiry notice is triggered.

As a threshold matter, the Court found that the statutory words could be read "as referring to the time a plaintiff actually discovered the relevant facts." Nevertheless, based on longstanding judicial precedent, "'discovery' as used in this statute encompasses not only those facts the plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known." The facts that must be known to the plaintiff, however, are the "facts constituting the violation." Scienter, as "an important and necessary element" of a securities fraud claim, clearly meets this definition. A plaintiff therefore must have discovered (or have been able to discover) scienter-related facts before the statute of limitations begins to run.

The Court rejected the "inquiry notice" standard, however, as inconsistent with the "discovery" rule. To the extent that the term "'inquiry notice' refers to the point where the facts would lead a reasonably diligent plaintiff to investigate further, that point is not necessarily the point at which the plaintiff would already have discovered facts showing scienter or 'other facts constituting the violation.'" In sum, the "discovery" limitations period "begins to run once the plaintiff did discover or a reasonably diligent plaintiff would have 'discover[ed] the facts constituting the violation' -- whichever comes first." The Court concluded that whether the plaintiff was on "inquiry notice" or failed to undertake "a reasonably diligent investigation" is not relevant to the analysis.

Turning to the case at hand, the Court agreed with the Third Circuit that the publicly-available information related to Merck's alleged fraud did not reveal facts indicating scienter. Therefore, the statute of limitations was not triggered more than two years before the filing of the complaint and the plaintiffs' suit was timely.

Holding: Judgment affirmed.

Notes on the Decision

(1) The Court is vague - perhaps deliberately so - on the question of exactly what quantum of evidence concerning scienter is sufficient to constitute discovery of the necessary facts. In various spots, the decision refers to "facts showing scienter" and "facts indicating scienter," but then also notes that the PSLRA requires a plaintiff to plead facts demonstrating a "strong inference" of scienter.

(2) The Court declined to decide whether there are other facts necessary to support a private securities fraud claim, beyond "facts showing scienter," that a plaintiff must have discovered (or have been able to discover) to trigger the running of the statute of limitations. Are facts concerning a plaintiffs' reliance or loss causation among the facts that constitute "the violation"?

(3) For defense counsel who are concerned about the Court's rejection of the inquiry notice standard, there may be some cold comfort in the fact that the decision could have been even more aggressive. Justice Scalia's concurrence (joined by Justice Thomas) argues that under a proper reading of the statute the limitations period should only start upon the plaintiffs' "actual discovery" of the facts constituting the violation.

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April 16, 2010

Idiosyncratic Reactions

In In re Omnicom Group, Inc. Sec. Litig., 597 F.3d 501 (2d Cir. 2010), 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. In particular, a June 12 article reported on the resignation of the Chair of Omnicom's Audit Committee and noted concerns about the company's aggressive accounting strategy.

The lower court granted summary judgment for the defendants based on the plaintiffs' failure to proffer evidence sufficient to support a finding of loss causation. On appeal, the Second Circuit affirmed on two grounds. First, the June 2002 news reports were not a "corrective disclosure" of the fraud because they failed to provide the market with any new facts. Second, the resignation of the director (and the accompanying negative publicity) was not a "materialization of the risk" that was supposedly concealed by the fraudulent statements. A mere concern over the company's accounting practices cannot satisfy that standard.

Holding: Grant of summary judgment affirmed.

Quote of note: "The securities laws require disclosure that is adequate to allow investors to make judgments about a company's intrinsic value. Firms are not require by the securities laws to speculate about distant, ambiguous, and perhaps idiosyncratic reactions by the press or even by directors. To hold otherwise would expose companies and their shareholders to potentially expansive liabilities for events later alleged to be frauds, the facts of which were known to the investing public at the time but did not affect share price, and thus did no damage at that time to investors. A rule of liability leading to such losses would undermine the very investor confidence that the securities laws were intended to support."

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March 29, 2010

NAB Argued

Oral argument in the National Australia Bank case took place this morning. By all accounts, it does not appear that the U.S. Supreme Court is likely to embrace the broad extraterritorial application of the antifraud provisions of the federal securities laws.

Already facing a tough battle, the petitioners could not have been happy to learn that in the Court's audience were several justices of the Supreme Court of Canada. And whether it was out of deference to their foreign guests, or genuine concern about the policy ramifications of allowing foreign investors access to the U.S. courts, the Court's questioning was hostile from the start.

A few highlights (based on the official transcript):

(1) The Court appeared uninterested in the petitioners' suggestion that it might be appropriate to remand the case to the Second Circuit without rendering a decision. Justice Scalia's verdict: "There is no reason to send it back."

(2) Justice Ginsburg started out the substantive questioning with what would turn out to be the quote of the day - "[T]his case is Australian plaintiff, Australian defendant, shares purchased in Australia. It has 'Australia' written all over it." The justices pressed this theme repeatedly, with questions about the existence of a United States interest, potential interference with the regulation of foreign securities markets, and the connection between the fraud and the United States.

(3) As for the respondents and the government (which received 10 minutes of argument time), the justices appeared interested in exploring the utility of a bright-line test - i.e., barring any claims based on transactions involving shares of foreign issuers purchased or sold on foreign exchanges. Counsel for the respondents was asked about the effect on Americans who purchased stock on foreign exchanges (J. Stevens) and given a hypothetical wherein the fraudulent conduct took place in the United States and the stock purchase took place overseas (J. Breyer). The government, which advocated a test focusing on whether "significant conduct material to the fraud's success occured in the United States," was asked about whether its test was simply too complicated to be workable (C.J. Roberts).

For coverage of the hearing, see SCOTUSblog, the New York Law Journal, and the Associated Press.

Posted by Lyle Roberts at 11:39 PM | TrackBack

NAB Day

As the U.S. Supreme Court gets ready to hear oral arguments in the National Australia Bank case today, here is all the information necessary to set the stage.

The briefs can be found here. The 10b-5 Daily has previously summarized the arguments made by the petitioners (investors) and respondents (corporate defendants). A couple of additional notes:

(1) There has been late supplemental briefing on the issue of whether the Supreme Court should remand the case back to the Second Circuit. According to the petitioners, all of the parties agree that the Second Circuit should not have decided the case on the basis of subject matter jurisdiction. The Second Circuit therefore should have the opportunity to reconsider its decision based on recent relevant Supreme Court decisions. The respondents disagree, arguing that the "jurisdictional label used by the court of appeals made no difference to the outcome of this case" and the real question before the Court is the substantive extraterritoriality issue.

(2) If amicus filings are a contest, the win goes to the respondents. There are three amicus briefs filed in support of the petitioners and fourteen amicus briefs filed in support of the respondents (including three separate briefs from the governments of France, Australia, and the United Kingdom).

For pre-argument coverage, see The Times (London), National Law Journal, and (most comprehensively) SCOTUSblog.

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March 5, 2010

The Sheriff of Orange County

Supreme Court Justice Sandra Day O'Connor may be retired, but she is not done creating securities law. Last year, she sat with the Fifth Circuit by designation and wrote an opinion on loss causation. In February, it was the Sixth Circuit and her opinion concerns 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.

In Demings v. Nationwide Life Ins. Co., 2010 WL 364335 (6th Cir. Feb. 3, 2010), the Sheriff of Orange County Florida brought a class action on behalf of all public employers who sponsor 457 deferred-compensation plans alleging that Nationwide implemented a scheme under which it improperly received revenue-sharing payments from mutual funds and mutual fund advisors that should have gone to the plan participants. The district court found that the case was precluded by SLUSA because the substance of the sheriff's claim was a covered class action alleging that "Nationwide misrepresented a relationship with mutual fund advisors, or, at a minimum, failed to disclose material facts about the relationship."

On appeal, the sheriff argued that his suit was subject to SLUSA's "state actions" exception, which exempts certain suits brought by states, political subdivisions thereof, and state pensions plans from SLUSA's preclusive effect. By its plain terms, however, the state actions exception only applies to a covered entity that brings an action "on its own behalf." Although the sheriff might be a "political subdivision," his complaint sought to bring an action on behalf of the deferred-compensation plan. In the absence of any allegation that the sheriff had the authority to bring an action as the plan, the district court was entitled not to consider that possibility. Moreover, the "state actions" exception requires the members of the proposed class to be "named plaintiffs . . . that have authorized participation, in such action." The sheriff was attempting to bring a class action on behalf of a prospective class of unnamed sponsors of deferred-compensation plans.

Holding: Affirmed dismissal based on SLUSA preclusion.

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February 26, 2010

More NAB Developments

The respondents have filed their brief in the National Australia Bank case pending before the U.S. Supreme Court. The case concerns the extraterritorial application of the antifraud provisions of the federal securities laws. Links to all of the briefs filed to date, including the extensive amicus submissions, can be found here.

The respondents argue that the Exchange Act does not contain any language "that clearly expresses an affirmative intention of Congress to apply the statute extraterritorially." In the absence of this language, there is a presumption against extraterritoriality that the Court should apply.

Moreover, acts of Congress should be interpreted to be in conformity with international choice-of-law provisions absent any contrary statement. Based on the law of nations in 1934 (when the Exchange Act was enacted), "Congress must be presumed to have intended that transactions on foreign exchanges must be governed by foreign law." The extraterritorial application of Section 10(b) to foreign transactions also would improperly supplant the substantive laws and remedies that already exist in foreign countries.

Finally, the Court has previously held that because the private right of action under Section 10(b) is judicially created it should be subject to practical limitations. The threat to the sovereign authority of other nations posed by the extraterritorial application of the statute is significant and warrants the limitation of Section 10(b) actions to persons who purchased or sold securities in the United States.

For a summary of the petitioners' arguments, see this earlier post.

Posted by Lyle Roberts at 11:29 PM | TrackBack

February 19, 2010

The Halliburton Odyssey

One of the very first posts on this blog, way back in May 2003, was about the Halliburton securities class action settlement. Who knew what was to come? The judge recused himself, the settlement was eventually rejected, the lead plaintiff switched counsel, and the court declined to certify a class.

Now, nearly eight years after the case was originally filed, the U.S. Court of Appeals for the Fifth Circuit has issued an opinion affirming the denial of class certification. In The Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 2010 WL 481407 (5th Cir. Feb. 12, 2010), the court considered whether the plaintiffs had adequately demonstrated the existence of loss causation. Based on Fifth Circuit precedent, the plaintiffs were required to show "(1) that an alleged corrective disclosure causing the decrease in price is related to the false, non-confirmatory positive statement made earlier, and (2) that it is more probable than not that it was this related corrective disclosure, and not any other unrelated negative statement, that caused the stock price decline."

The court found that the plaintiffs had failed to meet this standard based on the corrective disclosures they identified. The corrective disclosures either failed to indicate that any prior statements were misleading or the plaintiffs' expert was unable to adequately demonstrate that a particular corrective disclosure, as opposed to other negative news about the company, more probably affected the stock price.

Holding: Denial of class certification affirmed.

Quote of note: "Plaintiff asks us to draw an inference that the June 28, 2001 press release corrected prior allegedly false estimates of asbestos reserves merely because those reserves changed. But a company is allowed to be proven wrong in its estimates, and we can discern no indication from the June 28, 2001 press release that Halliburton's prior asbestos reserve estimates were misleading or deceptive."

Posted by Lyle Roberts at 10:20 PM | TrackBack

February 4, 2010

Knowing The Details

Courts can be skeptical about statements from confidential witnesses. One way to express that skepticism is to wonder why, if the witness knows so much about what went on at the company, he or she is unable to provide details about the alleged fraud.

In Konkol v. Diebold, Inc., 2009 WL 4909110 (6th Cir. Dec. 22, 2009), the defendants allegedly had access to internal financial reports demonstrating the falsity of their public statements. These reports included, as described by confidential witnesses who worked at the company, days sales outstanding reports and revenue scorecards.

In evaluating whether the confidential witness allegations contributed to a strong inference of scienter, the court reiterated its previous holding that statements from confidential witnesses should be discounted, especially when there is a lack of information about the witnesses in the complaint. Moreover, the court noted that because the investors had confidential witnesses who provided generalized statements about the reports, one would reasonably expect those witnesses to be able to provide more details about the reports and to be able to specifically connect them to the Defendants. In the absence of this specific information, the court declined to credit statements from the confidential witnesses about the fraudulent scheme being openly known or taking place at a high level within the company.

Holding: Dismissal affirmed.

Posted by Lyle Roberts at 10:19 PM | TrackBack

January 20, 2010

NAB Developments

A couple of items related to the National Australia Bank case. The case is pending before the U.S. Supreme Court and concerns the extraterritorial application of the antifraud provisions of the federal securities laws. Oral argument has been scheduled for March 29, 2010.

(1) The petitioners have filed their merits brief. In their brief, the petitioners argue that the "express terms" of Section 10 of the Exchange Act create subject matter jurisdiction for securities frauds involving the "use of any means or instrumentality of interstate commerce or of the mails" and there is no extraterritorial limitation. Moreover, any issues of foreign relations law or international comity can be addressed by the adoption of the "conduct" test suggested by the SEC and Solicitor General: the scheme involves significant conduct within the United States that is material to the frauds success.

(2) The National Law Journal has a column (subscrip. req'd) noting that the Supreme Court and Congress are on a "collision course" regarding the question of extraterritorial application. While the Court considers the National Australia Bank case, the House of Representatives has just passed the "Wall Street Reform and Consumer Protection Act" containing a provision similar to the conduct test urged by the petitioners (but arguably even broader because it does not contain the "materiality" requirement). Under Section 7216 of H.R. 4173 - an earlier version of the provision was discussed here - jurisdiction exists if there is "conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors." Whether the Senate will embrace this provision remains to be seen.

Posted by Lyle Roberts at 10:32 PM | TrackBack

December 11, 2009

Timing Is Everything

(1) Given that the PSLRA has been in effect since 1995, federal courts of appeals have been spending a surprising amount of time lately addressing writs of mandamus on how to interpret the statute's lead plaintiff provisions. Just last month, a Ninth Circuit panel held that a district court cannot reject the lead plaintiff's proposed lead counsel and substitute lead counsel of the court's own choosing. In In re Bard Associates, Inc., 2009 WL 4350780, (10th Cir. Dec. 2, 2009), the Tenth Circuit was asked to consider whether an investment advisor who applied to act as lead plaintiff, but did not obtain assignments of its clients' claims until after its motion was filed, made a valid application. The panel found that the district court did not abuse its discretion when it rejected the investment advisor's application on the grounds that the investment advisor had failed to establish its standing to sue as of the lead plaintiff application deadline.

(2) Settling a securities class action for $40 million is not that unusual. Settling a securities class action for $40 million after obtaining the dismissal of the case (and before any appellate ruling) is quite unusual. The D&O Diary and The American Lawyer have full coverage of Dell's interesting settlement announced last week. It certainly seems hard to argue with lead counsel's conclusion that it was "a very, very good result for the class . . . [p]articularly given the procedural posture of the case."

Posted by Lyle Roberts at 7:44 PM | TrackBack

November 30, 2009

Double Down

When it comes to securities litigation, all of today's action was in the U.S. Supreme Court.

First, the Court granted cert in the National Australia Bank case (over the objections of the DOJ and SEC) and will review the extraterritorial application of the U.S. securities laws. Bloomberg and Securities Docket have coverage of the decision. Interestingly, Justice Sotomayor recused herself from considering the cert petition.

Second, the Court heard arguments in the Merck case on when the running of the statute of limitations is triggered in securities fraud cases. According to press reports (which the oral argument transcript would appear to confirm), the justices seemed disinclined to overturn the Third Circuit's ruling and find that the plaintiffs' claims are barred by the statute of limitations. Exactly what the Court will hold is sufficient to begin the two-year "discovery" period, however, remains to be seen. The briefs filed in the case can be found here.

Posted by Lyle Roberts at 10:54 PM | TrackBack

October 30, 2009

Not So Fast

When the U.S. Supreme Court asked for the government's view on the National Australia Bank cert petition, it seemed a safe bet that the government would encourage the Court to take the case. After all, the SEC had filed an unsuccessful amicus brief in the Second Circuit in favor of the plaintiffs. Here was an opportunity to get a second bite at the apple.

Earlier this week, however, the Solicitor General and SEC filed a joint amicus brief arguing that the Supreme Court should deny cert. The government now asserts that the Second Circuit's decision was correct, even if its reasoning was wrong.

First, the government argues that the Second Circuit, along with all of the other circuits that have addressed the issue of the "transnational reach of Section 10(b)," have incorrectly described it as one of subject matter jurisdiction. In fact, the relevant jurisdictional provision has no geographical limitation. The need for a connection to the United States is better understood as being related to the elements of the claim. For a private plaintiff (but not the SEC), this includes the requirement that the plaintiff establish a connection between the defendant's violation and the alleged injury.

Second, the government takes issue with the Second Circuit's examination of where the "heart of the alleged fraud" took place. To the extent this analysis suggested that the conduct of National Australia Bank's U.S. subsidiary did not violate Section 10(b) - because it was not the "heart" of the fraud - the holding was "erroneous." Alternatively, the government proposes the following standard: "it is sufficient if the scheme involves significant conduct within the United States that is material to the fraud's success." The U.S. subsidiary's creation of false information that was incorporated into National Australia Bank's financial statements was sufficient to establish a violation of Section 10(b) and the SEC could have brought an action based on these facts.

For a foreign private plaintiff, however, an additional assessment must be made. According to the government, "the plaintiff should be required to prove that his loss resulted not simply from the fraudulent scheme as a whole, but directly from the component of the scheme that occurred in the United States." As to this assessment, the Second Circuit apparently got it right, concluding that causation was too attenuated given all of the activity that took place in Australia prior to the issuance of the false financial statements.

Finally, the government concedes that there is a circuit split over the "conduct" test, with the D.C. Circuit having adopted the most restrictive version. The D.C. Circuit requires that a defendant's "domestic conduct comprise all the elements . . . necessary to establish a violation of Section 10(b)." Nevertheless, the government argues that National Australia Bank "would not be a suitable vehicle for resolving that division" because the plaintiffs could not prevail under any of the existing conduct tests.

Whatever one makes of the government's arguments, it's overall position on granting cert is puzzling. Appellate court misunderstood fundamental legal question? Check. Appellate court applied wrong legal standard? Check. Appellate court decision caused or confirmed existence of circuit split? Check. The U.S. Supreme Court should resolve these important issues? Pass. Stay tuned for the Court's decision.

Quote of note: "[O]ther nations might perceive affording a private remedy to foreign plaintiffs as circumventing the causes of action and remedies (and the limitations thereon) that those nations provide their own defrauded citizens, particularly if the plaintiffs principal grievance appears directed at another foreign entity. Absent indications of a contrary congressional intent, the judicially-created private right of action under Section 10(b) should be tailored so as to minimize the likelihood of such international friction."

Posted by Lyle Roberts at 9:43 PM | TrackBack

October 23, 2009

Forbidden Alchemy

The U.S. Court of Appeals for the Sixth Circuit issued an opinion this week in Indiana State District Council v. Omnicare, Inc., 2009 WL 3365189 (6th Cir. Oct. 21, 2009) that has a few interesting holdings.

(1) Loss causation - The court held that loss causation was inadequately plead as to certain alleged misstatements premised on non-compliance with GAAP. In the absence of any financial restatement and given the continued willingness of Omnicare's auditors to certify the company's GAAP compliance, the court concluded that "the complaint does not suggest that the alleged GAAP violations were ever recognized or revealed to the market."

(2) Confidential Witnesses - The court reaffirmed its willingness to "steeply discount" the statements of confidential witnesses. In the instant case, the plaintiffs provided no information about a key confidential witness "except the title of his position" and there was a disconnect between what the witness knew and the alleged subject matter of the fraud.

(3) Pleading Standard for Section 11 Claims - The court joined the vast majority of other circuits (with the notable exception of the 8th Circuit) in holding that Section 11 claims that "sound in fraud" must be plead with particularity.

Holding: Dismissal of fraud claims affirmed; Section 11 claim remanded for evaluation of whether it met applicable pleading standard.

Quote of note: "Seizing on a few vague statements from management, the plaintiffs try to turn bad corporate news into a securities class action. Because the Private Securities Litigation Reform Act (PSLRA) forbids such alchemy, we generally affirm the district court's dismissal, although we reverse its disposition regarding the claims brought under the Securities Act of 1933."

Posted by Lyle Roberts at 10:11 PM | TrackBack

October 16, 2009

No License To Draw Lines

There have been two recent appellate decisions discussing the scope of the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), which pre-empts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The decisions address to what extent the statute requires the dismissal of "claims" as opposed to "actions."

In Proctor v. Vishay Intertechnology Inc., 2009 WL 3260535 (9th Cir. Oct. 9, 2009) the court found that SLUSA only precluded one of the plaintiff's three claims. As to the other two claims, the court (largely following a Third Circuit decision from earlier this year) held that they should not be dismissed but, instead, should be remanded to state court for further proceedings.

But what if the plaintiff does not carefully segregate the claims that may be precluded by SLUSA? In Segal v. Fifth Third Bank, 2009 WL 2958438 (6th Cir. Sept. 17, 2009), the complaint expressly disclaimed that any of its state-law claims were based upon alleged misrepresentations, but the court found that this was just "artful pleading" given the complaint's overall contents. As to the plaintiff's argument that his state-law claims did not "depend upon" any misrepresentations, the court held that even if the misrepresentations were "extraneous" there was no requirement that a misrepresentation be an element of a claim for the claim to be precluded by SLUSA. The court had "no license to draw a line between SLUSA-covered claims that must be dismissed and SLUSA-covered claims that must not be" and dismissed the entire action.

Posted by Lyle Roberts at 11:39 PM | TrackBack

September 25, 2009

SEC Endorses Creationism

Although it has not received much publicity (perhaps due to the fact that it does not appear on the agency's website), last month the Securities and Exchange Commission filed an amicus brief in the U.S. Court of Appeals for the Second Circuit on the issue of primary vs. aiding-and-abetting liability. The case is the Refco securities class action and the SEC takes dead aim at the Second Circuit's "bright line" test.

Under the "bright line" test, primary liability 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 SEC argues in its amicus brief that public attribution is unnecessary. Instead, a court should be able to find primary liability when the defendant "creates" the statement, even if investors are unaware of the defendant's involvement.

Given the long history of the "bright line" test in the Second Circuit, combined with the Supreme Court's recent emphasis in Stoneridge on the need to establish that investors relied on the defendant's actions, the SEC's legal arguments may not carry the day. The SEC seems prepared for this possibility, arguing that even if the Second Circuit keeps the "bright line" test, it should not be applied to government actions (where a showing of reliance is not required).

Quote of Note: "In the Commission's view, a person makes a false or misleading statement and thus can be liable as a primary violator of Rule 10b-5 when that person creates the statement. A person creates a statement in this context if the statement is written or spoken by him, or if he provides the false or misleading information that another person then puts into the statement, or if he allows the statement to be attributed to him."

Thanks to Securities Docket for the link to the SEC's amicus brief.

Posted by Lyle Roberts at 10:13 PM | TrackBack

September 11, 2009

The Dangers of Consolidation

The U.S. Court of Appeals for the Eighth Circuit does not issue many securities litigation decisions, but it apparently has decided to resolve the few cases it has all at once. For the second time in a week (see here), the court has affirmed the dismissal of a securities class action, although this opinion comes with an interesting twist.

In Horizon Asset Management Inc. v. H&R Block, Inc., 2009 WL 2870505 (8th Cir. Sept. 9, 2009) the court considered whether the plaintiffs had adequately plead a strong inference of scienter (i.e., fraudulent intent) in a case alleging financial misstatements. The opinion contains a few holdings of note:

Internal Investigation - The plaintiffs alleged that the slow pace of the internal investigation once the accounting errors where discovered strengthened the inference of scienter. The court disagreed, finding that it was "prudent" for the company to closely investigate the issue and consult with its independent auditors. Moreover, while the investigation was ongoing, the company publicly disclosed its corporate accounting control weaknesses.

Confidential Witness - The court discounted a statement by a confidential witness that he had been told that senior management was aware of the need for further financial restatements. First, the witness did not state whether his sources had actually spoken with senior management, including the individual defendants, or "merely conveyed hearsay information that was passed along by others." Second, the reliability of the confidential witness was called into question by another, clearly erroneous statement he had made concerning one of the individual defendants.

Corporate Scienter - The plaintiffs argued that even if their complaint did not raise a strong inference of scienter as to the individual officer defendants, the case should still proceed against the company based on the alleged scienter of another one of the company's officers. The court declined to address whether this imputation was proper because the plaintiffs failed, in any event, to establish a strong inference of scienter as to the officer in question.

The Eighth Circuit affirmed the dismissal of the complaint, but also addressed an unusual procedural issue. The district court had consolidated the various securities class actions and derivative cases brought against H&R Block into one case. It then named a lead plaintiff who declined to assert any derivative fiduciary claims in its consolidated complaint. When the derivative plaintiffs asked for reconsideration of the lead plaintiff decision, the district court denied the motion, finding that the proposed claims were "not really derivative claims."

On appeal, the court found that while it was "debatable" whether it was appropriate to have a single plaintiff bring both direct and derivative claims, it was erroneous for the district court to have named a single lead plaintiff who would not pursue the derivative claims the court had previously consolidated. Accordingly, the court reinstated the separate derivative complaints.

Holding: Dismissal of securities class action affirmed. Derivative complaints reinstated.

Posted by Lyle Roberts at 11:28 PM | TrackBack

September 4, 2009

The Guessing Game

In the early days of the Private Securities Litigation Reform Act and its new heightened pleading standards, courts regularly dismissed complaints that engaged in "puzzle pleading" (i.e., failed to specify the exact corporate statements that were false and the basis for their alleged falsity). Although plaintiffs quickly learned to be more careful, puzzle pleadings are still sometimes filed and the consequences can be severe.

In In re 2007 Novastar Financial, Inc. Sec. Litig., 2009 WL 2747281 (8th Cir. Sept. 1, 2009), the court considered a complaint against a subprime lender that "over the course of thirty-six pages . . . reproduced, either in their entirety or lengthy excerpts from, nineteen communications-including press releases, SEC filings, and conference call transcripts-issued by Novastar and the individual defendants during the class period that were allegedly false or misleading." What the complaint did not do, however, is give "any indication as to what specific statements within these communications are alleged to be false or misleading."

Although the lead plaintiff identified some specific false statements in his appellate brief, the court found that this did not "excuse" the "failure to comply with the pleading requirements under the PSLRA." The court also agreed with the district court's decision to deny leave to amend, noting that the lead plaintiff "never submitted a proposed amended complaint to the district court, nor did he proffer the substance of such an amended complaint until he filed his appellate brief."

Holding: Dismissal affirmed.

Quote of Note: "[E]ven after the district court dismissed [the lead plaintiff's] complaint and denied his request to amend the complaint, [the lead plaintiff] failed to file a motion under Federal Rules of Civil Procedure 15(a)(2), 59(e), or 60(b), seeking leave to file an amended complaint. As we have noted before, 'the district court [i]s not required to engage in a guessing game' as a result of the plaintiff's failure to specify proposed new allegations."

Posted by Lyle Roberts at 9:27 PM | TrackBack

August 28, 2009

Snowbird Jurisdiction

Time to catch up on a decision from a couple of weeks ago that might add some incentive for the Supreme Court to take up the issue of foreign-cubed cases. In In re CP Ships Ltd. Sec. Litig., 2009 WL 2462367 (11th Cir. Aug. 13, 2009), a class member objected to the proposed settlement because it covered certain foreign investors, some of whom might be prevented from participating in a related Canadian securities class action brought against the company. CP Ships is a Canadian company whose shares are traded on both the NYSE and Toronto Stock Exchange.

The court found, in contrast to the Second Circuit's decision in the National Australia Bank case, that the "conduct test" for subject matter jurisdiction was satisfied. Although the false financial statements were issued abroad as in the Second Circuit case, "not only did the manipulation and falsification of the numbers occur in Florida, the executives with responsibility for ensuring the accuracy of the accounting data operated from Florida."

Holding: District court properly exercised subject matter jurisdiction over the claims of foreign purchasers.

Posted by Lyle Roberts at 11:24 PM | TrackBack

August 14, 2009

Fatally Flawed

While it may be relatively easy to plead loss causation in the Fifth Circuit, things become a lot more difficult for plaintiffs when it comes time to offer proof. This week, in Fener v. Belo Corp., 2009 WL 2450674 (5th Cir. Aug. 12, 2009), the court considered a case where the corrective disclosure made by the company attributed a decline in newspaper circulation to three separate sources. Only one of the sources, however, was related to the alleged fraudulent conduct.

On appeal from the lower court's denial of class certification, the Fifth Circuit found that the plaintiff's expert report was inadequate. Notably, the plaintiff's expert failed to distinguish between the three different disclosures in conducting his event study, thereby making it impossible to conclude that the alleged fraud caused a significant amount of the post-disclosure stock price decline.

Holding: Denial of class certification affirmed.

Quote of note: "As the district court correctly held, [plaintiff's expert] testimony was fatally flawed; he wedded himself to the idea that the press release was only one piece of news and conducted his event study based on that belief. We reject any event study that shows only how a 'stock reacted to the entire bundle of negative information,' rather than examining the 'evidence linking the culpable disclosure to the stock-price movement.' Because [plaintiffs' expert] based his study on that incorrect assumption, it cannot be used to support a finding of loss causation."

Posted by Lyle Roberts at 10:52 PM | TrackBack

July 2, 2009

Bar Orders And Loss Causation

There have been two recent appellate decisions of note.

(1) In In re HealthSouth Corp. Sec. Litig., 2009 WL 1675398 (11th Cir. June 17, 2009), the court addressed the scope of the judicial bar order contained in the partial settlement between HealthSouth and the plaintiffs. The court found that the contractural claims by HealthSouth's former CEO (a non-settling defendant) against the company for (a) indemnification of any amounts he might pay in settlement of his liability to the plaintiffs, and (b) advancement of fees in connection with the litigation, were properly extinguished. (The D&O Diary has a post on the decision that questions the court's policy rationale for barring the advancement of fees claim.)

Holding: Affirmed.

(2) In Alaska Electrical Pension Fund v. Flowserve Corp., 2009 WL 1740648 (5th Cir. June 19, 2009), the court considered what type of corrective disclosure was necessary to establish loss causation. The defendants argued that "a 'fact-for-fact' disclosure of information that fully corrected prior misstatements" was necessary, while the plaintiffs asserted that it was sufficient to point to disclosures that revealed the "true financial condition" of the company. In a per curiam opinion by a panel that included retired Supreme Court Justice O'Connor, however, the court found that "the true standard lies in the middle." To establish loss causation the "disclosed information must reflect part of the 'relevant truth' - the truth obscured by the fraudulent statements," but the information can leak out over time and a "fact-for-fact" disclosure is not required.

Holding: Reversed and remanded for further proceedings consistent with opinion.

Posted by Lyle Roberts at 11:49 PM | TrackBack

June 1, 2009

What's Next?

After the U.S. Supreme Court gets done with the statute of limitations, will it turn to the issue of foreign-cubed cases? Bloomberg reports that the Court has asked the Solicitor General to present its views on the National Australia Bank cert petition. At issue in the case is whether a U.S. court should exercise jurisdiction over an action brought against a foreign issuer on behalf of a class of foreign investors who purchased their securities on a foreign exchange (otherwise known as a "foreign-cubed" case).

The 10b-5 Daily's discussion of the lower court decision can be found here. Thanks to John Letteri for the link to the Bloomberg article.

Posted by Lyle Roberts at 10:19 PM | TrackBack

May 27, 2009

Supreme Court To Address Circuit Split On Statute Of Limitations

The U.S. Supreme Court is going to address when the running of the statute of limitations is triggered in securities fraud cases, but not in the case many observers expected.

Last year, the Court asked the Solicitor General to weigh in on the cert petition filed in the Trainer Wortham (9th Cir.) case. When the Solicitor General finally did so this spring, however, it suggested that the Merck (3rd Cir.) case would be a clearer test of the statute of limitations issue. The Court apparently agreed and granted cert in the case yesterday.

The official question presented in Merck is:

Did the Third Circuit err in holding, in accord with the Ninth Circuit but in contrast to nine other Courts of Appeals, that under the "inquiry notice" standard applicable to federal securities fraud claims, the statute of limitations does not begin to run until an investor receives evidence of scienter without the benefit of any investigation?

The Court will hear the case in the term starting October 5, 2009. A summary of the Third Circuit's decision can be found here.

Posted by Lyle Roberts at 9:28 PM | TrackBack

May 22, 2009

No Guarantee Of Future Results

When a district court within the Fourth Circuit dismisses a securities class action, it usually stays dismissed. But past performance is no guarantee of future results. In In re Mutual Funds Investment Litig. 2009 WL 1241574 (4th Cir. May 7, 2009), the U.S. Court of Appeals for the Fourth Circuit has reversed the dismissal of a market timing case brought against Janus Capital Group. Moreover, the decision contains some significant legal holdings.

(1) Pleading of Loss Causation - While the Fifth Circuit recently held that loss causation is only subject to notice pleading, the Fourth Circuit is standing tough. The court reaffirmed that, pursuant to Fed. R. Civ. P. 9(b), loss causation must be plead with particularity.

(2) Making of a Misrepresentation - To satisfy the fraud-on-the-market theory, the defendant must have made "a misrepresentation that is public and attributable to the defendant." There is an ongoing circuit split over how to evaluate whether a statement can be attributed to a particular defendant. Some courts (e.g., the Second and Eleventh Circuits) have adopted a "bright line" rule requiring that the misstatement must be attributable on its face to the defendant. Other courts (e.g., the Ninth Circuit) have concluded that substantial participation in the making of the misstatement is sufficient.

The Fourth Circuit declined to fully adopt either approach, instead offering this compromise: it is sufficient for a plaintiff to "alleg[e] facts from which a court could plausibly infer that interested investors would have known that the defendant was responsible for the statement at the time is was made, even if the statement on its face is not directly attributable to the defendant." Applying its new standard to the instant case, the court found that Janus Funds investors would have attributed to Janus Capital Management, the investment advisor to the funds, "a role in the preparation or approval of the allegedly misleading prospectuses. " Janus Funds investors would have been unlikely to come to the same conclusion about Janus Capital Group, however, which was the parent company of the investment advisor.

(3) Scheme Liability - The court found that it did not have to separately evaluate the possible existence of scheme liability. Under Stoneridge, "the existence of a fraudulent scheme does not permit a plaintiff to avoid proving any of the traditional elements of primary liability, such a scienter and reliance." Since the court had already evaluated these elements in connection with the misrepresentation claims, it did not have to go any further.

Holding: Reversed and remanded.

Posted by Lyle Roberts at 8:59 PM | TrackBack

May 1, 2009

The Dictates of Conscience

In Institutional Investors Group v. Ayaya, Inc., 2009 WL 1151943 (3rd Cir. April 30, 2009), the U.S. Court of Appeals for Third Circuit has issued a comprehensive opinion that addresses a number of important pleading topics.

(1) Safe Harbor for Forward-Looking Statements - Whether the first prong of the PSLRA's safe harbor, which states that a defendant shall not be liable with respect to any forward-looking statement if it is accompanied by "meaningful cautionary statements," insulates the defendant from liability for false statements made with actual knowledge of their falsity is an open issue (see this post). The Third Circuit found that Avaya's cautionary language was "extensive and specific." In particular, the company had warned against the adverse effects of "price and product competition," which was exactly what the plaintiffs asserted "was responsible for Avaya's missing its projections." The court declined, however, to decide whether the cautionary language on its own was sufficient to avoid liability, instead finding that the plaintiffs had, in any event, failed to adequately plead actual knowledge of the projections' falsity.

(2) Confidential Witnesses - The Third Circuit considered whether, as some courts have held, the Tellabs decision requires a court to discount allegations attributed to confidential witnesses. The court found that its earlier decision on the issue remained good law. To wit, confidential witness allegations must be evaluated by examining "the detail provided by the confidential sources, the sources' basis of knowledge, the reliability of the sources, the corrobative nature of other facts alleged, including from other sources, the coherence and plausibility of the allegations, and similar indicia." The statements should only be "discounted" if they are "found wanting with respect to these criteria."

(3) Holistic Approach to Scienter Allegations - As predicted by The 10b-5 Daily following the Tellabs decision (see note 3 in this post), the Third Circuit found that it can no longer allow plaintiffs to plead scienter by either alleging facts establishing motive and opportunity or by alleging facts that constitute evidence of reckless or conscious behavior. Instead, all of the plaintiffs' scienter allegations must be considered collectively. (Along the same lines, the court rejected the Ninth Circuit's recent embrace of a dual inquiry in which scienter allegations are evaluated individually and then, if insufficient on their own, collectively.)

Holding: Reversed in part, affirmed in part, and remanded.

Quote of note: "Our conclusion that 'motive and opportunity' may no longer serve as an independent route to scienter follows also from Tellabs's general instruction to weigh culpable and nonculpable inferences. Individuals not infrequently have both strong motive and ample opportunity to commit bad acts-and yet they often forbear, whether from fear of sanction, the dictates of conscience, or some other influence. It cannot be said that, in every conceivable situation in which an individual makes a false or misleading statement and has a strong motive and opportunity to do so, the nonculpable explanations will necessarily not be more compelling than the culpable ones. And if that is true, then allegations of motive and opportunity are not entitled to a special, independent status."

Posted by Lyle Roberts at 9:20 PM | TrackBack

April 17, 2009

Pleading Loss Causation

The U.S. Court of Appeals for the Fifth Circuit has offered some guidance on how to analyze allegations of loss causation. In Lormand v. US Unwired, Inc., 2009 WL 941505 (5th Cir. April 9, 2009), the plaintiffs alleged that the truth about the fraud "leaked" to the market in a series of partial disclosures and led to stock price declines.

The Fifth Circuit made two holdings of note.

(1) In contrast to some other courts (including a recent Ninth Circuit decision), the court found that under Supreme Court precedent loss causation is only subject to a notice pleading requirement. In the court's lengthy formulation, a plaintiff must allege either a "facially 'plausible' causal relationship between the fraudulent statements or omissions and plaintiff's economic loss, including allegations of a material misrepresentation or omission, followed by the leaking out of relevant or related truth about the fraud that caused a significant part of the depreciations of the stock and plaintiff's loss" (citing Dura) or "enough facts to give rise to a reasonable hope or expectation that discovery will reveal evidence of the foregoing elements of loss causation" (citing Twombley).

(2) The disclosures that constitute the leaking out of the truth about the fraud may come from third parties.

Applying these legal standards, the Fifth Circuit held the plaintiffs had alleged, at least as to some of their claims, both a "plausible nexus" between the fraud and the cited disclosures and enough factual allegations to raise a reasonable expectation that discovery would reveal evidence of loss causation.

Holding: Affirmed in part, reversed in part, and remanded.

Posted by Lyle Roberts at 11:07 PM | TrackBack

March 6, 2009

Where Are They Now?

A visit to the U.S. Supreme Court does not necessarily mean the end of a securities class action, even if the defendants win their legal argument. The defendants in the Tellabs case successfully overturned the Seventh Circuit's interpretation of the "strong inference" pleading standard for scienter (i.e., fraudulent intent). On remand, however, the Seventh Circuit found that the plaintiffs had adequately plead scienter even under the Supreme Court's more rigorous interpretation and sent the case back to the district court for further proceedings.

A mere eight years after the case was filed, the issue of class certification has been decided. In Makor Issues & Rights, Ltd. v. Tellabs, Inc., 2009 WL 448895 (N.D. Ill. Feb. 23, 2009), the court rejected the defendants' attempts to limit the class period and class members. Among other rulings, the court found that in-and-out traders, members of the class in a related ERISA class action, and Tellabs employees should not be excluded from the class. However, the court did exclude one of the proposed representative plaintiffs because, under a last-in, first-out ("LIFO") analysis of his stock trading, his gains during the class period outweighed any losses.

Holding: Class certification granted.

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February 25, 2009

Not Expert Enough

In In re Williams Sec. Litig. - WCG Subclass, 2009 WL 388048 (10th Cir. Feb. 18, 2009), the court considered whether the plaintiffs' expert was able to "reliably link the class's losses to the revelation of the alleged misrepresentations." In examining the validity of the expert's methodology, the court also provided its views on the application of the Supreme Court's Dura decision on loss causation.

(1) Although loss causation "is easiest to show when a corrective disclosure reveals the fraud to the public and the price subsequently drops," a "leakage theory that posits a gradual exposure of the fraud rather than a full and immediate disclosure" is permissible under the Dura decision.

(2) To be a corrective disclosure, "the disclosure need not precisely mirror the earlier representation, but it must at least relate back to the misrepresentation and not to some other negative information about the company."

(3) The plaintiffs must be able to demonstrate that the stock price decline was due "to the revelation of the fraud and not to another significant piece of negative information that was released" at the same time.

As to the plaintiffs' expert, the court found that his "leakage theory" failed to adequately identify when the "materialization of the concealed risk" occurred. The expert's alternative theory - that there was a series of corrective disclosures at the end of the class period - was inadequate because he failed to show "that it was the revelation of the fraud, and not other factors, that caused the subsequent declines in price."

Holding: Affirmed district court's exclusion of expert testimony and grant of summary judgment in favor of defendants.

Addition: Note that the plaintiffs did not appeal the district court's rejection of the "constant percentage" method of calculating damages (see here for a discussion of that holding).

Addition: A summary of the case by the defendants' expert can be found here.

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February 19, 2009

CAFA and Securities Class Actions

There is now an official circuit split over the issue of whether a '33 Act securities class action that is not removable to federal court under the Securities Litigation Uniform Standards Act of 1998 ("SLUSA") is nevertheless subject to the removal provisions of the Class Action Fairness Act of 2005 ("CAFA") (see this post for more background). In Katz v. Gerardi, 2009 WL 18137 (7th Cir. Jan. 5, 2009), the court held, in contrast to the Ninth Circuit, that the '33 Act's general grant of state court jurisdiction is modified by CAFA, which clearly provides for the removal of certain securities class actions not otherwise covered by SLUSA.

Holding: Judgment of district court vacated and remanded for further proceedings.

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February 6, 2009

Two From The Third

The U.S. Court of Appeals for the Third Circuit has issued two interesting decisions.

(1) The Securities Litigation Uniform Standards Act of 1998 ("SLUSA") pre-empts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In In re Lord Abbett Mutual Funds Fee Litig., 2009 WL 117002 (3rd Cir. Jan. 20, 2009), the court considered whether Congress intended SLUSA to pre-empt the entire case or just the offending state-law claim(s). The court found that that nothing in the language or legislative history of SLUSA "mandate[s] dismissal of an action in its entirety where the action includes only some pre-empted claims." Moreover, interpreting SLUSA in this manner would have little practical effect: "plaintiffs could simply bring two or more actions in order to avoid having all of their claims dismissed - one action with the potentially pre-empted state law claims and one or more with the remaining claims."

(2) In Alaska Electrical Pension Fund v. Pharmacia Corp., 2009 WL 213095 (3rd Cir. Jan. 30, 2009), the court had an opportunity to apply its Merck decision on inquiry notice and the statute of limitations. The court found that "investors are not put on inquiry notice of fraud when, in the context of this case, an apparently legitimate scientific dispute arises between the FDA and a pharmaceutical company." Instead, to find the existence of inquiry notice the court required "some reason to suspect that defendants did not genuinely believe the accuracy of their statements."

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January 30, 2009

The Buck Stops Here

JP Morgan Chase was willing to settle with Enron's investors over its alleged complicity in the energy company's financial scandal, but not with its own investors. That turned out to be a prudent decision when the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of the JP Morgan Chase investors' securities class action last week.

In ECA v. JP Morgan Chase Co., 2009 WL 129911 (2d Cir. Jan. 21, 2009), the court found that the plaintiffs' scienter allegations suffered "from a basic problem concerning plausibility." The plaintiffs argued that JP Morgan "concealed its transactions with Enron in return for excessive fees." The court held, however, that it was "implausible to have both an intent to earn excessive fees for the corporation and also an intent to defraud Plaintiffs by losing vast sums of money [through loans to Enron that JP Morgan could not recover]."

Holding: Dismissal affirmed (on both scienter and materiality grounds).

Addition: The court considered whether Chase was motivated to artificially inflate its stock price via the Enron fraud so that it could use the stock as currency for its acquisition of JP Morgan. Whether this type of motive allegation can contribute to a strong inference of scienter has been an unsettled question. The court found that "a generalized desire to achieve a lucrative acquisition proposal" is common to all companies seeking to make an acquisition and fails "to establish the requisite scienter."

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January 16, 2009

A Second Bite At The Apple

The U.S. Court of Appeals for the Ninth Circuit issued two decisions this week affirming dismissals based on a failure to adequately plead scienter (i.e., fraudulent intent). The decisions - Zucco Partners, LLC v. Digimarc Corp., 2009 WL 57081 (9th Cir. Jan. 12, 2009) and Rubke v. Capitol Bancorp LTD, 2009 WL 69278 (9th Cir. Jan. 13, 2009) - are notable because they appear to tweak the court's approach to evaluating scienter allegations.

The panels found that the U.S. Supreme Court's decision in Tellabs meant that they could no longer dismiss a complaint because the individual scienter allegations were insufficient. Instead, as the Zucco panel held, the court needed to "conduct a dual inquiry: first, we will determine whether any of the plaintiff's allegations, standing alone, are sufficient to create a strong inference of scienter; second, if no individual allegations are sufficient, we will conduct a 'holistic' review of the same allegations to determine whether the insufficient allegations combine to create a strong inference of intentional conduct or deliberate recklessness." The Rubke panel agreed with this two-step approach, finding that it was required to perform a "second holistic analysis to determine whether the complaint contains an inference of scienter that is greater than the sum of its parts."

Whether this dual inquiry, which appears to afford plaintiffs a second bite at the apple, will have any practical effect is difficult to say. Both panels held that scienter was inadequately plead in the respective complaints (even when evaluated holistically), with the Zucco panel noting that "a comprehensive perspective of Zucco's complaint cannot transform a series of inadequate allegations into a viable inference of scienter." To put it another way, can zero plus zero plus zero ever add up to something? Stay tuned.

Posted by Lyle Roberts at 10:47 PM | TrackBack

January 13, 2009

Deceiving The Accountant

Last month, the U.S. Court of Appeals for the Fourth Circuit issued its first post-Tellabs decision on the pleading of scienter (i.e., fraudulent intent). The court is back this month with another scienter decision, this time in a case against an accounting firm.

In Public Employees' Retirement Assoc. of Col. v. Deloitte & Touche LLP, 2009 WL 19134 (4th Cir. Jan. 5, 2009), the court considered the alleged role of two Deloitte entities in the Royal Ahold fraud. (The corporate defendants settled for $1.1 billion in 2005.) The court found that "to establish a strong inference of scienter," the plaintiffs needed to "demonstrate that the Deloittes were either knowingly complicit in the fraud, or so reckless in their duties as to be oblivious to malfeasance that was readily apparent." The plaintiffs, however, could not "escape the fact that Ahold . . . went to considerable lengths to conceal the frauds from the accountants and it was the defendants that ultimately uncovered the frauds." The "strong inference to be drawn from this fact" is that the Deloitte entities "lacked the requisite scienter."

Holding: Dismissal affirmed.

Quote of note: "It is not an accountant's fault if its client actively conspires with others in order to deprive the accountant of accurate information about the client's finances. It would be wrong and counter to the purposes of the PSLRA to find an accountant liable in such an instance."

Posted by Lyle Roberts at 7:35 PM | TrackBack

December 17, 2008

Competitive Advantage

The U.S. Court of Appeals for the Fourth Circuit has issued its first opinion applying the Tellabs decision on the pleading of scienter (i.e., fraudulent intent). Those who follow the Fourth Circuit's jurisprudence in this area will be unsurprised to learn that the decision creates good law for defendants.

In Cozzarelli v. Inspire Pharmaceuticals, Inc., 2008 WL 5194311 (4th Cir. Dec. 12, 2008), the plaintiffs alleged that Inspire made false statements regarding a drug trial. The court found that in defining the PSLRA's "strong inference" pleading standard for scienter, the Supreme Court "gave that standard teeth, using adjectives like 'cogent,' 'compelling,' 'persuasive,' 'effective,' and 'powerful.'" Moreover, an inference of scienter "can only be strong - and compelling, and powerful - when it is weighed against the opposing inferences that may be drawn from the facts in their entirety."

Based on the facts before it, the court found the inference that any allegedly omitted information about the drug trial was withheld "to protect [Inspire's] competitive advantage" more "powerful and compelling than the inference that defendants acted with an intent to deceive." Moreover, the plaintiffs' motive allegations based on the company's need to raise capital, the CEO's performance-based compensation, and a limited amount of stock sales were "conclusory" and "lack[ed] merit."

The court also joined a number of other circuit courts in holding (a) the signing of allegedly false SOX certifications does not contribute to an inference of scienter, and (b) Section 11 and 12(a)(2) claims that "sound in fraud" must be plead with particularity pursuant to Fed R. Civ. P. 9(b).

Holding: Dismissal affirmed.

Quote of note: "All investments carry risk, particularly in a field like biopharmaceuticals. If we inferred scienter from every bullish statement by a pharmaceutical company that was trying to raise funds, we would choke off the lifeblood of innovation in medicine by fueling frivolous litigation-exactly what Congress sought to avoid by enacting the PSLRA. Furthermore, the fact that some analysts relied on defendants' hopeful statements to speculate-as the analysts admitted they were doing-that Study 109 would succeed adds little to an inference of scienter. Speculation by investors and subsequent buyers' remorse cannot support an Exchange Act suit alone."

Disclosure: The author of The 10b-5 Daily has previously represented the defendants in this case.

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December 10, 2008

Sliding Scale

What triggers the running of the statute of limitations for a securities fraud action is suddenly a hot topic, thanks to a possible Supreme Court case and a recent Second Circuit decision.

In Staehr v. Hartford Financial Services Group, Inc., 2008 WL 4899445 (2d Cir. Nov. 17, 2008), the court considered whether the plaintiffs had been put on inquiry notice of their claims based on the "cumulative effect" of news articles, public filings, and lawsuits referring to an industrywide fraudulent scheme. The court found that the news articles mostly did not mention Hartford and were in specialty publications, the company's public filings did not offer enough information about the subject of the fraud, and the lawsuits either did not mention Hartford or were not sufficiently publicized so as to be "reasonably accessible" to an ordinary investor. The New York Law Journal has a column (Dec. 10 edition - subscrip. req'd) on the decision.

Holding: Dismissal based on statute of limitations vacated.

Quote of note (decision): "Given the objective standard for inquiry notice, there is an inherent sliding scale in assessing whether inquiry notice was triggered by information in the public domain: the more widespread and prominent the public information disclosing the facts underlying the fraud, the more accessible this information is to plaintiffs, and the less company-specific the information must be."

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December 4, 2008

Definite Maybe

The U.S. Court of Appeals for the Ninth Circuit has issued an opinion on pleading scienter that includes new law (sort of) on the issues of collective scienter, SOX certifications, and profit motive.

In Glazer Capital Management LP v. Magistri, 2008 WL 5003306 (9th Cir. Nov. 26, 2008) the Ninth Circuit considered a case based on alleged misstatements in a merger agreement attached to an SEC filing. The district court found that the complaint failed to adequately plead falsity or scienter. On appeal, the Ninth Circuit made the following rulings (among others) regarding scienter:

(1) Collective scienter - The decision appears to open the door for collective scienter arguments in the Ninth Circuit, but it is far from clear on this point. The collective scienter theory holds that it is possible to raise the required inference of scienter about a corporate defendant without doing so with regard to a specific individual defendant. Although there is a published (and an additional unpublished) Ninth Circuit decision that appear to reject the collective scienter theory, in Glazer the panel found that the earlier published decision had "not foreclose[d] the possibility that, in certain circumstances, some form of collective scienter might be appropriate." In the instant case, however, the alleged misstatements were not susceptible to the theory because they were broad legal warranties contained in a single document. Accordingly, the panel did not need to decide whether the collective scienter theory was viable.

(2) SOX certifications/Profit motive - Following precedent from other circuits, the panel found that neither the signing of SOX certifications nor allegations that the individual defendant "was positioned to profit personally from the proposed merger" were sufficient to raise a strong inference of scienter.

Holding: Dismissal affirmed.

Quote of note: "If the doctrine of collective scienter excuses Glazer from pleading individual scienter with respect to these legal warranties, then it is difficult to imagine what statements would not qualify for an exception to individualized scienter pleadings. In fact, because the merger agreement warranted that the company was in compliance 'with all laws,' then under the collective scienter theory urged by Glazer, so long as any employee at InVision had knowledge of the violation of any law, scienter could be imputed to the company as a whole. This result would be plainly inconsistent with the pleading requirements of the PSLRA. We are thus not faced with whether, in some circumstances, it might be possible to plead scienter under a collective theory."

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November 20, 2008

No Longer Good Law

As discussed in The 10b-5 Daily before, whether the Tellabs decision on pleading scienter (i.e., fraudulent intent) can best be described as a victory for plaintiffs or defendants has to be evaluated on a circuit-by-circuit basis. In the U.S. Court of Appeals for the Sixth Circuit, for example, the pleading standard has been lowered.

In Frank v. Dana Corp., 2008 WL 4923012 (6th Cir. Nov. 19, 2008), the lower court found that it was "required to accept plaintiff's inferences of scienter only if those inference are the most plausible of competing inferences." On appeal, the Sixth Circuit noted that although its earlier decisions applied a "most plausible" standard, that standard was no longer good law. Instead, under Tellabs, the plaintiffs only needed to demonstrate an inference of scienter that was "at least as compelling" as any opposing inference one could draw from the facts alleged.

Holding: Dismissal vacated and case remanded to district court for reconsideration.

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November 14, 2008

Incomplete Peace

When only some of the defendants settle a securities class action, the extent to which they can avoid related litigation with non-settling defendants through the imposition of a judicial bar order is limited. In In re Heritage Bond Litig., 2008 WL 4415172 (9th Cir. Oct. 1, 2008), the court, agreeing with Second Circuit precedent, held that a permissible bar order "may only bar claims for contribution and indemnity and claims where the injury is the non-settling defendant's liability to the plaintiff." Non-settling defendants should still be able to bring "genuinely independent" claims against settling defendants, even if the claims arise out of the same facts as those underlying the securities class action.

Holding: Vacated challenged bar orders and remanded to district court for modification.

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November 5, 2008

Out In Left Field

Will the next U.S. Supreme Court securities case be about the statute of limitations? It is a strong possibility, given that the Court has asked the Solicitor General to weigh in on the cert petition filed in a Ninth Circuit case.

At issue in Betz v. Trainer Wortham & Co., Inc., 519 F.3d 863 (9th Cir. 2008) is when the two-year statute of limitations for a securities fraud begins to run. It is well-settled that if an investor has sufficient knowledge concerning the possibility or probability of fraud (courts have differed on the exact wording), he is deemed to have "inquiry notice" and must begin an investigation into the underlying facts. There is a conflict between the circuits, however, on whether the statute of limitations begins to run when the investor is put on inquiry notice, or later when a reasonably diligent investigation would have revealed the fraud.

The Ninth Circuit went even further then the existing case law and held that inquiry notice is triggered not by mere evidence of a misrepresentation (as in other circuits), but only by evidence of the defendant's fraudulent intent. It also adopted the more rigorous notice-plus-reasonable-diligence standard and found that even fairly mild reassurances from the defendant in response to a plaintiff's inquiries may require a jury determination as to whether a reasonably diligent investigation would have revealed the fraud. In a vigorous dissent from the denial of en banc review, Judge Kozinski described the court as being "out in left field again" and argued that "the panel effectively writes the statute of limitations off the books."

Stay tuned for whether the Court takes the case. In the interim, the amicus brief filed by the Organization for International Investment and the Chamber of Commerce of the United States of America in support of a cert grant can be found here. Thanks to LawyerLinks for noting the Court's invitation to the Solicitor General's office to express the government's views.

Posted by Lyle Roberts at 6:34 PM | TrackBack

October 24, 2008

No Safe Haven

"Foreign-cubed" cases are actions brought against a foreign issuer, on behalf of a class that includes not only investors who purchased the securities in question on a U.S. securities exchange, but also foreign investors who purchased the securities on a foreign securities exchange. These cases raise a number of jurisdictional issues.

In Morrison v. National Australia Bank Ltd., 2008 WL 4660742 (2nd Cir. Oct. 23, 2008), the court considered whether it should exercise subject matter jurisdiction over the claims brought by the foreign purchasers of the bank's ordinary shares (the lower court had dismissed the domestic purchasers' claims on other grounds). The court declined to impose a "bright-line ban" on foreign purchaser claims, expressing concern that "securities cheaters . . . should not be given greater protection from American securities laws because they carry a foreign passport or victimize foreign shareholders."

Instead, the court applied its existing "conduct test" for subject matter jurisdiction. Under the conduct test, the plaintiffs needed to adequately allege that "activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused losses to investors abroad." The court found that this test was not met: "the fact that the fraudulent statements at issue emanated from NAB's corporate headquarters in Australia, the complete lack of any effect on America or Americans, and the lengthy chain of causation between [the false numbers communicated to NAB by its U.S. subsidiary] and the statements that reached investors - add up to a determination that we lack subject matter jurisdiction."

Holding: Dismissal affirmed (note that the Second Circuit did not address a related issue that was recently raised in a S.D.N.Y. case - whether the fraud-on-the-market theory is applicable to foreign purchasers).

Quote of note: "[W]e are leery of rigid bright-line rules because we cannot anticipate all the circumstances in which the ingenuity of those inclined to violate the securities laws should result in their being subject to American jurisdiction. That being said, we are an American court, not the world's court, and we cannot and should not expend our resources resolving cases that do not affect Americans or involve fraud emanating from America. In our view, the 'conduct test' balances these competing concerns adequately and we decline to place any special limits beyond the 'conduct test' on 'foreign-cubed' securities fraud actions."

Posted by Lyle Roberts at 10:16 PM | TrackBack

October 21, 2008

Installing Tellabs

The latest application of the Tellabs decision on the pleading of scienter (i.e., fraudulent intent) comes from the U.S. Court of Appeals for the Eleventh Circuit. In Mizzaro v. Home Depot, Inc., 2008 WL 4498940 (11th Cir. Oct. 8, 2008), the court considered two controversial issues.

Confidential Witnesses - The court declined to embrace the Seventh Circuit's position that statements by confidential witnesses should be "heavily discounted." On the other hand, the court acknowledged that there were reasons to be "skeptical of confidential sources cited in securities fraud complaints," including that there are no harsh consequences if a witness lies to a plaintiff's attorney. The court concluded: "Confidentiality . . . should not eviscerate the weight given if the complaint otherwise fully describes the foundation of the confidential witness's knowledge, including the position(s) held, the proximity to the offending conduct, and the relevant time frame."

Collective Scienter - The court agreed with the Fifth Circuit's position that a defendant corporation's scienter is determined by looking "to the state of mind of the individual corporate official or officials who make or issue the statement . . . rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment." (For more on the circuit split over collective scienter, see this post.) The plaintiffs did "not argue that any Home Depot officials were responsible for the company's financial statements other than the named individual defendants." Accordingly, the court found that it "need not pursue this issue further."

Holding: Dismissal affirmed.

Quote of note: "To begin with, we indulge at least some skepticism about allegations that hinge entirely on a theory that senior management 'must have known' everything that was happening in a company as large as Home Depot, which operates over 2000 stores. The amended complaint, therefore, must at least allege some facts showing how knowledge of the fraud would or should have percolated up to senior management. The amended complaint does not come close to accomplishing that task. In particular, [plaintiff's] 'must have known' theory fails because the alleged amount of the fraud is wholly speculative, the type of fraud alleged would be very difficult for senior management to detect, [plaintiff] alleges no suspicious stock sales by management, and Home Depots 2004 overhaul of its RTV processing system does not suggest knowledge of widespread fraud."

Posted by Lyle Roberts at 11:09 PM | TrackBack

October 17, 2008

An Ounce of Prevention

Centene Corporation requires all insider stock transactions by its senior executives to be executed under pre-authorized Rule 10b5-1 stock trading plans. That policy turns out to have been helpful in obtaining the dismissal of a securities class action against the company.

In Elam v. Neidorff, 2008 WL 4587310 (8th Cir. Oct. 16, 2008), the Eighth Circuit reviewed the dismissal of the securities class action against Centene and certain individual officers. The plaintiffs argued that scienter (i.e., fraudulent intent) was demonstrated, among other things, by insider stock sales during the class period. The court, however, found that the stock sales could not support an inference of scienter because they were (a) done pursuant to Rule 10b5-1 trading plans, and (b) represented only a small portion of each seller's overall holdings. Interestingly, the court discussed the terms of the trading plans, suggesting that the trading plans were publicly disclosed. (For more on this issue and related posts, click here.)

Holding: Dismissal affirmed (for failure to adequately plead falsity and scienter).

Posted by Lyle Roberts at 9:09 PM | TrackBack

October 2, 2008

Posting On The Internet

Does the fraud-on-the-market presumption, pursuant to which reliance by investors on a material misrepresentation is presumed if the company's shares were traded on an efficient market, apply in suits alleging misrepresentations by analysts (and other non-issuers)?

The U.S. Court of Appeals for the Second Circuit was poised to answer that question in 2004, but Citigroup's settlement of the claims against it in the WorldCom litigation rendered its appeal moot. Based on the order granting the appeal, issued a day after the agreement to settle was reached, it appeared that the court was inclined to limit the reach of the fraud-on-the-market presumption. Four years later, before a completely different panel, the plaintiffs' bar has a significant win on the same issue.

In In re Salomon Analyst Metromedia Litigation, No. 06-3225 (2nd Cir. Sept. 30, 2008), the court found that nothing in Basic, the Supreme Court case creating the fraud-on-the-market presumption, limited the presumption's application to misrepresentations by issuers. Indeed, the "logic" of the Basic decision, which is based on the economic theory that share prices reflect all publicly available information in an efficient market, suggests "it does not matter, for purposes of establishing entitlement to the presumption, whether the misinformation was transmitted by an issuer, an analyst, or anyone else."

In the alternative, the defendants argued that to establish the materiality of the misrepresentations, and thereby invoke the fraud-on-the-market presumption, the plaintiffs had the burden of proving that the misrepresentations had a quantifiable effect on the company's stock price. The court disagreed, holding that inherent in the fraud-on-the-market theory is the presumption that material misrepresentations have an effect on stock price. Therefore, it was the defendants' burden to rebut the presumption by demonstrating the absence of a price impact.

A couple of notes on the decision:

(1) The Second Circuit cited the Supreme Court's recent Stoneridge decision in support of its holding. In Stoneridge, however, the Court found that the fraud-on-the-market presumption was inapplicable to the non-issuer defendants based on the fact that their "deceptive acts" were not communicated to the public. The issue of the scope of the fraud-on-the-market presumption was not squarely before the Court. Moreover, the Court expressed grave reservations about expanding securities fraud liability, something the Second Circuit's decision arguably does.

(2) The Second Circuit brushed aside the defendants' arguments concerning the expansion of liability (see full quote below), but offered an interesting codicil in a footnote. The court noted that "the identity of the speaker may be significant, because a court may determine that the reasonable investor would only rely on misrepresentations made by some speakers, but not by others."

Holding: Vacate order of class certification and remand for further proceedings (including providing the defendants with an opportunity to rebut the presumption of a price impact).

Quote of note: "Defendants worry that if no heightened test is applied in suits against non-issuers, any person who posts material misstatements about a company on the internet could end up a defendant in a Rule 10b-5 action. The worry is misplaced. The law guards against a flood of frivolous or vexatious lawsuits against third-party speakers because (1) plaintiffs must show the materiality of the misrepresentation, (2) defendants are allowed to rebut the presumption, prior to class certification, by showing, for example, the absence of a price impact, and (3) statements that are 'predictions or opinions,' and which concern 'uncertain future event[s],' such as most statements made by research analysts, are generally not actionable."

Posted by Lyle Roberts at 11:05 PM | TrackBack

September 26, 2008

We're Better Than Those Guys

The recent string of appellate decisions involving securities class actions includes Ley v. Visteon Corp., 2008 WL 3905469 (6th Cir. Aug. 26, 2008), which contains a couple of interesting holdings.

Comparisons to Competition - The plaintiffs alleged that Visteon failed to disclose how high its costs were relative to its competition. The court declined to "advocate a rule that requires companies to draw such comparisons." Quoting from an older Third Circuit opinion, the court found that "it is precisely and uniquely the function of the prudent investor, not the issurer of securities, to make such comparisons among investments."

Discounting Confidential Witnesses - The Seventh Circuit has held that in evaluating the pleading of scienter (i.e. fraudulent intent), allegations from confidential witnesses must be "discounted" and that discount will usually be "steep." Although there is some confusion as to whether that holding remains good law, the Sixth Circuit cited it favorably in concluding that the confidential witness allegations in the Visteon complaint were insufficient to establish any inference of scienter.

Holding: Dismissal affirmed.

Posted by Lyle Roberts at 8:19 PM | TrackBack

September 19, 2008

Core Operations

There is a recent appellate trend of finding "must have known" allegations sufficient to establish a strong inference of scienter in situations where the underlying events are deemed to be highly important to the corporation (e.g., Dynex Capital (2nd Cir.), Tellabs II (7th Cir.), and Applied Signal (9th Cir.)).

In South Ferry LP v. Killinger, 2008 WL 4138237 (9th Cir. Sept. 9, 2008), the court examined exactly when "a scienter theory that infers that facts critical to a business's 'core operations' or an important transaction are known to a company's key officers" establishes a strong inference of scienter. The court found that these allegations may help to satisfy the pleading standard in three circumstances.

(1) "[T]he allegations may be used in any form along with other allegations that, when read together, raise an inference of scienter that is 'cogent and compelling, thus strong in light of other explanations.'" (citing Tellabs)

(2) The "allegations may independently satisfy the [scienter pleading standard] where they are particular and suggest that defendants had actual access to the disputed information."

(3) The "allegations may conceivably satisfy the [scienter pleading] standard in a more bare form, without accompanying particularized allegations, in rare circumstances where the nature of the relevant fact is of such prominence that it would be 'absurd' to suggest that management was without knowledge of the matter."

Although the first two tests are uncontroversial, the "absurdity" test appears difficult to apply in a consistent fashion. The court cited the Applied Signal case, where the defendants allegedly failed to disclose stop-work orders from the company's largest customers even though they had a devastating effect on revenues, as one of the "exceedingly rare" cases where the core operations inference, without more, was sufficient. But whether lower courts will find that the core operations inference is sufficient only in "exceedingly rare" cases remains to be seen.

Holding: Remanded for further proceedings consistent with the opinion.

Posted by Lyle Roberts at 9:57 PM | TrackBack

September 12, 2008

Unifying Intent

Can the sheer number of accounting errors negate an inference of fraud? In In re Ceridian Corp. Sec. Litig., 2008 WL 4163782 (8th Cir. Sept. 11, 2008), the U.S. Court of Appeals for the Eighth Circuit had an opportunity to address that question.

Between February 2004 and April 2005, Ceridian announced three financial restatements. The restatements were based on a variety of apparently unrelated accounting errors over a number of years. The district court found that the sheer number of accounting errors, which involved dozens of employees, made it "almost inconceivable that there could have been any unifying intent behind the errors, much less an intent to defraud."

The Eighth Circuit agreed. Even in conjunction with the plaintiffs' other scienter allegations - including insider trades, SOX certifications, confidential witness statements about pre-class period conduct, and an ongoing SEC investigation - the court found that "the opposing inference that Ceridian and the controlling officer defendants should have known about the many accounting errors" was more compelling than the inference that they knew about the errors. The court concluded that the plaintiffs had "a viable claim of negligence, but not of fraud."

Holding: Dismissal affirmed.

Posted by Lyle Roberts at 10:43 PM | TrackBack

September 9, 2008

The Emperor's New Clothes

The U.S. Court of Appeals for the Third Circuit has issued a notable decision on the application of the statute of limitations in securities cases. In In re Merck & Co., Inc. Sec., Derivative & ERISA Lit., Nos. 07-2431, 07-2432 (3rd Cir. Sept. 9, 2008), the court considered whether Merck investors were on inquiry notice of their securities claims relating to Vioxx disclosures more than two years before the case was filed. If so, the plaintiffs' claims would be barred by the statute of limitations. The decision has a number of interesting holdings:

(1) There has been some ambiguity in the Third Circuit over whether inquiry notice is triggered by evidence alerting an investor to the "possibility" or the "probability" of wrongdoing. The decision clarified that the Third Circuit's standard is: "whether the plaintiffs, in the exercise of reasonable diligence, should have knows of the basis for their claims depends on whether they had sufficient information of possible wrongdoing to place them on inquiry notice or to excite storm warnings of culpable activity." Although the court adopted the lower "possibility" standard, it emphasized that the evidence must be substantial, especially in light of the PSLRA's heightened pleading standards.

(2) The district court found the existence of inquiry notice based upon a public FDA warning letter stating that Merck was misrepresenting the safety profile of Vioxx, press and scholarly articles about the risk of heart attack associated with the drug, and various lawsuits filed against Merck over Vioxx safety issues. On appeal, however, the court found that these "storm warnings" were dissipated by Merck's reassuring statements to the market or undermined by the failure of the disclosures to have any significant impact on Merck's stock price or projections by analysts. In particular, the court focused on the fact that Merck put forward an alternative hypothesis as to why the relevant clinical study showed increased heart attack risks associated with Vioxx that may have led to the limited stock price reaction. Also, none of the lawsuits alleged securities fraud.

(3) In a vigorous dissent, Judge Roth argued that the FDA warning letter, by itself, was a sufficient storm warning that Merck had engaged in misrepresentations concerning Vioxx. Moreover, the subsequent press coverage and consumer lawsuits should have led investors to an awareness "of the possibility that Merck had been fraudulently misrepresenting the cardiovascular safety of Vioxx."

(4) The majority's footnote response to the dissent appears ill-considered: "It is ironic that the dissent, although noting what might be viewed as Merck's misrepresentations, would apply the statute of limitations to deprive plaintiffs of the opportunity to prove a viable case against Merck for such misrepresentations." Bad facts make for bad law? After all, as The 10b-5 Daily has noted before, an inquiry notice argument presupposes the possibility of misrepresentations and the statute of limitations can limit liability even where misconduct has occurred.

Holding: Reversed and remanded.

Quote of note (majority opinion): "Mercks stock price dipped slightly following the disclosure of the FDA warning letter before closing higher than it did before that disclosure just a week and a half later. Although the lack of significant movement in Mercks stock price following the FDA warning letter is not conclusive, it supports a conclusion that the letter did not constitute a sufficient suggestion of securities fraud to trigger a storm warning of culpable activity under the securities laws. This conclusion is also supported by the fact that more than a half-dozen securities analysts continued to maintain their ratings for Merck stock and/or project increased future revenues for Vioxx after the warning letter was made public."

Quote of note (dissent): "In applying the above inquiry notice standard to the instant case, I am reminded of a classic fairytale: The Emperors New Clothes, by Danish author and poet, Hans Christian Anderson. As the child in The Emperors New Clothes saw that the Emperor walked naked down the street any reasonable investor reading the FDAs September 17, 2001, warning letter could see the problem with Vioxx the misrepresentation of its safety profile and the 'possibility' that Merck had fraudulently misrepresented the cardiovascular safety of its 'blockbuster' product."

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August 29, 2008

Negotiated Fees

Does the PSLRA require courts to find the attorneys' fees agreed upon by the lead plaintiff presumptively reasonable? In In re Nortel Networks Corp. Sec. Litig., 2008 WL 3840916 (2d Cir. Aug. 19, 2008), the lead counsel made this argument on appeal after the district court reduced its fee request from the negotiated 8.5% of the settlement amount to 3% of the settlement amount. The Second Circuit found that the lead counsel had waived the argument, which was based on Third Circuit precedent, by failing to raise it before the district court. The appellate court nevertheless made it clear that while district courts should give "serious consideration" to negotiated fee arrangements, "the only PSLRA provision related to attorneys' fees places an obligation on district courts to ensure independently that fees are reasonable." As for the 3% fee award (resulting in a 2.04 lodestar multiplier), the appellate court found that it was "toward the lower end of reasonable fee awards," but the district court had not abused its discretion in setting the award at that level.

Holding: Fee award affirmed.

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August 21, 2008

Pleading By Euphemism

Two recent decisions from the U.S. Court of Appeals for the Ninth Circuit demonstrate that a fair amount of judicial discretion goes into determining whether the inference of loss causation created by a complaint's factual allegations is either "unreasonable" or "facially plausible."

(1) In Metzler Investment GMBH v. Corinthian Colleges, Inc., 2008 WL 2853402 (9th Cir. July 25, 2008), the court examined whether a news story and a press release that lead to stock price declines could "be reasonably read to reveal widespread financial aid manipulation by Corinthian." The court found that the news story only discussed a Department of Education investigation into improper financial aid practices at one of Corinthian's schools and, therefore, could not have revealed the supposed fraud. As for the later press release, the plaintiffs alleged that the announcement of higher than anticipated student attrition was understood by the market as the company's "euphemism for an admission that they had enrolled students who should not have been signed up at all, resulting in a 45% stock price drop." The court was unwilling to credit this inference, holding that although the corrective disclosure does not have to be an admission of fraud, "that does not allow a plaintiff to plead loss causation through 'euphemism.'"

Holding: Dismissal affirmed.

Quote of note: "So long as there is a drop in a stock's price, a plaintiff will always be able to contend that the market 'understood' a defendant's statement precipitating a loss as a coded message revealing the fraud. Enabling a plaintiff to proceed on such a theory would effectively resurrect what Dura discredited - that loss causation is established through an allegation that a stock was purchased at an inflated price. Loss causation requires more."

(2)In In re Gilead Sciences Sec. Litig., 2008 WL 3271039 (9th Cir. Aug. 11, 2008), the court examined whether loss causation was adequately plead where the market was alerted to the company's off-label marketing efforts by an FDA warning letter in August 2003 (no decline in stock price), but the alleged financial impact to the company of the FDA warning letter was not announced until October 2003 (12% decline in stock price). The lower court found that it was unreasonable to infer that the August 2003 revelation caused a stock price decline nearly three months later and that the October 2003 announcement of a slowing increase in demand for the relevant product was too speculative a basis for finding loss causation. On appeal, the court held that "a limited temporal gap between the time a misrepresentation is publicly revealed and the subsequent decline in stock value does not render a plaintiff's theory of loss causation per se implausible." Moreover, the warning letter's effect on product demand may not have been understood by the market until the October 2003 announcement.

Holding: Dismissal reversed.

Quote of note: "It is true that the court need not accept as true conclusory allegations, nor make unwarranted deductions or unreasonable inferences. But so long as the plaintiff alleges facts to support a theory that is not facially implausible, the court's skepticism is best reserved for later stages of the proceedings when the plaintiff's case can be rejected on evidentiary grounds."

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August 13, 2008

Shaw Enough

The Shaw Group is on a roll. Following the recent dismissal of the securities class action against the company in the S.D.N.Y., it has obtained an unusual victory in an earlier, unrelated securities class action filed in the D. of La. As noted in The 10b-5 Daily nearly two years ago, the D. of La. court denied Shaw's motion to dismiss in the case, but certified its denial for appeal. The court found that "reasonable minds might disagree on the issue of whether the Plaintiffs have satisfied their pleading burden under the heightened standards for securities claims." Apparently so.

In Indiana Electrical Workers' Pension Trust Fund IBEW v. Shaw Group, Inc., 2008 WL 2894793 (5th Cir. July 29, 2008), the court held that the plaintiffs had failed to allege a strong inference of scienter. Interestingly, the court agreed with the Seventh Circuit that "[f]ollowing Tellabs, courts must discount allegations from confidential sources." In the absence of any financial restatement, the court found that the complaint's circumstantial allegations of scienter (based largely on confidential sources) were insufficient and there were plausible, non-fraudulent explanations for the officer stock sales during the class period.

Holding: Reversed and remanded with instructions to dismiss.

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July 11, 2008

Must Have Known

In Berson v. Applied Signal Tech., Inc., 527 F.3d 982 (9th Cir. 2008), the company allegedly misled investors into believing it was likely to perform contracted work. According to the plaintiffs, however, the work had actually ceased pursuant to stop-work orders and was not likely to be resumed. On appeal, the U.S. Court of Appeals for the Ninth Circuit reversed the dismissal of the case. A couple of interesting holdings in the decision:

(1) Scienter - The plaintiffs did not allege particular facts indicating that the individual defendants knew about the stop-work orders. Instead, they argued that Applied Signals CEO and CFO must have known about the stop-work orders because of the devastating effect of the orders on the corporations revenue. The court agreed and found that the stop-work orders were prominent enough that it would be absurd to suggest that top management was unaware of them. The decision continues a recent appellate trend of finding "must have known" allegations sufficient in situations where the underlying events are deemed to be highly important to the corporation.

(2) Loss Causation The Supreme Courts Dura decision left open the question of whether loss causation is subject to a heightened pleading standard. A number of courts have held that notice pleading pursuant to F.R.C.P. 8(a)(2) is sufficient (see, e.g., Greater Penn. Carpenters Pension Fund v. Whitehall Jewellers, Inc., 2005 WL 1563206 (N.D. Ill. June 30, 2005)), while a few others have required pleading with particularity pursuant to F.R.C.P. 9(b) (see, e.g., In re The First Union Corp. Sec. Litig., 2006 WL 163616 (W.D.N.C. Jan. 20, 2006)). The Applied Signal court noted that this is still an open question in the Ninth Circuit, but declined to decide it because the loss causation allegations in the case met the more stringent standard.

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July 2, 2008

The GM Paradigm

Whether a plaintiff can establish the scienter of a defendant corporation based on the collective knowledge of the corporation's employees, commonly referred to as the "collective scienter" theory, is a topic that is getting increased attention in the courts. The author of The 10b-5 Daily wrote a New York Law Journal column (with a colleague) on collective scienter earlier this year.

The main case discussed in that column was decided by the Second Circuit last week. In Teamsters Local 445 Freight Division Pension Fund v. Dynex Capital, Inc., 2008 WL 2521676 (2nd Cir. June 26, 2008), the court drew a distinction between the pleading and proving of corporate scienter. Although to prove corporate liability "a plaintiff must prove that an agent of the corporation committed a culpable act with the requisite scienter, and that the act (and accompanying mental state) are attributable to the corporation," the court found that at the pleading stage a plaintiff is only required to create a strong inference that "someone whose intent could be imputed to the corporation acted with the requisite scienter." This pleading burden can be met "with regard to a corporate defendant without doing so with regard to a specific individual defendant." The court went on to hold, however, that the generic allegations of knowledge and motive in the complaint failed to meet this standard.

Practitioners, especially in the defense bar, are likely to find the decision disappointing. First, the court did not address what type of factual allegations would be sufficient to find the existence of a strong inference of corporate scienter (in the absence of sufficient factual allegations concerning an individual defendant). The only hint is a quote from the Seventh Circuit's decision in Tellabs II discussing a hypothetical in which "General Motors announced that it had sold one million SUVs in 2006, and the actual number was zero." Although General Motors now knows one situation to avoid, that fact pattern offers limited guidance for the lower courts. Second, the court provided no legal basis for its announced pleading standard (other than the citation to Tellabs II) and did not address the growing circuit split on this issue.

Disclosure: The author of The 10b-5 Daily submitted an amicus brief in the Dynex Capital case on behalf of the Washington Legal Foundation.

Posted by Lyle Roberts at 8:17 PM | TrackBack

May 20, 2008

Contrary To Common Sense

One of the concerns raised by Congress, as part of the PSLRA, was that the application of traditional joint and several liability in securities cases may be unfair, given the enormous potential damages. To combat this problem, the PSLRA replaced joint and several liability with a proportionate liability scheme for defendants who are not found to have knowingly violated the securities laws. An unanswered question, however, is whether this proportionate liability scheme also applies to defendants who are found to have controlling person liability. Section 20(a) of the '34 Act, which creates controlling person liability, specifically states that the controlling person shall be liable "jointly and severally with and to the same extent" as the primary violator.

In Laperriere v. Vesta Ins. Group, Inc., 2008 WL 1883482 (11th Cir. April 30, 2008), the Eleventh Circuit has held that the proportionate liability provisions of the PSLRA also apply to controlling persons. In the comprehensive decision, which discusses the relevant statutory provisions at length, the court found that both the plain language and legislative history suggest that Congress intended to include controlling persons.

Quote of Note: "We ought to avoid any interpretation of the statute that would treat controlling persons more harshly than the primary violator - that would put derivatively liable controlling persons on the hook for all damages, but let primary violators off the hook for any damages that their actions did not cause. That result would be contrary to common sense, to what the committee that drafted the PSLRA said it intended to do, and to what Congress actually did in the plain language of the PSLRA."

Posted by Lyle Roberts at 5:11 PM | TrackBack

April 18, 2008

Need The Details

The U.S. Court of Appeals for the First Circuit has previously held that the Tellabs decision lowered the pleading standard for scienter in its court. While that determination did not lead to a reversal of the dismissal in the ACA Financial case, the same cannot be said of a new First Circuit decision issued this week.

In Mississippi Public Employees' Retirement System v. Boston Scientific Corp., 2008 WL 1735390 (1st Cir. April 16, 2008), the court specifically noted that its application of Tellabs lead it to conclude that the district court, which "did not have the benefit" of the Supreme Court's opinion, had erroneously dismissed the complaint based on a failure to adequately plead scienter. The court based its holding on allegations suggesting that Boston Scientific may have known of the relevant manufacturing problem during the class period, the closeness in time between alleged misstatements by the company and an announced product recall, and stock sales by the individual defendants.

On the issue of insider trading, the court addressed the defendants' argument that many of the alleged insider stock sales were effectuated pursuant to Rule 10b5-1 trading plans and therefore could not have supplied a motive to engage in fraud. The court concluded, however, that there was insufficient evidence about the nature of the plans to credit this argument. (The author of The 10b-5 Daily has co-written an article on the potential use of Rule 10b5-1 trading plans in defending against securities class actions, including the importance of public disclosure of the nature of the plans. In addition, a discussion of other relevant cases can be found here.)

Quote of note: "It was the defendants' choice to move to dismiss the case on the pleadings without presenting evidence. As a result, there is no evidence of when the [Rule 10b5-1] trading plans went into effect, that such trading plans removed entirely from defendants' discretion the question of when sales would occur, or that they were unable to amend these trading plans."

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April 7, 2008

Stoneridge Applied

The Seventh Circuit is determined to be the market leader in interpreting U.S. Supreme Court securities litigation opinions. Following up on its application of Tellabs, last week it issued the first appellate decision utilizing the Stoneridge decision.

In Pugh v. Tribune Co., 2008 WL 867739 (7th Cir. April 2, 2008), the court considered the issue of "scheme liability" in the context of a corporate insider's activities (as opposed to the actions of a third party). One of the individual defendants was a Tribune vice-president, as well as the director of circulation for a subsidiary. In his capacity as an officer of the subsidiary, the individual defendant allegedly signed false circulation audits that inflated the paid circulation figures for two publications. The plaintiffs argued that it was "'forseeable' that this scheme [to defraud the advertisers] would result in improper revenue which, in turn, would be reflected in Tribune's published financial statements."

The Seventh Circuit found that these allegations were insufficient. As in Stoneridge, the individual defendant "participated in a fraudulent scheme but had no role in preparing or disseminating Tribune's financial statements or press releases." Moreover, there was no allegation that Tribune investors had been informed of the false circulation audits. Accordingly, the plaintiffs failed to establish "the requisite proximate relation" between the advertiser fraud and the harm to Tribune's investors.

Interestingly, the Seventh Circuit also addressed the issue of whether the scienter of this individual defendant could be imputed to Tribune on a respondeat superior theory. The court concluded that it could not because: (a) the individual defendant had no primary liability; (b) the misconduct of an employee of a subsidiary is not normally attributable to the corporate parent; and (c) the advertiser fraud was not undertaken to benefit Tribune. (For a discussion of the lower court's decision on corporate scienter, see this post.)

Holding: Dismissal affirmed.

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February 22, 2008

In Case Of A Tie

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.

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February 7, 2008

The Trouble With Tellabs

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."

Posted by Lyle Roberts at 11:00 PM | TrackBack

January 25, 2008

January 22, 2008

Enron Denied

The first impact of the Stoneridge decision has been felt. The U.S. Supreme Court issued an order today denying review of California Regents v. Merrill Lynch, the Enron-related case from the Fifth Circuit that raised similar scheme liability issues.

The Court also vacated and remanded a Ninth Circuit case on scheme liability, Avis Budget Group, Inc. v. Ca. State Teachers' Retirement, for further consideration in light of Stoneridge (see here for a summary of the Ninth Circuit opinion). Bloomberg and SCOTUSBlog have reports on the decisions.

Quote of note (Bloomberg): "The court's rejection of the Enron investor appeal came without any published dissent. The rebuff 'further confirms that there is no financial services exception' to the Stoneridge ruling, said [counsel for] the suppliers in last week's case."

Posted by Lyle Roberts at 2:30 PM | TrackBack

January 15, 2008

Stoneridge Decided

In the Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. (a.k.a. Charter Communications) case, the U.S. Supreme Court has held that the implied private right of action under Sec. 10(b) for securities fraud does not extend to third parties who neither make alleged misstatements nor engage in deceptive conduct on which investors relied. The 5-3 decision (Justice Breyer did not participate) authored by Justice Kennedy resolves a circuit split over the scope of "scheme liability."

In Stoneridge, the plaintiffs alleged that Charter and two of its suppliers and customers, Scientific-Atlanta and Motorola, knowingly engaged in a business scheme that allowed Charter to artificially inflate its reported revenues and operating cash flow. The plaintiffs sought to hold Scientific-Atlanta and Motorola primarily liable for the misstatements contained in Charter's financial statements. The district court, with an affirmance from the U.S. Court of Appeals for the Eighth Circuit, dismissed these claims. On the issue of scheme liability, the Eighth Circuit found that Scientific-Atlanta and Motorola had not participated in the making of the misstatements and "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."

On appeal, the Supreme Court took a notably different approach. The Court rejected the Eighth Circuit's decision to the extent that it could be "read to suggest there must be a specific oral or written statement before there could be liability under Sec. 10(b) or Rule 10b-5." The Court found that "[c]onduct itself can be deceptive" and provide the basis for liability. Instead, the Court focused on whether the Charter investors could be said to have relied upon the deceptive acts of Scientific-Atlanta and Motorola in purchasing their securities.

The Court concluded that there was no basis for finding that the investors could be presumed to have relied upon the relevant deceptive acts. First, Scientific-Atlanta and Motorola had no duty to disclose their conduct to Charter's investors. Second, the fraud-on-the-market doctrine was inapplicable because the conduct was "not communicated to the public." Accordingly, the Court held that the investors could not "show reliance upon any of respondents' actions except in an indirect chain that we find too remote for liability."

The rest of the opinion is devoted to various legal and policy defenses of this limitation on the scope of scheme liability. The Court noted that Charter's investors were seeking to apply Section 10(b) "beyond the securities markets - the realm of financing business - to purchase and supply contracts - the realm of ordinary business operations." To do so would "invite litigation beyond the immediate sphere of securities litigation and in areas already governed by functioning and effective state-law guarantees." Moreover, adopting the position advocated by Charter's investors would "revive in substance the implied cause of action against all aiders and abettors except those who committed no deceptive act in the process of facilitating the fraud" and would undermine Congress' determination in the PSLRA that this "class of defendants should be pursued by the SEC and not by private litigants." Finally, the Court expressed concern that "scheme liability" would "raise the cost of being a publicly traded company" and "shift securities offerings away from domestic capital markets."

Holding: Affirmed.

Notes on the Decision

(1) The Court adhered closely to the argument made by the Department of Justice in its amicus brief. Although some commentators predicted that outcome, the Court's focus on reliance is interesting given that Chief Justice Roberts (who joined the majority opinion) expressed skepticism at oral argument over whether the issue was properly before the Court. The dissent (Stevens, J.) agreed that the issue was not ripe and suggested that "the fairest course to petitioner would be for the majority to remand to the Court of Appeals to determine whether petitioner properly alleged reliance, under a correct view of what Section 10(b) covers."

(2) While the media is likely to trumpet the decision as a victory for corporate defendants, it is important to note that the victory was not as sweeping as it could have been. Contrary to the holdings of both the Eighth Circuit and the Fifth Circuit (see here), the Court held that deceptive conduct, even without the existence of an oral or written misstatement, can provide the basis for securities fraud liability if the plaintiffs can establish that they relied on that conduct. Indeed, many courts have defined the distinction between "aider and abettor" and "primary violator" by reference to the level of participation of the individual defendant in making the misstatement at issue and whether the public became aware of the defendant's alleged involvement. Does Stoneridge open the door to a broader view of "participation"?

(3) The Court's references to the possible deterrence of overseas firms from doing business in this country and the shifting of "securities offerings away from domestic capital markets" are going to draw criticism as being excessively policy oriented (see here for an early example).

(4) In support of its holding that the investors could not establish reliance, the Court repeatedly cited the investors' lack of knowledge about the "deceptive acts" in which Scientific-Atlanta and Motorola were alleged to have engaged. Presumably the Court was referring to the failure of the investors to allege that they were aware of the transactions between the companies and Charter, not to a lack of knowledge that the transactions were deceptive. Nevertheless, it struck a discordant note when the Court stated, for example, that the defendants' "deceptive acts were not communicated to the public." If the deceptive acts had been communicated to the public, of course, the defendants would have had a completely different lack of reliance defense.

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October 26, 2007

Two From Chicago

This month has seen two noteworthy decisions from the U.S. Court of Appeals for the Seventh Circuit.

(1) In Sutton v. Bernard, 2007 WL 2963940 (7th Cir. Oct. 12, 2007), the court addressed an appeal by the lead counsel in a securities class action brought against Marchfirst, Inc. Following the settlement of the case, the district court rejected the lead counsel's fees request, reducing it from 28% of the gross settlement amount to 15% or $2,605,000. On appeal, the court held that the district court had improperly failed to take into account "the market price for legal services" in making its determination, instead focusing only on the results achieved in the case.

Quote of note: "The trouble we have with the district court's methodology is that the fee determination began and ended with the amount actually recovered for the class; the court did not consult the market for legal services for guidance in what constituted, as an abstract matter, a 'reasonable percentage.'"

(2) In Asher v. Baxter Int'l Inc., 2007 WL 3010617 (7th Cir. Oct. 17, 2007), the court considered another appeal in a case that had previously generated a well-known decision on the PSLRA's safe harbor for forward-looking statements. This time the court addressed whether, pursuant to Fed. R. Civ. P. 23(f), a plaintiff is entitled to appeal subsequent denials of class certification if it does not appeal the first denial within the 10-day statutory period. The court found that the "time limit would not be worth anything if it restarted with each new motion" and declined to allow the appeal. The opinion also contains interesting dicta on the representative plaintiff selection process in the case.

Quote of note: "The district court deemed both the Alaska and the Fayetteville funds inadequate because their investments are much smaller than those of other mutual or pension funds. One can't help thinking that the unwillingness of any substantial shareholder to step forward as a representative suggests that the suit may not be in investors' interest. To the district judge, the fact that two modestly sized pools with modest stakes in Baxter had been recruited by the lawyers already trying to represent a plaintiff class implied that they would be subservient to counsel."

Posted by Lyle Roberts at 5:23 PM | TrackBack

October 17, 2007

Stoneridge Predictions

Despite all of the fanfare leading up to the oral argument in the Stoneridge (a.k.a. Charter Communications) case on scheme liability, the aftermath has been quite subdued. That may be because the post-argument consensus (at least in the blogosphere) is that the plaintiff investors have no chance of obtaining a reversal. On exactly what basis the court will decide against them, however, is still the subject of debate. Summaries and predictions can be found at BusinessAssociationsBlog, Legal Pad, Securities Law Prof Blog, Business Law Prof Blog, Ideoblog, and The Race to the Bottom.

Posted by Lyle Roberts at 7:04 PM | TrackBack

October 9, 2007

Stoneridge Transcript

The Supreme Court has released the transcript of today's oral argument in the Stoneridge case. A few highlights from the justices:

(1) Justice Scalia noted that private actions pursuant to Rule 10b-5 are a judicial creation. He then wondered why they could not also be judicially limited.

"If it's our creation, couldn't we sensibly limit it so that, for example, schemes can be attacked by the SEC, but schemes do not form the basis for private attorney generals' actions? You need actual conveyance of a misrepresentation to the injured party." (p. 5)

(2) Chief Justice Roberts, on the other hand, appeared inclined to defer to Congress given its active legislating in the area of securities litigation.

"My suggestion is that we should get out of the business of expanding [Rule 10b-5 liability], because Congress has taken over and is legislating in the area in the way they weren't back when we implied the right of action under 10(b)." (p. 7)

(3) Justice Kennedy expressed concern over the potentially broad scope of liability under a scheme theory (while painting an unflattering portrait of the corporate world).

"[T]here are any number of kickbacks and mismanagements and petty frauds that go on in business, and business people know that any publicly held company's shares are going to be affected by its profits, so I see no limitation to your - to your proposal []." (p. 18)

(4) Justice Ginsburg wondered whether scheme liability occupied a middle ground between aiding and abetting, which is a claim that can only be brought by the SEC, and a primary violation by the company.

"That's if they are aiders and abettors, which is what Congress covered. And I again go back to, is there another category or is everyone - either Charter, the person whose stock is at stake, the company whose stock is at stake and everyone else is an aider?" (p. 35)

(5) Justice Souter alluded to the public controversy over the Solicitor General's amicus brief by asking the government "whether the SEC has publicly taken a position" on the question of whether there was a violation of Rule 10b-5. Counsel for the government outlined the course of events, but noted that there has not been "any official SEC Commission statement." (pp. 49-50)

(6) Chief Justice Roberts and Justice Ginsburg expressed skepticism over whether the issue of reliance, which the government focused on, was addressed by the appellate court. Counsel for the government replied that "it's not as complete a discussion of the reliance issue as we would have thought appropriate if we had been writing the opinion, but it certainly does touch on the question and we think it's wholly presented." (pp. 56-7)

Posted by Lyle Roberts at 10:35 PM | TrackBack

Stoneridge Argument

Early reports from today's Supreme Court oral argument in the Stoneridge case suggest that the court is unlikely to side with the plaintiff investors and adopt a broad definition of "scheme liability." First-hand accounts can be found at SCOTUSBlog and the WSJ Law Blog. (Also worth reading is today's coverage of the case in the Wall Street Journal, including an op-ed by SEC Commissioner Paul Atkins.)

Quote of note (SCOTUSBlog): "'Congress has kind of taken over for us . . . They picked up the ball and are running with it . . . My suggestion is that we should get out of the business of expanding [the key securities fraud section]; Congress has taken over,' the Chief Justice told New York attorney Stanley M. Grossman."

Posted by Lyle Roberts at 1:30 PM | TrackBack

September 21, 2007

He's Back

As predicted by some observers, Chief Justice Roberts is rejoining the Stoneridge (a.k.a. Charter Communications) case after initially recusing himself. The speculation is that he has sold the securities that caused the conflict of interest. Justice Breyer remains recused, however, setting up the possibility of a split decision. Coverage can be found in SCOTUSBlog, the Blog of Legal Times, and the WSJ Law Blog.

Quote of note (SCOTUSBlog): "If the Court were to divide evenly, 4-4, on Stoneridge, the result would simply be to affirm the Eighth Circuit decision without an opinion. The Court might then seek another test case in which to address the underlying legal question. A major Enron case, California Regents v. Merrill Lynch, et al. (docket 06-1341), raises the same issue; that case apparently is being held to await the outcome of the Stoneridge case."

Posted by Lyle Roberts at 5:42 PM | TrackBack

August 24, 2007

In Toto

Two recent appellate decisions of interest:

(1) In Central Laborers' Pension Fund v. Integrated Electrical Services, Inc., 2007 WL 2367776 (5th Cir. August 21, 2007), the court addressed the pleading of scienter under the Supreme Court's recent Tellabs decision. Notably, the court found that (a) the confidential witness allegations lacked sufficient detail supporting their reliability (although the court stopped short of suggesting that the plaintiffs should provide the names of the witnesses), (b) the argument that the stock trading of one of the defendants was non-suspicious because he traded pursuant to a Rule 10b5-1 plan was "flawed" because the plan was put into effect during the class period, and (c) an inference of scienter cannot be drawn from a Sarbanes-Oxley certification unless the person signing the certification had reason to know or should have suspected that the financial statements contained misrepresentations. The court concluded that the "allegations read in toto do not permit a strong inference of scienter."

(2) In Employers-Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Anchor Capital Advisors, 2007 WL 2325079 (9th Cir. August 16, 2007), the court considered whether a lead plaintiff decision can be appealed following the dismissal of the underlying case. A group of public pension funds had unsuccessfully moved to serve as lead plaintiff. The lower court subsequently granted the defendants' motion to dismiss the case. The appointed lead plaintiff declined to file an amended complaint and instead requested that the individual uncertified actions be dismissed with prejudice. The pension funds moved to appeal the earlier lead plaintiff decision, but the appellate court held that because the pension funds never filed their own complaint or intervened in the pending action, they were merely "potential class members in a potential class action suit" and had no standing to bring an appeal.

Posted by Lyle Roberts at 3:52 PM | TrackBack

August 22, 2007

Resolving Conflicts And Making Friends

Two more items regarding the Stoneridge (a.k.a. Charter Communications) case on scheme liability:

(1) Although Chief Justice Roberts and Justice Breyer initially recused themselves from the case because of personal stockholdings, the New York Law Journal reports that they may be back in time for the argument (scheduled for October 9, 2007). Under a new federal law, the justices could sell their stockholdings and, because the sale was done to resolve a conflict of interest, defer any capital gains tax. The article speculates that Chief Justice Roberts may have rejoined a case earlier this year, the day before oral argument, by resolving a conflict through a stock sale.

Quote of note: "'The justices who recused are - I don't want to use the term - business-friendly,' said Stephen Bainbridge, who participated in a brief that opposed the investors' broad liability theory. But Mr. Bainbridge, a professor at UCLA School of Law, said the Court can be especially unpredictable in securities cases, because the justices and their law clerks are 'institutionally incompetent' to resolve complex securities cases. 'I would never count the chickens before they hatch,' he said."

(2) The WSJ Law Blog has a post on the large number of amicus briefs that have been filed in the case.

Quote of note: "At final count, about 30 'friend of the court' briefs (aka amicus briefs) were filed with the court in Stoneridge, which asks whether shareholders can sue to hold third parties e.g., investment banks, accountants and law firms liable for a companys fraud. Its a 'startling' number of friend-of-the-court briefs for a securities-law case, says Tom Goldstein, a Supreme Court practitioner at Akin Gump, not involved in the case."

Posted by Lyle Roberts at 5:54 PM | TrackBack

August 15, 2007

The SG Speaks

The long wait is over and everyone will be at least slightly disappointed. After significant public and private debate, the Solicitor General has submitted an amicus brief in support of the corporate defendants in the Stoneridge (a.k.a. Charter Communications) case on scheme liability.

The government's legal argument appears to be something of a compromise position. The brief states that the Eighth Circuit erred to the extent it held that "non-verbal deceptive conduct is somehow beyond the reach of Section 10(b)." Instead, the plain language of the statute makes it clear that it reaches "all conduct that is 'manipulative' or 'deceptive,'" in whatever form.

Nevertheless, the government argues that the Eighth Circuit correctly upheld the dismissal of the complaint based on the plaintiffs' failure to adequately plead reliance and loss causation. The plaintiffs allege "only that the backdating of the contracts assisted Charter in mischaracterizing the payments from [its business partners] as revenue (and thus inflating its operating cash flow in its financial statements)." The "critical point" is that it was Charter's misrepresentation of its cash flow, not the allegedly deceptive conduct of its business partners, on which the plaintiffs relied in purchasing their shares. The presumption of reliance created by the fraud-on-the-market theory also is unavailable to the plaintiffs, the government argues, because it applies only to public misrepresentations and the complaint "does not identify any public statements or actions" by the business partners. Finally, the brief states that for "many of the same reasons" the complaint fails to adequately allege that the conduct of the business partners caused the plaintiffs' losses.

A few additional notes: (1) SCOTUSblog has a summary of the filing and additional coverage can be found on the WSJ Law Blog and the Blog of the Legal Times; (2) many (if not all) of the briefs in the case, including the briefs of the corporate defendants filed today, are available on the DU Sturm College of Law Corporate Governance site; and (3) the Stoneridge docket reveals that oral argument in the case has been scheduled for October 9, 2007.

Quote of note (SG's brief - citations omitted): "More fundamentally, Congresss unwillingness to recognize a private right of action for aiding and abetting suggests that this Court should be loath to create the functional equivalent of such a right of action itself. Such an action would upset the deliberate balance struck by Congress. Insofar as petitioner and its amici advance various policy arguments in favor of broad liability for secondary actors, there are ample policy arguments to the contrary (some of which apparently struck a chord when Congress last expressly addressed the issue). In any event, all of those policy arguments 'are more appropriately addressed to Congress than to this Court.'"

Posted by Lyle Roberts at 10:19 PM | TrackBack

August 10, 2007

Legal Wisdom

The Wall Street Journal has an editorial (subscrip. req'd) on the amicus brief filed by Congressmen Frank and Conyers in the Stoneridge case. The newspaper is critical of the congressmen's decision to have a law firm that does lobbying work for plaintiffs lawyers write the brief.

Quote of note: "We trust the Supreme Court Justices, who are due to hear Stoneridge arguments as early as October, will notice the provenance of Mr. Frank's legal wisdom."

Posted by Lyle Roberts at 11:57 PM | TrackBack

August 1, 2007

Tellabs Applied

The first circuit court opinion to extensively apply the Tellabs decision has arrived and it contains a number of interesting holdings. Given that the opinion comes from the U.S. Court of Appeals for the Seventh Circuit and is authored by Judge Easterbrook, that will come as no surprise to any regular reader of this blog.

In Higginbotham v. Baxter Intern., Inc., 2007 WL 2142298 (7th Cir. July 27, 2007), the court addressed the impact of Tellabs on the use of confidential witnesses. Noting that the Supreme Court has required plaintiffs to plead an inference of scienter that is both cogent and at least as compelling as any opposing inference that can be drawn from the alleged facts, the court found that "anonymity frustrates that process." In particular, the failure to name sources "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."

The court went on to find that the plaintiffs had failed to plead a strong inference of scienter. In addition to discounting the statements of confidential witnesses, the court also poked holes in a number of other alleged inferences of scienter put forward by the plaintiffs. Notably, the court found that allegations of a publicly-announced antitrust investigation, stock sales by two company managers, and the company's failure to disclose a fraud at its Brazilian subsidiary as soon as management was informed of its possible existence were insufficient to meet the plaintiffs' pleading burden.

Holding: Dismissal affirmed.

Quote of note: "It is hard to see how information from anonymous sources could be deemed 'compelling' or how we could take account of plausible opposing inferences. Perhaps these confidential sources have axes to grind. Perhaps they are lying. Perhaps they don't even exist."

Quote of note II: "Prudent managers conduct inquiries rather than jump the gun with half-formed stories as soon as a problem comes to their attention. Baxter might more plausibly have been accused of deceiving investors had managers called a press conference before completing the steps necessary to determine just what had happened in Brazil. Taking the time necessary to get things right is both proper and lawful. Managers cannot tell lies but are entitled to investigate for a reasonable time, until they have a full story to reveal."

Posted by Lyle Roberts at 10:13 PM | TrackBack

July 31, 2007

More Late Arrivals

The Solicitor General's decision not to support the investor plaintiffs in the Stoneridge (a.k.a. Charter Communications) case has spurred another attempt at a post-deadline amicus brief filing, this time from a pair of prominent congressmen. The Washington Post reports that House Financial Services Committee Chairman Barney Frank (D-Mass.) and House Judiciary Committee Chairman John Conyers Jr. (D-Mich.) have sought permission to file an amicus brief in the case. The effort follows on the heels of a similar request from a group of former high-ranking SEC officials. The congressmen's proposed amicus brief can be found here.

Quote of note (proposed amicus brief): "The interpretation of Section 10(b) and Rule 10b-5 adopted by the Court of Appeals and urged by Respondents ultimately rests on policy considerations at odds with the statutory text that should more appropriately be addressed to Congress than to this Court."

Posted by Lyle Roberts at 7:33 PM | TrackBack

July 17, 2007

Late Arrivals

The Washington Post has an article on an unusual effort by three former high-ranking SEC officials to file a post-deadline amicus brief in the Stoneridge (a.k.a. Charter Communications) case. The request evidently is being made in response to the Solicitor General's decision not to file a brief in support of the investor plaintiffs. Professor Arthur Miller, who recently argued the Tellabs case before the U.S. Supreme Court, is representing the officials.

Posted by Lyle Roberts at 6:51 PM | TrackBack

June 29, 2007

The SEC's Story

Chairman Christopher Cox of the SEC testified before the House Financial Services Committee this week. CFO.com has an article on a mostly unnoticed part of his testimony where Chairman Cox discussed his participation in the SEC's decision to ask the Solicitor General to support the investor plaintiffs in the Stoneridge (a.k.a. Charter Communications) case. The Solicitor General ultimately decided not to file the requested amicus brief.

Quote of note: "Cox's vote was part of the majority in a 3-2 SEC vote in the so-called StoneRidge case. 'It is my view that precedent matters,' he said during a House Financial Services Committee hearing at which all five commissioners attended. 'The SEC rules and policies should not be so effervescent as to change with one or two people on board.' . . . In 2004 a year before Cox joined the commission the SEC weighed in favor of a broad definition of liability for companies indirectly involved in violations of the securities laws."

Addition: In a related story, the WSJ Law Blog had an interesting post this week on the campaign by the American Association of Justice (i.e., the main trial lawyer association) to influence public opinion regarding the government's position in the case.

Posted by Lyle Roberts at 6:22 PM | TrackBack

June 21, 2007

Tellabs Decided

In the Tellabs v. Makor Issues & Rights case, the U.S. Supreme Court has held that in determining whether the pleaded facts give rise to a "strong inference" of scienter, a court must take into account "plausible opposing inferences." The 8-1 decision authored by Justice Ginsburg addresses the application of the PSLRA's heightened scienter pleading standard.

To survive a motion to dismiss, a securities fraud complaint must contain factual allegations giving rise to a "strong inference" that the defendant acted with scienter (i.e., fraudulent intent). In creating this pleading standard as part of the PLSRA, however, Congress did not define the term "strong inference" and courts subsequently construed it differently. Among the outstanding issues was how courts should address competing inferences in determining whether the standard is met.

In Tellabs, the Court described its task as prescribing "a workable construction of the 'strong inference' standard, a reading geared to the PSLRA's twin goals: to curb frivolous, lawyer-driven litigation, while preserving investors' ability to recover on meritorious claims." To that end, the Court established a three-step evaluation process for lower courts.

First, when faced with a motion to dismiss a securities fraud claim, "courts must, as with any motion to dismiss for failure to plead a claim on which relief may be granted, accept all factual allegations in the complaint as true."

Second, courts should consider complaints in their entirety, as well as other sources of information it is appropriate for courts to consider on a motion to dismiss. The proper inquiry is "whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard."

Finally, courts must take into account "plausible opposing inferences." 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."

Although the Court evaluated the factual allegations in the Tellabs complaint, it did not reach any conclusions. Instead, the Court merely emphasized that courts must "assess all the allegations holistically." To that end, it found that the mere absence of insider trading allegations or the existence of "omissions or ambiguities" in the allegations of improper channel-stuffing may "count against inferring scienter," but they were not, by themselves, dispositive as to whether the plaintiffs had met the "strong inference" standard. The Court also addressed an issue that attracted a great deal of attention at oral argument: whether the heightened pleading standard for scienter improperly required a court to act as a fact-finder on the merits of the suit in violation of the Seventh Amendment right to jury trial. The Court held that Congress has the power to establish pleading standards for a federal statutory claim and this power did not implicate the Seventh Amendment.

Holding: Judgment vacated and case remanded for further proceedings

Notes on the Decision

(1) Justices Scalia and Alito wrote concurrences. Justice Scalia argued that "the test should be whether the inference of scienter (if any) is more plausible than the inference of innocence." Although he noted that this test is unlikely "to produce results much different from the Court's," Justice Scalia found that it is more in keeping with the "normal meaning" of "strong inference." Justice Alito agreed with the "more plausible" test put forward by his colleague and also argued that a court should not consider "nonparticularized" allegations in evaluating scienter.

(2) Justice Stevens filed a dissent and argued that Congress had "implicitly delegated significant lawmaking authority to the Judiciary in determining how [the scienter] standard should operate in practice." He suggested that applying a "probable cause" standard "would be both easier to apply and more consistent with the statute." Under that standard, Justice Stevens believed it "clear" that the plaintiffs had sufficiently plead scienter.

(3) Although attention is likely to be focused on the Court's "competing inferences" holding, it is worth noting that the Court's "holistic" approach to evaluating scienter also addresses a circuit split. The decision would appear to alter the evaluation of scienter in the Second Circuit and Third Circuit, both of which have held that a court can examine allegations of motive or knowledge/recklessness separately to find that the "strong inference" standard has been met.

(4) The majority opinion contains some ambiguities itself. In two consecutive sentences, for example, it states: (a) the inference of scienter "must be cogent and compelling, thus strong in light of other explanations;" and (b) the inference of scienter must be "cogent and at least as compelling as any opposing inference one could draw from the facts alleged." The second statement (which also appears in the introduction to the opinion) appears to allow for a "tie" to go to the plaintiff. As noted by Justice Scalia in his dissent, this result arguably is not in keeping with Congress' desire to heighten the pleading standard.

Posted by Lyle Roberts at 10:45 PM | TrackBack

June 11, 2007

Looking Unlikely

The Stoneridge (a.k.a. Charter Communications) case on scheme liability pending before the U.S. Supreme Court may or may not be "the biggest securities litigation case in a generation," but it has certainly generated more pre-argument media coverage than Dura and Tellabs put together. Much of that coverage has focused on whether the SEC/DOJ would submit a brief today in support of the plaintiff investors (see here, here, and here). The Wall Street Journal had an editorial on the topic this past weekend.

Although the SEC apparently recommended that the Solicitor General file the brief - see this Bloomberg article for the details - it does not appear that the recommendation was accepted. Reuters reported earlier today that it was "unlikely" the filing would be made and, as of the time of this post, there is no indication that it has happened. If not, the government has the option of filing a brief in support of the defendants (due in 30 days) or simply remaining silent.

Whatever the government's position, however, the show goes on for the parties. The plaintiff investors filed their brief today and it can be found here.

Quote of note (plaintiffs' brief): "Legitimate business will be unaffected if the Court adopts a test giving effect to the plain text of Section 10(b) and Rule 10b-5, but going no further. One proposed test would be that: a person engages in a deceptive act as part of a scheme to defraud investors, and violates Section 10(b) and Rule 10b-5(a) and/or (c), if the purpose and effect of his conduct is to create a false appearance of material fact in furtherance of that scheme."

Addition: As predicted, the government did not file an amicus brief in support of the investor plaintiffs. Press coverage can be found in Bloomberg and the Washington Post.

Posted by Lyle Roberts at 6:38 PM | TrackBack

May 23, 2007

Charter Chatter

Some interesting tidbits from around the web on the Stoneridge (a.k.a. Charter Communications) case on scheme liability set to be heard by the U.S. Supreme Court next term.

Whether, and on which side, the SEC will participate in the case has been a hot issue. SCOTUSblog reports that there are two dates to keep in mind: (1) amicus briefs urging the Supreme Court to hear a similar Enron-related case on scheme liability (maybe in tandem or consolidated with Stoneridge) are due on June 1; and (2) amicus briefs in support of the investor plaintiffs in Stoneridge are due on June 11.

Meanwhile, Point of Law speculates that Justice Alito may be the swing vote in the Stoneridge case. Justices Breyer and Roberts are recused because of stockholdings, leaving seven justices to consider the case.

Posted by Lyle Roberts at 9:05 PM | TrackBack

March 30, 2007

Tellabs Roundup

There has been a fair amount of media and blog coverage of the oral argument in the Tellabs case. Here is a partial roundup:

Media - Articles can be found in the Washington Post, the Associated Press (here and here), and Bloomberg News.

Blogs - Commentary, with some predictions on the outcome of the case, can be found on the Wall Street Journal Law Blog, the Sixth Circuit Blog, and LawMemo.

Click here for the transcript.

Posted by Lyle Roberts at 7:05 PM | TrackBack

March 28, 2007

Notes From The Tellabs Argument

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.

Posted by Lyle Roberts at 4:08 PM | TrackBack

March 27, 2007

When SCOTUS Attacks

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 Courts 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 corporations 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.

Posted by Lyle Roberts at 6:24 PM | TrackBack

March 20, 2007

What Is A Deceptive Act?

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."

Posted by Lyle Roberts at 8:41 PM | TrackBack

March 15, 2007

Tellabs Briefs

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)

National Conference on Public Employee Retirement Systems and National Association of Shareholder and Consumer Attorneys (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).

Posted by Lyle Roberts at 8:09 PM | TrackBack

February 23, 2007

Let's Play Two

The U.S. Court of Appeals for the Fourth Circuit has issued a decision that addresses two pressing securities litigation issues. In Teachers' Retirement System of Louisiana v. Hunter, 2007 WL 509787 (4th Cir. Feb. 20, 2007), the court considered: (a) whether the plaintiffs could establish the scienter of the corporate defendant using a collective scienter theory; and (b) what is the proper pleading standard for loss causation. (For a discussion of the lower court decision, see this post.)

Collective scienter - The court rejected the idea that a corporate defendant's scienter can be established based on the collective knowledge of its employees. Specifically, the court held that "if the defendant is a corporation, the plaintiff must allege facts that support a strong inference of scienter with respect to at least one authorized agent of the corporation, since corporate liability derives from the actions of its agents." Although the court did not expressly determine whether the agent also must be alleged to have made a misstatement, the court's citation to the Southland decision (5th Cir.) offers some support for that interpretation.

Loss causation - The court noted that in Dura the U.S. Supreme Court expressly did not decide whether the pleading of loss causation is governed by Fed. R. Civ. P. 9(b). In examining the issue, the court found that a "strong case can be made that because loss causation is among the 'circumstances constituting fraud' for which Rule 9(b) demands particularity, loss causation should be pleaded with particularity." Based on this observation and the public policy concerns outlined in Dura, the court concluded that loss causation must be plead "with sufficient specificity to enable the court to evaluate whether the necessary causal link exists." In the instant case, the court found that the plaintiffs did not adequately plead loss causation. Although the disclosure that caused the stock price decline accused the corporate defendant of fraud, it did not provide any "new facts" that "revealed [the corporate defendant's] previous representations to have been fraudulent."

Holding: Dismissal affirmed (based on the failure to adequately plead falsity, scienter, and loss causation).

Disclosure: The author of The 10b-5 Daily represented the defendants in this litigation.

Posted by Lyle Roberts at 8:45 PM | TrackBack

February 16, 2007

Audited vs. Unaudited

A recent decision by the U.S. Court of Appeals for the Second Circuit offers some interesting clarifications on the scope of accountant liability for securities fraud. In Lattanzio v. Deloitte & Touche LLP, 2007 WL 259877 (2d Cir. Jan. 31, 2007), the court addressed whether Deloitte could be held liable for statements in audited and unaudited financial filings.

As to the company's unaudited financial filings, the court found that Deloitte's regulatory obligation to review the company's quarterly statements did not turn those statements into accountant's statements. Even if the public understood that Deloitte was engaging in these reviews, the accountant's "assurances were never communicated to the public." The court also rejected plaintiffs' argument that the reviews created a duty to correct the quarterly financial statements if false and that a breach of this duty amounted to a misstatement by Deloitte. The court noted that there is a distinct difference between the duties and liabilities created by a review of interim financial statements and those created by an audit of annual financials.

As to the company's audited financial filings, the court dismissed the relevant claims based on a failure to adequately plead loss causation. The court held that the "plaintiffs had to allege that Deloitte's misstatements [in the company's annual reports concerning accounts payable and inventories] concealed the risk of [the company's] bankruptcy." Given that Deloitte had issued a going concern warning - along with the disclosed (if understated) collapse in the company's value - the risk of bankruptcy was apparent. Accordingly, the court found that the plaintiffs had not alleged facts showing that Deloitte's misstatements were the "proximate cause of plaintiffs' loss; nor have they alleged facts that would allow a factfinder to ascribe some rough proportion of the whole loss to Deloitte's misstatements."

Holding: Dismissal affirmed.

Quote of note: "Public understanding that an accountant is at work behind the scenes does not create an exception to the requirement that an actionable misstatement be made by the accountant. Unless the public's understanding is based on the accountant's articulated statement, the source for that understanding - whether it be a regulation, an accounting practice, or something else - does not matter."

Addition: Retired Supreme Court Justice Sandra Day O'Connor sat on the panel.

Posted by Lyle Roberts at 9:18 PM | TrackBack

February 13, 2007

Scienter And The SEC

The U.S. Supreme Court's decision to hear a case on the pleading standards for scienter (i.e., fraudulent intent) has received little media attention . . . until today. The New York Times has an article on the SEC's recent activities related to private securities litigation, including the agency's decision to file an amicus brief in the Tellabs case in support of the defendants.

In their brief, the SEC/DOJ rejected the "reasonable person" test applied by the U.S. Court of Appeals for the Seventh Circuit in evaluating whether the "strong inference" of scienter pleading standard was met (see this post under "Competing Inferences"). Instead, "a court should determine whether, taking the alleged facts as true, there is a high likelihood that the conclusion that the defendant possessed scienter follows from those facts." If the same facts both support and negate an inference of scienter, "the court should consider the relative strength of both inferences, because, where there is a substantial possibility that the defendant acted without scienter, the inference of scienter will not be 'strong.'"

Quote of note (New York Times): "Critics said that the moves signaled a major retrenchment from the post-Enron changes and showed that a lobbying push by big companies, Wall Street firms and the accounting industry was gaining traction as they seek to roll back what they see as onerous regulation and excessive investor litigation. But Christopher Cox, the chairman of the commission, said in an interview Monday that both efforts were in the best interests of investors because they aimed at preventing the accounting industry from further consolidation and at limiting what he called 'fraudulent lawsuits,' including some he said were filed by 'professional plaintiffs.'"

Posted by Lyle Roberts at 4:15 PM | TrackBack

January 8, 2007

Supreme Court To Address Scienter

After eleven years, the PSLRA's scienter pleading standard finally will be addressed by the U.S. Supreme Court. On Friday, the court granted certiorari in Tellabs, Inc. v. Makor Issues & Rights, Ltd. on appeal from the U.S. Court of Appeals for the Seventh Circuit. (The 10b-5 Daily's summary of the lower court decision can be found here.)

The question presented on appeal is whether, and to what extent, a court must consider or weigh competing inferences in determining whether a complaint has alleged sufficient facts to establish a strong inference of scienter. The Seventh Circuit held that the plaintiff was entitled to more than the most plausible of competing inferences. Instead, a court should "allow the complaint to survive if it alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent." In their cert petition (via SCOTUSblog), defendants argued that this is the most lenient of the "four meaningfully different interpretations of the strong inference standard" that have been adopted by federal circuit courts and urged the Supreme Court to resolve the circuit split.

Links to the various cert petition briefs can be found on SCOTUSblog, which also notes that the Supreme Court has ordered expedited briefing in the case and may be planning to hear it during the March 2007 session. Thanks to Greg Harris for the tip.

Posted by Lyle Roberts at 11:17 PM | TrackBack

December 10, 2006

The Class Certification Hurdle

In an opinion issued in the IPO allocation cases, the Second Circuit has held that in evaluating a motion for class certification under Federal Rule of Civil Procedure 23, district judges must receive and review enough evidence to be satisfied that each requirement of Rule 23 is met, even if there is some overlap between class certification and the merits of a case. The court cautioned that while district judges must reach a full "determination" (but not a finding) regarding fulfillment of the class certification requirements, they should avoid reviewing any aspects of case merits that are unrelated to those requirements. The decision brings the Second Circuit's jurisprudence on class certification into line with the majority of federal appellate courts (including the Fourth, Fifth, Seventh, Eighth and Eleventh Circuits).

More importantly (at least for securities litigators), the court went on to decide whether class certification could be granted in the representative IPO allocation cases at issue. The Second Circuit held that, under the new, stronger standard, the plaintiffs were unable to satisfy the predominance of common questions over individual questions requirement for a Rule 23(b)(3) class action. Accordingly, the court vacated the district court's order granting class certifications and remanded the case for further proceedings.

Although the court's class certification analysis is short, it contains two interesting holdings.

Reliance: The court held that the "fraud on the market" presumption could not be applied because the market for IPO shares cannot be efficient under any circumstances. Interestingly, the court cited the Sixth Circuit's decision in Freeman v. Laventhol & Horwath, 915 F.2d 193, 199 (6th Cir. 1990) in support of this position, even though Freeman is a case about newly traded municipal bonds, not securities traded on a national exchange. The court went on to find that an efficient market cannot be established, for example, because during the 25-day "quiet period" analysts cannot report publicly concerning securities in an IPO and a significant number of reports by securities analysts is a "characteristic of an efficient market." Finally, the court reiterated its skepticism (also found in an earlier Second Circuit decision related to the WorldCom securities litigation) that the fraud on the market presumption can be applied in cases based on anything other than statements by an issuer or its agents.

Knowledge: For both Rule 10b-5 and Section 11 claims, plaintiffs must show that they traded without knowing that the stock price was affected by the alleged false or misleading statements. The Court held that lack of knowledge could not be established in the IPO allocation cases because many of the investors were fully aware of the alleged fraudulent scheme (due in large part to the unusual facts of the case). Thus, the court held that the plaintiffs were unable to fulfill the predominance requirement because lack of knowledge was not common throughout the class.

Reports on the decision and its potential impact on the proposed settlement by the issuer defendants can be found in the American Lawyer, Wall Street Journal (subscrip. req'd), and WSJ Law Blog. There is also a Bloomberg article on dissension among the plaintiffs' firms handling the litigation.

Posted by Lyle Roberts at 2:55 PM | TrackBack

November 15, 2006

No Cert For You!

In a decision issued earlier this year in the Qwest securities litigation, the U.S. Court of Appeals for the Tenth Circuit declined to adopt the selective waiver doctrine. Specifically, the court found that Qwest could not withhold documents from the plaintiffs on the grounds of attorney-client privilege or the work-product doctrine if those documents were previously produced to the SEC. On Monday, the U.S. Supreme Court denied cert in the case.

The Denver Business Journal has an article on the decision. Most of the defendants have settled (including Qwest), but the case is continuing against two former officers. The 10b-5 Daily has posted frequently about the settlement - for the latest post, click here.

Posted by Lyle Roberts at 5:22 PM | TrackBack

October 17, 2006

Sign On The Dotted Line

The Sarbanes-Oxley Act of 2002 ("SOX") requires the chief executive officer and chief financial officer of a company to certify the accuracy of each periodic report containing financial statements. Plaintiffs often argue that these certifications can support the pleading of scienter (i.e., fraudulent intent) in cases alleging accounting misrepresentations.

In what appears to be the first circuit court opinion to address the issue, the U.S. Court of Appeals for the Eleventh Circuit has held that SOX certifications, by themselves, are not indicative of scienter. In Garfield v. NDC Health Corp., 2006 WL 2883238 (11th Cir. Oct. 12, 2006), the court found that SOX "does not indicate any intent to change the requirements for pleading scienter set forth in the PSLRA [Private Securities Litigation Reform Act of 1995]." Accordingly, a SOX certification "is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements."

Quote of note: "If we were to accept [plaintiff's] proferred interpretation of Sarbanes-Oxley, scienter would be established in every case were there was an accounting error or auditing mistake made by a publicly traded company, thereby eviscerating the pleading requirements for scienter set forth in the PSLRA."

Posted by Lyle Roberts at 9:34 PM | TrackBack

September 25, 2006

Dura In The Fourth Circuit

The U.S. Court of Appeals for the Fourth Circuit has issued its first post-Dura decision on loss causation. In Glaser v. Enzo Biochem, Inc., 2006 WL 2692848 (4th Cir. Sept. 21, 2006), the court examined whether the plaintiffs had adequately alleged a Virginia common law fraud claim related to the sale of securities. (The federal securities claims had previously been dismissed on statute of limitations grounds.)

The court found that it "is only after the fraudulent conduct is disclosed to the investing public, followed by a drop in the value of the stock, that the . . . investor has suffered a 'loss' that is actionable after the Supreme Court's decision in Dura." Because the complaint appeared to concede that the plaintiffs had sold their shares before the "alleged truth about Enzo's science" was "publicly revealed," any losses they suffered "must have been the result of market factors or other factors, not the revelation of the alleged truth."

Posted by Lyle Roberts at 10:52 PM | TrackBack

September 21, 2006

You, Sir, Are A No-Good Defrauder

Whether plaintiffs who combine nonfraud and fraud securities claims in the same complaint are subject to the particularity pleading requirement of Fed. R. of Civ. P. 9(b) has been an open issue. Although claims under Section 11 and Section 12(a)(2) of the Securities Act of 1933 do not require the plaintiff to establish fraudulent intent, a number of federal circuits (2nd, 3rd, 5th, 7th, and 9th - with only the 8th disagreeing) have held that these claims must be plead with particularity if they "sound in fraud" based on the existence of a related securities fraud claim.

The U.S. Court of Appeals for the Eleventh Circuit has joined the majority position this week. In Jacobson v. First Horizon Pharm. Corp., 2006 WL 2661652 (11th Cir. Sept. 18, 2006), the court found that a Section 11 or Section 12(a) claim "must be pled with particularity when the facts underlying the misrepresentation at stake in the claim are said to be part of a fraud claim, as alleged elsewhere in the complaint."

The court also addressed whether the complaint was improperly dismissed pursuant to Fed. R. Civ. P. 12(b)(6) on the basis that it was a "shotgun pleading" that did not clearly link its alleged facts to the causes of action. Interestingly, the district court had granted the dismissal and conditioned any amendment of the complaint "on the [plaintiffs'] payment of the defendants' costs and fees associated with the motion to dismiss." On appeal, the court avoided that issue by holding that instead of dismissing the complaint, the district court should have sua sponte ordered a repleading for a more definitive statement of the claim pursuant to Fed. R. Civ. P. 12(e).

Quote of note: "It is not enough to claim that alternative pleading saves the nonfraud claims from making an allegation of fraud because the risk to the defendant's reputation is not protected. It would strain credulity to claim that Rule 9(b) should not apply in this allegation: The defendant is a no good defrauder, but, even if he is not, the plaintiff can still recover based on the simple untruth of the otherwise fraudulent statement."

Posted by Lyle Roberts at 9:31 PM | TrackBack

September 14, 2006

Fifth Circuit Agrees: No Revival Of Time-Barred Claims

The Sarbanes-Oxley Act of 2002 ("SOX") extends the statute of limitations for federal securities fraud to the earlier of two years after the discovery of the facts constituting the violation or five years after the violation. Although the legislation clearly provides that it "shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002]," left unresolved is whether Congress intended to revive claims that had already expired under the earlier one year/three years statute of limitations.

In an opinion issued this week - Margolies v. Deason, 2006 WL 259788 (5th Cir. Sept. 11, 2006) - the Fifth Circuit has joined the clear majority of federal appellate courts (including the Second, Third, Fourth, Seventh, and Eighth Circuits) in holding that the new statute of limitations should not be applied retroactively. The Eleventh Circuit remains the only dissenter (see this post).

Posted by Lyle Roberts at 10:13 PM | TrackBack

September 7, 2006

Big Bang

The Securities Litigation Uniform Standards Act of 1998 ("SLUSA") pre-empts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The "in connection with" requirement has been a continuous source of litigation and was the subject of the Dabit decision by the U.S. Supreme Court earlier this year.

Not to be outdone, the U.S. Court of Appeals for the Seventh Circuit has issued its own opinion discussing the scope of the "in connection with" requirement. In Gavin v. AT&T Corp., 2006 WL 2548238 (7th Cir. Sept. 6, 2006), the court addressed a class action arising out of the merger between MediaOne and AT&T in 2000. The terms of the merger entitled shareholders of MediaOne to obtain, in exchange for their MediaOne shares, a certain amount of AT&T stock plus cash and any accrued but unpaid dividends. After AT&T solicited MediaOne shareholders twice to make this exchange, it hired a shareholder communications company to "clean up" any MediaOne shareholders who had not yet responded. The letter from the shareholder communications company specified a fee of $7 per MediaOne share for the exchange service, without mentioning that MediaOne shareholders could still do the exchange at no cost through AT&T's exchange agent. The failure to mention the "no cost" option is the fraud charged in the complaint.

In an opinion by Judge Posner, the court was highly critical of the defendants' position that the case should be pre-empted by SLUSA because the alleged fraud was in connection with the purchase or sale of MediaOne stock. Noting that MediaOne's shareholders "became the beneficial owners of AT&T stock" when the merger was consummated, the court found that the alleged fraud "happened afterwards and had nothing more to do with the federal securities law than if [the shareholder communication company] had asked the MediaOne shareholders 'do you want your AT&T shares sent to you by regular mail or by courier?' and had charged an inflated fee for the courier service." Accordingly, the court reversed the pre-emption decision and instructed the district court to remand the case back to state court.

Quote of note: "Of course there is a literal sense in which anything that happens that would not have happened but for some prior event is connected to that event. In that sense the fraud of which the plaintiff complains is connected to the merger, without which there would not have been such a fraud against the plaintiff and her class. But in the same sense the fraud is connected to the Big Bang, without which there would never have been a MediaOne or even an AT&T."

Posted by Lyle Roberts at 6:43 PM | TrackBack

July 31, 2006

Sliding Up

Today's edition of the New Jersey Law Journal has an interesting article (subscrip. req'd) on an appellate decision upholding an attorneys' fees award. In In re AT&T Corp. Sec. Litig., 2006 WL 2021033 (3d Cir. July 20, 2006), the Third Circuit found that the upward sliding fee scale (i.e., the fee percentage increased as the size of the settlement increased) agreed to by the lead plaintiff was permissible. Notably, the total fee of $21.25 million was only 1.28 times the lodestar calculation of the reasonable attorney hours expended times their hourly rates. (An earlier post on the AT&T settlement can be found here.)

Quote of note: "St. John's University Law Professor Michael Perino says, 'It is a matter of dispute among academics as to whether an upward sliding scale or a downward sliding scale creates the best set of incentives for plaintiffs. Downward is more common.'"

Disclosure: The author of The 10b-5 Daily is quoted in the article.

Posted by Lyle Roberts at 8:11 PM | TrackBack

July 7, 2006

Scheme Liability In The Ninth Circuit

Whether secondary actors who did not prepare or substantially participate in preparing corporate financial misstatements can still be held liable for them under Rule 10b-5 as scheme participants is a hot topic in the courts. In Simpson v. AOL Time Warner, Inc., 2006 WL 1791042 (9th Cir. June 30, 2006), the U.S. Court of Appeals for the Ninth Circuit has issued an opinion in the Homestore securities litigation that addresses the issue. (A discussion of the lower court decision and SEC amicus brief on appeal can be found here.)

In Simpson, the court held 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." It is not sufficient, the court concluded, "that a transaction in which a defendant was involved has a deceptive purpose and effect; the defendant's own conduct contributing to the transaction or overall scheme must have had a deceptive purpose and effect." The court rejected the defendants' argument that Sec. 10(b) liability is limited to those who make material misstatements or omissions, but ultimately found that the district court had correctly dismissed the claims against them.

Held: Dismissal affirmed.

Posted by Lyle Roberts at 10:48 PM | TrackBack

June 22, 2006

Selective Waiver

The U.S. Court of Appeals for the Tenth Circuit has issued an opinion in the Qwest securities litigation on the issue of selective waiver. See In re Qwest Communications Int'l Inc. Sec. Litig., 2006 WL 1668246 (10th Cir. June 19, 2006). In particular, the court considered whether the company could withhold documents from the plaintiffs on the grounds of attorney-client privilege or the work-product doctrine even though those documents had previously been produced to the SEC.

After an exhaustive survey of related decisions, revealing that circuit courts generally have rejected the concept of selective waiver, the court held that the record in the case did "not establish a need for a rule of selective waiver to assure cooperation with law enforcement, to further the purposes of the attorney-client privilege or work-product doctine, or to avoid unfairness to the disclosing party." In the court's view, Qwest was seeking "the substantial equivalent of an entirely new privilege, i.e., a government-investigation privilege," which the court was disinclined to create. (Note that the production of opinion work product was not an issue in the case.)

The Rocky Mountain News has an article on the decision.

Quote of note: "At least to the degree exhorted by amici, 'the culture of waiver' appears to be of relatively recent vintage. Whether the pressures facing corporations in federal investigations present a hardened, entrenched problem suitable for common-law intervention or merely a passing phenomenon that may soon be addressed in other venues is unclear."

Posted by Lyle Roberts at 10:37 PM | TrackBack

June 16, 2006

Kircher Decided

In the Kircher v. Putnam Funds case, the U.S. Supreme Court has held that a district court's decision to remand a case to state court pursuant to the Securities Litigation Uniform Standards Act of 1998 ("SLUSA") is not subject to appellate review. The 9-0 decision authored by Justice Souter (with a separate concurrence by Justice Scalia) resolves a circuit split between the Second Circuit (not appealable) and the Seventh Circuit (appealable) on the issue.

SLUSA generally prohibits the bringing of a securities class action based on state law in state court. The defendants are permitted to remove the case to federal district court for a determination on whether the case is precluded by the statute. If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.

As a matter of federal procedural law, a remand based on a district court's decision that it does not have subject-matter jurisdiction over a case cannot be reviewed on appeal. In Kircher, however, the Seventh Circuit found that this general proposition is inapplicable to a case removed and remanded under SLUSA because the district court is making a substantive decision of no preclusion, as opposed to a procedural decision of no subject-matter jurisdiction.

The Supreme Court disagreed. Based on SLUSA's text, the Court found that "removal and jurisdiction to deal with removed cases is limited to those precluded" by the statute. Under these circumstances, "a motion to remand claiming the action is not precluded must be seen as posing a jurisdictional issue." The district court's exercise of its "adjudicatory power" is "jurisdictional, as is the conclusion reached and the order implementing it." Accordingly, the remand decision is not subject to appellate review.

Interestingly, the Supreme Court also addressed the Seventh Circuit's assumption that SLUSA gives federal courts exclusive jurisdiction to decide the preclusion issue, so that "a remand order based on a finding that the action is not precluded would arguably be immune from review." The Court found that nothing in SLUSA creates this exclusive jurisdiction and on remand the state court would be "perfectly free to reject the remanding court's reasoning" and make its own determination as to preclusion. Moreover, any error in that decision could "be considered on review by this Court." The issue was of particular importance in the instant case, because the Court had recently held that holder claims, arguably like those brought by Kircher, are precluded under SLUSA.

Holding: Judgment vacated and case remanded with instructions to dismiss the appeal for lack of jurisdiction.

Posted by Lyle Roberts at 6:10 PM | TrackBack

April 17, 2006

The Limits Of Scheme Liability

There is a district court split over whether secondary actors who did not prepare or substantially participate in preparing corporate financial misstatements can still be held liable for them under Rule 10b-5 as scheme participants. Last week, the U.S. Court of Appeals for the Eighth Circuit weighed in on the issue and flatly rejected this theory of liability.

In In re Charter Communications, Inc. Sec. Litig., 2006 WL 925354 (8th Cir. April 11, 2006), the court addressed allegations that the vendor defendants entered into sham transactions with Charter knowing that the company "intended to account for them improperly and that analysts would rely on the inflated revenues and operating cash flow in making stock recommendations." The plaintiffs argued (relying primarily on a district court decision in the Parmalat case) that the vendors violated Rule 10b-5(a) and (c) by participating in a fraudulent scheme or course of business.

The court found, however, 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." Since the plaintiffs did not allege that the vendor defendants made or approved Charter's financial misrepresentations, the claims against them were properly dismissed.

Holding: Dismissal affirmed.

Quote of note: "To impose liability for securities fraud on one party to an arm's length business transaction in goods or services other than securities because that party knew or should have known that the other party would use the transaction to mislead investors in its stock would introduce potentially far-reaching duties and uncertainties for those engaged in day-to-day business dealings. Decisions of this magnitude should be made by Congress."

Posted by Lyle Roberts at 10:12 PM | TrackBack

April 7, 2006

More On Kircher

The respondents' brief in the Kircher case before the U.S. Supreme Court is now available online. The docket reveals that an amicus brief in support of Kircher has been filed by four law professors. Putnam Funds, in turn, is supported by amicus briefs from the Washington Legal Foundation, the Securities Industry Association and the Bond Market Association, and the U.S. Chamber of Commerce. Oral argument is scheduled for April 24.

Posted by Lyle Roberts at 5:13 PM | TrackBack

March 21, 2006

Dabit Decided

It turns out that sometimes you can tell what the justices are thinking by the questions they ask. As was predicted by some observers following oral argument in the Dabit case, the U.S. Supreme Court has held that the Securities Litigation Uniform Standards Act ("SLUSA") pre-empts state-law class actions brought on behalf of persons who were induced to hold (but not purchase or sell) securities. The 8-0 decision authored by Justice Stevens resolves a circuit split between the Second Circuit and the Seventh Circuit on the issue.

SLUSA preempts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The primary goal of SLUSA was to prevent plaintiffs from using state law claims to avoid the heightened pleading standards imposed on federal securities class actions. The issue before the Supreme Court in Dabit was the meaning of SLUSA's "in connection with" requirement.

Dabit is a former Merrill Lynch broker who filed a class action in federal court claiming, under Oklahoma state law, that Merrill Lynch breached its fiduciary duty to its brokers by disseminating misleading analyst research. Dabit asserted that this practice caused the brokers to hold onto overvalued securities too long and lose commission fees when their clients took their business elsewhere. The Second Circuit found that Dabit's claims were not pre-empted by SLUSA to the extent that he "alleged that brokers were fraudulently induced, not to sell or purchase, but to retain or delay selling their securities."

The Supreme Court previously had held that only purchasers and sellers of securities have standing to bring a private securities fraud action pursuant to Rule 10b-5. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). In Dabit, however, the Court clarified that its earlier decision to limit the potential plaintiffs in Rule 10b-5 cases was based on policy considerations, not on an attempt to define the phrase "in connection with the purchase or sale." Indeed, the Court has generally "espoused a broad interpretation" of that phrase, holding that "it is enough that the fraud alleged 'coincide' with a securities transaction - whether by the plaintiff or by someone else."

The Court found that this broad interpretation must have been known to Congress when it drafted SLUSA and used the "in connection with" language. Given that "class actions brought by holders pose a special risk of vexatious litigation," it would be "odd, to say the least, if SLUSA exempted that particularly troublesome subset of class actions from its pre-emptive sweep." Moreover, allowing state class actions brought by holders "would give rise to wasteful, duplicative litigation" if parallel state court (holders) and federal court (purchasers) class actions were brought based on the same facts.

Holding: Judgment vacated and case remanded for further proceedings consistent with opinion.

Quote of note: "The holder class action that respondent tried to plead, and that the Second Circuit envisioned, is distinguishable from a typical Rule 10b5 class action in only one respect: It is brought by holders instead of purchasers or sellers. For purposes of SLUSA pre-emption, that distinction is irrelevant; the identity of the plaintiffs does not determine whether the complaint alleges fraud 'in connection with the purchase or sale' of securities. The misconduct of which respondent complains herefraudulent manipulation of stock pricesunquestionably qualifies as fraud 'in connection with the purchase or sale' of securities as the phrase is defined in Zandford, 535 U. S., at 820, 822, and OHagan, 521 U. S., at 651."

Posted by Lyle Roberts at 5:33 PM | TrackBack

March 13, 2006

Kircher Update

Oral argument in the Kircher case before the U.S. Supreme Court will be held on April 24. The case addresses whether a party may appeal a district court's decision to remand a case to state court pursuant to the Securities Litigation Uniform Standards Act of 1998. The official question presented can be found here and the petitioner's brief can be found here. Thanks to Adam Savett for the links.

Posted by Lyle Roberts at 9:32 PM | TrackBack

February 23, 2006

Very Efficient

An interesting appellate decision from late last year illustrates the double-edged nature of the efficient market hypothesis for securities fraud litigants. In In re Merck & Co. Sec. Litig., 432 F.3d 261 (3rd Cir. 2005), the Third Circuit addressed whether Merck's failure to disclose certain accounting practices of a wholly-owned subsidiary was a material omission.

On April 17, 2002, in connection with the initial public offering of the subsidiary, Merck filed a Form S-1 that disclosed for the first time that the subsidiary had recognized as revenue the co-payments paid by consumers. The Form S-1 did not disclose, however, the total amount of co-payments recognized. On the day the Form S-1 was filed, Merck's stock price went up. Two months later, the Wall Street Journal reported that the subsidiary had been recognizing the co-payments as revenue and estimated the total amount of this revenue in 2001 at over $4 billion. Merck's stock price dropped two dollars.

On appeal, the Third Circuit held that in an efficient market the materiality of disclosed information may be measured by looking at the movement of the company's stock price immediately following the disclosure. Since Merck's stock price did not decline when the Form S-1 was filed, the court found that the revenue recognition information was immaterial as a matter of law. In response to the plaintiffs' argument that the real disclosure took place when the Wall Street Journal made public the estimated magnitude of the co-payment recognition, the court found that the "minimal, arithmetic complexity of the calculation" made by the reporter "hardly undermines faith in an efficient market." The court noted that this was especially true given how closely Merck was followed by analysts.

Holding: Dismissal affirmed.

Quote of note: "[Plaintiff] is trying to have it both ways: the market understood all the good news that Merck said about its revenue but was not smart enough to understand the co-payment disclosure. An efficient market for good news is an efficient market for bad news. The Journal reporter simply did the math on June 21; the efficient market hypothesis suggests that the market made these basic calculations months earlier."

Addition: One of the panel judges was Samuel Alito, who has since become Justice Alito.

Posted by Lyle Roberts at 10:17 PM | TrackBack

February 16, 2006

SLUSA Before The Supreme Court

For readers interested in more analysis of the Securities Litigation Uniform Standards Act (SLUSA) issues before the U.S. Supreme Court this term, the New York Law Journal (via law.com - regist. req'd) has two recent columns on the cases. The column on Dabit (Feb. 15) can be found here; the column on Kircher (Feb. 8) can be found here.

Posted by Lyle Roberts at 10:26 PM | TrackBack

January 27, 2006

Here At Last

It took ten years, but the U.S. Court of Appeals for the Seventh Circuit has finally issued an opinion that comprehensively interprets the PSLRA's heightened pleading standards. In Makor Issues & Rights, Ltd. v. Tellabs, Inc., 2006 WL 172142 (7th Cir. Jan. 25, 2006) (Wood, J.), the court addressed the following issues:

(1) Pleading of all facts - Although the PLSRA requires a complaint based on information and belief to state "all facts on which that belief is formed," courts generally have held that this requirement should not be applied literally. The Seventh Circuit agreed with the Second Circuit that the relevant question is "whether the facts alleged are sufficient to support a reasonable belief as to the misleading nature of the statement or omission."

(2) Confidential witnesses - In accord with a number of other circuit courts, the Seventh Circuit found that plaintiffs are not required to provide the identify of their confidential sources. It is enough for plaintiffs to describe the sources with sufficient particularity to support the probability that the person would "have access to, or knowledge of, the facts underlying the allegations."

(3) Substantive scienter standard - The Seventh Circuit found that the PSLRA did not raise the substantive scienter standard for securities fraud, which continues to be knowledge or recklessness. (Only the Ninth Circuit has reached a different conclusion.)

(4) Pleading scienter - Under the PSLRA, a plaintiff must plead sufficient facts to create a "strong inference" of scienter or the complaint shall be dismissed. The key issue has been whether motive and opportunity allegations (e.g., insider stock trading), by themselves, can meet this pleading burden. The Second and Third Circuits say yes. The Ninth and Eleventh Circuits disagree. A number of other circuit courts, however, have taken a more holistic approach and require that all of the allegations in the complaint be collectively examined to determine whether the requisite strong inference of scienter is demonstrated. The Seventh Circuit adopted this middle ground, finding that motive and opportunity allegations may be "useful indicators."

(5) Competing inferences - Although the Sixth Circuit has found that the "strong inference" requirement creates a situation in which plaintiffs are only entitled to the most plausible of competing inferences when a court evaluates their scienter allegations, the Seventh Circuit disagreed. Instead, the Seventh Circuit stated that it "will allow the complaint to survive if it alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent."

(6) Group pleading for scienter - The Seventh Circuit found that the PSLRA requires a strong inference of scienter to be pled for each defendant. Accordingly, scienter allegations made against one defendant cannot be imputed to other defendants on the theory that the officers of the company acted collectively.

For all of the legal windup, the application of the law to the facts in Makor is surprisingly brief. The district court had found that the plaintiffs failed to adequately allege scienter for any of the defendants. On appeal, the Seventh Circuit held that the allegations concerning marketing, sales, and production information available to the CEO were sufficient to establish a strong inference that he acted with fraudulent intent. The CEO's scienter could then be imputed to the company. As for the other individual defendant, the company's Chairman, the scienter allegations appeared to be of the "must have known" variety, and he only sold 1% of his stock holdings during the class period. Accordingly, the Rule 10b-5 claim against the Chairman was dismissed.

Holding: Affirmed in part, reversed in part. (The court also evaluated whether falsity and materiality was adequately pled for all of the statements and whether the forward-looking statements were protected by the PSLRA's safe harbor, but its holdings on these issues were not dispositive of the overall claims against any of the defendants.) The oral argument in the case can be listened to here - thanks to The PSLRA Nugget for the link.

Posted by Lyle Roberts at 4:45 PM | TrackBack

January 18, 2006

Dabit Argument

Early reports from today's Supreme Court oral argument in Merrill Lynch v. Dabit (see post below) suggest that the Second Circuit may be reversed. The justices evidently were skeptical that Congress, in passing SLUSA, meant to allow holders to bring a securities class action in state court, while forcing purchasers and sellers to bring the same case in federal court. Dow Jones Newswires (via wsj.com - subscrip. req'd) and the Financial Times (via MSNBC.com) have articles, while the Wall Street Journal's Law Blog gets a first-hand report from a law professor who attended the hearing.

Quote of note (Financial Times): "Justice Stephen Breyer said he was worried that permitting such suits in state court would allow investors to circumvent the limits imposed by federal securities laws on purchaser and seller suits. Mr. Breyer said nothing would stop them from proceeding in state court, simply by filing their suits as holders rather than sellers. Justice Ruth Bader Ginsburg asked: 'Why would Congress with respect to this category want there to be a more plaintiff-friendly rule than it put in place for the purchaser-seller?'"

Posted by Lyle Roberts at 5:28 PM | TrackBack

Dabit Previews

Media interest in Merrill Lynch v. Dabit, the SLUSA case being heard by the U.S. Supreme Court today, has been muted. Nevertheless, there are some good Internet sources on the case. Scotusblog provides an in-depth preview of the oral argument. The Wall Street Journal's new Law Blog also has a post.

Posted by Lyle Roberts at 1:27 PM | TrackBack

January 12, 2006

Dabit's Lineup

The respondent's brief in Merrill Lynch v. Dabit, the first of two SLUSA cases that will be heard by the Supreme Court this term (see post below), can be found here. The following entities have filed amicus briefs in support of Dabit's position: the National Association of Shareholders and Consumer Attorneys and AARP, IJG Investments Limited Partnership and Iriys Guy, Phillip Goldstein and Bulldog Investors, and New York. Oral argument is scheduled for next Wednesday.

Posted by Lyle Roberts at 10:02 PM | TrackBack

January 9, 2006

SLUSA Again

When you're hot, you're hot. The Securities Litigation Uniform Standards Act of 1998 (SLUSA) will be the subject of a second U.S. Supreme Court argument this year following the granting of certiorari in the Kircher v. Putnam Funds Trust case. The question presented is whether a party may appeal a district court's decision to remand a case to state court pursuant to SLUSA. There is currently a circuit split between the Second and Ninth Circuits (not appealable) and the Seventh Circuit (appealable) on this issue. Scotusblog reports that the case will be heard in April. (The 10b-5 Daily's discussion of the underlying Seventh Circuit opinion can be found here.)

Posted by Lyle Roberts at 11:48 PM | TrackBack

December 14, 2005

Ethically Challenged Is Not Enough

The U.S. Court of Appeals for the First Circuit has issued an interesting opinion in a research analyst case. The decision - Brown v. Credit Suisse First Boston LLC, 2005 WL 3359728 (1st Cir. Dec. 12, 2005) - affirms the dismissal of securities fraud claims based on alleged false "buy" recommendations made by CSFB's analysts with respect to the stock of Agilent Technologies.

The court held that the plaintiffs needed to plead facts "sufficient to indicate that the speaker did not actually hold the opinion expressed." In examining the existence of this "subjective falsity," the analysis of the falsity of the statement and the defendants' fraudulent intent (i.e., scienter) cannot be separated. Accordingly, the PSLRA's heightened pleading standard for scienter should be applied and the plaintiffs must "plead provable facts strongly suggesting that the speaker did not believe [a] particular opinion to be true when uttered."

Turning to the complaint, the court found that "while the plaintiffs' allegations regarding the obvious conflicts of interest and general state of corruption within CSFB's analyst ranks may be enough to turn the stomach of an ethically sensitive observer, they are insufficient, on their own, to support a fraud pleading with respect to the subjective falsity of the eight 'buy' recommendations issued on Agilent stock." In particular, the court rejected a series of CSFB e-mails that suggested its analysts engaged in "sharp practice," but fell short of creating a strong inference that any particular "buy" rating did not reflect the personal belief of the analyst in question.

Holding: Dismissal affirmed.

Quote of note: "The plaintiffs' allegations, if true, show beyond hope of contradiction that the defendants operated without much concern for ethical standards. But the fact that an organization is ethically challenged does not impugn every action that it takes. In a securities fraud case, the plaintiffs still must carry the burden, imposed by the PSLRA, of pleading facts sufficient to show that the particular statements sued upon were false or misleading when made. This is as it should be: the securities laws - and section 10(b) in particular - were designed to provide a damages remedy for losses incurred as a result of false or misleading statements, not to punish defendants for bad behavior in a vacuum."

Posted by Lyle Roberts at 7:30 PM | TrackBack

December 6, 2005

Merrill Lynch's Lineup

There is no lack of amici curiae who have filed briefs on behalf of Merrill Lynch in Merrill Lynch v. Dabit, the SLUSA case before the Supreme Court. The list includes (with hyperlink to the brief where available) the Department of Justice/SEC, the U.S. Chamber of Commerce, the Investment Company Institute, Lord Abbett & Co./Vance Management, the Washington Legal Foundation, the Securities Industry Association/Bond Market Association, and Pacific Life Insurance.

Posted by Lyle Roberts at 8:14 PM | TrackBack

November 16, 2005

Dabit Update

Oral argument in Merrill Lynch v. Dabit, the SLUSA case before the Supreme Court, has been scheduled for Wednesday, January 18. The petitioner's brief can be found here.

Posted by Lyle Roberts at 5:39 PM | TrackBack

October 19, 2005

More on Dabit

The official question presented in the Dabit case before the U.S. Supreme Court is:

"Whether, as the Seventh Circuit held earlier this month and in direct conflict with the decision below, SLUSA preempts state law class action claims based upon allegedly fraudulent statements or omissions brought solely on behalf of persons who were induced thereby to hold or retain (and not purchase or sell) securities?"

For more on the decision below, see this post.

Posted by Lyle Roberts at 6:18 PM | TrackBack

October 11, 2005

Supreme Court Declines To Revisit Loss Causation

The Associated Press reports that the U.S. Supreme Court has declined to grant cert in the Lentell v. Merrill Lynch case. In Lentell, the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of two research analyst cases based on the plaintiffs' failure to adequately plead loss causation. The 10b-5 Daily's summary of the Second Circuit decision can be found here.

Posted by Lyle Roberts at 12:47 PM | TrackBack

October 10, 2005

Control Person Puzzle

In a typical securities class action, the dismissal of the claims against the individual defendants leads to the dismissal of the claims against the company. In the absence of an underlying Rule 10b-5 violation, there also can be no control person liability. But consider this scenario: the suit is stayed against the controlled entity because it is in bankruptcy. Can the control person claims continue against the individual defendants even if the Rule 10b-5 claims against them have been dismissed? The U.S. Court of Appeals for the First Circuit says yes, but how the district court is supposed to implement the decision is unclear.

In In re Stone & Webster, Inc. Sec. Litig., 414 F.3d 187 (1st Cir. 2005), the court affirmed the dismissal of the Rule 10b-5 claims against the CEO and CFO of Stone & Webster (the only individual defendants in the case) based on the failure to adequately plead scienter (i.e., fraudulent intent). The Section 20(a) claims for control person liability against the CEO and CFO, however, were allowed to continue. The CEO and CFO petitioned for rehearing on this issue, arguing that the dismissal of the underlying Rule 10b-5 claims necessitated the dismissal of the Section 20(a) claims.

In a separate opinion, the court denied the petition. See In re Stone & Webster, Inc. Sec. Litig., 2005 WL 2216319 (Sept. 13, 2005). The claims against the company had not been dismissed. Instead, they had been stayed when the company filed for bankruptcy protection. The court held that the dismissal of the Rule 10b-5 claims against the CEO and CFO "is in no way incompatible with the establishment of their secondary liability under Sec. 20(a) as controlling persons of Stone & Webster, predicated on Stone & Webster having violated Rule 10b-5."

On remand, however, the district court appears to be presented with a difficult puzzle. Whether a defendant corporation has acted with scienter is normally determined by looking "to the state of mind of the individual corporate official or officials who make or issue the statement . . . rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment." Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004). The CEO and CFO were the only individual defendants in the case. If the case is not going to proceed against them, how can the corporation be found to have acted with scienter? The opinion refers to the possibility that "the acts of other agents might also serve as predicates for the Sec. 20(a) liability," but this seems like merely a theoretical assertion if all of the individual defendants have been dismissed. Stay tuned.

Posted by Lyle Roberts at 6:32 PM | TrackBack

September 27, 2005

Supreme Court To Address Circuit Split On SLUSA

The Supreme Court has granted cert in the Dabit case (2d. Cir.) and will address the scope of the Securities Litigation Uniform Standards Act of 1998 ("SLUSA").

SLUSA preempts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The issue before the Supreme Court is the application of the "in connection with" requirement. In particular, the court will resolve the circuit split between the Second and Seventh Circuits over whether SLUSA preemption applies to claims brought solely on behalf of persons who were induced to hold (but not purchase or sell) securities.

The 10b-5 Daily has posted frequently on this issue, including posts on the underlying Second Circuit opinion in the Dabit case finding that SLUSA only applies to purchaser/seller claims and the Seventh Circuit's opinion in the Putnam Funds II case reaching the opposite conclusion. For a cite to an article discussing the circuit split and its ramifications, see this post.

Posted by Lyle Roberts at 10:54 AM | TrackBack

August 24, 2005

More On SLUSA Preemption

The Securities Litigation Uniform Standards Act of 1998 ("SLUSA") preempts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The defendants are permitted to remove the case to federal district court for a determination on whether the case is preempted by the statute. If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.

Earlier this year, the U.S. Court of Appeals for the Seventh Circuit held in the Putnam Funds cases that the "in connection with" language in SLUSA merely "ensures that the fraud occurs in securities transactions rather than some other activity." Accordingly, plaintiffs could not avoid SLUSA by limiting their proposed class to investors in the funds who merely held their shares, rather than purchased or sold them, during the class period.

The Seventh Circuit has now confirmed that holding under slightly different factual circumstances. In Disher v. Citigroup Global Markets Inc., 2005 WL 1962942 (7th Cir. Aug. 17, 2005), the court found that a class action suit brought in state court on behalf of customers of Salomon Smith Barney alleging that they were mislead by false stock ratings was subject to preemption. The proposed class definition "of all SSB customers who retained certain securities in reliance on SSB's misrepresentations is no more narrowly drawn than the class definitions discussed in [the Putnam Funds decision]." Accordingly, the court ordered that the case be dismissed.

Holding: Reversed and remanded with instructions to vacate the remand order and dismiss the claims.

Posted by Lyle Roberts at 7:38 PM | TrackBack

August 8, 2005

PEC Solutions Opinion Published

The U.S. Court of Appeals for the Fourth Circuit has decided to publish its opinion in the PEC Solutions securities class action. As discussed in this post from last March, the opinion is the first post-PSLRA decision by the Fourth Circuit to address the common scienter allegations of insider stock sales and violations of generally accepted accounting principles ("GAAP").

Disclosure: The author of The 10b-5 Daily argued the case before the appellate court on behalf of the defendants.

Posted by Lyle Roberts at 1:46 PM | TrackBack

July 29, 2005

A Curious Statute

The PSLRA created a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. Under the first prong of the safe harbor, a defendant is not liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by "meaningful cautionary statements" that alert investors to the factors that could cause actual results to differ.

Some commentators have described this provision as a "license to lie," because it arguably protects companies from liability based on even deliberately false forward-looking statements. The U.S. Court of Appeals for the First Circuit agrees. In In re Stone & Webster, Inc., Sec. Litig., 2005 WL 1654040 (1st Cir. July 14, 2005), the court evaluated an allegedly misleading statement that the company "has on hand . . . sufficient sources of funds to meet its anticipated [needs]." The district court found the statement to be forward-looking based on its reference to an anticipated futher need for funds and dismissed the claim based on the PSLRA's safe harbor. On appeal, the First Circuit found "that the meaning of this curious statute, which grants (within limits) a license to defraud, must be somewhat more complex and restricted."

In the instant case, the statement was "composed of elements that refer to estimates of future possibilities and elements that refer to present facts." The court found that the specific claim of fraud related to whether the defendants were "lying about the Company's present access to funds," not whether the defendants "were underestimating the amount of their future cash needs." Under these circumstances, the "mere fact that a statement contains some reference to a projection of future events cannot sensibly bring the statement within the safe harbor."

Holding: Judgment affirmed in part and vacated in part. (The decision contains holdings on a number of other pleading issues. It also creates an interesting bit of nomenclature, referring to the PSLRA's heightened pleading standards for false statements as the "clarity-and-basis" requirement.)

Posted by Lyle Roberts at 7:13 AM | TrackBack

July 14, 2005

The PSLRA And The Supreme Court

Why has the Supreme Court declined to hear cases that would clarify the PSLRA? Business Week has a "news analysis" on the Supreme Court's reluctance to take cases in "vital areas such as antitrust, environmental, intellectual-property, securities, and tax law." In particular, the article cites the varied application of the PSLRA's heightened pleading standards as a "prime example of the legal confusion that the Supreme Court has allowed to fester."

The article does not state how many cert petitions involving interpretations of the PSLRA the Supreme Court has rejected. That said, anecdotal evidence abounds. A recent example is the Supreme Court's decision not to hear the Baxter case, an appeal from a Seventh Circuit decision that created a circuit split over the PSLRA's safe harbor for forward-looking statements.

Posted by Lyle Roberts at 7:37 PM | TrackBack

July 5, 2005

Second Circuit To Hear IPO Allocation Appeal

The IPO allocation cases (brought against the underwriters of over 300 initial public offerings) generally allege that the defendants ramped up trading commissions in exchange for providing access to IPO shares and required investors allocated IPO shares to buy additional shares in the after-market to help push up the share price. Last year, Judge Scheindlin (S.D.N.Y.) granted class certification in six "focus" cases that have been used to test the sufficiency of the overall allegations.

A reader points out that the Second Circuit has agreed to hear an appeal from that grant (by order dated June 30, 2005). Moreover, the court has specifically asked for briefing on two hot-button issues:

(1) Whether the Second Circuit's previous position that plaintiffs are only required to make "some showing" that the proposed class comports with all of the elements of Federal Rule of Civil Procedure 23 is consistent with the 2003 amendments to that rule.

(2) Whether the presumption of reliance established in Basic v. Levinson, 485 U.S. 224 (1988) (i.e., the fraud-on-the-market theory) was properly extended to plaintiffs' claims against the non-issuer defendants and to the market manipulation claims.

The Second Circuit has come close to addressing the scope of the fraud-on-the-market theory before, but was thwarted by a settlement. The resolution of this issue has wide-ranging implications for securities fraud litigation. Take a look, for example, at The 10b-5 Daily's discussion of two opposing district court decisions in cases brought against research analysts. Stay tuned.

Posted by Lyle Roberts at 7:55 PM | TrackBack

June 16, 2005

Sixth Circuit Applies Dura

In the first circuit court decision to apply the Supreme Court's holding in the Dura case, the Sixth Circuit has affirmed the dismissal of a securities class action based on the plaintiffs' failure to adequately plead loss causation. The case was brought against several former Kmart executives and PricewaterhouseCoopers. The plaintiffs alleged that the defendants misled Kmart's investors in 2000 and 2001 prior to the company's bankruptcy.

In D.E. & J. Limited Partnership v. Conaway, 2005 WL 1386448 (6th Cir. June 10, 2005) (unpublished), the Sixth Circuit found that the plaintiffs "did not plead that the alleged fraud became known to the market on any particular day, did not estimate the damages that the alleged fraud caused, and did not connect the alleged fraud with the ultimate disclosure or loss." In the end, the plaintiffs relied entirely on allegations that they had paid artificially inflated prices for their Kmart stock and that Kmart's stock price declined after the company announced its bankruptcy. The Sixth Circuit held that price inflation had been expressly rejected by the Supreme Court as an adequate basis for pleading loss causation. As for the bankruptcy filing, the plaintiffs "never alleged that Kmart's bankruptcy announcement disclosed any prior misrepresentations to the market."

Holding: Dismissal affirmed.

Posted by Lyle Roberts at 9:22 PM | TrackBack

June 10, 2005

Reviewing The Second Circuit

The National Law Journal has a review (via law.com - free regist. req'd) of the Second Circuit's major securities law cases over the past year. Click on the case name for The 10b-5 Daily's take on the featured decisions - Dabit, Rombach, and Enterprise Mortgage.

Posted by Lyle Roberts at 6:06 PM | TrackBack

June 7, 2005

More On The Revival Of Time-Barred Claims

The Sarbanes-Oxley Act of 2002 ("SOX") extends the statute of limitations for federal securities fraud to the earlier of two years after the discovery of the facts constituting the violation or five years after the violation. Although the legislation clearly provides that it "shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002]," left unresolved is whether Congress intended to revive claims that had already expired under the earlier one year/three years statute of limitations.

Two circuit courts (the 2nd and 7th) have declined to apply the new statute of limitations to revive time-barred claims. In the past week, the Eleventh and Eighth Circuits have also issued opinions addressing the question.

In its long-awaited decision in Tello v. Dean Witter Reynolds, Inc., 2005 WL 1279130 (11th Cir. June 1, 2005), the Eleventh Circuit held that it could not decide "the statutory-interpretation issue of whether previously time-barred claims are revived by the [SOX] statute of limitations" until the district court determined if the plaintiffs were on inquiry notice of their claims prior to the passage of the legislation.

In contrast, the Eight Circuit's opinion in In re ADC Telecommunications, Inc. Sec. Litig., 2005 WL 1322576 (8th Cir. June 6, 2005) simply follows the earlier appellate holdings in finding that SOX did not revive time-barred claims. The opinion (in a footnote) and concurrence clarify that the issue of the retroactivity of the new statute of limitations (i.e., its application to "causes of action that had already accrued at the time of the change in law") is separate from the issue of whether Congress intended to revive time-barred claims.

Posted by Lyle Roberts at 6:41 PM | TrackBack

April 27, 2005

Lead Plaintiff Controls Attorneys' Fees

In an interesting decision from earlier this month, the U.S. Court of Appeals for the Third Circuit has held that deference should be given to a lead plaintiff's decision not to compensate non-lead counsel. The case stems from the $3.2 billion settlement in the Cendant Corp. securities litigation. Lead counsel for the plaintiffs obtained $52 million in legal fees, which it shared with twelve other law firms that had been authorized to work on the case. An additional forty-five firms that represented individual plaintiffs, however, were frozen out of any fees. Three of these firms appealed the lower court's rejection of their fee applications.

In In re Cendant Corp. Sec. Litig., 2005 WL 820592 (3rd Cir. April 11, 2005), the Third Circuit held that the PSLRA "significantly restricts the ability of plaintiffs' attorneys to interpose themselves as representatives of a class and expect compensation for their work on behalf of that class." As a result, the lead plaintiff's "refusal to compensate non-lead counsel will generally be entitled to a presumption of correctness." The court did find that non-lead counsel can ask the court to compensate them for work done before the appointment of a lead plaintiff, but they must "demonstrate that their work actually benefited the class."

The Legal Intelligencer has an article (via law.com - free regist. req'd) on the decision.

Quote of note: "After the lead plaintiff is appointed, however, the PSLRA grants that lead plaintiff primary responsibility for selecting and supervising the attorneys who work on behalf of the class. We conclude that this mandate should be put into effect by granting a presumption of correctness to the lead plaintiff's decision not to compensate non-lead counsel for work done after the appointment of the lead plaintiff. Non-lead counsel may refute the presumption of correctness only by showing that lead plaintiff violated its fiduciary duties by refusing compensation, or by clearly demonstrating that counsel reasonably performed work that independently increased the recovery of the class."

Posted by Lyle Roberts at 7:18 PM | TrackBack

April 19, 2005

Dura Decided

The U.S. Supreme Court has issued an opinion in the Dura Pharmaceuticals v. Broudo case. It is a unanimous decision authored by Justice Breyer. As predicted, the court rejected the Ninth Circuit's price inflation theory of loss causation. Instead, the court held that a plaintiff must prove that there was a causal connection between the alleged misrepresentations and the subsequent decline in the stock price.

Loss causation (i.e., a causal connection between the material misrepresentation and the loss) is an element of a securities fraud claim. In the Dura case, the Ninth Circuit had held that to satisfy this element a plaintiff only need prove that "the price at the time of purchase was inflated because of the misrepresentation." (See this post for a full summary of the Ninth Circuit's decision.)

On appeal, the Supreme Court made three key findings in rejecting the price inflation theory of loss causation. First, the court dismissed the idea that price inflation is the equivalent of an economic loss. The court noted that "as a matter of pure logic, at the moment the transaction takes place, the plaintiff has suffered no loss; the inflated purchase payment is offset by ownership of a share that at that instant possesses equivalent value." Moreover, it is not inevitable that an initially inflated purchase price will lead to a later loss. A subsequent resale of the stock at a lower price may result from "changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events, which taken separately or together account for some or all of that lower price."

Second, the court found that the price inflation theory of loss causation has no support in the common law. The common law has "long insisted" that a plaintiff in a deceit or misrepresentation action "show not only that if had he known the truth he would not have acted but also that he suffered actual economic loss." Accordingly, it was "not surprising that other courts of appeals have rejected the Ninth Circuit's 'inflated purchase price' approach."

Finally, the court noted that the price inflation theory of loss causation was arguably at odds with the objectives of the securities statutes, including the PSLRA. The statutes make private securities fraud actions available "not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause." In particular, the PSLRA "makes clear Congress' intent to permit private securities fraud actions for recovery where, but only where, plaintiffs adequately allege and prove the traditional elements of causation and loss."

As clear as the opinion is on the issue of the price inflation theory, it fails to provide much guidance on what a plaintiff must allege on loss causation to survive a motion to dismiss. The court assumed, without deciding, "that neither the [Federal Rules of Civil Procedure] nor the securities statutes impose any special further requirements in respect to the pleading of proximate causation or economic loss." Even under the notice pleading requirements, however, the complaint's bare allegation of price inflation was deemed insufficient. As stated by the court, "it should not prove burdensome for a plaintiff who has suffered an economic loss to provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind."

Holding: Reversed and remanded for proceedings consistent with opinion.

Addition: A few initial thoughts on the Dura opinion:

(1) The case is a significant victory for defendants in the Eighth and Ninth Circuits, which were the only two courts to adopt the price inflation theory of loss causation.

(2) Although the Supreme Court has put the price inflation theory to rest, its opinion raises some complicated questions about recoverable loss. For example, the Supreme Court notes that many factors other than misrepresentations can cause a stock price decline, but does not provide any guidance on how plaintiffs can meet their burden of proof for loss causation in cases where some or all of these other factors are present.

(3) The opinion is unclear on an issue that was raised on appeal: does the stock price decline need to be the result of a corrective disclosure that reveals the "truth" to the market? The Supreme Court makes some opaque references to when "the relevant truth begins to leak out" and "when the truth makes its way into the market place," but does not squarely address whether there is any need for plaintiffs to establish the existence of a corrective disclosure.

(4) Finally, as noted above, the Supreme Court expressly leaves open the question of whether F.R.C.P. 9(b) or the PSLRA requires plaintiffs to plead loss causation with particularity. The lower courts will need to decide whether these statutes are applicable.

News reports on the Dura opinion can be found in the New York Times, the Washington Post , and Reuters.

Posted by Lyle Roberts at 11:28 PM | TrackBack

April 8, 2005

Applying SLUSA

When Judge Easterbrook of the U.S. Court of Appeals for the Seventh Circuit writes a securities law opinion, it is invariably going to be worth talking about. His latest is no exception.

The Securities Litigation Uniform Standards Act of 1998 ("SLUSA") preempts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The defendants are permitted to remove the case to federal district court for a determination on whether the case is preempted by the statute. If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.

In an earlier opinion in the Putnam Fund cases, Judge Easterbrook found that the district court's decision to remand the actions back to state court was appealable. This week's opinion, Kircher v. Putnam Funds Trust, 2005 WL 757255 (7th Cir. April 5, 2005), addressed the merits of that remand decision. In particular, Judge Easterbrook grappled with the question that has confronted the Second and Third Circuits recently (see this post): what is the scope of SLUSA's "in connection with the purchase or sale of securities" requirement?

In contrast to the Second Circuit, the Seventh Circuit found that SLUSA preemption is not limited to actions where the plaintiffs are purchasers or sellers of securities. One of the complaints filed in the Putnam Fund cases defined its class as "all investors who held the fund's securities during a defined period and neither purchased or sold shares during that period." The court held that the "in connection with" language in SLUSA merely "ensures that the fraud occurs in securities transactions rather than some other activity." Although private actions under Rule 10b-5 (from which SLUSA adopted the "in connection with" requirement) can only be brought by purchasers or sellers, it "would be more than a little strange" if this judicially-created limitation on private actions "became the opening by which that very litigation could be pursued under state law, despite the judgment of Congress (reflected in SLUSA) that securities class actions must proceed under federal securities laws or not at all." Accordingly, the complaint was subject to dismissal under SLUSA.

Holding: Cases remanded with instructions to undo the remand orders and dismiss plaintiffs' state-law claims.

Quote of note: "[M]ost of the approximately 200 suits filed against mutual funds in the last two years alleging that the home-exchange-valuation rule can be exploited by arbitrageurs have been filed in federal court under Rule 10b-5. Our plaintiffs effort to define non-purchaser-non-seller classes is designed to evade PSLRA in order to litigate a securities class action in state court in the hope that a local judge or jury may produce an idiosyncratic award. It is the very sort of maneuver that SLUSA is designed to prevent."

Posted by Lyle Roberts at 10:10 PM | TrackBack

April 4, 2005

Appellate Roundup

Two appellate decisions from earlier this year that are worth noting:

(1) In Barrie v. Intervoice-Brite, Inc., 2005 WL 57928 (5th Cir. Jan. 12, 2005), the Fifth Circuit considered a securities fraud claim based on revenue recognition issues at a software company. The defendants argued that a charge the company took against its revenues was caused by the SEC's issuance of new revenue recognition guidance. To counter this argument, the plaintiffs apparently attached a sworn expert analysis to their amended complaint stating that "Intervoice's reversal of revenue in the first quarter fiscal 2001 was not a result of SAB 101, but rather was required because Intervoice's prior revenue recognition practice did not comply with GAAP, specifically SOP 97-2." The Fifth Circuit reversed the dismissal of the revenue recognition claims, finding that the "accounting questions in this case are disputed" and that plaintiffs' position "was adequately supported by expert opinion."

(2) In In re Daou Systems, Inc. Sec. Litig., 2005 WL 237645 (9th Cir. Feb. 2, 2005), the Ninth Circuit clarified its position on confidential witnesses (by adopting the pleading standard used in the First and Second Circuits) and muddied its position on loss causation.

Confidential witnesses - The court held that "[n]aming sources is unnecessary so long as the sources are described 'with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged' and the complaint contained 'adequate corroborating details.'"

Loss causation - The court found that "if the improper accounting did not lead to the decrease in Daou's stock price, plaintiffs' reliance on the improper accounting in acquiring the stock would not be sufficiently linked to their damages." This position is the exact opposite of the one adopted by the Ninth Circuit in the Dura case and recently reviewed by the U.S. Supreme Court. Curious.

Posted by Lyle Roberts at 11:35 PM | TrackBack

March 29, 2005

Fourth Circuit On Scienter

Although the U.S. Court of Appeals for the Fourth Circuit established its pleading standards for scienter (i.e., fraudulent intent) in securities fraud cases over a year ago, it has not had a subsequent opportunity to apply these standards. Moreover, the Hanger Orthopedic decision did not address the common scienter allegations of insider stock sales and violations of generally accepted accounting principles ("GAAP").

The Fourth Circuit's decision in In re PEC Solutions, Inc. Sec. Litig., 2005 WL 646070 (March 18, 2005), although unpublished, offers some guidance on how the court will evaluate the existence of a "strong inference" of scienter as required under the PSLRA. In PEC Solutions, plaintiffs alleged that scienter was demonstrated by, among other things, the stock trading of the individual defendants and a failure of the company to take a reserve against non-payment of a contract in violation of GAAP.

As to the stock sales, the court found that they were "nearly de minimus" given that the individual defendants only sold between 1.17% and 13% of their holdings during the class period. Moreover, the individual defendants exercised stock options during the class period, but did not sell the underlying stock, and actually lost hundreds of millions of dollars in stock value due to the price drop. The court concluded that "[i]f this all give rise to a 'strong inference' of anything, it is that no scienter exists."

Turning to the alleged GAAP violation, the court noted that "it is certainly possible that some egregious GAAP violations may help support an inference of scienter for pleading purposes." The supposed lack of a reserve, however, added "nothing new" to the scienter allegations because the complaint had failed to plead facts establishing that PEC believed it would not be paid for its work.

Holding: Dismissal affirmed.

Quote of note: ""But this alleged GAAP violation adds nothing new; rather it simply rides around in circles on the inadequate coattails of the scienter pleading. For if PEC was to take a reserve only when it believed non-payment was 'probable' . . . and that 'the amount of the loss can be reasonably estimated,' we are brought back to Appellants' previous problem that they have not pled facts that give rise to a strong inference that PEC ever believed it would not get paid by Pearson while making the public statements that the [Complaint] challenges."

Disclosure: The author of The 10b-5 Daily argued the case before the appellate court on behalf of the defendants. Note that the case has also received some attention for the results of the court's spell-checking.

Posted by Lyle Roberts at 4:31 PM | TrackBack

March 23, 2005

Lightning Fails To Strike Twice

It may have been too much to expect that the U.S. Supreme Court would grant cert in two securities litigation cases within the span of a year. Having just addressed the issue of loss causation, the court has passed on the opportunity to interpret the PSLRA's safe harbor for forward-looking statements.

The PSLRA created the safe harbor to encourage companies to provide investors with information about future plans and prospects. Under the first prong of the safe harbor, a defendant is not liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by "meaningful cautionary statements" that alert investors to the factors that could cause actual results to differ.

As discussed in a post in The 10b-5 Daily from last August, entitled "The Safe Harbor May Just Be A Safe Puddle," the U.S. Court of Appeals for the Seventh Circuit has weakened the protection afforded by the safe harbor. In Asher v. Baxter Int'l, the court found that it may be impossible, on a motion to dismiss, to determine whether a company's cautionary statements are "meaningful." Prior to this decision, however, numerous courts had dismissed cases pursuant to the first prong of the safe harbor. The defendants petitioned for a writ of certiorari to the Supreme Court to address the circuit split.

On Monday, however, the Supreme Court denied the cert petition. The Chicago Tribune has an article on the decision.

Quote of note: "Numerous business groups filed legal briefs in support of Baxter with the Supreme Court urging review of the case. The Business Roundtable, in its brief, argued that the 7th Circuit decision could affect how public companies across the country handle disclosures. 'The ramifications of the decision below could be enormous,' it wrote, adding that companies 'may choose to avoid making forward-looking disclosures rather than risk lawsuits like this one.'"

Posted by Lyle Roberts at 12:41 PM | TrackBack

March 7, 2005

Fifth Circuit Rejects "Statistical" Tracing

Section 11 of the '33 Act creates civil liability for misstatements in a registration statement. The class of persons who can sue under the statute, however, is limited to those who purchased shares issued pursuant to the registration statement in question. To have standing, an investor must have either acquired his shares in the offering or, if he purchased them in the aftermarket, be able to "trace" them back to the offering. As a general matter, the later introduction of non-offering shares into the market (e.g., via the sale of shares by insiders) generally defeats the ability of subsequent investors to trace their shares back to the offering because the intermingling of the shares makes it virtually impossible to establish that the purchased shares are offering shares.

In Krim v. pcOrder.com, 2005 WL 469618 (5th Cir. March 1, 2005), the plaintiffs tried a statistical approach to solving the problem of aftermarket standing for Section 11 claims. Although the plaintiffs conceded that they could not demonstrate that their shares were issued pursuant to the registration statement, they asserted the existence of standing based on expert testimony indicating that given the number of shares they owned and the percentage of offering stock in the market, the probability that they owned at least one share of offering stock was nearly 100%. The court rejected this statistical tracing theory, finding that "Congress conferred standing on those who actually purchased the tainted stock, not on the whole class of those who possibly purchased tainted shares - or, to put it another way, are at risk of having purchased tainted shares."

Holding: Dismissal affirmed.

Quote of note: "The fallacy of Appellants position is demonstrated with the following analogy. Taking a United States resident at random, there is a 99.83% chance that she will be from somewhere other than Wyoming. Does this high statistical likelihood alone, assuming for whatever reason there is no other information available, mean that she can avail herself of diversity jurisdiction in a suit against a Wyoming resident? Surely not."

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February 22, 2005

SLUSA And The "In Connection With" Requirement

The litigation arising out of the research analyst scandals (where major investment banks have been accused of disseminating overly optimistic research and investment recommendations to garner investment banking business) continues to raise interesting legal issues. Both the Second and Third Circuits, for example, have recently addressed whether the Securities Litigation Uniform Standards Act of 1998 (SLUSA) mandates the dismissal of class actions based upon state law seeking to recover various types of damages related to the allegedly biased research.

SLUSA preempts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In Dabit v. Merrill Lynch, 2005 WL 44434 (2d Cir. Jan. 11, 2005), the Second Circuit addressed two state class actions (brought on behalf of Merrill Lynch brokers and brokerage customers respectively) alleging losses based on biased research. In both cases, the plaintiffs generally did not dispute that the lawsuits were covered class actions and concerned covered securities. The issue was whether Merrill Lynchs alleged misrepresentations were in connection with the purchase or sale of those securities. The court held that to be prohibited under SLUSA an action must allege a purchase or sale of covered securities made by the plaintiff or members of the alleged class. As for the brokers, the court found that the proposed class of brokers who were injured by holding the recommended stocks included purchasers and therefore, in part, satisfied the in connection with requirement. Because the court could not distinguish any non-preempted subclass, SLUSA requires that the claim be dismissed. A separate claim regarding commissions lost by the brokers when their customers left Merrill Lynch due to the scandal, however, was allowed to proceed in state court.

The brokerage customers also received a mixed decision. The Second Circuit followed a number of other circuits in finding that the claims based on commissions paid to Merrill Lynch in reliance on the research were preempted because they necessarily involve allegations of a purchase or sale in connection with this alleged misconduct. In contrast, the claims related to the annual fees paid by the customers were not preempted because the fees were paid whether or not the customer transacts in the account, and the misrepresentations inherent in the alleged nonperformance and statutory violations therefore do not necessarily coincide with a securities transaction.

Last week, the Third Circuit addressed the same issues and came to similar conclusions. In Rowinski v. Salomon Smith Barney, Inc., 2005 WL 356810 (3rd Cir. Feb. 16, 2005) a putative class of Salomon brokerage customers brought a class action in Pennsylvania state court alleging that the companys dissemination of biased investment research breached the parties service contract, unjustly enriched Salomon, and violated state consumer protection law. The plaintiffs sought an amount equal to the amount of any and all fees and charges collected from the class by Salomon. The court held that the in connection with the purchase or sale requirement under SLUSA must, as it is in the context of Rule 10b-5 actions, be broadly interpreted. Looking at a number of factors, including whether the fraudulent scheme coincided with the purchase or sale of securities and whether the nature of the parties relationship was such that it necessarily involved the purchase or sale of securities, the court found that the class action fell well within the bounds of SLUSA and upheld its dismissal.

Quote of note (Rowinski): Plaintiff also contends that as master of his own complaint, he is entitled to plead around SLUSA. But SLUSA stands as an express exception to the well-pleaded complaint rule, and its preemptive force cannot be circumvented by artful drafting. In this context where Congress had expressly preempted a particular class of state law claims the question is not whether a plaintiff pleads or omits certain key words or legal theories, but rather whether a reasonable reading of the complaint evidences allegations of a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security.

Posted by Lyle Roberts at 11:13 PM | TrackBack

February 8, 2005

That's A Lot Of Underpants

Under the PSLRA, plaintiffs must plead facts creating a strong inference that the defendants acted with scienter (i.e., fraudulent intent) to survive a motion to dismiss. Several courts have found that the sheer size of an alleged financial fraud can support a finding of fraudulent intent. In a recent decision, however, the U.S. Court of Appeals for the Sixth Circuit has disagreed.

In Fidel v. Farley, 2004 WL 2901274 (6th Cir. Dec. 16, 2004), the plaintiffs argued that the magnitude of the financial fraud allegedly perpetrated by Fruit of the Loom, including a write-down of over $220 million of inventory in 1999, supported an inference that the company's auditors had acted with scienter. The court found that "[a]llowing an inference of scienter based on the magnitude of fraud 'would eviscerate the principle that accounting errors alone cannot justify a finding of scienter.'" Moreover, the fact that Fruit of the Loom took the write-offs in 1999, "in no way implied that [the auditors] acted with scienter while auditing the 1998 financial data."

Holding: Dismissal affirmed.

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January 26, 2005

Transcript Of Dura Argument

Did The 10b-5 Daily's summary of the Dura Pharmaceuticals v. Broudo oral argument get it right? Here's a chance to find out: the U.S. Supreme Court has posted the transcript. Thanks to Richard Zelichov for pointing out the link.

Posted by Lyle Roberts at 8:48 PM | TrackBack

January 21, 2005

Loss Causation And The Research Analyst Cases

The general theme of the research analyst cases is straightforward: the defendants allegedly committed fraud by disseminating research reports that they knew to be overly optimistic. A key question, however, has been whether the subsequent decline in the company's stock price was caused by the research reports. In an important decision, the U.S. Court of Appeals for the Second Circuit has affirmed the dismissal of two research analyst cases based on the plaintiffs' failure to adequately plead loss causation.

The appeal was from Judge Pollack's seminal decision in June 2003 dismissing the securities class actions brought against Merrill Lynch based on allegedly biased research reports concerning 24/7 Real Media, Inc. and Interliant, Inc. Judge Pollack found that the plaintiffs had failed to adequately allege loss causation because there was no alleged connection between the analyst reports and the companies' financial troubles or the collapse of the overall market. (See this post, among others, for a discussion of the decision.)

In Lentell v. Merrill Lynch & Co., 2005 WL 107044 (2d Cir. Jan. 20, 2005), the Second Circuit affirmed Judge Pollack's ruling. The court held that to establish loss causation, a plaintiff must allege that the subject of the misrepresentation was the cause of the actual loss suffered. In other words, the misrepresentation must have "concealed something from the market that, when disclosed, negatively affected the value of the security." In these cases, however, the court found there was "no allegation that the market reacted negatively to a corrective disclosure regarding the falsity of Merrill's 'buy' and 'accumulate' recommendations and no allegation that Merrill misstated or omitted risks that did lead to the loss." Accordingly, the plaintiffs failed to adequately plead loss causation.

The Second Circuit's decision would appear to have two potential impacts. First, it will make it difficult for the numerous other research analyst cases to go forward. The plaintiffs will need to adequately allege that either: (1) the disclosure of the false recommendations caused a stock price decline; or (2) the recommendations concealed risks about the stocks that later lead to a loss. Certain complaints, however, may satisfy these requirements (see the roundup of cases in this post). Second, the decision could affect the Supreme Court's pending ruling in the Dura loss causation case. Although the Second Circuit does not alter its previous position on loss causation (rejecting the price inflation theory), the case illustrates the serious impact that loss causation standards can have on securities fraud litigation.

Quote of note: "We are told that Merrill's 'buy' and 'accumulate' recommendations were false and misleading, and that the Firm failed to disclose conflicts of interest, salary arrangements, and collusive agreements among analysts, bankers, and 24/7 Media and Interliant. But plaintiffs nowhere explain how or to what extent those misrepresentations and omissions concealed the risk of a significant devaluation of 24/7 Media and Interliant securities. The reports indicate that 24/7 Media and Interliant were high-risk investments, a designation that specifies, inter alia, a 'high potential for price volatility,' and 'no proven track record of earnings.' And the unchallenged financial analyses presented (e.g., negative EPS ratios and consistent quarterly losses) certainly indicate weakness."

Addition: The New York Law Journal has an article (via law.com - free regist. req'd) on the decision. Thanks to all of the The 10b-5 Daily's readers who sent in the opinion.

Posted by Lyle Roberts at 4:02 PM | TrackBack

January 19, 2005

Third Circuit On Confidential Sources

Barred from taking discovery until after a motion to dismiss has been decided, plaintiffs frequently attempt to meet the PSLRA's heightened pleading standards for securities fraud by citing statements from confidential sources (often former or current employees of the defendant corporation). In its seminal decision in Novak v. Kasaks, the Second Circuit found that it was not necessary to name these confidential sources "provided that they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged."

The Third Circuit has now weighed in on the issue. In California Public Employees' Retirement System v. The Chubb Corp., 2004 WL 3015578 (3rd Cir. Dec. 30, 2004), the court adopted the Novak standard, but also stated that this standard requires "an examination of the detail provided by the confidential sources, the sources' basis of knowledge, the reliability of the sources, the corrobative nature of other facts alleged, including from other sources, the coherence and plausibility of the allegations, and similar indicia." After engaging in this rigorous examination, the court rejected most of the allegations based on confidential sources contained in the complaint. The opinion is notable for its in-depth discussion of different types of confidential sources, including former employees at various levels within Chubb's corporate organization, and what knowledge reasonably can be imputed to them.

Holding: Dismissal affirmed.

Quote of note: "Citing to a large number of varied sources may in some instance help provide particularity, as when the accounts supplied by the sources corroborate and reinforce one another. In this case, however, the underlying prerequisite - that each source is described sufficiently to support the probability that the source possesses the information alleged - is not met with respect to the overwhelming majority of Plaintiffs' sources. Cobbling together a litany of inadequate allegations does not render those allegations particularized in accordance with Rule 9(b) or the PSLRA."

Posted by Lyle Roberts at 7:42 PM | TrackBack

January 14, 2005

Seventh Circuit Agrees: No Revival Of Time-Barred Claims

The U.S. Court of Appeals for the Seventh Circuit is the latest court to hold that the Sarbanes-Oxley Act of 2002, which extended the statute of limitations for federal securities fraud actions, did not revive previously time-barred claims. In Foss v. Bear, Stearns & Co., Inc., 2005 WL 43724 (7th Cir. Jan 11, 2005), the court found the Second Circuit's recent decision in the Enterprise Mortgage case (posted about here) "persuasive" on this issue and noted that it had "nothing to add."

Posted by Lyle Roberts at 7:21 PM | TrackBack

January 12, 2005

Notes From The Dura Argument

Oral argument in the Dura Pharmaceuticals v. Broudo case took place in the U.S. Supreme Court this morning (links to all of the main briefs can be found here). The question presented was: "Whether a securities fraud plaintiff invoking the fraud-on-the-market theory must demonstrate loss causation by pleading and proving a causal connection between the alleged fraud and the investment's subsequent decline in price."

Chief Justice Rehnquist did not attend the hearing, but reserved his right to participate in the decision. Argument was heard from counsel for Dura Pharmaceuticals, the U.S. government (in support of Dura's position), and Broudo. Here are a few notes on the main issues that were discussed:

Overall Impressions - Predicting how the Supreme Court will rule based on oral argument is a tricky business. That said, the Court appeared likely to reject the 9th Circuit's price inflation theory of loss causation. Whether the Court will attempt to lay out what a plaintiff in a fraud-on-the-market case must plead as to loss causation to survive a motion to dismiss, however, was unclear.

Dura's Position - Consistent with their briefs, Dura's counsel argued that a loss only occurs when a corrective disclosure is made. Justice Breyer posed the following hypothetical - a company says it has found gold and its stock price is $60; the company later discloses that no gold has been discovered and the stock price declines to $10; the loss is clearly $50. But what if the gold never existed but the company finds platinum and the stock price rises to $200? Are plaintiffs permitted to show that the stock price would have been $250 if the company had also found gold? Dura's counsel did not disagree that it might be possible to demonstrate loss causation under these circumstances, but argued that there would need to be a disclosure about the absence of gold.

Difference Between Dura And Government? - Justice Ginsburg, in particular, noted that there appeared to be a difference between Dura's position and the one put forward by the government, because the government allowed for the possibility that something other than a corrective disclosure might be sufficient to establish loss causation. Justice Scalia emphasized that plaintiffs simply need to show that the market knows the truth, however that truth comes to be revealed.

Government's Position - The government's counsel then argued that to establish loss causation, plaintiffs must demonstrate that the price inflation caused by any misrepresentation was removed or reduced by the dissemination of corrective information (but there is no need for a formal disclosure from the company).

Rule 8 vs. Rule 9(b) - Having established its basic position, the government's counsel found himself in the awkward position of spending most of his time defending a proposition of law that was not really briefed in the case. At least two justices, Ginsburg and Stevens, appeared to feel strongly that the pleading of loss causation is only subject to the notice pleading requirements of Fed. R. Civ. P. 8. The government's counsel countered that, as an element of fraud, loss causation must be plead with particularity pursuant to Fed. R. Civ. P. 9(b) and it was important to make an assessment about loss causation at the pleading stage of a case before defendants are forced to pay millions in discovery costs or settlement of the claims.

Need A Viable Theory of Loss? - Even if Broudo was only required to engage in notice pleading on the issue of loss causation, Justice Breyer questioned whether the complaint still needed to articulate a viable theory of loss. Broudo's counsel conceded that the complaint could have contained more on this point, but later noted that the pleading was in conformity with 9th Circuit law at the time it was filed.

When Does Loss Occur? - As expected, a large portion of the argument concerned whether the 9th Circuit's price inflation theory of loss causation (i.e., that the loss occurs, and a viable claim exists, at the time the purchaser buys the stock at an artificially inflated price) is correct. Broudo's counsel argued in favor of the 9th Circuit's position, but conceded that to show recoverable damages the plaintiffs would eventually have to establish that the inflation in the stock price was reduced or eliminated. A number of justices expressed skepticism that there could be any cause of action for fraud prior to actual damages having been suffered. Justices Souter and Scalia suggested that the inflation in the stock price simply established the limit of the potential loss, not that any loss had occurred. Justice Scalia also wondered whether the entire case was simply a "great misunderstanding," since the parties both agreed that plaintiffs would eventually have to establish that the inflation in the stock price was reduced or eliminated. Broudo's counsel noted, however, that there was also an issue over what plaintiffs needed to plead in their complaint on this issue and it may be possible for "lowered expectations" to result in stock price drops that are related to the fraud, even though the fraud is not revealed.

Posted by Lyle Roberts at 3:15 PM | TrackBack

January 10, 2005

Circuit Split On Safe Harbor

The PSLRA created a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. Under the first prong of the safe harbor, a defendant is not liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by "meaningful cautionary statements" that alert investors to the factors that could cause actual results to differ.

As discussed in a post in The 10b-5 Daily from last August entitled "The Safe Harbor May Just Be A Safe Puddle," the U.S. Court of Appeals for the Seventh Circuit has weakened the protection afforded by the safe harbor. In Asher v. Baxter International, the court found that may be impossible, on a motion to dismiss, to determine whether a company's cautionary statements are "meaningful."

The New York Law Journal has an article (via law.com - free regist. req'd) discussing the Seventh Circuit's decision and comparing it to a contrary decision issued by the Second Circuit last year. Baxter International apparently has indicated that it will appeal to the U.S. Supreme Court and the article suggests that this could be the next securities litigation issue, after loss causation in the Dura case, that the Court hears.

Posted by Lyle Roberts at 8:16 PM | TrackBack

January 7, 2005

Dura Preview

The National Law Journal has a solid preview (via law.com - free regist. req'd) of the Supreme Court argument in Dura Pharmaceuticals v. Broudo. Counsel for both parties in the case, which addresses the issue of loss causation, are quoted extensively. The argument will take place next Wednesday.

Posted by Lyle Roberts at 6:42 PM | TrackBack

January 5, 2005

Dura Reply Brief

Securities litigators eagerly awaiting oral argument in Dura Pharmaceuticals v. Broudo, the loss causation case currently before the U.S. Supreme Court, will want to take a look at Dura's reply brief (this post has links to the earlier briefs). The argument will take place on January 12, 2005. Thanks to SecuritiesLawblog for the link.

Posted by Lyle Roberts at 6:10 PM | TrackBack

January 3, 2005

Restating Your CEO's Resume

The chief executive officer ("CEO") of MCG Capital Corp. ("MCG") misled his company into believing that he had an undergraduate degree in economics from Syracuse University. MCG repeated this false statement in its SEC filings. Once the CEO admitted the truth, MCG corrected its public statements and the company's stock price declined. A securities class action suit filed in the E.D. of Va. soon followed. The district court dismissed the case, finding that the CEO's educational background was immaterial as a matter of law. Plaintiffs appealed.

In Greenhouse v. MCG Capital Corp., 2004 WL 2940871 (4th Cir. Dec. 21, 2004), the U.S. Court of Appeals for the Fourth Circuit has affirmed the district court's decision. The court held that an action brought pursuant to Rule 10b-5 must "allege a fact that is both untrue and material." It follows that Rule 10b-5 "does not prohibit any misrepresentation - no matter how willful, objectionable, or flatly false - of immaterial facts, even if it induces reactions from investors that, in hindsight or otherwise, might make the misrepresentation appear material." The court went on to find that although the statements made about the CEO's educational background were clearly false, they were immaterial because there was no credible basis for believing that the CEO's lack of an undergraduate degree would have altered the "total mix" of information available to investors about the company.

Holding: Affirming dismissal.

Quote of note: "In conclusion, while we acknowledge that [the CEO's] lie is indefensible, it does not follow invariably that it is illegal. We hold that, viewed properly, it is not substantially likely that reasonable investors would devalue the stock knowing that [the CEO] skipped out on his last year at Syracuse. That is, if one imagines a parallel universe of affairs where the one and only thing different was that MCG's filings made no mention of [the CEO's] education (or, instead, said simply that he 'attended' Syracuse or 'studied economics' there), we find it incredible to believe that MCG's stock would be worth even a penny more to a reasonable investor."

Posted by Lyle Roberts at 8:13 PM | TrackBack

December 16, 2004

For Whom The Case Tolls

The U.S. Court of Appeals for the Third Circuit has issued an interesting decision on the tolling of the statute of limitations for class claims. In Yang v. Odom, No. 03-2951 (3rd Cir. Dec. 15, 2004), the court found that "where class certification has been denied solely on the basis of the lead plaintiffs' deficiencies as class representatives, and not because of the suitability of the claims for class treatment," the statute of limitations is tolled for subsequent class claims from the commencement of the earlier case until there is a final adverse determination of the earlier class claims. As a result of this holding, the plaintiffs will be able to proceed with their securities class action brought in the D. of N.J. even though a "substantively identical" securities class action brought in the N.D. of Ga. had previously had been denied class certification. (Note that there appears to be a circuit split on this issue that is discussed in the opinion.)

Quote of note: "Drawing the line arbitrarily to allow tolling to apply to individual claims but not to class claims would deny many plaintiffs with small, potentially meritorious claims the opportunity for redress simply because they were unlucky enough to rely upon an inappropriate lead plaintiff. For many, this would be the end result, while others would file duplicative protective actions in order to preserve their rights lest the class representative be found deficient under [F.R.C.P.] 23."

Thanks to Adam Savett for sending in the case.

Addition: The Legal Intelligencer has an article (via law.com - free regist. req'd) on the decision.

Posted by Lyle Roberts at 7:42 PM | TrackBack

December 7, 2004

Second Circuit Declines To Revive Time-Barred Claims

The Sarbanes-Oxley Act of 2002 extends the statute of limitations for federal securities fraud to the earlier of two years after the discovery of the facts constituting the violation or five years after the violation. Although the legislation clearly provides that it "shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002]," left unresolved is whether Congress intended to revive claims that had already expired under the earlier one year/three years statute of limitations.

A growing majority of district courts has held that these claims must be dismissed. The U.S. Court of Appeals for the Second Circuit agrees. In In re Enterprise Mortgage Acceptance Co., LLC, Sec. Litig., 2004 WL 2785776 (2nd Cir. Dec. 6, 2004), the court, which combined a number of cases presenting this issue into one decision, held that Congress did not clearly provide or intend for retroactive application of the new statute of limitations. Accordingly, the court declined to revive any previously time-barred claims. (Note that this issue is also currently before the Eleventh Circuit.)

Holding: Dismissals affirmed.

Addition: In reaching its decision, the Second Circuit took judicial notice of the amicus brief filed by the SEC in the AIG Asian Infrastructure case, which urged the court to hold that Sarbanes-Oxley revived previously time-barred claims. The court rejected the SEC's position and noted that the SEC was not entitled to any deference on the issue given that the new statute of limitations is only applicable to private actions, and not to SEC enforcement actions.

Posted by Lyle Roberts at 6:35 PM | TrackBack

December 6, 2004

Two On Falsity

Two circuit court opinions were issued last week affirming dismissals based on the plaintiffs' failure to adequately plead that any false or misleading statements were made.

In the 8th Circuit case, In re Amdocs Ltd. Sec. Litig., 2004 WL 2735530 (8th Cir. Dec. 2, 2004), the court held that the "bespeaks caution" doctrine rendered Amdocs' statements about its customer demand immaterial as a matter of law because the statements were accompanied by warnings of market erosion.

In the 4th Circuit case, Nolte v. Capital One Financial Corp., 2004 WL 2749867 (4th Cir. Dec. 2, 2004), the court held that the plaintiffs had failed to adequately allege that Capital One's management did not believe its stated opinions about the sufficiency of the company's reserves and computer infrastructure. Moreover, the plaintiffs could not rely on a memorandum of understanding with federal regulators that required Capital One to make prospective changes to its business to establish that the company's past practices were deficient.

Posted by Lyle Roberts at 7:34 PM | TrackBack

December 3, 2004

Is A Billion Dollars In Stock Sales Significant?

Insider stock sales are often used by plaintiffs to establish that the individual defendants had a motive to artificially inflate the company's stock price. As a general matter, however, courts have held that insider stock sales cannot create an inference of fraudulent intent if the defendants only sold a small percentage of their overall holdings.

In its recent decision in Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226 (9th Cir. 2004), the Ninth Circuit purported to discover an exception to the rule. Larry Ellison, the CEO of Oracle, was alleged to have sold only 2.1% of his holdings during the class period, but that amounted to almost $900 million in proceeds. The court held that "where, as here, stock sales result in a truly astronomical figure, less weight should be given to the fact that they may represent a small portion of the defendant's holdings." But is that a sensible exception?

The Delaware Court of Chancery, which addressed the exact same stock sales in its recent summary judgment decision in In re Oracle Corp. Derivative Litigation, C.A. No. 18751 (Del. Ch. Dec. 2, 2004), appears to disagree. The court found that "however wealthy Ellison is and however envious that may make some, the fact remains that Ellison sold only 2% of his Oracle holdings. Ellison remained the person with more equity at stake in Oracle than anyone anywhere. Plaintiffs continually emphasize the nearly $1 billion that he made on the sale, but ignore the roughly $18.9 billion in equity that he lost in the ensuing share price collapse." In other words, a billion dollars in stock sales may be significant for most people, but not necessarily for everyone.

Addition: The Delaware Court of Chancery's decision can be found here. Thanks to Adam Savett for the link.

Posted by Lyle Roberts at 4:03 PM | TrackBack

November 22, 2004

Broudo Briefs

The respondents' brief has been filed in Dura Pharmaceuticals v. Broudo, the loss causation case currently before the U.S. Supreme Court. Amicus briefs in support of Broudo's position have been filed by the National Association of Shareholder and Consumer Attorneys, the New Jersey Department of the Treasury and its Division of Investment, and the Regents of the University of California (links will be posted when available - click here for the petitioners' brief).

Oral argument is set for January 12, 2005. The question presented is: "Whether a securities fraud plaintiff invoking the fraud-on-the-market theory must demonstrate loss causation by pleading and proving a causal connection between the alleged fraud and the investment's subsequent decline in price."

Addition: The amicus brief filed by the National Association of Shareholder and Consumer Attorneys and two other public interest organizations can be found here.

Posted by Lyle Roberts at 8:25 PM | TrackBack

October 25, 2004

Who Is A Primary Violator?

In Central Bank, the U.S. Supreme Court held that private action under Rule 10b-5 can only be brought against persons who are primary violators and not against those who aid and abet a primary violator. How to tell the difference between a primary violator and an aider and abettor, however, has been the subject of much debate.

The SEC has filed an amicus brief in the Homestore securities litigation currently pending before the U.S. Court of Appeals for the Ninth Circuit that urges the court to adopt a broad test for determining who is a "primary violator." The lower court dismissed the claims against three companies - AOL Time Warner, Cendant, and L90 (as well as a few of their executives) - that were Homestore's business partners in transactions whose alleged purpose was to inflate Homestore's revenues. The lower court reasoned that these business partners could not be primary violators because they did not have a special relationship with Homestore (e.g., accountant or attorney).

The plaintiffs appealed these dismissals. In support of the plaintiffs, the SEC argues that Central Bank did not create a "special relationship" test for a primary violator and that engaging in a transaction whose purpose was to create a false appearance of revenues constitutes a deceptive act that can support primary liability.

Quote of note: "The Commission urges the following test for determining when a person's conduct as part of a scheme to defraud constitutes a primary violation: Any person who directly or indirectly engages in a manipulative or deceptive act as part of a scheme to defraud can be a primary violator of Section 10(b) and Rule 10b-5; any person who provides assistance to other participants in a scheme but does not himself engage in a manipulative or deceptive act can only be an aider and abettor."

Posted by Lyle Roberts at 9:09 PM | TrackBack

October 22, 2004

Sixth Circuit Embraces Collective Scienter

The "collective scienter" theory is beginning to gain a foothold in securities litigation caselaw, even if courts are not expressly acknowledging the nature of their holdings. As a general matter, whether a defendant corporation has acted with scienter (i.e., fraudulent intent) is determined by looking "to the state of mind of the individual corporate official or officials who make or issue the statement . . . rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment." Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004). Another way of putting this is that courts recognize corporations only act through their officers and directors, and, therefore, can only be held liable for fraud if one or more of those individuals can be held liable for fraud. A steady trickle of decisions, however, appears to be rejecting this principle in favor of a collective scienter theory.

The U.S. Court of Appeals for the Sixth Circuit recently affirmed the dismissal of a securities class action against Ford based on statements relating to faulty tires, but the manufacturer of those tires has not been as fortunate. In City of Monroe Employees Retirement System v. Bridgestone Corp., No. 03-5505 (6th Cir. 2004), the court found that some of the statements made by Bridgestone and its wholly-owned subsidiary, Firestone, were actionable. On the issue of scienter, the court examined the state of mind of the corporate entities separately from the state of mind of the sole individual defendant (Firestone's CEO). The court concluded that scienter was adequately plead against Bridgestone and Firestone, even though it failed to identify any individual officers or directors who acted with scienter. Moreover, the court rejected the scienter allegations against Firestone's CEO and affirmed the dismissal of the claims against him. Leading to the inevitable question: if an officer makes the statement and a janitor knows the statement is false, has the corporation acted with fraudulent intent?

Holding: Affirmed in part and reversed in part.

Posted by Lyle Roberts at 7:59 PM | TrackBack

September 20, 2004

Dura Briefs

The first set of briefs have been filed in Dura Pharmaceuticals v. Broudo, the loss causation case currently before the U.S. Supreme Court. Available on the web are Dura's brief, along with amicus briefs from the Department of Justice and the SEC, the Chamber of Commerce of the United States, the Securities Industry Association and Bond Market Association, the American Institute of Certified Public Accountants, and Technology Network. (The Washington Legal Foundation, Broadcom, and Merrill Lynch also filed amicus briefs and links will be posted when available.)

Dura and its supporters argue that, contrary to the Ninth Circuit's holding, a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead and prove loss causation. Broudo's time to respond has been extended until November 17.

Addition: The Merrill Lynch brief can be found here. (Thanks to Adam Savett for the link.) The Washington Legal Foundation brief can be found here. (Thanks to Glenn Lammi for the link.)

Posted by Lyle Roberts at 8:50 PM | TrackBack

September 17, 2004

Waiving Privilege In Government Investigations

The battle in the McKesson HBOC securities litigation over whether providing investigatory reports to the SEC and the DOJ constitutes a waiver of attorney-client privilege continues - now in federal court. Last February, the California Court of Appeal held in a case involving McKesson that providing investigatory reports to government entities was a waiver under California law.

Some of McKesson's former executives have been indicted by the DOJ and also want access to the reports. A federal district court agreed with the California Court of Appeal that the privilege had been waived, but McKesson wants to prevent the reports from going to the shareholder plaintiffs who have brought cases against it in federal court. McKesson appealed the decision and the SEC is supporting the company's position. The Recorder has an article (via law.com - free regist. req'd) on the recent hearing before the U.S. Court of Appeals for the Ninth Circuit.

Quote of note: "White-collar practitioners are closely watching the case, U.S. v. Bergonzi, 03-10511, because it highlights the collision of civil and criminal prosecutions in cases of alleged corporate wrongdoing. Companies share internal reports in order to win favor with government investigators. But if those reports end up exposing them to liability in securities fraud suits, they may not be as cooperative on the criminal side."

Posted by Lyle Roberts at 9:24 PM | TrackBack

September 14, 2004

First Circuit On Safe Harbor

In the Baxter decision issued in July, the U.S. Court of Appeals for the Seventh Circuit severely limited the application of the PSLRA's safe harbor by holding that it may be impossible, on a motion to dismiss, to determine whether a company's cautionary statements are "meaningful." Baxter may turn out to be influential, but for the moment other appellate courts are continuing to affirm dismissals based on the safe harbor.

In Baron v. Smith, 2004 WL 1847751 (1st Cir. Aug. 18, 2004) the U.S. Court of Appeals for the First Circuit addressed claims based on forward-looking statements in a press release. The court cited the company's safe harbor language and found that to "the extent that plaintiffs seek to state a claim under the securities laws for a deceptive press release or as an indication that the company omitted material information from its filings, we agree with the district court that the press release contained forward-looking statements, as stated therein, and therefore comes under the protection of the statutory safe harbor."

Holding: Affirming grant of motion to dismiss.

Posted by Lyle Roberts at 12:15 AM | TrackBack

September 2, 2004

Oracle Dismissal Reversed On Appeal

In a high-profile securities class action brought against Oracle Corp., the U.S. Court of Appeals for the Ninth Circuit has reversed the lower court's decision to dismiss the case with prejudice. The issue on appeal was whether the plaintiffs had plead a strong inference of scienter (i.e., fraudulent intent) as required by the PSLRA. The decision can be found here and The Recorder has an article (via law.com - free regist. req'd) summarizing the holding.

Posted by Lyle Roberts at 9:11 PM | TrackBack

September 1, 2004

SEC Weighs In On The Revival Of Time-Barred Claims

The Sarbanes-Oxley Act of 2002 extends the statute of limitations for federal securities fraud to the earlier of two years after the discovery of the facts constituting the violation or five years after such violation. Although the legislation clearly provides that it "shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002]," left unresolved is whether Congress intended to revive claims that had already expired under the earlier one year/three years statute of limitations. District courts are split (although the trend appears to be against reviving time-barred claims) and the issue is currently before the U.S. Court of Appeals for the 11th Circuit.

In the midst of this debate, the Wall Street Journal reports (subscrip. req'd) that the SEC has filed an amicus brief in the U.S. Court of Appeals for the Second Circuit arguing that Sarbanes-Oxley did revive time-barred claims. The SEC's primary argument is that Congress was not required to specifically express its "retroactive intent" and the "natural meaning of the statutory language" supports its position. The underlying case, AIG Asian Infrastructure Fund, L.P. v. Chase Manhattan Asia Limited, et al., alleges Rule 10b-5 violations based on a 1998 purchase of securities.

Addition: In related news, the Legal Intelligencer has an article (via law.com - free regist. req'd) today on a district court decision (from the E.D. of Pa.) that rejects the revival of time-barred claims.

Posted by Lyle Roberts at 7:38 PM | TrackBack

August 24, 2004

Ford Dismissal Upheld

The U.S. Court of Appeals for the Sixth Circuit has upheld the dismissal of a securities class action originally brought against Ford Motor Co. in 2000. The plaintiffs alleged that Ford failed to disclose safety problems with the tires on its Ford Explorer vehicles (prior to a tire recall) and failed to account for the possibility of future recall costs as a loss contingency.

In its decision (In re Ford Motor Co. Sec. Litig., 2004 WL 1873808 (6th Cir. August 23, 2004)), the court found that none of the alleged misrepresentations were actionable. Most of the statements were "either mere corporate puffery or hyperbole" and did not specifically address the safety of Ford Explorers. As for the few statements that did talk about the safety of Ford Explorers, the court held that the plaintiffs failed to establish that these statements were knowingly or recklessly false. Ford also warned investors about potential recall costs and the plaintiffs did not "allege any facts that establish that anyone at Ford thought or anticipated a massive recall of tires was necessary in the United States before the recall was announced."

Holding: Motion to dismiss with prejudice affirmed.

The Associated Press has an article on the decision.

Posted by Lyle Roberts at 7:11 PM | TrackBack

August 2, 2004

The Safe Harbor May Just Be A Safe Puddle

The PSLRA created a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. Under the first prong of the safe harbor, a defendant is not liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by "meaningful cautionary statements" that alert investors to the factors that could cause actual results to differ.

In a controversial decision, the U.S. Court of Appeals for the Seventh Circuit has held that it may be impossible, on a motion to dismiss, to determine whether a company's cautionary statements are "meaningful." In Asher v. Baxter Intern. Inc., 2004 WL 1687885 (7th Cir. July 29, 2004), the court addressed whether Baxter's published risk factors were sufficient to foreclose liability for its allegedly false financial projections. The court, in an opinion authored by Judge Easterbrook, made three important holdings:

(1) The plaintiffs relied on the fraud-on-the-market theory (i.e., reliance by investors on an alleged misrepresentation is presumed if the company's shares were traded on an efficient market) in bringing their claims. The court found that an "investor who invokes the fraud-on-the-market theory must acknowledge that all public information is reflected in the price." Accordingly, a company's cautionary statements, no matter where found, "must be treated as if attached to every one of its oral and written statements."

(2) A company does not have to have "prevision." It is enough for the cautionary statements "to point to the principal contingencies that could cause actual results to depart from the projection."

(3) Nevertheless, the court found that Baxter's cautionary statements, though company-specific and not boilerplate, may have fallen short because there "is no reason to think - at least, no reason that a court can accept at the pleading stage, before plaintiffs have access to discovery - that the items mentioned in Baxter's cautionary language were those thought at the time to be the (or any of the) 'important' sources of variance." The court noted that Baxter's cautionary language had remained fixed even as the risks faced by the company changed.

Prior to Baxter, numerous courts had dismissed cases pursuant to the first prong of the Safe Harbor (see, e.g., the Blockbuster decision discussed in this post). The Seventh Circuit's holding cuts sharply against the prevailing judicial trend and weakens the protections of the Safe Harbor. Will other circuit courts adopt the Seventh Circuit's reasoning?

Quote of note: "What [plaintiffs] do say is that the projections were too rosy, and that Baxter knew it. That charges the defendants with stupidity as much as with knavery, for the truth was bound to come out quickly, but the securities laws forbid foolish frauds along with clever ones."

Quote of note II: "[A] word such as 'meaningful' resists a concrete rendition and thus makes administration of the safe harbor difficult if not impossible. It rules out a caution such as: 'This is a forward-looking statement: caveat emptor.' But it does not rule in any particular caution, which always may be challenged as not sufficiently 'meaningful' or not pinning down the 'important factors that could cause actual results to differ materially'--for if it had identified all of those factors, it would not be possible to describe the forward-looking statement itself as materially misleading."

Posted by Lyle Roberts at 8:33 PM | TrackBack

July 2, 2004

Appealing A SLUSA Remand

The Second and Ninth Circuits previously have held that a district court's decision to remand a case that has been removed under the Securities Litigation Uniform Standards Act of 1998 ("SLUSA") is not appealable. In a decision issued this week, the Seventh Circuit has disagreed.

SLUSA generally prohibits the bringing of a securities class action based on state law in state court. The defendants are permitted to remove the case to federal district court for a determination on whether the case is preempted by the statute. If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.

A remand based on a district court's decision that it does not have subject-matter jurisdiction over a case cannot be reviewed on appeal. In Kircher v. Putnam Funds Trust, 2004 WL 1470350 (7th Cir. June 29, 2004), however, the Seventh Circuit found that this general proposition is inapplicable to a case removed and remanded under SLUSA. The Supreme Court "has observed that a court lacks 'subject-matter jurisdiction' only when Congress has not authorized the federal judiciary to resolve the sort of issue presented by the case (or the Constitution forbids adjudication)." In contrast, SLUSA expressly authorized the district court to accept the removal of the Kircher case and "[o]nly after making the substantive decision that Congress authorized it to make [i.e., whether the case was preempted] did the district court remand." This means that the district court had "no adjudicatory competence to do more," the Seventh Circuit concluded, not that it lacked subject-matter jurisdiction. Accordingly, a SLUSA remand may be appealed.

Holding: Appeal will proceed to briefing and a decision on the merits.

Quote of note: "Both the second and ninth circuits were mesmerized by the word 'jurisdiction' and did not see the difference between a case that never should have been removed and a case properly removed and remanded only when the federal job is done."

Quote of note II: "Appellate consideration of what amounts to a venue dispute slows things down to little good end, for the state court is competent to address the merits. SLUSA means, however, that one specific substantive decision in securities litigation must be made by the federal rather than the state judiciary. Appellate review of decisions under [SLUSA] will promote accurate and consistent implementation of that statute, at little cost in delay beyond what the authorized removal itself creates."

Posted by Lyle Roberts at 7:03 PM | TrackBack

June 28, 2004

Supreme Court To Address Circuit Split on Loss Causation

It turns out that the combination of a clear circuit split, the U.S.'s encouragement, and yet another opportunity to overturn the Ninth Circuit, is irresistible. (See this post.) The Associated Press reports that the Supreme Court has granted the cert petition filed by the defendants in the Dura Pharmaceuticals securities litigation, which should lead to a resolution of the circuit split over what is necessary to adequately plead loss causation in a securities fraud case.

A majority of circuit courts hold that a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead loss causation, while a minority of circuit courts hold that a plaintiff merely needs to demonstrate that the alleged misrepresentations artificially inflated the stock price. In Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003), the Ninth Circuit came down squarely in favor of the minority position.

The court found that loss causation "merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause." Based on this holding, the Ninth Circuit reversed the lower court's dismissal and remanded the case for further proceedings. The defendants petitioned for a writ of certiorari to the Supreme Court. The U.S. (the SEC and the Solicitor General) later filed an amicus brief in support of the petition, arguing that the case was wrongly decided and the Supreme Court should adopt the majority position. Will it? Stay tuned.

Posted by Lyle Roberts at 11:15 PM | TrackBack

June 23, 2004

Just The Fact(s)

In an unusual opinion, the U.S. Court of Appeals for the Eleventh Circuit has clarified its position on the pleading of scienter (i.e., fraudulent intent) under the PSLRA. The district court in the Scientific-Atlanta securities litigation had denied the defendants' motion to dismiss, finding that "although individual allegations in the complaint, considered in isolation, may not have given rise to a strong inference of scienter, the allegations created such an inference when viewed collectively." The defendants petitioned for interlocutory appeal, which the district court certified on the narrow question of whether factual allegations may be aggregated to create the necessary strong inference.

In Phillips v. Scientific-Atlanta, Inc., 2004 WL 1382906 (11th Cir. June 22, 2004) the Eleventh Circuit affirmed the lower court's ruling. The PSLRA states that the complaint "shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." As a threshold matter, the court noted "the Defendants have largely conceded the narrow, certified question and have attempted to parlay the appeal into a much broader review of the district court." Under these circumstances, the court had little difficulty joining a number of other circuits in finding that nothing in the PSLRA suggests that scienter may only be inferred from individual facts.

The court also went beyond the certified question and found that scienter must be adequately plead with respect to each defendant and with respect to each alleged violation. In the instant case, however, "Plaintiffs' complaint sufficiently alleges facts giving rise to a strong inference of scienter on the part of each defendant alleged to have committed each violation of the statute."

Holding: Denial of motion to dismiss affirmed.

Quote of note: "We believe that the plain meaning of the statutory language compels the conclusion that scienter must be alleged with respect to each alleged violation of the statute. Although the plain language is less compelling with respect to alleging the scienter of each defendant, the statute does use the singular term 'the defendant,' and we believe that the most plausible reading in light of congressional intent is that a plaintiff, to proceed beyond the pleading stage, must allege facts sufficiently demonstrating each defendant's state of mind regarding his or her alleged violations."

Posted by Lyle Roberts at 6:24 PM | TrackBack

June 17, 2004

Alpharma Dismissal Affirmed

On Tuesday, the U.S. Court of Appeals for the Third Circuit affirmed the dismissal, with prejudice, of the Alpharma securities class action. See In re Alpharma, Inc. Sec. Litig., 2004 WL 1326013 (3rd Cir. June 15, 2004). A few highlights from the opinion:

(1) Collective scienter - The court appeared to reject the idea that a corporate defendant's scienter (i.e., fraudulent intent) can be properly alleged on the basis of the collective knowledge of all of the corporation's officers and employees. The plaintiffs alleged that a sales manager in one of Alpharma's divisions notified employees in the main office of accounting irregularities. The court held that "the mere fact that the information was sent to Alpharma's headquarters and therefore was available for review by the individual defendants is insufficient to 'giv[e] rise to a strong inference that [defendants] acted with the required state of mind.'"

(2) Insider stock sales - The court held that the insider stock sales were not unusual in their scope or timing and, therefore, could not support a strong inference of scienter. The allegation that the defendants had not sold any stock during the preceding fifteen months was deemed insufficient. The defendants asserted they were precluded from selling any stock by a blackout period. Although the court could not technically consider this assertion, it found that the "plaintiffs failed to allege the absence of a blackout period or other facts which would demonstrate that the fifteen month period of inactivity was in any way unusual."

(3) Leave to amend - The court upheld the district court's denial of leave to amend where the plaintiffs had failed to proffer any proposed amendment. The denial was "further supported by the fact that plaintiffs (1) had already filed previous complaints and (2) were given an extension of time to assemble the amended consolidated complaint currently at issue."

Holding: Affirm grant of motion to dismiss with prejudice.

Posted by Lyle Roberts at 9:49 PM | TrackBack

June 1, 2004

U.S. Urges Supreme Court To Resolve Circuit Split On Loss Causation

As The 10b-5 Daily has frequently discussed (indeed, this is the third post in a row on the topic), there is a circuit split over what is necessary to adequately plead loss causation in a securities fraud case. A majority of the courts hold that a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead loss causation, while a minority of courts hold that a plaintiff merely needs to demonstrate that the alleged misrepresentations artificially inflated the stock price.

In Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003), the Ninth Circuit came down firmly in the minority camp. The court found that loss causation "merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause." Based on this holding, the court reversed the lower court's dismissal and remanded the case for further proceedings. (See this post discussing the opinion.) The defendants petitioned for a writ of certiorari to the Supreme Court.

On Friday, the U.S. (the SEC and the Solicitor General) filed an amicus brief in support of the defendants' petition. In the brief, the U.S. argues that there is "an acknowledged circuit conflict regarding the nature and scope of the plaintiff's burden to plead and prove loss causation in a fraud-on-the-market case under Rule 10b-5; the court of appeals decided that question incorrectly; the question is one of recurring importance; and this case is a suitable vehicle for resolving it."

Specifically on the issue of whether the case was incorrectly decided, the U.S. makes two main arguments. First, the U.S. argues that measuring the loss in these types of cases "as of the time of the purchase, and not requiring any allegations of a subsequent loss of value attributable to the fraud, would grant a windfall to investors who sold before the reduction or elimination of the artificial inflation, because they would recover the portion of the purchase price attributable to the fraud on resale, and then would be entitled to recover that same amount again in damages." Second, the U.S. argues that the decision improperly conflated the separate elements of transaction causation (i.e., the alleged misconduct induced the plaintiff to engage in the transaction in question) and loss causation (i.e., the alleged misconduct caused the plaintiffs economic loss).

The Supreme Court rarely takes on securities litigation issues. But the combination of a clear circuit split, the U.S.'s encouragement, and yet another opportunity to overturn the Ninth Circuit, may well prove irresistible.

Thanks to David Tabak for sending a copy of the brief to The 10b-5 Daily.

Addition: The brief has been posted by SCOTUSblog (thanks to Adam Savett for the link).

Posted by Lyle Roberts at 10:01 PM | TrackBack

May 24, 2004

Defining The Outer Limits

In the typical securities class action, the plaintiffs allege the defendant company made material misrepresentations that inflated the value of the company's stock. But what if the alleged misrepresentations also inflated the value of another company's stock? Do the purchasers of the second company's stock have standing to sue the first company?

The U.S. Court of Appeals for the Second Circuit thinks this is stretching the boundaries of Rule 10b-5 too far. In Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks Corp., 2004 WL 1110496 (2d Cir. May 19, 2004), the court addressed whether purchasers of JDS Uniphase stock, which was in the process of selling its laser business to Nortel during the class period, had standing to sue Nortel for alleged misstatements about Nortel's business prospects that inflated the stock prices of both companies. Based on Supreme Court precedent, the court found that the purchaser-seller requirement for Rule 10b-5 liability limits standing to those who have dealt in the security to which the misrepresentation relates. (The court left open the question, however, of whether a potential merger between two companies, which would create a more direct relationship between the companies' stock prices, might require a different outcome.)

Holding: Affirming lower court's dismissal.

Quote of note: "Stockholders do not have standing to sue under Section 10(b) and Rule 10b-5 when the company whose stock they purchased is negatively impacted by the material misstatement of another company, whose stock they do not purchase."

Posted by Lyle Roberts at 11:18 PM | TrackBack

May 21, 2004

Monday Morning Settling (Another Look At Citigroup)

In settling a case, timing is important. Citigroup's settlement of the WorldCom litigation for $2.65 billion was the subject of a handshake agreement as of Thursday, May 6. According to press reports, Citigroup told analysts that the timing was influenced by the Second Circuit argument in the case scheduled for the following Monday.

At issue in that appeal was whether the district court had properly granted class certification for the claims against Citigroup based on analyst statements about WorldCom's securities. The district court had applied the fraud-on-the-market doctrine (i.e., reliance by investors on an alleged misrepresentation is presumed if the company's shares were traded on an efficient market) to help establish that common issues predominated over individual ones for the class members. Citigroup argued on appeal that the fraud-on-the-market doctrine could not be applied to claims based on analyst statements. Meanwhile, the SEC submitted an amicus brief to the court opposing Citigroup's position. Citigroup, in discussing its decision to settle the case before the appeal was heard, stated "to have the SEC come out against that obviously worsened the odds against us." But, with the benefit of hindsight, were the odds better than they appeared?

Although the Second Circuit had agreed to hear Citigroup's appeal, as of May 6 (the date of the handshake agreement) it had not issued an opinion explaining its ruling. That would come the next day, May 7, and the opinion certainly suggested that Citigroup's arguments would be considered carefully.

In Hevesi v. Citigroup Inc., 2004 WL 1008439 (2d Cir. May 7, 2004), the court explained that it had agreed to hear the appeal because the certification order "implicates a legal question about which there is a compelling need for immediate resolution." The question was "whether a district court may certify a class in a suit against a research analyst and his employer, based on the fraud-on-the-market doctrine, without a finding that the analyst's opinions affected the market prices of the relevant securities." In discussing its decision to address that question, the court expressed skepticism about the lower court's ruling. Among other indications that it might be favorably disposed to Citigroup's position, the court: (1) discussed a Seventh Circuit case in which the court had declined to apply the fraud-on-the-market doctrine on class certification; (2) noted that "the application of the fraud-on-the-market doctrine to opinions expressed by research analysts would extend the potentially coercive effect of securities class actions to a new group of corporate and individual defendants - namely, to research analysts and their employers;" and (3) cited a prominent Columbia Law School professor on the point that analyst opinions should be treated differently from issuer statements.

If that were not enough, just five days later the Fourth Circuit issued an opinion establishing that a district court must make a factual finding that the fraud-on-the-market doctrine is applicable before it can be used to support class certification. In Gariety v. Grant Thornton, LLP, 2004 WL 1066331 (4th Cir. May 12, 2004), the court addressed whether a district court could accept "at face value the plaintiffs' allegations that the reliance element of their fraud claims could be presumed under a 'fraud-on-the-market' theory." At issue was whether the relevant securities had been traded on an efficient market (one of the requirements for the application of the theory). The court concluded that because "the district court concededly failed to look beyond the pleadings and conduct a rigorous analysis of whether Keystone's shares traded in an efficient market, we must remand the case to permit the district court to conduct the analysis and make the findings required by Rule 23(b)(3)."

While there are undoubtedly many other factors that go into a settlement (especially one of this magnitude), would the Citigroup settlement have looked different just a week later based on these judicial developments? Maybe not, but it's interesting to speculate.

Posted by Lyle Roberts at 8:42 PM | TrackBack

April 16, 2004

The 5th Circuit And The Fraud On The Market Theory

Under the fraud on the market theory, reliance by investors on an alleged misrepresentation is presumed if the company's shares were traded on an efficient market. The investors are not entitled to the presumption, however, if they are unable to show that the misrepresentation actually affected the market price of the stock.

The U.S. Court of Appeals for the Fifth Circuit issued an opinion this week, Greenberg v. Crossroads Systems, Inc., No. 03-50311 (5th Cir. April 14, 2004), discussing the fraud on the market theory in a case where the plaintiffs failed to establish that the defendants' falsely positive statements had increased the company's stock price. Under these circumstances, the determinations of reliance and loss causation essentially merged, with the court holding that the plaintiffs were only entitled to a presumption of reliance for the falsely positive statements that they could connect to the subsequent decline in the company's stock price when the "truth" was revealed.

Holding: Affirming in part and vacating in part the district court's grant of summary judgment.

Quote of note: "We are satisfied that plaintiffs cannot trigger the presumption of reliance by simply offering evidence of any decrease in price following the release of negative information. Such evidence does not raise an inference that the stocks price was actually affected by an earlier release of positive information. To raise an inference through a decline in stock price that an earlier false, positive statement actually affected a stocks price, the plaintiffs must show that the false statement causing the increase was related to the statement causing the decrease. Without such a showing there is no basis for presuming reliance by the plaintiffs."

Thanks to David O'Brien for the link.

Posted by Lyle Roberts at 12:33 AM | TrackBack

April 14, 2004

No Damages? No Problem!

Here's a good law school exam question -- does a finding of liability under Rule 10b-5 in a private securities case require a reward of damages? The U.S. Court of Appeals for the Fourth Circuit submitted an essay answer today in the form of an opinion in Miller v. Asensio & Co., Inc., No. 03-1225 (4th Cir. April 14, 2004).

Asensio was a short seller that publicized negative statements about Chromatics Color Sciences Int., Inc. ("CCSI"), a company in which it had a significant short sell interest. Stockholders of CCSI sued Asensio alleging that the statements were material misrepresentations, "which Asensio initiated to defraud the market for its benefit, and which caused their CCSI stock to decline in value resulting in substantial losses to them." After a trial, the jury returned a verdict finding Asensio liable, but awarding $0.00 in damages. On appeal, the stockholders argued that the finding of liability required the award of damages in some amount.

The Fourth Circuit disagreed (after noting that the issue was one of first impression). Courts "often refer to the fact of proximately caused damage and the amount of proximately caused damage as involving separate, although related, inquiries." To establish Rule 10b-5 liability, a plaintiff only has to prove that the defendants misrepresentation was a "substantial cause of the loss" by showing a "direct or proximate relationship between the loss and the mispresentation." Accordingly, a jury could find that "(1) the plaintiff proved the defendant's fraud constituted a substantial cause of plaintiff's loss and so find the defendant liable but (2) the plaintiff failed to provide a method to discern, by just and reasonable inference, the amount of plaintiff's loss solely caused by defendant's fraud, and so refuse to award the plaintiff any damages."

Applying these principles to the case in hand, the Fourth Circuit found that "the evidence at trial provided the jurors with a sound basis on which to reach the result they did."

Holding: Affirmed.

Quote of note: "In the vast majority of cases, a finding of the fact of proximately caused loss will result in the award of some amount of damages. However, it would seem contrary to Congress' mandate that a plaintiff prove that the defendant 'caused the loss,' 15 U.S.C. 78u4(b)(4), and that no plaintiff 'shall recover . . . a total amount in excess of his actual damages on account of the act complained of,' 15 U.S.C. 78bb(a), to direct a jury that it must award damages, even if faced, as here, with a record from which it cannot do so."

Posted by Lyle Roberts at 11:36 PM | TrackBack

April 5, 2004

No Group Pleading

The "group pleading" doctrine creates the presumption that the senior officers of a company are collectively responsible for misrepresentations or omissions contained in public statements made by the company (e.g., press releases, SEC filings). District courts are divided over whether a plaintiff's ability to plead in this manner has survived the enactment of the PSLRA with its heightened pleading standards for securities fraud.

Last week, the U.S. Court of Appeals for the Fifth Circuit made a strong statement against the use of group pleading. In Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 2004 WL 626721 (5th Cir. March 31, 2004), the court held that group pleading "cannot withstand the PSLRA's specific requirement that the untrue statements be set forth with particularity as to 'the defendant' and that scienter be pleaded with regard to 'each act or omission sufficient to give rise to a strong inference that the defendant acted with the required state of mind.'" As a result of the PSLRA's repeated references to "the defendant," the court found that Congress intended plaintiffs to inform each defendant of his or her particular role in the alleged fraud.

Holding: Affirmed in part, reversed in part (the decision also contains an interesting, if relatively uncontroversial, discussion on determining scienter for a corporate defendant).

Quote of note: "[C]orporate officers may not be held responsible for unattributed corporate statements solely on the basis of their titles, even if their general day-to-day involvement in the corporation's affairs is pleaded. However, corporate documents that have no stated author or statements within documents not attributed to any individual may be charged to one or more corporate officers provided specific factual allegations link the individual to the statement at issue."

Posted by Lyle Roberts at 9:57 PM | TrackBack

March 16, 2004

That'll Cost You 1 Million Euros

Securities class actions brought against foreign companies, or their advisors, in U.S. court can be an adventure.

KPMG-Belgium was the auditor for Lernout & Hauspie Speech Products NV, the Belgian software maker that collapsed amid revelations of accounting fraud. A securities class action was brought against KPMG-Belgium and others in the D. of Mass. After the denial of KPMG-Belgium's motion to dismiss, pretrial discovery commenced in September 2002 with plaintiffs serving document requests for auditor work papers.

KPMG-Belgium refused to comply with the requests, asserting that producing the papers would violate Belgian law (plaintiffs were, however, able to examine the documents as part of the Belgian criminal investigation). Plaintiffs moved to compel the production of the documents and, on November 13, 2003, a magistrate judge granted the motion. Shortly thereafter, KPMG-Belgium filed an ex parte petition with a court in Brussels seeking to enjoin the plaintiffs from "taking any step" to proceed with the requested discovery. To obtain compliance, they asked the Belgian court to impose a 1 million euros fine for each violation of the proposed injunction.

The U.S. district court issued an antisuit injunction enjoining KPMG-Belgium from pursuing the Belgian court action. KPMG-Belgium appealed. Last week, the First Circuit affirmed the district court injunction order, holding that "[w]here, as here, a party institutes a foreign action in a blatant attempt to evade the rightful authority of the forum court, the need for an antisuit injunction crests."

The First Circuit opinion can be found here. The Wall Street Journal has an article (subscrip. req'd) on the decision.

Quote of note (WSJ article): "That means KPMG-Belgium could soon be faced with a stark choice: It can hand over the documents. Or the firm can disregard [the district judge's] orders. In that event, she has warned that she may enter a default judgment for the plaintiffs, exposing KPMG-Belgium to potentially billions of dollars of liability. A KPMG-Belgium spokesman, Jos Hermans, on Friday said, 'There hasn't been a final decision on what we're going to do,' although one could come this week.'"

Posted by Lyle Roberts at 11:16 PM | TrackBack

February 6, 2004

Research Analyst Claims Not Time-Barred

Similar to the Merrill Lynch cases, a securities class action was filed against First Union in May 2001 accusing the financial services company of inflating the price of Ask Jeeves stock by issuing "strong buy" recommendations while acting under an undisclosed conflict of interest. In LaGrasta v. First Union Securities, 2004 WL 178937 (11th Cir. Jan. 30, 2004), the U.S. Court of Appeals for the 11th Circuit reversed the lower court's decision to dismiss the case based based on the statute of limitations. The lower court had found that the sharp decline in the price of Ask Jeeves stock in April 2000, even though First Union was continuing to make "strong buy" recommendations, was sufficient to put the plaintiffs on inquiry notice of fraud, thus making the filing of their complaint more than a year later untimely.

On appeal, the 11th Circuit held that a stock price decline is insufficient to create inquiry notice of fraud. The court laid out five reasons: (1) stock price fluctuations are always possible; (2) Ask Jeeves stock was highly volatile; (3) the stock price decline may have resulted from reasons other than fraud; (4) the investors may have been looking for a speculative investment and therefore expected large fluctuations; and (5) the investors are suing First Union, not Ask Jeeves, so a stock price drop would not necessarily have alerted them to First Union's misconduct. The court also rejected First Union's argument that its disclosure of the possibility of a conflict in its analyst reports was sufficient to put investors on notice of the possibility of fraud. Based on the record, the court found that the most it could conclude as a matter of law was that the plaintiffs were on inquiry notice as of June 2000 (less than a year before the complaint was filed) when a Smart Money article expressly disclosed that First Union was in the running to be selected as the underwriter for Ask Jeeves' secondary stock offering.

Holding: Dismissal on statute of limitations ground reversed. Case remanded for district court to consider loss causation argument.

Quote of note: "[T]he district court's orders [in the Merrill Lynch cases finding the claims in those cases time-barred] were based only partially on the dramatic decline in the price of the shares. In fact, most of the discussion on inquiry notice by the district court concerns the newspaper articles about the conflict of interest and similar information in the public domain. We view the Merrill Lynch orders as consistent with our own conclusion that, on the face of the complaint, the publication of the Smart Money article exposing the conflict of interest of First Union and Ms. Trabuco was the event which put the La Grastas on inquiry notice."

Posted by Lyle Roberts at 1:46 AM | TrackBack

January 22, 2004

2nd Circuit Clarifies Pleading Standard For '33 Act Claims

Section 11 and Section 12(a)(2) of the Securities Act of 1933 impose liability, under various circumstances, for untrue or misleading statements in registration statements. The statute does not require a plaintiff to establish that the defendant acted with scienter (i.e., fraudulent intent). Nevertheless, a number of federal circuits (3rd, 5th, 7th, and 9th - with only the 8th disagreeing) have found that Federal Rule of Civil Procedure 9(b)'s particularity pleading requirement applies to these claims if they "sound in fraud."

In Rombach v. Chang, 2004 WL 77928 (2d Cir. Jan. 20, 2003), the Second Circuit addressed the issue for the first time. The court noted that Rule 9(b) applies to "all averments of fraud" and "is not limited to allegations styled or denominated as fraud or expressed in terms of the constituent elements of a fraud cause of action." Although fraud is not an element of Sections 11 and 12(a)(2) claims, these claims are often predicated on the same course of conduct that would support a Rule 10b-5 claim. Accordingly, "while a plaintiff need allege no more than negligence to proceed under Section 11 and Section 12(a)(2), claims that do rely upon averments of fraud are subject to the test of Rule 9(b)."

The Rombach plaintiffs brought Section 11, Section 12(a)(2), and Rule 10b-5 claims based on the same course of conduct. Although they asserted that their Section 11 claims did not sound in fraud, the court held that "the wording and imputations of the complaint are classically associated with fraud: that the Registration statement was 'inaccurate and misleading;' that it contained 'untrue statements of material facts;' and that 'materially false and misleading written statements' were issued." Having found that the particularity requirement of Rule 9(b) was applicable, the court then affirmed the lower court's decision that the plaintiffs' had failed to adequately plead that the statements at issue were false or misleading.

Holding: Affirm grant of motion to dismiss.

Quote of note: "The particularity requirement of Rule 9(b) serves to 'provide a defendant with fair notice of a plaintiff's claim, to safeguard a defendant's reputation from improvident charges of wrongdoing, and to protect a defendant against the institution of a strike suit.' These considerations apply with equal force to 'averments of fraud' set forth in aid of Section 11 and Section 12(a)(2) claims that are grounded in fraud."

The New York Law Journal has an article (via law.com - free regist. req'd) on the decision.

Posted by Lyle Roberts at 3:23 PM | TrackBack

January 8, 2004

Short Whoppers Do Count

The Ninth Circuit has issued an opinion in Employee Teamsters Local Nos. 175 and 505 Pension Trust Fund v. Clorox Co., 2004 WL 32963 (9th Cir. Jan. 7, 2004) that addresses discovery, the PSLRA's safe harbor for forward-looking statements, and scienter issues.

An interesting part of the opinion deals with the plaintiff's contention that the lower court "incorrectly held that knowingly false statements made by [an officer defendant] during her April 22 conference call are not actionable as long as they are short, and that it improperly relied on limited and general cautions to protect Clorox under the PSLRA's safe harbor and the 'bespeaks caution' doctrine." The Ninth Circuit disagreed, finding the basis for the district judge's holding was that the forward-looking statements were accompanied by meaningful cautionary language, not the relative length of the statements. Although plaintiffs argued that the lower court should not have considered cautionary language contained in Clorox's Form 10-K filing in making this determination, the appellate court found that the officer defendant had referenced the risk factors in the Form 10-K during the call and "the PSLRA does not require that the cautions physically accompany oral statements."

Holding: Affirming grant of partial summary judgment and judgment on the pleadings.

Quote of note: "It is with respect to these statements that the court observed that [the officer defendant] 'spoke only a couple of sentences and provided an approximate timetable.' Investors submit that the court's holding that 'short whoppers don't count' is error, but we read its decision as turning on context rather than word count."

Posted by Lyle Roberts at 8:45 PM | TrackBack

January 2, 2004

Fourth Circuit Breaks Silence On Scienter

To survive a motion to dismiss, the PSLRA requires plaintiffs bringing a securities fraud claim to plead facts establishing a "strong inference" that the defendants acted with scienter (i.e., fraudulent intent). There are two components to this analysis: (1) what is the substantive standard for scienter; and (2) what must a plaintiff allege to meet the "strong inference" pleading requirement. Until last week, the U.S. Court of Appeals for the Fourth Circuit had declined to take a position on either of these issues. Not anymore.

In Ottmann v. Hanger Orthopedic Group, 2003 WL 22992292 (4th Cir. Dec. 22, 2003), the court joined every other circuit in holding that scienter may be established by pleading not only intentional misconduct, but also recklessness (although it must be "severe recklessness [that] is, in essence, a slightly lesser species of intentional misconduct"). Having established the substantive standard, the court turned to what a plaintiff must plead to meet the PSLRA's "strong inference" pleading requirement.

The court found that "Congress ultimately chose not to specify particular types of facts that would or would not show a strong inference of scienter [as part of the PSLRA]." As a result, the court concluded that a "flexible, case-specific analysis is appropriate in examining scienter pleadings." Although facts establishing "motive and opportunity to commit fraud (or lack of such facts) may be relevant to the scienter inquiry, the weight accorded to those facts should depend on the circumstances of each case."

In applying this flexible analysis to the instant case, the court found that there were insufficient facts demonstrating that any of the alleged misstatements were the product of reckless or intentional conduct (as opposed to negligence). Moreover, the court noted that the plaintiffs failed to allege that the individual defendants had any personal motive to make the alleged misstatements, "such as to facilitate personal sales of Hanger stock." Instead, plaintiffs argued that the defendants were motivated to misrepresent Hanger's financial situation so as to maintain the company's positive relationships with its creditors, avoid additional interest payments, and promote future acquisitions. The court concluded that other courts "have repeatedly rejected these types of generalized motives -- which are shared by all companies -- as insufficient to plead scienter under the PSLRA."

Holding: Affirm the dismissal of complaint.

Quote of note: "We therefore conclude that courts should not restrict their scienter inquiry by focusing on specific categories of facts, such as those relating to motive and opportunity, but instead should examine all of the allegations in each case to determine whether they collectively establish a strong inference of scienter."

Addition: Note that the facts of the case do not allow the Fourth Circuit to address an important issue. Based on the analysis in the opinion, it appears clear that the court could have affirmed the dismissal of the complaint based on the lenient Second Circuit pleading standard, as it has in other cases. See Phillips v. LCI Int., Inc. 190 F.3d 609 (4th Cir. 1999). Instead, the court chose to adopt and apply a new pleading standard in a case where the plaintiffs did not allege any personal motive to commit securities fraud (e.g., stock sales by the individual defendants). District courts in the Fourth Circuit are left with no practical guidance on what "weight" the appellate court thinks should be given to those types of allegations in determining whether a strong inference of scienter has been plead.

Posted by Lyle Roberts at 7:50 PM | TrackBack

December 10, 2003

Can Too Many Cooks Spoil The Settlement?

Many courts have declined to appoint a group of unrelated investors as the lead plaintiff in a securities class action, concluding that a group of this nature will be unable to effectively direct the litigation as envisioned by the PSLRA. See, e.g., In re Milestone Scientific Sec. Litig., 183 F.R.D. 404 (D.N.J. 1998) ("Where multiple lead plaintiffs have divergent interests, the leadership of the class may be divided, and rendered factious."). If it did not agree with this reasoning before, the U.S. Court of Appeals for the Eighth Circuit probably does now.

In In re BankAmerica Corp. Sec. Litig., 2003 WL 22844301 (8th Cir. Dec. 2, 2003), the court addressed what weight a district court must give to "a fraction of a fractured lead plaintiff group" that objected to the settlement terms agreed to by lead counsel. The plaintiffs alleged losses caused by misrepresentations and omissions surrounding the 1998 merger of NationsBank and BankAmerica to form Bank of America. After the consolidation of numerous actions, the district court appointed a seven-member lead plaintiff group to represent the NationsBank classes and a six-member lead plaintiff group to represent the BankAmerica classes. According to the appellate court, "[n]o members of the lead plaintiff groups were institutional investors nor did they have relationships with one another prior to this litigation."

Shortly before trial, there was a mediation that led to the signing of a memorandum of understanding with the defendants for a $490 million global settlement of all claims. Three members of the NationsBank lead plaintiff group objected to the settlement. In particular, "[t]hey alleged that class counsel instructed them to leave the mediation because it was futile, but that class counsel remained and reached the proposed global settlement for an amount far below that which they had authorized." The district court found that the PSLRA is silent on what to do under these circumstances. In the absence of legislative guidance, it held a fairness hearing and determined to approve the settlement despite the objections.

On appeal, the Eight Circuit noted that while the PSLRA "is explicit on the lead plaintiff's authority to select and retain counsel, it is silent on the other responsibilities and rights that lead plaintiffs have to control, direct, and manage class action securities litigation." It certainly does not address whether a group of lead plaintiffs have to agree on a proposed settlement before it can be reviewed and approved by the district court. In any event, the appellate court limited itself to the narrower question of "what weight a district court must give to objections from a fraction of a fractured lead plaintiff group" and held that the district court did not abuse its discretion under Fed.R.Civ.P. 23 in approving the settlement despite the objections.

Holding: Judgment of district court is affirmed.

Quote of note: "We leave for another day a determination of how much control over litigation the [PSLRA] confers on a singular lead plaintiff or unified lead plead plaintiff group."

Posted by Lyle Roberts at 7:45 PM | TrackBack

November 25, 2003

Did Congress Intend To Revive Time-Barred Claims?

In Roberts v. Dean Witter Reynolds Inc., 2003 WL 1936116 (M.D. Fla. March 31, 2003), the court found that the legislative history of the Sarbanes-Oxley Act of 2002, which extended the statute of limitations for federal securities fraud claims to the earlier of two years after the discovery of the facts constituting the violation or five years after such violation, revealed Congress's intent to revive claims that had already expired as of the date of the legislation's enactment (July 30, 2002). The court, however, primarily relied on floor statements made by a single senator and a few sentences in a congressional analysis of the legislation in reaching this conclusion. It also certified an interlocutory appeal.

The Fulton County Daily Report has coverage of the oral argument in Roberts before the U.S. Court of Appeals for the 11th Circuit. The panel apparently expressed skepticism about the lower court decision, including Chief Judge Edmonson's comment that to establish Congress meant to revive time-barred claims: "You're going to have to show me something with neon light and underlined by Congress." The 11th Circuit will be the first federal court of appeals to rule on this issue.

Quote of note: "[Visiting 9th Circuit Senior Judge] Farris later chimed in that Congress knows how to use the word 'revive,' suggesting that if Congress had wanted Sarbanes-Oxley to be able to revive previously expired claims, it could have done so. 'They didn't,' Farris added."

The 10b-5 Daily has previously posted about the recent district court decisions (including Roberts) addressing the retroactivity of the new statute of limitations.

Posted by Lyle Roberts at 6:58 PM | TrackBack

October 13, 2003

How Many Bites At The Apple Are Too Many?

Rule 15(a) of the Federal Rules of Civil Procedure provides that leave to amend a complaint "should be freely given when justice so requires." The PSLRA, on the other hand, states "[i]n any private action arising under this chapter, the court shall, on the motion of any defendant, dismiss the complaint if the [pleading] requirements . . . are not met." It is a tension-packed clash leading to the inevitable question: how many bites at the apple are too many in a securities class action?

The U.S. Court of Appeals for the Sixth Circuit does not give an exact answer in Miller v. Champion Enterprises, Inc., 2003 WL 22298649 (6th Cir. Oct. 8, 2003), but it does conclude that repeated amendments should not be permitted. In Miller, the plaintiffs moved for leave to file a second amended complaint (the fourth complaint in the action) after their first amended complaint was dismissed for failure to meet the PSLRA's pleading requirements. The district court denied the motion for two reasons: (1) the PSLRA was designed to prevent strike suits and "could not achieve this purpose if plaintiffs were allowed to amend and amend until they got it right;" and (2) the proposed amended complaint was futile because it did not correct the earlier pleading deficiencies.

In affirming the decision, the Sixth Circuit states that the "district court also correctly held that allowing repeated filing of amended complaints would frustrate the purpose of the PSLRA." The appellate court expressly rejects the argument that courts should be lenient in allowing amendments to pleadings in securities fraud cases because plaintiffs do not have discovery available to them.

Holding: Dismissal affirmed.

Quote of note: "In light of [the PSLRA's heightened pleading] requirements, we think it is correct to interpret the PSLRA as restricting the ability of plaintiffs to amend their complaint, and thus as limiting the scope of Rule 15(a) of the Federal Rules of Civil Procedure."

Posted by Lyle Roberts at 8:50 PM | TrackBack

September 15, 2003

Everybody's Talking About Loss Causation

Just when you thought there could not possibly be another appellate loss causation pleading case this summer, along comes the Second Circuit to clarify its position on the issue.

To recap the current scorecard, a clear split in authority has developed between courts that believe plaintiffs must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to establish loss causation (Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir. 2000); Robbins v. Koger Props, Inc., 116 F.3d 1441 (11th Cir. 1997)) and courts that believe plaintiffs merely need to demonstrate that the alleged misrepresentations artificially inflated the stock price (Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824 (8th Cir. 2003); Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003)). (The 10b-5 Daily has discussed the Gebhardt and Broudo cases, both decided in the last few months, in previous posts.)

Breaking the apparent tie is the Second Circuit's opinion in Emergent Capital Investment Management, LLC v. Stonepath Group, Inc., 2003 WL 22053957 (2d Cir. Sept. 4, 2003), which clarifies some confusion over the Second Circuit's approach to loss causation. Several courts, including the Ninth Circuit in the Broudo decision, have concluded that the Second Circuit finds allegations of artificial price inflation sufficient to plead loss causation (relying on a 2001 opinion in the Suez Equity case). Not so fast.

In Emergent Capital, the court found that the plaintiff's "pump-and-dump" allegations were sufficient to establish loss causation. Judge Cardamone, however, took exception to the plaintiff's attempt to cite his earlier decision in Suez Equity for the position that a "purchase-time value disparity" can satisfy the loss causation pleading requirement. Devoting an entire section of the opinion to the question, Judge Cardamone clarifies:

"We did not mean to suggest in Suez Equity that a purchase-time loss allegation alone could satisfy the loss causation pleading requirement. To the contrary, we emphasized that the plaintiffs had 'also adequately alleged a second, related, loss--that [the executive's] concealed lack of managerial ability induced [the company's] failure.' Moreover, we expressly distinguished that case from one where the ultimate decline in the market price of a company's securities would be unrelated to that company's manager's concealed negative history."

The court goes on to conclude that Suez Equity did not undermine the Second Circuit's "established requirement that securities fraud plaintiffs demonstrate a causal connection between the content of the alleged misrepresentations or omissions and 'the harm actually suffered.'"

So now we know where the Second Circuit stands. Anybody else? There's still a week of summer left!

Holding: Judgment of the district court is affirmed, in part, and vacated, in part, and remanded to the district court.

Many thanks to Colin Wrabley for pointing The 10b-5 Daily to this case.

Posted by Lyle Roberts at 9:24 PM | TrackBack

August 25, 2003

How Much Particularity Is Enough?

Less than many other circuit courts have required, is the answer from the U.S. Court of Appeals for the Tenth Circuit in Adams v. Kinder-Morgan, Inc., 2003 WL 21906117 (10th Cir. August 11, 2003). Pursuant to the PSLRA, plaintiffs attempting to plead securities fraud based on information and belief (as opposed to personal knowledge) must "state with particularity all facts" supporting their belief that the specified statements were misleading. Courts have routinely grappled with the meaning of the words "all facts."

The Second Circuit, in Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000), concluded that interpreting the text literally would lead to absurd results, including requiring dismissal "where the complaint pled facts fully sufficient to support a convincing inference if any known facts were omitted." The Second Circuit tempered its holding, however, by finding that it is not enough for plaintiffs to baldly allege facts in support of their allegations, they must provide "documentary evidence and/or a sufficient general description of the personal sources of the plaintiffs' beliefs." (The Fifth Circuit has also adopted this approach, while the First and Ninth Circuits have required detailed source information.)

In Adams, the Tenth Circuit agreed with the Second Circuit that "all facts" should not be interpreted literally, but declined to impose a requirement that plaintiffs state the source of their facts. Noting that the PSLRA did not "purport to move up the trial to the pleadings stage" and does not mention the pleading of sources, the court held that it will "apply a common-sense, case-by-case approach in determining whether a plaintiff has alleged securities fraud with the particularity required by [the PSLRA] without adding a per se judicial requirement that the source of facts must always be alleged to support substantive allegations of fraud in an information and belief complaint." The court did note, however, that in the absence of source information, the facts in the complaint "will usually have to be particularly detailed, numerous, plausible, or objectively verifiable by the defendant before they will support a reasonable belief that the defendant's statements were false or misleading."

Holding: Reversed in part (dismissal based on a lack of particularity, and other grounds, as to all defendants), affirmed in part (dismissal based on insufficient scienter allegations and lack of control as to one defendant).

Quote of note: "While the PSLRA certainly heightened pleading standards for securities fraud lawsuits, we believe that if Congress had intended in securities fraud lawsuits to abolish the concept of notice pleading that underlies the Federal Rules of Civil Procedure, Congress would have done so explicitly."

Posted by Lyle Roberts at 8:16 PM | TrackBack

August 15, 2003

Man's Attempt To Bite Dog Rejected

The McKesson HBOC securities fraud cases have generated a number of interesting legal developments over the years. The cases are based on the 1999 merger between McKesson and HBO & Co. After the merger was closed, McKesson announced that HBOC had improperly recorded certain software sales as revenues and that HBOC's financial results would have to be restated. Several securities class actions were filed and the New York State Common Retirement Fund was eventually selected as the lead plaintiff.

In January 2001, McKesson filed a complaint and compulsory counterclaim against the Fund and former HBOC shareholders who exchanged more than 20,000 shares of HBOC stock for McKesson stock. The theory was that the investors were unjustly enriched by trading inflated HBOC shares for properly-valued McKesson shares. The district court dismissed the claim.

On Wednesday, the U.S. Court of Appeals for the Ninth Circuit weighed in on the case, holding that McKesson cannot sue its own investors on an unjust enrichment theory. First, the court held that an equitable remedy for McKesson was unnecessary given that there are legal remedies available to the company for the same alleged wrong. "McKesson has potential legal claims against any number of parties who, unlike the former shareholders, actually played a substantial role in the decision to enter the Merger Agreement; the former HBOC shareholders are not the only targets for recovery." Second, the court declined to pierce the corporate veil to create liability for HBOC's shareholders, noting that "there is no allegation that the HBOC shareholders exercised - or even had the ability to exercise - domination or control over HBOC." Finally, the court concluded that the expansion of liability to the shareholders, who were unaware of the risk that they could be personally liable for corporate acts, would be unjust.

The Recorder has a story on the case (via law.com) and the decision can be found here. The case certainly highlights the difficulties in determining the winners and losers in securities fraud.

Posted by Lyle Roberts at 4:30 PM | TrackBack

August 13, 2003

Tenth Circuit Partially Reverses Novell Dismissal

The Salt Lake Tribune reports today that the U.S. Court of Appeals for the Tenth Circuit has partially reversed the earlier dismissal of a securities class action against Novell. The appellate court held that claims alleging that Novell and certain of its officers "created a fictional 'in transit' category and improperly recorded shipments to OEMs (or original equipment manufacturers, companies that incorporated Novell products into retail computers, or acted as resellers) as sales revenue" could proceed. The suit is based on conduct that allegedly occurred in 1996 and 1997. The decision can be found here.

Posted by Lyle Roberts at 7:50 AM | TrackBack

August 8, 2003

What Is Necessary To Allege Loss Causation?

It has been a big summer for loss causation cases. A clear split in authority has developed between courts that believe plaintiffs must demonstrate a causal connection between the misrepresentations and a subsequent decline in the stock price (Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir. 2000); Robbins v. Koger Props, Inc., 116 F.3d 1441 (11th Cir. 1997)) and courts that believe plaintiffs merely need to allege that the misrepresentations artificially inflated the stock price (Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824 (8th Cir. 2003)). (The 10b-5 Daily discussed the ConAgra decision here.)

In Broudo v. Dura Pharmaceuticals, 2003 WL 21789028 (9th Cir. Aug. 5, 2003), the Ninth Circuit clarified that it will not require plaintiffs to establish a causal connection between the misrepresentations and a decline in the stock price: loss causation "merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause." The facts of the case, however, underline the problems with this reasoning. Broudo is a securities class action on behalf of investors who purchased Dura stock between April 15, 1997 and February 24, 1998. The defendants allegedly made misleading statements during that time period about, among other things, the clinical trials necessary to obtain new drug approval from the FDA for Dura's Albuterol Spiros delivery device for asthma medication. On February 24, 1998, Dura revealed that it expected lower-than-forecast 1998 revenues and 1998 earnings per share, but did not make any disclosures about its Albuterol Spiros delivery system. The February 24 announcement caused Dura's stock price to decline by 47%. It was not until November 1998, nearly nine months after the end of the class period, that Dura announced the FDA had "found the Albuterol Spiros device not approvable due to electro-mechanical reliability issues and chemistry, manufacturing, and control concerns." The district court found that the plaintiffs had failed to properly plead loss causation for his claims based on misleading statements concerning the Albuterol Spiros device because the complaint did "not contain any allegations that the FDA's non-approval [of the Albuterol Spiros device] had any relationship to the February price drop."

The 9th Circuit reversed. The court did not address the logical inconsistency of the plaintiffs' argument that statements revealed to be misleading in November caused them to suffer losses the previous February. Instead, the court found that it was unnecessary for the plaintiffs to plead "that a disclosure and subsequent drop in the market price of the stock have actually occurred, because the injury occurs at the time of the transaction."

The decision improperly conflates transaction causation and loss causation. Plaintiffs may have purchased on the basis of the alleged misrepresentations, but any loss requires the stock they purchased to decline in value. The practical problems created by the Broudo opinion are significant. As noted by Judge Pollack in the Merrill Lynch cases, "allowing plaintiffs in a fraud on the market case to satisfy loss causation simply by alleging that a misrepresentation caused the price to be artificially inflated without having to allege any link between the conduct and the decline in price would undoubtedly lead to speculative claims and procedural intractibility." Moreover, the PSLRA expressly states that plaintiffs have the burden of establishing that their losses were caused by the defendants' acts or omissions. How can plaintiffs' claims be plead with particularity if they do not connect the alleged fraudulent conduct to any loss?

Holding: Reversed and remanded with leave to amend.

Posted by Lyle Roberts at 6:56 PM | TrackBack

August 1, 2003

The Scope Of The Stay Of Discovery

The PSLRA provides that "all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party." With the passage of SLUSA, Congress attempted to strengthen the discovery stay by granting the power to federal court judges to quash discovery in state court actions if discovery in the state case conflicted with an order of the federal court.

In Newby v. Enron Corp., 2003 WL 21658666 (5th Cir. July 30, 2003), the underlying lawsuit was a state court action in Texas (Bullock), filed on behalf of thirteen individuals, against many of the same defendants as in the Enron federal securities class action litigation (Newby). The plaintiffs received permission from the state court to commence discovery, even though there was no dispute "that the discovery sought in Bullock would have fallen squarely within the discovery that may eventually take place in Newby if the plaintiffs survive a motion to dismiss." The defendants requested emergency injunctive relief from the U.S. District Judge presiding over the Newby case to stay discovery in the Bullock case. Pursuant to SLUSA, the discovery was enjoined until a ruling on the motion to dismiss in the Newby case. The Bullock plaintiffs appealed.

In Newby, the Fifth Circuit addressed whether the power granted to federal court judges to quash state court actions is only limited to state court actions brought on behalf of a class of investors. The plain language in SLUSA would appear to suggest otherwise, "a court may stay discovery in any private action in a State court . . . ." Appellants argued, however, that (1) the PSLRA and SLUSA were enacted to combat abuses in class action securities cases; and (2) other provisions of SLUSA refer specifically to state court class actions and control over the more general terminology in the operative provision.

Not surprisingly, the Fifth Circuit decided to stick with the plain language of the statute. "The title of [the SLUSA provision] reflects its purpose: to prevent the 'circumvention of stay of discovery' provided for in [the PSLRA]. The provision in [SLUSA] allows the federal court presiding over an action subject to the automatic stay of discovery to order a similar stay in a state court action. On its face [the SLUSA provision] applies to 'any private action in a State court.' The action stayed by the district court is plainly within the scope of this clause."

Holding: Stay of discovery affirmed (the panel also upheld additional injunctive relief granted by the district court).

Posted by Lyle Roberts at 6:04 PM | TrackBack

July 3, 2003

Ninth Circuit Affirms Read-Rite Dismissal

The Securities Law Beacon reports that the Ninth Circuit has affirmed the dismissal of the securities class action against Read-Rite Corp. The court agreed with the lower court's determination that the plaintiffs failed to adequately plead scienter. The opinion can be found here.

Posted by Lyle Roberts at 6:37 PM | TrackBack

July 1, 2003

Eight Circuit On Materiality/Loss Causation

The Eighth Circuit's decision in the ConAgra case (Gebhardt v. ConAgra Foods, Inc., (8th Cir. June 30, 2003)) highlights how difficult it can be to establish the immateriality of alleged fraudulent statements at the motion to dismiss stage of a securities class action.

In ConAgra, plaintiffs alleged that the company had engaged in fraud by permitting its United Agri Products subsidiary to prematurely recognize revenue from sales where the delivery of the goods had not yet taken place. The Eighth Circuit found that "the problem was mostly one of having the money attributed to the wrong year, as opposed to not having ever made the money at all." As a result, "ConAgra's income, before taxes, was reduced by $111 million for the years 1998 through 2000, while its income for 2001 was increased by $127 million." When the restatement was announced in May 2001, the stock price dropped from $20.61 to $20.07. It quickly recovered, however, and began to trend higher.

The district court dismissed the case on two bases. First, the lower court noted that the amount of earnings misrepresented was merely .4% of ConAgra's total revenues during the years in question. The lower court concluded that "[a] reasonable investor with complete knowledge of the UAP accounting issues would have realized that ConAgra's overall earnings were basically unaffected by any of those issues." Second, the lower court held that the plaintiffs' pleadings failed to allege loss causation. The alleged misrepresentations were immaterial and the company's stock price was barely affected by the announcement of the restatement.

The Eighth Circuit disagreed with both conclusions. On the issue of materiality, the appellate court found that focusing on the percentage of total revenues misstated was insufficient. As a result of its revenue recognition problems, ConAgra overstated its net income for 1999 and 2000 by 8%. A discrepancy of that magnitude is not immaterial as a matter of law. The appellate court also found that it was inappropriate for the lower court to rely on the fact that ConAgra was eventually able to receive the revenues it prematurely recognized. The company "could not know for certain it would receive the profits it had booked." Accordingly, a reasonable investor, at the time of the misrepresentation, may have found information about the premature revenue recognition to be material.

As for loss causation, the Eighth Circuit found that because the alleged misrepresentations were material, the plaintiffs can "invoke the fraud-on-the-market theory and assume that the misrepresentations inflated the stock's price." Even though the stock price did not decline when the restatement was announced, the appellate court declined "to attach dispositive significance to the stock's price movements absent sufficient facts and expert testimony, which cannot be considered at this procedural juncture, to put this information in its proper context."

The Eighth Circuit's opinion leaves little room for a materiality argument to succeed on a motion to dismiss. Here, the amount of the restatement was relatively small (even for net income), the company's overall finances were unaffected, and the stock market had virtually no reaction upon being told of the problem. Nevertheless, the appellate court goes out of its way to justify a finding that materiality and loss causation were adequately plead, including dismissing the lack of a negative stock market reaction by holding that "stockholders can be damaged in ways other than seeing their stocks decline. If a stock does not appreciate as it would have absent the fraudulent conduct, investors have suffered harm." The allegations in the case, however, were that the company's stock price was artificially inflated, not lowered, as a result of the misrepresentations.

Holding: Judgment of the district court reversed.

Quote of note: "A reasonable investor might be concerned about one of ConAgra's subsidiaries reporting earnings not yet received, especially if this was done under orders from ConAgra's senior management. The fraud-on-the-market theory then would allow the fact finder to presume that the stock's price reflected the inflated earnings, and it makes sense to conclude that the plaintiffs were harmed when they paid more for the stock than it was worth."

Addition: Note that the Eighth Circuit comes to virtually the opposite conclusion on materiality as the S.D.N.Y in the Allied Capital case. A discussion of Allied Capital can be found here.

Addition: Note also that other courts have expressly rejected the idea that the fraud on the market theory supports a presumption of loss causation. See, e.g., Robbins v. Koger Props, Inc., 116 F.3d 1441, 1448 (11th Cir. 1997).

Posted by Lyle Roberts at 11:11 PM | TrackBack

Eighth Circuit Overturns ConAgra Dismissal

The Associated Press reports that the 8th Circuit has overturned the district court's dismissal of the securities class action against ConAgra Foods, Inc. Plaintiffs allege that ConAgra overstated the earnings of its subsidiary, UAP, by recognizing sales when the delivery of the goods had not yet taken place. As a result, ConAgra prematurely recognized revenue in the years 1998 through 2000. The case was originally filed in the D. of Neb.

The court's opinion can be found here and contains an interesting discussion of materiality. More to follow.

Posted by Lyle Roberts at 10:48 AM | TrackBack

June 17, 2003

4th Circuit Upholds Dismissal of Duratek Case

The U.S. Court of Appeals for the Fourth Circuit has upheld the dismissal of a securities class action against Duratek, Inc., a Columbia, Md.-based company that disposes of radioactive waste materials for nuclear facililties. The opinion can be found here.

Any securities litigation opinion from the Fourth Circuit has the potential to be big news, because the court has never decided whether recklessness suffices to meet the scienter requirement for 10b-5 actions and, correspondingly, what a plaintiff must plead to satisfy the PSLRA's heightened pleading standards for scienter. But no luck today. Duratek is a per curiam opinion and simply holds that "even under the lenient Second Circuit standard" the complaint failed to adequately plead scienter.

Posted by Lyle Roberts at 12:25 AM | TrackBack

May 30, 2003

Sarbanes-Oxley Stays Ahead Of The Curve

In Cantrell v. Cal-Micro, Inc. (9th Cir. May 28, 2003), the Ninth Circuit addressed whether a corporate officer who is personally liable for corporate fraud can discharge such a debt in bankruptcy. The panel held that the directors or officers of a California corporation are not fiduciaries within the meaning of the federal bankruptcy code. As a result, the judgment against Cantrell, for breach of his fiduciary duties, was dischargeable in bankruptcy. The Recorder has an article on the opinion and its potential impact on collecting judgments.

Note, however, that the Ninth Circuits ruling should not affect the ability of plaintiffs to collect judgments based on securities fraud claims. Section 803 of the Sarbanes-Oxley Act has amended the federal bankruptcy code to make judgments and settlements that result from a violation of federal and state securities laws (or common law securities fraud) non-dischargeable.

Posted by Lyle Roberts at 10:54 AM | TrackBack