In a strange story, a court in the S.D.N.Y. has dismissed the lead plaintiff from a securities class action brought against Smith Barney Fund Management and Citigroup Global Markets because, after six years of litigation, it was revealed that the entity had not actually purchased the securities at issue. The lawsuit, originally filed in 2005, alleges various misrepresentations by an investment advisor for certain Smith Barney mutual funds, which later were acquired by Citigroup. According to counsel for the plaintiffs, the relevant brokerage documentation erroneously showed that the Operating Local 639 Annuity Trust Fund had invested in one of the relevant mutual funds (when, in reality, its investment was in a similarly named fund).
The court, in an apparently scathing decision, cited "epic failures" by the attorneys on both sides of the case in not investigating the issue earlier. For its part, "[h]ad Smith Barney simply checked its records, it would have avoided six years of sparring with a phantom opponent." Bloomberg and the WSJ Law Blog have articles on the decision.
How do you know when a judge does not think much of your case? When the quips start flying around in her decision.
In City of Brockton Retirement System v. The Shaw Group Inc., 2008 WL 833943 (S.D.N.Y. March 18, 2008), District Judge Colleen McMahon addressed a securities class action brought after The Shaw Group was forced to restate its 2Q 2006 financials. In particular, the restatement resulted from two accounting errors: (a) an arithmetic error related to the computation of percent complete on one contract; and (b) a failure to account properly for a minority interest in a variable interest entity. The court dismissed the case based on the plaintiffs' failure to adequately plead a strong inference of scienter (i.e., fraudulent intent) and made its overall feelings about the claims quite clear. Here are some of the more quotable lines:
(1) "Calling the failure to catch [the simple arithmetic error] a 'failure of accounting controls' makes it sound sinister, but it does not change the fundamental nature of the 'failure' - somebody forgot to check his/her work. This is not sinister at all. Mistakes like this happen a lot in the third grade, and sometimes they happen in public companies, too. There is no reason to make a federal case out of it."
(2) "It may not be prudent as a business matter to have an accounting department that has a hard time keeping up with new information technology, but it is not a violation of the federal securities laws to do so."
(3) "So none of the matters cited by plaintiffs admits of an inference of fraud. Plaintiffs argue, however, that zero plus zero plus zero plus zero plus zero adds up to something. In this, its arithmetic is as faulty as Shaw Group's was."
Thanks to an alert reader for sending in the decision.
Three unusual recent decisions addressing the PSLRA's discovery stay, appeals from the denial of a motion to dismiss, and prolixity in complaints:
(1) While the primary securities class action against Time Warner was settled last year, a consolidated action consisting of suits by institutional investors that opted out of the main case continues on. Moreover, the plaintiffs in the consolidated action have access to the approximately 14 million documents that Time Warner produced in the primary securities class action and related state court litigation. In re AOL Time Warner, Inc. Sec. Litig., 2006 WL 1997704 (S.D.N.Y. July 13, 2006), the court addressed a "unique" request by the defendants to lift the PSLRA's discovery stay to allow them to obtain discovery from the plaintiffs. Time Warner argued, and the court agreed, that the discovery stay should be lifted because "prohibiting Time Warner's discovery of Plaintiffs while Plaintiffs are able to formulate their litigation and settlement strategy on the basis of the massive discovery Time Warner has already produced constitutes undue prejudice."
(2) The denial of a motion to dismiss is not a final judgment in a securities class action and is normally not subject to appeal. Although a district court might certify an interlocutory appeal based on the existence of a novel and dispositive legal issue, whether the district court correctly found that the plaintiff met the heightened pleading standards of the PSLRA is not usually thought to meet that criteria. In Thompson v. Shaw Group, Inc., 2006 WL 2038025 (E.D. La. July 18, 2006), however, the district court certified its denial of the defendants' motion to dismiss for appeal, finding that "reasonable minds might disagree on the issue of whether the Plaintiffs have satisfied their pleading burden under the heightened standards for securities claims." The court noted that an immediate appeal was justified because "a ruling favorable to Defendants on this issue would render years of discovery, enormous expenses incurred by the parties, and a trial on the merits unnecessary."
(3) The modern securities class action complaint can be a massive tome, primarily because of the need to meet the PSLRA's heightened pleading standards. That said, not every court appreciates getting so much reading material. In In re Leapfrog Enterprises, Inc. Sec. Litig. 2006 WL 2192116 (N.D. Cal. Aug. 1, 2006), the court addressed a 147-page consolidated complaint that it believed was unnecessarily long. After clarifying the issues in the case at oral argument, the court granted leave to amend with the express condition that the amended complaint "not exceed fifty (50) pages in length."
The editors of the Jackson Clarion-Ledger are not pleased with the WorldCom settlements. Of course, they also appear to believe that Citigroup and JPMorgan Chase will be receiving, rather than providing, most of the settlement funds.
Quote of note: "But the settlement is top heavy: $2.58 billion to Citigroup and $2 billion to JPMorgan Chase & Co. with the rest divided among about 830,000 people and institutions. That's small solace to the small investor, including those in Mississippi who trusted Ebbers."
Securities class actions brought in U.S. courts by foreign investors? Lots of them. Securities class actions brought in U.S. courts against foreign companies? Commonplace. But how about a securities class action brought in a U.S. court against a foreign state? Now we're talking.
In Aguayo v. Republic of Italy, 05 CV 7717 (S.D.N.Y.), filed last week, the plaintiff has brought a suit against Italy and the underwriters of its debt securities issued in this country. The complaint alleges that the relevant registration statements "understated Italy's debt, so that Italy could report that it complied with the European Union requirement that debt be limited to 3% of gross domestic product."
Thanks to Pietro Adami for sending in the complaint, which can be found here.
Everything a CEO does can effect his company's public disclosures. Regular readers will recall the case of the company that was forced to restate its CEO's resume. A similar type of case was decided earlier this year.
In In re Ariba, Inc. Sec. Litig., 2005 WL 608278 (N.D. Cal. March 16, 2005), the company failed to disclose that its outgoing CEO had personally, out of his own funds, paid another officer $10 million (plus $1.2 million in travel benefits and expenses) to assume the CEO position. Ariba was eventually forced to restate its financial statements to record the payments as capital contributions. In the resulting securities class action, the plaintiffs alleged that the payments were made to "create the false impression that Ariba was doing better than it was" and that "confidence in Ariba's management would have eroded completely" had it been disclosed that the new CEO had only agreed to accept the position after receiving the payments.
The court found that the plaintiffs had failed to adequately plead that the defendants acted with a fraudulent intent (i.e., scienter). The complaint relied heavily on statements from a confidential witness identified as an "executive assistant," the existence of GAAP violations, and the individual defendants' positions at the company. The court held that these allegations did not "constitute the strong circumstantial evidence of deliberately reckless or conscious misconduct with respect to each omission required for Plaintiff to overcome Moving Defendants' motion to dismiss."
Holding: Dismissed with prejudice.
Note to companies headquartered in Kansas: be careful when telling investors that you are eager to retain your senior officers.
In a securities class action against Sprint Corp., the plaintiffs based their claims on Sprint's March 26, 2001 statement that it had entered into new employment contracts with its CEO and COO that were "designed to insure their long-term employment with Sprint." According to the plaintiffs, this statement was misleading because Sprint knew that it might have to fire these officers as the result of a tax avoidance issue. In its motion to dismiss, Sprint argued that it had no duty to disclose this information because its statement did not "foreclose the possibility" that the CEO and COO might later be terminated.
The court disagreed with this characterization of the statement. See State of New Jersey and its Division of Investment v. Sprint Corp., 2004 WL 1960130 (D. Kan. Sept. 3, 2004). In finding that a duty to disclose existed, the court held that "Sprint's statements that the contracts were 'designed to insure' the long-term employment of [the CEO and COO] could reasonably have led an investor to conclude that the termination of [their] employment (at least in the near future) was simply not an option from Sprint's perspective."
Although the court may have correctly found that a duty to disclose existed, the rationale it used is curious. Did Sprint really need to say, "then again, we might fire them," for a reasonable investor to realize that it is always possible for the employment of a CEO or COO of a corporation to be terminated? Guess so.
Last year, The 10b-5 Daily posted about the unusual legal battle over the estate of Harvey Greenfield. Greenfield was a well-known plaintiffs' securities class action lawyer who passed away in 2002. Although Greenfield had told people that he planned to leave the bulk of his estate (valued at $35 million) to Harvard Law School, a will could not be located after his death. Harvard filed a claim against the estate. The New York Law Journal reports today that a settlement has been reached between Harvard and Greenfield's sole living heir to fund a securities law professorship in Greenfield's name with about $2.8 million.
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."
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.'"
Close on the heels of the Copper Mountain decision (the "fairy tale" case) comes another remarkable lead plaintiff/lead counsel order. In the Terayon securities class action, Judge Marilyn Hall Patel of the N.D. of Cal. has both disqualified two of the lead plaintiffs and found it "probable" that lead counsel must also be removed.
Terayon Communication Systems, Inc. is a Santa Clara-based maker of cable modem equipment. The securities class action against the company, initially filed in April 2000, is based on allegedly misleading statements concerning the company's ability to obtain certification for its technology.
Judge Patel originally appointed Cardinal Investment Co. and Marshall Payne (an employee of Cardinal) as two of the lead plaintiffs in the case. It came out in discovery, however, that Cardinal and Payne were significant short sellers of Terayon stock (hundreds of thousands of shares) and in early 2000 had begun a campaign to flood the market with negative information about the company. The campaign included phone calls to the certification entity, starting Internet chat room rumors, letters to the SEC, and contacts with financial reporters.
Moreover, Cardinal was apparently working closely with plaintiffs' counsel (later lead counsel for the class) during this period. Starting in February 2000, Internet website postings encouraged parties to contact plaintiffs' counsel about a proposed lawsuit against Terayon. According to Judge Patel, "the class period in the original complaint, i.e. the first day on which plaintiffs claim they were damaged, was February 9, 2000 the same day these Internet postings appeared. Defendants assert that these web postings were part of plaintiffs’ alleged scheme to drive the price of the stock down."
On April 11, 2000, the same day as a Terayon earnings conference call during which the company's executives were sharply criticized by short sellers using phony names, an investor plaintiff signed a sworn statement authorizing the filing of a complaint that closely tracked the language of Cardinal’s letters to the SEC. It was not until the next day, however, that the price of Terayon's stock dropped significantly. The complaint was filed on April 13.
Following the revelation of these facts, defendants moved to have Cardinal and Payne removed as lead plaintiffs. (See this earlier post in The 10b-5 Daily about press coverage of the hearing held last September.) Judge Patel has agreed and more.
The court found "[w]hile some short sales may not, in and of themselves render a lead plaintiff’s claims atypical, a pattern of affirmatively engaging in campaigns devised to lower the price of the stock in question certainly contains within it the seeds of discord between lead plaintiffs and the remaining plaintiffs." Accordingly, the court removed Cardinal and Payne as lead plaintiffs (and also noted that they "appear to have participated, if not perpetrated, a fraud of their own on the market" and could be subject to claims by their fellow shareholders).
As for lead counsel, the court expressed concern over lead counsel's pre-suit involvement with Cardinal and its apparent efforts "to mislead the court as to the scope and nature of lead plaintiffs’ holdings in Terayon stock" as part of the lead plaintiff selection process. Based on this course of events, the court wondered "whether counsel for plaintiffs actively participated in or provided advice to plaintiffs regarding their scheme to cause a fall in Terayon’s stock price" and invited a motion on whether lead counsel had waived privilege. In any event, the court found "it is probable that there is a conflict not only between lead plaintiffs and the class but also between lead counsel and the remainder of the class." Lead counsel was asked to provide a written response to a number of questions and defendants were given leave to take further discovery on the issue.
If the judge ain't happy, ain't nobody happy. Proving that axiom correct, Judge Vaughn Walker of the N.D. of Cal. issued a fairly amazing order last week in the Copper Mountain securities litigation, expressing displeasure with both plaintiffs and the 9th Circuit over the lead plaintiff/lead counsel selection process in that case.
The PSLRA provides that the "presumptively most adequate lead plaintiff" in a securities class action is the movant who "has the largest financial interest in the relief sought by the class" and "otherwise satisfies the requirements of Rule 23 of the Federal Rules of Civil Procedure." To summarize the process, the judge's task is to determine which plaintiff has the largest financial interest, evaluate whether that plaintiff meets the adequacy and typicality tests of Rule 23(a), and, if that plaintiff meets the requirements, declare that plaintiff the presumptive lead plaintiff (a presumption that may then be rebutted by other plaintiffs). The court must also approve the lead plaintiff's choice of counsel.
Three years ago, Judge Walker determined that he would not name the lead plaintiff movant in the Copper Mountain case with the largest financial interest as lead plaintiff because that candidate, known as the CMI Group, failed to demonstrate that it was an adequate lead plaintiff. Judge Walker based his decision on the CMI Group's failure to negotiate a "competitive" fee arrangement with proposed lead counsel and named a different movant as lead plaintiff. See In re Quintus Sec. Litig., 201 F.R.D. 475 (N.D. Cal. 2001) and In re Quintus Sec. Litig., 148 F. Supp. 2d 967 (N.D. Cal. 2001).
The CMI Group petitioned the Ninth Circuit for a writ of mandamus. In In re Cavanaugh, 306 F.3d 726 (9th Cir. 2002), the court overruled Judge Walker's decision. The panel, in an opinion written by Judge Alex Kozinski, found that the lower court had failed to follow the statutory language of the PSLRA in appointing the lead plaintiff. In particular, the court found that "a straightforward application of the statutory scheme . . . provides no occasion for comparing plaintiffs with each other on any basis other than their financial stake in the case." Moreover, the lead plaintiff process "is not a beauty contest" and information about fee arrangements "is relevant only to determine whether the presumptive lead plaintiff's choice of counsel is so irrational, or so tainted by self-dealing or conflict of interest, as to cast genuine or serious doubt on that plaintiff's willingness or ability to perform the functions of lead plaintiff." Accordingly, the Ninth Circuit vacated the lower court's order and instructed the lower court to proceed with the CMI Group as the presumptive lead plaintiff.
On remand, however, the CMI Group apparently decided to no longer seek lead plaintiff status (or, as Judge Walker puts it, "vanished - fled the scene - gone south - maybe vaporized"). In his order, Judge Walker compares the situation to a "heroic prince" turning into a "frog" and is incredulous over the course of events:
"By vindicating their 'right' to be the presumptive lead plaintiffs through the extraordinary remedy of mandamus (and establishing circuit precedent of no little value to their lawyers), the CMI group might seem to possess a tenacity and determination seldom seen on the battlegrounds of federal litigation. But what might seem apparently is not. Could there have been some motivation other than vindicating the interests of defrauded investors behind the mandamus proceedings? Could it be that the Ninth Circuit panel, perceiving the black letter of the PSLRA, was actually reading a fairy tale?"
Also not surprisingly, Judge Walker appears to believe that the CMI Group's decision vindicates his earlier order. Noting that "Cavanaugh would seem to establish that the largest stakeholder's selection of counsel must be approved unless that selection is either mad or crooked," the court finds that the opinion converts the PSLRA into "a straightjacket against judicial measures to ensure that [securities class actions] genuinely benefit investors, not lawyers." In the absence of the CMI Group, Judge Walker ends up simply reappointing the earlier lead plaintiff to the position. "The moral of the story," the court concludes, "will be left to you, dear readers."
The Recorder has an article (via law.com - free regist. req'd) on the case in today's edition. Judge Walker's order is not yet available online.
Addition: The opinion is now on Westlaw - In re Copper Mountain Sec. Litig., 2004 WL 369859 (N.D. Cal. Feb. 10, 2004).
According to a Reuters report, plaintiffs' counsel in the securities class action pending against Parmalat SpA in the S.D.N.Y. has sought a court order preventing the destruction of documents by the company and its advisors. District Judge Lewis Kaplan was apparently unimpressed with the request. Noting that destruction of documents is a criminal offense and any order would be redundant, the judge suggested at a hearing on Friday that the request for an order was done mainly for the benefit of the media. "If anyone wants to file papers on this, God bless them," Judge Kaplan said. "But don't waste my time."
Quote of note: In response to plaintiffs' counsel's description of the Parmalat case as "unusually high-profile," Judge Kaplan responded - "Not by the standards of this district. There is nobody named Martha in this case."
The State Treasury and Attorney General of Connecticut are leading a securities class action against JDS Uniphase Corp. (Nasdaq: JDSU), a San Jose-based fiber-optic components maker. In an interesting development, Reuters reports that the Attorney General has taken out an advertisement in the Ottawa Citizen newspaper (JDS Uniphase used to have part of its headquarters in Ottawa and still has 580 employees there) discussing the case and urging JDS Uniphase employees to dislcose what they know about the company even if they've signed confidentiality agreements.
Quote of note: "'Some employees may have signed confidentiality agreements, but the court agreed with the Treasurer's Office and the Attorney General that employees cannot be prevented from telling what they know,' the advertisement said."
Want the plaintiffs to voluntarily dismiss their securities class action? All you have to do is get the SEC to approve your "unusual" accounting practices. According to an article in the Boston Globe, PolyMedica Inc. (Nasdaq: PLMD - a maker of diabetes test kits) has convinced the SEC to approve its use of a "1993 accounting rule to record marketing costs as an asset on its balance sheet." This accounting treatment was the subject of the securities class actions pending against the company, which may now be dropped.
Quote of note: "PolyMedica argued it operates like an insurance company because customers sign up immediately upon viewing an ad. The company is well known for the blood-glucose test kits it sells via television ads under its Liberty brand name. The company said the SEC has decided that 'PolyMedica should continue to capitalize its direct response advertising costs related to the acquisition of new customers, rather than expensing such costs as incurred.'"
Harvey Greenfield was a plaintiffs' securities class action lawyer who passed away in 2002. A proud alumnus of Harvard Law School, Greenfield indicated to people that he planned to leave the bulk of his $35 million estate to the school. But a year after Greenfield's death, his will cannot be located and there is an ongoing battle between Harvard and his sole living heir over who will receive the money. The August 20, 2003 edition of the New York Law Journal contains an article (via law.com - free registration required) discussing Greenfield (including his famously abrasive dealings with other lawyers) and the legal contest over his estate.
According to the Recorder (via law.com), a prominent securities class action plaintiffs' attorney stated at a recent ABA seminar that "he has been offered 50 percent of any judgment that comes directly from the pocketbooks of individual directors and officers." Moreover, his institutional clients are committed to defending this type of fee arrangement in court.
Note, however, that this is not really a new revelation. An article in the January 2003 issue of the Corporate Legal Times (only available online via Westlaw or LexisNexis) discussed the use of premium fee arrangements to target the personal assets of alleged corporate wrongdoers under the sub-headline "Institutional Investors Place a Bounty on Directors and Officers." Just something else to keep corporate executives up at night.
Fortune magazine has a short, often funny, and very effective interview with former SEC commissioner Joseph Grundfest. Among other things, Grundfest has a two-word explanation for the recent spate of corporate scandals: Winona Ryder. (Thanks to the Securities Law Beacon for the link.)
Quote of note:
Interviewer: "You've argued historically the class-action system has compensated investors - but hasn't deterred future misbehavior. Why?"
Grundfest: "I'm not suggesting that it has no deterrent effect. It's just weak compared with the criminal and the SEC enforcement mechanisms. The reason is that only 0.5% of the settlements in the 15 largest settlements came out of the pockets of the wrongdoer."
Gary Winnick, the former Global Crossing executive, was not amused to find that his likeness appears on the "Shareholders' Most Wanted" playing cards and sent a cease-and-desist letter directly to the distributers. The distributers, however, claim in this Reuters article that the letter was inappropriate because they are plaintiffs in the Global Crossing securities class action.
In the wake of his recent opinions, Judge Pollack of the S.D.N.Y. is profiled in today's Wall Street Journal (suscrip. required).
Quote of note: "Judge Pollack was just as brassy in his days as a plaintiffs' lawyer, said Michael Mukasey, chief judge of the Southern District where Judge Pollack sits. As Judge Mukasey tells the story, one day when taking a deposition from Spyros Skouras, then head of the 20th Century Fox movie studio, in Mr. Skouras's wood- paneled office, Mr. Pollack calmly selected a cigar from a humidor, bit off the end and lit up. Visibly reddening, Mr. Skouras said: 'Mr. Pollack, I don't remember offering you a cigar.' Mr. Pollack replied, 'Those aren't your cigars, those are the stockholders' cigars.'"