February 13, 2014

Applying the Safe Harbor

There are two prongs to the PSLRA's safe harbor for forward-looking statements. First, a defendant is not liable with respect to any forward-looking statement that is identified as forward-looking and is accompanied by "meaningful cautionary statements" alerting investors to the factors that could cause actual results to differ. Second, a defendant is not be liable with respect to any forward-looking statement, even in the absence of meaningful cautionary statements, if the plaintiff cannot establish that the statement was made with "actual knowledge" that it was false or misleading.

Although the circuit courts agree that the two prongs operate separately, they are split as to whether the defendant's state of mind should be considered in determining whether the cautionary statements are sufficiently "meaningful." The Sixth, Ninth, and Eleventh Circuits have held that the defendant's state of mind is irrelevant. The Seventh and Second Circuits, however, have suggested that it might be necessary to inquire into what the defendant knew about the risks facing the company before making that determination.

In In re Harman Int'l Indus., Inc. Sec. Litig., 2014 WL 197919 (D.D.C. Jan. 17, 2014), the district court agreed with the majority position and found that the defendant's state of mind is irrelevant. First, the plain text and the legislative history of the PSLRA make it clear that the first prong should be considered without reference to the defendant's state of mind. Second, considering the defendant's state of mind would improperly collapse the two prongs together, essentially making it impossible for a defendant to invoke the first prong at the pleadings stage of the case.

Holding: Motion to dismiss granted.

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January 17, 2014

Following The Rules

If an SEC rule states that certain information does not have to be disclosed in a public filing, does that mean a company cannot act recklessly in failing to disclose that information? In In re Hi-Crush Partners L.P. Sec. Litig., 2013 WL 6233561 (S.D.N.Y. Dec. 2, 2013), the defendants noted that under the SEC's Form 8-K rules, they were not required to disclose that a major customer had terminated its contract with the company because the purported termination was invalid. In support of their argument that the plaintiffs had failed to adequately plead scienter, the defendants cited a different district court, addressing a similar set of facts, which held that "defendants' compliance with [SEC regulations] suggests that Lead Plaintiff has failed to show defendants acted recklessly in omitting such information."

The Hi-Crush court agreed that the Form 8-K rules did not require the disclosure, but disagreed that this meant the defendants had not acted recklessly. First, the court found that even in the absence of an affirmative disclosure obligation, the defendants could have a duty to disclose the information to avoid misleading investors. Second, given that the contract was supposed to generate 18.2% of Hi-Crush's revenue stream, it was "imperative" that investors be told about the threat of termination.

Holding: Motion to dismiss granted in part and denied in part.

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December 27, 2013

Last Man Standing

The Gentiva securities class action is based on allegations that the company violated Medicare rules and artificially inflated the Medicare payments it received. In a previous post, The 10b-5 Daily discussed the motion to dismiss decision in the case, where the court found that the plaintiffs had adequately plead a strong inference of scienter against the company and two of its officers based solely on alleged suspicious insider trading. The defendants moved for reconsideration.

In In re Gentiva Sec. Litig., 2013 WL 6486326 (Dec. 10, 2013), the court reevaluated the trading and came to some different conclusions. As to the former CFO's trading, the court found "that trades under a Rule 10b5-1 plan do not raise a strong inference of scienter." If those type of trades were removed from the CFO's trading, all that would remain was a sale of 20,000 shares (or 12% of his holdings) that "occured more than six months before the announcement of the government investigation." Under these circumstances, the trading was not sufficiently suspicious and the court dismissed the securities fraud claim against the CFO.

But what did that mean for the two remaining defendants in the case - the former CEO and the company? As to the CEO, the court found that he sold 99% of his shares during the class period for approximately $2.14 millon and those sales were not made pursuant to a Rule 10b5-1 trading plan. The fact that no other officers were adequately alleged to have engaged in suspicious trading did not alter the court's conclusion that the CEO's trading created a strong inference of scienter as to him. When it came to the company, however, the court reversed field and found that the suspicious sale of stock by only one officer - as opposed to two officers - could not support a finding of corporate scienter and dismissed the securities fraud claim against the company.

So, after reconsideration, the case apparently will move forward against a single individual defendant - the former CEO.

Holding: Motion for partial reconsideration granted in part and denied in part.

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December 13, 2013

That's Not Suspicious At All

The impact of a Rule 10b5-1 trading plan on a court's scienter analysis depends largely on the overall facts and circumstances surrounding the trading. In Koplyay v. Cirrus Logic, Inc., 2013 WL 6233908, (S.D.N.Y. Dec. 2, 2013), the court considered allegations that during the class period the individual defendants sold 14%, 11%, 46% and 10% of their stock holdings (for profits ranging from less than $1m to $4m). In surveying the case law, the court found that this trading was not "suspicious" for the following reasons:

(1) The timing of the sales, which allegedly took place at the "height" of the class period, "actually weighs against a finding of scienter, as the majority of the sales were neither at the beginning of the Class Period, soon after the misleading statements, nor clustered at its end, when insiders theoretically would have rushed to cash out before the fraud was revealed and stock prices plummeted."

(2) The court declined to adopt a rule that an insider's sale of more than 10% of his holdings is suspicious. Instead, the court noted that "courts have found scienter based on sales similar to these only where the volume of sales and total profit is overwhelming or where some other factor, such as the timing of the sales, further tips the balance."

(3) The court found that all but one of the sales were made pursuant to Rule 10b5-1 trading plans that "were entered into months before the class period." Although the plaintiffs argued that the defendants could have "timed the release of good and bad news to maximize insider trading profits based on triggers in the plan," the court found that "this argument effectively reduced to a claim that Defendants had scienter because they were motivated to raise the price of Cirrus stock."

Holding: Motion to dismiss granted.

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December 6, 2013

The Fateful Work of Supernatural Forces

If the judge likens the events surrounding the collapse of your company to a "massive train wreck," is moving to dismiss the related securities class action worthwhile? That was the question facing the defendants in the MF Global Holdings case and the court did not like their answer.

In In re MF Global Holdings Ltd. Sec. Litig., 2013 WL 5996426 (S.D.N.Y. Nov. 12, 2013), the court started out by noting that its "train wreck" analogy "was meant as a hint giving a form of guidance." The case involved the alleged disappearance of $1.6 billion from customer accounts that was later found to have been "improperly commingled and used to cover questionable company transactions." Under these circumstances, the court believed that the parties would "turn to the search for relevant evidence," but instead was surprised to find that the defendants "seem convinced that no one named in this lawsuit could possibly have done anything wrong." Indeed, the defendants' contention that all twenty-three claims against them should be dismissed must mean that MF Global's collapse was "the fateful work of supernatural forces, or else that the explanation for a spectacular multi-billion dollar crash of a global corporate giant is simply that 'stuff happens.'"

The court went on to reject the motion to dismiss in its entirety. However, the court did make at least one legal ruling in favor of the defendants. A key issue in the case is whether MF Global's statements about its deferred tax assets were false or misleading. Deferred tax assets are losses, credits and other tax deductions that may be used to offset taxable income in the future, but they can only be recorded as assets on a company's balance sheet to the extent the company determines it is "more likely than not" they will be realized. The court found that under Second Circuit precedent, "statements about the realization of the DTA are statements of opinion, not of fact." Accordingly, the plaintiffs ultimately will need to prove that these statements were both false and not honestly believed at the time they were made.

Holding: Motion to dismiss denied.

Quote of note: "In evaluating the application of law that Defendants argue would allow the outcome that they seek at this stage of the litigation, the Court's assessment may be simply stated: It cannot be."

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November 22, 2013

Stick To The Plan

Does the fact that an individual defendant's stock trading took place pursuant to a pre-determined Rule 10b5-1 trading plan undermine any inference that the trades were "suspicious"? Courts continue to be split on this question, with the answer often depending on the exact circumstances surrounding the plan's formation and execution.

In In re Questor Sec. Litig., 2013 WL 5486762 (C.D. Cal. Oct. 1, 2013), the court examined a plan that was created around the beginning of the class period and lead to periodic sales of 30,000 shares each until July 2012. When the plan terminated, however, the defendant "made two additional sales of 40,000, more than his usual 30,000 sales, in August and September 2012 [just prior to the end of the class period]." Based on this fact pattern, the court found that while the sales could have been innocent, it was "equally as plausible that, after observing the success of Questcor's aggressive and misleading marketing strategies, [the defendant] set up the plan to avoid the appearance of improper sales."

More generally, the decision contains an extensive analysis of the scienter implications of the defendants' stock trading. The court holds, inter alia, that (a) even where the percentage of stock sold is not suspicious, the sales can support an inference of scienter if the profits are "substantial," and (b) a company's implementation of a stock repurchase plan during the class period can be inconsistent with scienter, because it is illogical for a company to buy shares if it knows the price will fall.

Holding: Motion to dismiss denied.

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September 27, 2013

That Word Does Not Mean What You Think It Means

In its Tellabs decision, the U.S. Supreme Court held that a court must assess a plaintiff's scienter (i.e., fraudulent intent) allegations "holistically" in determining whether the plaintiff has met the requisite "strong inference" pleading standard. The 10b-5 Daily noted at the time of the Tellabs decision that this holding "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." The Second Circuit has failed to address this inconsistency, however, leading to decisions that are arguably at odds with binding precedent.

In In re Gentiva Sec. Litig., 2013 WL 5291297 (E.D.N.Y. Sept. 19, 2013), the court addressed allegations that the company violated Medicare rules and artificially inflated the Medicare payments it received. In its first motion to dismiss decision, the court found that the plaintiffs had failed to adequately plead either motive and opportunity to commit fraud or sufficient circumstantial evidence of conscious misbehavior.

As to the amended complaint, the court again concluded that there were insufficient allegations to establish that the "Individual Defendants knew or had access to information showing that Gentiva was pressuring its staff to provide as many therapy visits as possible to receive extra Medicare payments without consideration of patients' needs." On the issue of motive, however, the court found that two of the individual defendants had exercised stock options and sold a significant amount of shares during the class period. It also found that corporate scienter could be "inferred from the 'suspicious' insider stock sales." Accordingly, the court denied the motion to dismiss "to the extent the Plaintiff seeks to establish scienter of the Defendants Malone, Potapchuk, and Gentiva based on a theory of 'motive and opportunity.'"

What does it mean to "holistically" examine the complaint's scienter allegations if they are divided into two categories? The court offers no explanation, but the responsibility ultimately lies with the Second Circuit, which needs to address this question.

Holding: Motion to dismiss denied, with the court curiously stating the plaintiff would "not be permitted to present . . . at trial" a theory of scienter based on circumstantial evidence of misbehavior or recklessness.

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August 23, 2013

Staying On Track

Under the PSLRA's safe harbor for forward-looking statements, such statements cannot form the basis for securities fraud liability unless (a) the statements were not accompanied by "meaningful cautionary statements" and (b) the defendants had "actual knowledge" of their falsity. A company's forward-looking statements, however, often contain some reference to present facts. Does that make these statements ineligible for the safe harbor?

In IBEW Local 98 Pension Fund v. Best Buy Co., Inc., 2013 WL 3982629 (D. Minn. Aug. 5, 2013), the court considered this question in evaluating whether the company's statements that it was "on track to deliver and exceed our annual EPS guidance" and that its earnings were "essentially in line" with expectations were forward-looking. Although the defendants argued that these statements were simply affirmations of the projected guidance, and therefore forward-looking, the court concluded that they really were statements of present condition. Accordingly, the statements were not subject to the safe harbor.

Holding: Motion to dismiss granted in part and denied in part.

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August 16, 2013

It's A Question Of Ethics

Are a company's ethical guidelines material (i.e., important to the investment decision of a reasonable investor)? In Cement & Concrete Workers District Council Pension Fund v. Hewlett Packard Co., 2013 WL 4082011 (N.D. Cal. Aug. 9, 2013), the plaintiffs alleged that the CEO's undisclosed relationship with an independent consultant (which lead to his firing and a significant stock price drop) caused the company's ethical guidelines to be misleading "because in light of [the CEO's] endorsement of these tenets, there was an implication that [he] was in fact in compliance with them." In addition, the company's public filings contained a disclosure about the risk to HP's operations associated with the need to retain key executives, which the plaintiffs claimed was rendered misleading by the omission of the CEO's "actual, fraudulent, and noncompliant business practices."

The court concluded that both sets of statements were immaterial. As to the ethical guidelines, the court found that they were "not specific, nor do they suggest that [the CEO] was in compliance with them at the time they were published." Indeed, no reasonable investor would "depend on [them] as a guarantee that [HP] would never take a step that might adversely affect its reputation." Similarly, the plaintiffs' argument that the risk factor about executive retention was material improperly conflated "the materiality of statements concerning whether [the CEO] would, in fact, remain at HP with the materiality of vague and routine statements concerning the retention of executives in general."

Holding: Motion to dismiss granted (without prejudice).

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July 12, 2013

Gossip Sessions

The use (and potential abuse) of confidential witnesses continues to be a controversial topic in securities class actions. Some court decisions, particularly in the Boeing securities litigation, have been sharply critical of how the plaintiffs' bar conducts its pre-filing investigations and decides what statements to include in its complaints. A recent decision from Judge Rakoff (S.D.N.Y), however, suggests that at least some of the problems may arise from witness "indiscretions."

In City of Pontiac General Employees' Retirement System v. Lockheed Martin Corp., 2013 WL 3389473 (S.D.N.Y. July 9, 2013), the court denied the defendants' motion to dismiss. The defendants subsequently deposed the confidential witnesses cited in the complaint and filed a "limited motion for summary judgment" arguing that these witnesses had either recanted their statements or never made them in the first place. The court held an evidentiary hearing, denied the motion, and the parties settled. Nevertheless, the court decided to issue a memorandum on the issue of the confidential witness statements.

In its memorandum, the court noted that the testimony presented by the five confidential witnesses suggested "that some, though not all, of the CWs had been lured by the [plaintiff's] investigator into stating as 'facts' what were often mere surmises, but then, when their indiscretions were revealed, felt pressured into denying outright statements they had actually made." The court took particular issue with two of the confidential witnesses claiming that they only had short calls with the investigator when the plaintiffs' phone records revealed that the main calls were both around an hour long. Moreover, two of the witnesses "confirmed the substance of the statements attributed to them in the Amended Complaint, while noting that such snippets did not always convey the nuances of what they had told [the investigator]." The fact that these witnesses testified to the accuracy of what the investigator had reported created an inference that the investigator's report "was accurate in all material respects."

Holding: Motion for summary judgment denied.

Quote of note: "It seems highly unlikely that Congress or the Supreme Court, in demanding a fair amount of evidentiary detail in securities class action complaints, intended to turn plaintiffs' counsel into corporate 'private eyes' who would entice naive or disgruntled employees into gossip sessions that might help support a federal lawsuit. Nor did they likely intend to place such employees in the unenviable position of having to account to their employers for such indiscretions, whether or not their statements were accurate. But, as it is, the combined effect of the PSLRA and cases like Tellabs are likely to make such problems endemic."

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April 12, 2013

Draining the Safe Harbor

Securities class actions alleging that a company issued false or misleading earnings guidance are frequently dismissed. Among other things, to overcome the PLSRA's safe harbor for forward-looking statements a plaintiff must adequately plead (a) the guidance was not accompanied by "meaningful cautionary statements" and (b) the company had "actual knowledge" of its falsity. Given the vagaries of business performance, courts generally find that one or the other pleading burden has not been met.

With that background, the decision in City of Providence v. Aeropostale, Inc., 2013 WL 1197755 (S.D.N.Y. March 25, 2013) is interesting because the court found that the plaintiffs successfully plead an "earnings guidance" claim, albeit with the help of a unique fact pattern and (arguably) a misreading of the law. Aeropostale is a clothing retailer. In the second half of 2010, the company decided to change the design of its women's fashion line and placed orders for the new styles that would provide inventory through the fall of 2011. The new styles sold poorly and, in December 2010, the company fired the officer who led the change.

In response to the poor sales, Aeropostale provided 2011 earnings guidance that was below its 2010 results. According to the complaint, however, this guidance still understated the sales and inventory problems and failed to disclose that the unpopular new styles had been pre-ordered and would continue to be stocked for the next several quarters. The defendants argued that its earnings guidance (and other statements about the company's future performance) were protected by the PSLRA's safe harbor, but the court disagreed.

First, the court found that Aeropostale had failed to provide "meaningful cautionary statements." While the company disclosed risks concerning "consumer spending patterns," "fashion preferences," and "inventory management," its failure to disclose that the new styles would continue to be sold throughout most of 2011 meant that these risks were not hypothetical. Accordingly, the cautionary statements were inadequate because they did not "disclose hard facts critical to appreciating the magnitude of the risks described."

Second, the court found that the "safe harbor does not apply to material omissions" and, as a result, the failure to dislose the pre-ordering of the unpopular new styles was "unprotected by the safe harbor, regardless of whether the statements thereby rendered misleading were forward-looking." Because the court "declined to find that the misleading nature of the statements rests on the forward-looking aspects of the statements," it also declined to find that the safe harbor's "actual knowledge" requirement was applicable.

The court's interpretation of the scope of the safe harbor is questionable (and perhaps unnecessary, given the court's general view of the strength of the complaint's allegations). The PSLRA expressly states that the safe harbor applies "in any private action that is based on an . . . omission of a material fact necessary to make the statement not misleading." While the safe harbor does not apply to statements of current fact (whether they are alleged to be misstatements or rendered misleading by a material omission), that is different than concluding that the safe harbor does not apply to forward-looking statements that are alleged to be misleading because of the omission of a current fact. Indeed, reading the statute in this manner would severely limit its application. Plaintiffs routinely allege that a company's projections were misleading based on its failure to disclose certain current facts.

Holding: Motion to dismiss denied.

Addition: The complaint also contained "opinion evidence from an expert in the retail and wholesale industry," who concluded that the "Defendants had no reasonable basis to believe that Aeropostale could meet the guidance they issued." Although the court summarized this opinion evidence in its decision, it also stated that it "did not consider any of the 'expert testimony' that was included - inappropriately in the Court's view - in the pleading."

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February 22, 2013

The Continuing Omission Theory

Pursuant to 28 U.S.C. Sec. 1658(b), a private securities fraud action "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." While there are a number of cases that have explored what triggers the 2-year period (the statue of limitations), fewer courts have examined what triggers the 5-year period (the statute of repose).

In Intesa Sanpaolo, S.p.A. v. Credit Agricole Corporate and Investment Bank, 2013 WL 525000 (S.D.N.Y. Feb. 13, 2013), the plaintiff argued that its securities fraud claim was not time-barred under the 5-year deadline "because a 'violation' for 1658(b) purposes is the transaction that forms the basis of the Sec. 10(b) claim at issue (rather than the alleged misrepresentation)." Alternatively, the plaintiff argued that even if the misrepresentation triggered the time period, its claim was still timely because the defendants had concealed the truth until less than five years before the complaint was filed. The court rejected both arguments.

First, the court found that the majority of courts have held that the "violation" is the misrepresentation, not the securities transaction, and there was no dispute that the last alleged misrepresentation took place more than five years before the plaintiff brought its suit. Second, the court rejected the "continuing omission" theory proposed by the plaintiff. The court noted that "applying the concept of a continuing omission to the five-year deadline would essentially render that element of 1658(b) a nullity with respect to any securities fraud case that does not involve a corrective disclosure."

Holding: Federal claims time-barred.

Quote of note: "For example, if it is assumed that an individual purchased a company's stock in February 2007 in reliance upon an offering memorandum that contained a material omission that was never subsequently acknowledged or corrected, under the continuing omission theory urged by Inesta, not only would a claim based on that omission be timely even today, six years after the omission, despite 1658(b)'s five-year deadline, but the five-year deadline would not have even begun running on the claim."

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January 11, 2013

A Lengthy, Uncertain Process

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 growing 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 New Jersey Carpenters Health Fund v. Residential Capital, LLC, 2013 WL 55854, (S.D.N.Y. Jan. 3, 2013), the court surveyed this case law and sided with the majority position. In particular, the court found that failing to toll the statute of repose would undermine the purpose of FRCP 23 and its endorsement of class actions. Indeed, the court noted that "in a securities case, the risk that potential class members would flood the courts is particularly serious, since class certification is a lengthy, uncertain process." Moreover, any former class members would have effectively been a party to an action against the defendant already. Tolling their individual claims therefore would not be "contrary to the purpose of the repose period that the right to initiate suit against a defendant be within a legislatively determined time period."

Holding: Denying motion to dismiss claims.

Addition: On the Case has a post on the decision and notes that the Second Circuit is considering the tolling issue in a pending appeal.

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December 14, 2012

They Can't Both Be Right

Let's say a company provides a financial statement to a government regulator, but then provides a different (and significantly more favorable) financial statement to investors. The financial statement given to the investors has to be false, right? Not so fast.

In In re L&L Energy, Inc. Sec. Litig., 2012 WL 6012787 (W.D. Wash. Dec. 3, 2012), the court addressed a securities class action brought against a U.S. company engaged in coal mining and related operations in China. The plaintiffs alleged that L&L Energy's revenue and income for FY2009, as disclosed in its SEC filings, was grossly overstated. The allegation was "based primarily on the fact that L&L Energy's subsidiaries in China reported much lower revenue and income to the PRC State Administration for Industry and Commerce ('SAIC') over a comparable period." Moreover, the plaintiffs asserted, it was clear that the SAIC numbers reflected L&L Energy's true financial performance because "there are strict penalties, including the revocation of an entity's business license, for filing false statements with the SAIC."

The court was less sure about which numbers to believe. As a threshold matter, the court found that it was difficult to determine whether the plaintiffs were actually comparing apples to apples, given that the SAIC data appeared to "differ[] in material ways from the information provided to the SEC, and not just in amounts." Even if one of the filings must be incorrect, however, the court held that the plaintiffs had failed to adequately plead it was the SEC numbers that were false. Willful misstatements in an SEC filing can also result in significant penalties and, therefore, the "only reasonable inference is that corporations make false statements to both the SAIC and the SEC at their peril."

Holding: Motion to dismiss granted with leave to amend.

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September 28, 2012

Merck Again

A recent decision in the long-running Merck securities litigation contains a pair of interesting holdings. In In re Merck & Co., Inc. Securities, Derivative & ERISA Litigation, 2012 WL 3779309 (D.N.J. Aug. 29, 2012), the court considered the impact of its rulings in a related individual suit on the securities class action.

(1) False or Misleading Statements - Can accurate financial statements be rendered false or misleading because the company fails to disclose ongoing business problems? Plaintiffs frequently bring claims based on these types of allegations, with mixed results in the courts. In Merck, the court found that this theory of liability “would expose a company to liability every time it reported previous successes without disclosing any and every reason, established or not, the company had for second-guessing the reported performance, be it a contemplated change in business strategy, dissension among company management or adverse information about a key product.” Accordingly, the court declined to find that the company’s earnings statements could have been rendered inaccurate by the company’s failure to disclose drug safety issues.

(2) Control Person Liability - Does a plaintiff have to adequately plead that the defendant was a “culpable participant” to move forward with a control person claim? The Merck court noted that other judges in the District of New Jersey have held that it is not necessary to provide factual support for this element. The court held that this position is no longer tenable, however, following the Supreme Court’s Iqbal decision, which clarified that a claim cannot survive a motion to dismiss unless “the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Moreover, because pleading “culpable participation” is akin to pleading scienter, it is subject to the PSLRA’s heightened pleading standard. A plaintiff asserting a control person claim therefore “must plead with particularity facts giving rise to a strong inference that the controlling person knew or should have known that the primary violator, over whom the person had control, was engaging in fraudulent conduct.”

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August 17, 2012

Made In America

While the Morrison decision limits Section 10(b) liability to securities transactions that take place in the United States, the complexity of the global securities market can lead to transactions that are difficult to define geographically. As a result, lower courts have struggled to consistently apply Morrison to different fact patterns.

In Phelps v. Stomber, 2012 WL 3276969 (D.D.C. Aug. 13, 2012), the court addressed whether there could be Section 10(b) liability for "Class B Shares" and "Restricted Depositary Shares (RDS)" issued by a closed-end investment fund. The Class B Shares were sold only outside the U.S. to foreign investors. The RDSs were sold to investors in the U.S.

As to the Class B Shares, the court held it was of no significance that Euronext, the exchange upon which the shares were traded, is owned by a Delaware company. Euronext was still a "foreign exchange" for purposes of the Morrison analysis and there could be no Section 10(b) liability. In contrast, the RDSs were clearly bought and sold in the U.S., but the defendants argued that the purchase of a RDS also should be considered a foreign transaction because it represented the shareholder's ownership of a Class B Share traded on Euronext. Among other precedent, the defendants cited the Societe Generale decision, which held that American Depository Receipts were the "functional equivalent" of trading a company's shares on a foreign exchange. The court rejected this view, finding that while the contention that "an investor could not purchase an RDS in the United States without a corresponding overseas transaction may be true, it does not change the fact that a purchase in the United States still took place." Accordingly, Morrison did not bar the RDS claims.

Holding: Motion to dismiss granted (on other grounds as to the RDS claims).

Quote of note: "[P]laintiffs' efforts to label everything "Made in America" to get around Morrison requires the Court to ignore allegations in the complaint and information contained in the Offering documents referenced in the complaint."

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August 10, 2012

What Does "Holistic" Mean?

In its Tellabs decision, the U.S. Supreme Court held that a court must assess a plaintiff's scienter (i.e., fraudulent intent) allegations "holistically" in determining whether the plaintiff has met the requisite "strong inference" pleading standard. The 10b-5 Daily noted that this holding "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." In the intervening years, however, the Second Circuit has not directly addressed this inconsistency, to the benefit of plaintiffs.

George v. China Automotive Systems, Inc., 2012 WL 3205062 (S.D.N.Y. Aug. 8, 2010) is a "Chinese reverse merger" case alleging that the company engaged in accounting fraud. In their motion to dismiss, the defendants argued that the plaintiffs had failed to adequately plead scienter. The court, citing Second Circuit precedent, noted that the "requisite 'strong inference' of scienter can be established by alleging facts showing (a) defendants' 'motive and opportunity' to commit the alleged fraud, or (b) strong circumstantial evidence of conscious misbehavior or recklessness." After examining the complaint, the court held that the plaintiffs' insider trading allegations, by themselves, were sufficient to establish motive and opportunity. In particular, four of the seven individual defendants "sold over 50% of their CAAS stock during the class period" and the individual defendants collectively made a net profit of nearly $42 million on their class period sales.

The defendants offered two counterarguments, both of which were rejected by the court. First, the defendants noted that the individual defendants had entered into Rule 10b5-1 stock trading plans. As a result "more than two-thirds of [their] sales were made pursuant to the 10b5-1 plans and the remaining sales are too small a fraction of total sales to establish 'unusual' trading." The court held that because the 10b5-1 trading plans were entered into during the class period, they could not be invoked "to disarm any inference of scienter raised by the Individual Defendants' sales of CAAS stock." Second, the defendants asserted that "the alleged accounting errors and misstatements regarding internal controls are insufficient to sustain a securities fraud claim." The court found that this assertion was "immaterial at this stage" because the plaintiffs had "sufficiently plead motive and opportunity."

It is difficult, in the wake of Tellabs, to see how a lower court can engage in the required weighing of competing inferences of scienter if it stops the exercise after finding that there has been "unusual" insider trading. The Second Circuit needs to sort this out.

Holding: Motion to dismiss denied (except as to an auditor defendant).

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May 25, 2012

Back From The Dead

Can a plaintiff in a securities class action use information gained through the discovery process to resurrect previously dismissed claims? In In re Constellation Energy Group, Inc. Sec. Litig., 2012 WL 1067651 (D. Md. March 28, 2012), the court dismissed all of the fraud claims (1934 Act), but allowed the non-fraud claims (1933 Act) to proceed. Following discovery, the plaintiff argued that it had found "new evidence of scienter" and moved for lead to amend its complaint to re-plead the fraud claims.

The court held that neither the plain language nor the purpose of the PSLRA would be frustrated by allowing the fraud claims to go forward. The PSLRA's discovery stay provision (which stays all discovery pending the resolution of a motion to dismiss) was designed to "limit the pressure on innocent defendants to settle cases in lieu of proceeding to expensive discovery" not "to shield all defendants from any adverse evidence that may properly be discovered over the course of litigation." Moreover, the case was still ongoing against the same defendants, so they would not be prejudiced by having to defend themselves against the new claims. In this instance, however, the court denied the motion for leave to amend as futile, finding that even with the new evidence the plaintiff had failed to satisfy the "strong inference" pleading standard for scienter.

Holding: Motion for leave to amend denied.

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February 20, 2012

The Importance of Being Listed

A federal court has repelled an attempt to circumvent the Morrison decision through the use of state and foreign law claims. In In re BP P.L.C. Sec. Litig., 2012 WL 432611 (Feb. 13, 2012 S.D. Tex.), the plaintiffs brought claims on behalf of U.S. investors who purchased BP common shares on the London Stock Exchange ("Ordinary Share Purchasers). The claims included federal securities fraud claims, as well as New York common law and English law claims.

The court's analysis hinged largely on the fact that BP's common shares are listed, but not traded, on the New York Stock Exchange (to comply with SEC requirements governing the company's American Depositary Shares program).

(1) Federal securities fraud claims - Following a number of other recent decisions, the court held that the mere fact that BP's common shares were listed on the NYSE did not allow the Ordinary Share Purchasers to bring a federal securities fraud claim. Moreover, the court rejected plaintiffs' additional arguments that it should consider both the U.S. residency of the Ordinary Share Purchasers and the fact that the London Stock Exchange rules "allow trades to occur directly through third-party, U.S.-based market makers." Accepting these arguments would reinstate the old conduct and effect tests and they could not override the key point "that the Ordinary Share Purchasers bought BP ordinary shares on the LSE, the only exchange where BP ordinary shares trade."

(2) New York common law and English law claims – The fact that BP's common shares were listed, but not traded, on the NYSE also helped the defendants in the court's assessment of the state law and foreign law claims, but for an entirely different reason. Under the Securities Litigation Uniform Standards Act of 1998 (SLUSA), a plaintiff cannot bring a class action based on state law fraud claims if the case involves "covered securities." Covered securities are defined, among other things, as securities “listed, or authorized for listing, on the New York Stock Exchange.” There is no requirement that the securities also be traded on the NYSE and the court declined the plaintiffs' invitation to read one into the statute. The court therefore held that the New York common law claims involved covered securities and were precluded by SLUSA. Plaintiffs also argued that the court had jurisdiction over the English law claims based on diversity jurisdiction under the Class Action Fairness Act (CAFA). CAFA, however, excludes claims based on "covered securities" and uses the same definition of that term as SLUSA. Accordingly, the court found that it did not have original jurisdiction over the English law claims.

Holding: Dismissed claims of Ordinary Share Purchasers (but other claims in the case were allowed to proceed).

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January 27, 2012

The Little Birdy Sings A Different Tune

The use (and sometimes abuse) of confidential witnesses in securities cases is a contentious issue. Prior to full discovery, what remedy does the defendant have if a confidential witness was misquoted in the complaint? One possibility, recently approved by the Second Circuit, is to allow the witness to be deposed prior to the filing of a motion to dismiss. A recent decision from the D. of Minn. suggests another possible tactic, although the defendants were ultimately unsuccessful.

In Minneapolis Firefighters Relief Assoc. v. Medtronic, Inc., 2011 WL 6962826 (D. Minn. Dec. 12, 2011), the court considered the issue of class certification prior to the completion of discovery. In opposition to certification, the defendants argued that the plaintiffs could not adequately represent the class "because of alleged misrepresentations counsel made in the Amended Complaint regarding the testimony of the confidential witnesses." The defendants presented the court with declarations from thirteen of the fifteen confidential witnesses cited in the complaint. In their declarations, the witnesses took issue with how they were quoted, ranging from complaints about the plaintiffs' interpretation of their statements to an assertion by one witness that the statements attributed to him were "fabrications."

The court found that "the inquiry Defendants urge the Court to undertake - whether Plaintiffs misrepresented what the confidential witnesses said - is premature." In particular, the court noted that "[c]ounsel-drafted declarations are not a substitute for deposition testimony" and it declined to come to any conclusion about the conduct of plaintiffs' counsel until discovery was complete. The court therefore found that the plaintiffs were adequate class representatives and granted class certification.

Posted by Lyle Roberts at 11:26 PM | TrackBack

January 6, 2012

Improper Use

Does the fact that an individual defendant's stock trading took place pursuant to a pre-determined Rule 10b5-1 trading plan undermine any inference that the trades were "suspicious"? Courts continue to grapple with this issue in evaluating the existence of scienter (i.e., fraudulent intent) in securities fraud cases.

(1) In In re Novatel Wireless Sec. Litig,, 2011 WL 5873113 (S.D. Cal. Nov. 23, 2011), the court reviewed insider trading claims brought as a part of a securities class action. Defendants argued that several of the challenged trades were inactionable because they had been made pursuant to Rule 10b5-1 trading plans. The court noted, however, that "each defendant entered new or amended 10b5-1 plans . . . that contained accelerator clauses that called for immediate sales." Because the "improper use of 10b5-1 trading is evidence of scienter," the court found that a genuine issue of material fact precluded summary judgment on the insider trading claims.

(2) In The Mannkind Sec. Actions, 2011 WL 6327089 (C.D. Cal. Dec. 16, 2011), the court evaluated whether the plaintiffs had adequately pled motive based on a "suspicious" stock sale by one of the individual defendants. The defendant pointed out that the sale was only 10.5% of his holdings and "was made pursuant to a pre-determined 10b5-1 trading plan, and was identical to another 10b5-1 trading sale made 11 months earlier." The court concluded that the timing of the sale "appears suspicious." The plaintiffs' failure to rebut the contention that the sale had been made pursuant to a Rule 10b5-1 trading plan, however, meant that the sale could not "provide support for Plaintiffs' pleading of scienter."

Posted by Lyle Roberts at 10:16 PM | TrackBack

November 9, 2011

Not So Suspicious

The Apollo Group, a large private education provider, has been a magnet for securities litigation. In the most recent securities class action brought against Apollo, investors allege that from May 2007 to October 2010 the company made false and misleading statements about its financial condition, business focus, ethics, compensation and recruitment practices, and compliance with federal student loan regulations. In a recent decision - In re Apollo Group, Inc. Sec. Litig., 2011 WL 5101787 (D. Ariz. Oct. 27, 2011) - the court dismissed the claims. The decision has a few interesting holdings:

(1) Internet Postings - The complaint cited certain anonymous internet postings. The court noted that "the only appreciable difference between anonymous internet postings and confidential witness statements is that anonymous internet postings are less reliable." As a result, "with regard to anonymous internet postings, it is Plaintiffs' burden to plead reliability and knowledge that are indicative of scienter to at least the same extent as it must when pleading scienter with regard to confidential witness statements."

(2) Suspicious Stock Trading - There were nine individual defendants in the case. The plaintiffs alleged that four of those defendants sold Apollo stock during the class period (21%, 15%, 34%, and 26% of their holdings respectively). The court found that these stock sales did not support a strong inference of scienter because (a) they were not "large sales amounts," and (b) there were no "corroborative sales" by the other individual defendants.

(3) SEC Investigation - There is a district court split regarding whether the announcement of an SEC investigation is sufficient to establish loss causation (presuming that the announcement does not otherwise disclose any information about the alleged fraud). In Apollo's case, the relevant press release stated that the SEC was conducting an informal investigation into the company's revenue recognition practices. The court found that this disclosure had a sufficient nexus to the alleged fraud, because it could have signaled to a "reasonable investor that there were improprieties in Apollo's revenue recognition policies."

Holding: Motion to dismiss granted based on failure to adequately plead scienter.

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October 28, 2011

Win Big Or Go Home

A variation on the normal securities fraud case occurs when a short seller alleges that a company's misstatements caused it to cover its short positions at artificially high prices. Although few cases have directly addressed loss causation in the context of short selling, they generally are not favorable for the plaintiffs. That trend continues in the recent decision in Wilamowsky v. Take-Two Interactive Software, Inc., 2011 WL 4542754 (S.D.N.Y. Sept. 30, 2011).

Take-Two previously had settled a securities class action related to options backdating, but the settlement's plan of allocation excluded short sellers from recovery. Wilamowsky opted out of the settlement and brought his own individual action. On the issue of loss causation, however, the court noted that Wilamowsky's transactions in Take-Two stock (both short sales and covering purchases) ended "prior to the relevant curative disclosure." As a result, Wilamowsky could not "plausibly articulate why [his alleged] losses are attributable to Defendants' misstatements and omissions" as opposed to "legitimate market circumstances and intervening events." The court found that was "particularly so here, where the in-and-out stock transactions began after the stock price was already inflated, spanned an extended time period punctuated by constant legitimate market stimuli and repeated misstatements, and terminated more than a year prior to the corrective disclosure."

Holding: Dismissed with prejudice.

Quote of note: "With hindsight, Plaintiff may wish that he either covered immediately at the end of his short-selling period in January 2005, when the stock fell below his average sale price, or waited until after the corrective disclosure, by which point the price declined enough to put him in a position to earn millions of dollars. But allowing him to state a claim under these circumstances would permit a short seller in any standard misrepresentation case to either win big in the marketplace by covering after a corrective disclosure, or win in court by 'transforming a private securities action into a partial downside insurance policy.'"

Posted by Lyle Roberts at 6:20 PM | TrackBack

September 16, 2011

Foreign Claims

At one point, it looked like the UBS securities class action would be a test case on the application of the Morrison decision (in which the U.S. Supreme Court rejected the extraterritorial application of Section 10(b) in private litigation). As it turned out, a number of district court decisions on the issue have been issued while the UBS court considered its ruling. This week, however, the court finally weighed in with a sweeping victory for the defendants. See In re UBS Sec. Litig., 1:07-cv-11225-RJS (S.D.N.Y. Sept. 13, 2011).

The court dismissed two sets of claims that Morrison arguably precluded. First, the court held that claims asserted by foreign plaintiffs who purchased UBS stock on a foreign exchange ("foreign-cubed claims") were barred even though UBS common stock is cross-listed on the New York Stock Exchange. The court found that Morrison "makes clear that its concern was with respect to the location of the securities transaction and not the location of an exchange where the security may be dually listed." Second, the court held that claims asserted by U.S. investors who purchased UBS stock on a foreign exchange ("foreign-squared claims") were barred even though the orders were placed from the United States. The court found that neither the location of the buy order nor the place of injury converted the purchase into a "domestic" securities transaction.

Holding: Foreign-cubed and foreign-squared claims dismissed.

Posted by Lyle Roberts at 12:37 PM | TrackBack

September 2, 2011

Ultimate Authority

As noted by The 10b-5 Daily in its writeup of the Janus decision, a key open question was whether the Supreme Court's "ultimate authority" requirement for primary liability also applied to corporate insiders. Just a few months later, there is already a district court split on the issue.

In In re Merck & Co., Inc. Sec., Derivative & "ERISA" Litigation, 2011 WL 3444199 (D.N.J. Aug. 8, 2011) the company's executive vice president for science and technology argued that he did not have "ultimate authority" over the statements attributed to him in Merck's public filings. (It is the same Merck case that led to the Supreme Court's recent decision concerning the statute of limitations for securities fraud claims.) The court found that the holding in Janus was limited to cases involving a "separate and independent entity" and could not "be read to restrict liability for Rule 10b-5 claims against corporate officers to instances in which a plaintiff can plead, and ultimately prove, that those officers - as opposed to the corporation itself - had 'ultimate authority' over the statement." Accordingly, the court declined to dismiss the claims against the Merck officer on that basis.

The ink was barely dry on the Merck decision, however, before another district court disagreed with its analysis. In Hawaii Ironworkers Annuity Trust Fund v. Cole, No. 3:10CV371 (N.D. Ohio Sept. 1, 2011), the court found that "nothing in the Court's decision in Janus limits the key holding - the definition of the phrase 'to make . . . a statement' under Rule 10b-5 - to legally separate entities." Indeed, the dissent in Janus clearly believed that the majority's holding also applied to corporate insiders. In the instant case, the plaintiffs' own complaint made it clear that the defendants, who were officers in one of the company's business units, did not have ultimate authority over the alleged false statements in the company's filings. The court also noted that the alleged false statements, unlike in the Merck case, were not specifically attributed to the defendants (a fact that might otherwise be sufficient to establish "ultimate authority"). The court therefore dismissed the Rule 10b-5(b) claims against the defendants for making false statements, but declined to dismiss the related Rule 10b-5(a) and (c) claims based on deceptive conduct.

What will the next court to address the issue hold? Stay tuned.

Posted by Lyle Roberts at 10:28 PM | TrackBack

July 15, 2011

No Piggybacks

In the wake of the Morrison decision, U.S. courts have proven reluctant to endorse any securities fraud claims by foreign purchasers. And no bonus points for cleverness. In In re Toyota Motor Corp. Securities Litig., 2011 WL 2675395 (C.D. Cal. July 7, 2011), plaintiffs argued that they should be able to bring (a) U.S. securities fraud claims on behalf of ADS purchasers and domestic purchasers of Toyota common stock, and (b) Japanese securities fraud claims on behalf of all purchasers (foreign and domestic) of Toyota common stock. The plaintiffs posited two possible bases for jurisdiction over the Japanese law claims: original jurisdiction under the Class Action Fairness Act (CAFA) and supplemental jurisdiction.

The court disagreed with both. As to CAFA, the court found that Toyota's common shares are "listed" on the NYSE and, as a result, are "covered securities." Claims related to "covered securities" are expressly excluded from CAFA. The court also declined to exercise supplemental jurisdiction over the Japanese securities fraud claims for two reasons. First, the Japanese law claims would "substantially predominate over the American law claims" due to the much larger proposed class. Second, the "exceptional circumstance of comity to the Japanese courts." The National Law Journal and Thomson Reuters have articles on the decision.

Holding: Motion to dismiss granted as to Japanese law claims and certain other claims.

Quote of note: The "respect for foreign law would be completely subverted if foreign claims were allowed to be piggybacked into virtually every American securities fraud case, imposing American procedures, requirements, and interpretations likely never contemplated by the drafters of the foreign law. While there may be instances where it is appropriate to exercise supplemental jurisdiction over foreign securities fraud claims, any reasonable reading of Morrison suggests that those instances will be rare."

Posted by Lyle Roberts at 10:30 PM | TrackBack

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

May 20, 2011

The Loss Causation Loophole

An interesting issue, which has generated a district court split, is whether securities class actions can be brought against a mutual fund based on misstatements about the fund's investment objective and holdings. Mutual funds have argued that it is impossible for plaintiffs to establish loss causation. The price of mutual fund shares is not determined by market securities trading, but rather is based on the fund's net asset value (NAV). The NAV is a statutorily defined formula that depends on the value of the underlying securities held by the fund. Accordingly, the NAV can only decline in response to a change in the value of those securities, not as a result of the disclosure of hidden facts about the fund.

Courts have been reluctant to embrace this argument, with several courts noting that as a matter of public policy mutual funds should not be allowed to escape securities liability. In In re State Street Bank and Trust Co. Fixed Income Funds Investment Litigation, 2011 WL 1206070 (S.D.N.Y. March 31, 2011), however, the court examined claims brought under Section 11 and 12 of the '33 Act and found that this policy rationale cannot trump the required legal analysis.

Under the Lentell (2d Cir.) decision, plaintiffs must show "that the misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security." Moreover, the damages provisions in Sections 11 and 12 both "tie the recovery of a potential plaintiff to the value of the security." Given that "the NAV does not react to any misstatements [about the fund's investment objective and holdings], no connection between the alleged material misstatement and a diminution in the security's value had been or could be alleged." The court therefore granted the defendants' motion to dismiss.

Holding: Case dismissed with prejudice.

Quote of note: "In this case, however, the Court is constrained by the plain language of Section 11(e) and 12(a)(2), which requires a connection between the alleged material misstatements and a diminution in the security's value. It seems likely that Congress never considered that it might be creating a loophole for fraudulent misrepresentations by mutual fund managers when enacting these provisions. But if this is so, closing the loophole requires legislative action."

Posted by Lyle Roberts at 9:49 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

February 25, 2011

After The Vivendi Verdict

A trial verdict that results in $9.3 billion in potential damages is likely to engender a slew of post-trial motions. The court's decision on those motions in the Vivendi securities class action was made public this week.

The media focus has been on the court's application of the National Australia Bank (NAB) decision to dismiss the fraud claims by purchasers (including U.S. purchasers) of Vivendi shares on foreign exchanges. The dismissal was in line with other post-NAB cases, although the Vivendi court was quick to point out that the Supreme Court's decision contains imprecise language. In particular, on the issue of whether the decision permits, based on the existence of a dual listing (U.S. and foreign exchange), a U.S. cause of action for investors who purchased their shares on the foreign exchange, the court suggested that "perhaps Justice Scalia simply made a mistake." That is to say, "[Scalia] stated the test as being whether the alleged fraud concerned the purchase or sale of a security 'listed on an American stock exchange,' when he really meant to say a security 'listed and traded' on a domestic exchange." In any event, there was no indication that the Supreme Court "read Section 10(b) as applying to securities that may be cross-listed on domestic and foreign exchanges, but where the purchase and sale does not arise from the domestic listing."

The Vivendi court's other rulings are at least as interesting and two of them stand out.

(1) Corporate scienter - The court addressed how the jury could have found that Vivendi acted with scienter in committing securities fraud, while dismissing the claims against Vivendi's former CEO and CFO. The court agreed that to prove corporate scienter, the plaintiffs needed to establish that a Vivendi agent committed a culpable act with scienter. However, the court found, the "fact that the jury absolved [the former officers] of liability does not negate the fact that there was sufficient evidence in the record in the first instance to enable a reasonable jury to find against all three defendants on the issue of scienter, thereby foreclosing judgment as a matter of law in Vivendi's favor." As to whether the verdicts were inconsistent, which is a possible ground for a new trial, the court concluded that "significant evidence admitted against Vivendi, but not against [the former officers], could have led the jury to find that plaintiffs proved that Vivendi violated Section 10(b) based on the scienter of [the former officers], even if the jury was unable to conclude the plaintiffs had met their burden of proof against [the former officers]."

(2) Reliance - The court noted that "certain means of rebutting the presumption of reliance require an individualized inquiry into the buying and selling decisions of particular class members." Vivendi should have the opportunity to make this rebuttal as to individual class members, perhaps even through separate jury trials if necessary, although the exact procedures for the "individual reliance phase" would have to be determined. As a result, the court declined to enter a final judgment in the case.

Holding: Dismissed claims brought by purchasers of ordinary shares (as opposed to American Depositary Shares). Denied Vivendi motion for judgment as a matter of law or, in the alternative a new trial, except as to one statement. Denied entry of final judgment.

Posted by Lyle Roberts at 11:19 PM | TrackBack

February 18, 2011

Waking the Tiger

Item 303(a) of Regulation S-K, which requires issuers to disclose known trends or events "reasonably likely" to have a material effect on operations, capital, and liquidity, has been referred to as the "sleeping tiger" of securities litigation. Item 303(a) certainly has two attributes that are attractive to plaintiffs: it requires the issuer to offer a prediction on the effects of a known trend, but the disclosure arguably is not subject to the PSLRA's safe harbor for forward-looking statements (other than two subsections dealing with off-balance sheet arrangements and contractual obligations). The use of Item 303(a) in securities litigation has a mixed history, but the Second Circuit may have woken the tiger last week.

In Litwin v. The Blackstone Group, L.P., 2011 WL 447050 (2d Cir. Feb. 10, 2011), the court considered whether the plaintiffs had adequately alleged that Blackstone failed to make required disclosures under Item 303(a) related to two portfolio companies and its real estate investment funds. The claims were brought pursuant to Section 11 and 12 of the '33 Act, based on omissions in Blackstone's registrations statement and prospectus, so the applicable pleading standard was notice pleading (i.e., enough facts that the claim is plausible on its face). Moreover, there was no dispute that there was a downturn in the real estate market at the time of Blackstone's IPO. Accordingly, the sole issue was the pleading of materiality.

The court made the following key holdings.

First, the court rejected Blackstone's argument that it was not required to make an Item 303(a) disclosure because the downturn in the real estate market was already part of the "total mix" of information available to the market. While investors knew about the downturn, the "potential future impact [on Blackstone's investments] was certainly not public knowledge."

Second, the court declined to find that Blackstone was not required to disclose information about particular portfolio companies because the investments were relatively small and the gains or losses from the investments were aggregated at the fund level. To hold otherwise, the court found, would "effectively sanction misstatements in a registration statement or prospectus related to particular portfolio companies so long as the net effect on the revenues of a public private equity firm like Blackstone was immaterial." Moreover, the portfolio company investments were in key sectors of Blackstone's business.

Finally, the court held that the plaintiffs were not required to identify specific real estate investments that had been adversely effected by the downturn. Indeed, that was the exact information, along with potential effect of the downturn, that the plaintiffs claimed was omitted. In any event, the plaintiffs had alleged enough facts connecting the real estate downturn with potential adverse effects on Blackstone's real estate investments to state a plausible claim.

So what impact will the Blackstone decision have? At a minimum, the decision seems likely to encourage the use of Item 303(a) as a vehicle for private securities litigation, although obviously not every case is amenable to an allegation that there was a known, undisclosed trend. Second, the decision can be read to create a low materiality threshold (although this case did not allege fraud and therefore was not subject to the heightened pleading standard of Rule 9(b)). While the district court relied heavily on the fact that the investment losses did not have a significant impact on Blackstone's overall financial results, the Second Circuit applied a more holistic, "what would a reasonable investor want to know," standard. Of course, the Supreme Court soon will be weighing in on the issue of materiality. Stay tuned.

Holding: Dismissal vacated and remanded for further proceedings.

Posted by Lyle Roberts at 8:33 PM | TrackBack

October 1, 2010

A Step Too Far

While defendants have had the better of the post-NAB decisions to date, a court in the S.D.N.Y. may have gone a step too far this week. In In re Societe Generale Sec. Litig., 08 Civ. 2495 (S.D.N.Y. Sept. 29, 2010), the court found that NAB's prohibition on claims based on the purchase of securities on foreign exchanges also extends to claims based on the purchase of American Depository Receipts in the U.S. Because Societe Generale's ADRs "were not traded on an official American securities exchange," the court held that trading in them was a "predominately foreign securities transaction" and Section 10(b) was inapplicable. The D&O Diary has a lengthy post on the decision and expresses some skepticism about the court's reasoning.

Posted by Lyle Roberts at 8:54 PM | TrackBack

September 17, 2010

Trip Delayed

No one should pack their bags for Shangri-La quite yet. The defendants in the UBS case have received a huge boost from another S.D.N.Y. court regarding the scope of the National Australia Bank (NAB) decision.

At issue is whether a foreign issuer listed on both a foreign exchange and a U.S. exchange can be subject to suit in the U.S. by investors who purchased their shares on the foreign exchange. In In re Alstom SA Sec. Litig., 03 Civ. 6595 (VM) (S.D.N.Y. Sept. 14, 2010), the court found that NAB's use of the phrase "listed on domestic exchanges" did not, based on the existence of a dual listing (U.S. and France), create a U.S. cause of action for investors who purchased their Alstom shares on the French exchange.

The court also declined to exercise supplemental jurisdiction over the claims of the foreign purchasers and apply French law to adjudicate them. Among other things, the court noted that "Plaintiffs have not given any indication that the French claims were unavailable when they began this action and the Court is not now persuaded they should be allowed to press the reset button here, particularly where, by Plaintiffs' own reckoning, France's ten-year statute of limitations allows the claims to be brought in France."

Holding: Claims of plaintiffs who purchased securities on foreign exchanges dismissed.

Quote of note: "That the transactions themselves must occur on a domestic exchange to trigger application of Sec. 10(b) reflects the most natural and elementary reading of [the NAB decision]."

Posted by Lyle Roberts at 5:44 PM | TrackBack

September 10, 2010

On The Road To Shangri-La

The scope of the National Australia Bank (NAB) decision on the extraterritorial application of Section 10(b) continues to be tested in the lower courts. A case to keep an eye on is In re UBS AG Sec. Litig. (S.D.N.Y.), where the issue is what the Supreme Court meant when it stated that Section 10(b) applies to "the purchase of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States." To wit, does it mean that if a foreign issuer is listed on both a foreign exchange and a U.S. exchange it can be subject to suit in the U.S. by investors who purchased their shares on the foreign exchange?

The AmLaw Litigation Daily has a post (subscrip. req'd) on the case, which includes a link to UBS's recent motion to dismiss. Not surprisingly, UBS argues that reading "listed" to authorize U.S. securities class actions based on the purchases of securities on a foreign exchange would "fly in the face" of the Supreme Court's conclusion that Section 10(b) does not regulate foreign exchanges. Stay tuned.

Quote of note (UBS brief): "Over 850 foreign issuers, including NAB and UBS, list and register their shares on both a foreign exchange and a U.S. exchange. It defies logic to believe that Justice Scalia, without explanation and contrary to the rest of his majority opinion, included the word 'listed' to expand Section 10(b) in a way that will discourage foreign issuers from listing their shares on U.S. exchanges and make the United States the 'Shangri-La' for worldwide securities class actions."

Posted by Lyle Roberts at 9:40 PM | TrackBack

June 11, 2010

Time Bombs

In Freudenberg v. E*TRADE Financial Corp., 2010 WL 1904314 (S.D.N.Y. May 11. 2010), the plaintiffs alleged that E*TRADE had fraudulently concealed the high risk nature and deterioration of the company's mortgage portfolio. The court's decision, which denies the defendants' motion to dismiss, addresses a couple of interesting topics.

(1) Rule 10b5-1 stock trading plans - The utility of a Rule 10b5-1 stock trading plan in defeating the inference of scienter caused by large stock sales varies widely. (The 10b-5 Daily's most recent post on the topic, with links to other relevant posts, can be found here.) In the E*TRADE case, the individual defendants had entered into their plans during the class period. In other words, they allegedly "were already aware of the Company's mortgage exposure time bombs" when they decided to sell shares. Under these circumstances, the court declined to find that any inference of scienter created by the stock sales was dispelled.

(2) Announcement of SEC investigation - On the last day of the class period, E*TRADE announced additional mortgage losses , withdrew its guidance, and disclosed that the SEC has commenced an investigation. The company's stock price declined significantly. The court found that the announcement of the SEC investigation, which was "linked to the purportedly fraudulent misconduct," was within the "zone of risk" concealed by E*TRADE's alleged misrepresentations. As a result, it was "akin to a corrective disclosure" and could be used to adequately plead loss causation. (A post by The 10b-5 Daily on a contrary decision can be found here.)

Holding: Motion to dismiss denied.

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June 4, 2010

Whither Collective Scienter?

Under the collective scienter theory, it is possible for a plaintiff to adequately plead scienter with respect to a corporate defendant even where the plaintiff is unable to adequately plead scienter with respect to any individual corporate employee who made a false statement. There is a circuit split on the issue, with the Second Circuit and Seventh Circuit adopting the theory and the Fifth Circuit rejecting the theory. That leaves a lot of room for district courts in other circuits to come to their own conclusions.

In City of Roseville Employees' Retirement System v. Horizon Lines, Inc., 2010 WL 1994693 (D. Del. May 18, 2010), the court considered the potential liability of the corporate defendants (Horizon and a wholly-owned subsidiary) for making false statements related to a price fixing conspiracy. Certain of the corporate defendants' officers had already plead guilty to price fixing. The court declined to apply the collective scienter theory, finding that the Third Circuit's rejection of group pleading (i.e., the presumption that the senior officers of a company are collectively responsible for any misrepresentations contained in the company's public statements) made the appellate court unlikely to adopt collective scienter. Instead, the court followed the Fifth Circuit's requirement that there must be "a showing that at least one individual officer who made, or participated in the making of, a false or misleading statement did so with scienter."

The officers who had plead guilty to criminal charges were not alleged to have made any public statements on behalf of the corporate defendants. Nevertheless, the plaintiffs argued that these officers "participated" in the making of the statements because the corporations must have obtained the false data from them. As a result, the plaintiffs argued, the scienter of these officers should be imputed to the corporations. The plaintiffs provided no facts to support their assertion about the source of the false data and the court declined to find that corporate scienter had been adequately established.

Holding: Complaint dismissed with prejudice as to certain defendants.

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April 9, 2010

The Perils Of Investing Abroad

While the Supreme Court considers the National Australia Bank case, the lower courts continue to issue rulings that explore the extraterritorial application of the U.S. securities laws.

In In re European Aeronautic Defence & Space Co. ("EADS") Sec. Litig., 2010 WL 1191888 (S.D.N.Y. March 26, 2010), the plaintiffs alleged that the defendants mislead investors about production delays in the Airbus A380 super-jumbo aircraft. EADS is a Dutch company and its shares are traded exclusively on European exchanges. Three depository banks, however, have issued unsponsored American Depositary Receipts ("ADR's") in EADS shares. The putative class consisted of U.S. residents who had purchased or otherwise acquired EADS common stock.

The court applied the conduct and effects tests to determine the existence of subject matter jurisdiction. As to whether sufficient conduct had taken place in the U.S., the court held that (a) EADS's holding of investor meetings in the U.S., and (b) the participation of U.S. analysts in EADS earnings conference calls, were "incidental to the alleged fraud." Nor could the plaintiffs satisfy the effects test, despite their limitation of the putative class to U.S. residents. The court found that the "putative class acquired its EADS shares in Europe and any losses were suffered on foreign exchanges." The fact that some class members may have acquired shares as ADRs was insufficient, standing alone, to establish a "substantial" U.S. effect. Finally, the court also noted that EADS could successfully argue forum non conveniens, having demonstrated that France, the Netherlands, and Germany (where a number of U.S. investors had already brought individual actions against EADS) were adequate alternative fora.

Holding: Motion to dismiss granted.

Quote of note: "The Complaint is a narrative of the peril Americans face when they invest abroad. It is understandable that [lead plaintiff] would seek the robust protections of federal securities laws in a United States court. But a court of limited jurisdiction lacks the authority to hear every grievance that arises overseas. On this record, [lead plaintiff] will have to pursue its claims where it purchased shares - Europe."

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March 12, 2010

Waiting On The Supreme Court

(1) The "group pleading" doctrine allows plaintiffs to rely on a presumption that statements in corporate documents are the collective work of individuals with direct involvement in the everyday business of the company. In its Tellabs decision, the U.S. Supreme Court declined to address whether this presumption is permissible under the PSLRA's heightened pleading standards, but noted that there is "a disagreement among the circuits" on the issue. The New York Law Journal has a column (March 12 - subscrip. req'd) discussing the circuit split and recent "group pleading" decisions.

Quote of note: "Ultimately, as is clear from Tellabs, [the issue] is likely to be resolved by the Supreme Court. As suggested by Tellabs, the odds are the Supreme Court will conclude that a generalized assumption based on a defendant's 'title' with no supporting evidence cannot constitute the particularity required by the PSLRA."

(2) While the U.S. Supreme Court considers the National Australia Bank case, decisions in foreign-cubed cases are still being issued. In Copeland v. Fortis, 2010 WL 569865 (S.D.N.Y. Feb. 18, 2010), the plaintiffs alleged that Fortis, a Belgium-based provider of banking and insurance services, mislead investors concerning its financial condition. The primary markets for Fortis securities, however, were overseas (the only alleged trading in the U.S. was American Depository Shares on the over-the-counter market). In apply the "conduct" and "effects" tests for subject matter jurisdiction, the court found: (a) that any U.S. conduct was "ancillary to the fraud committed in Belgium," and (b) the plaintiffs had failed to provide sufficient allegations about the number and percentage of U.S. investors to establish that the effect of the fraud on the U.S. was substantial. The court dismissed the complaint.

Quote of note: "I have no doubt that some Fortis investors are U.S. residents, and that Fortis's alleged fraud had some effect upon U.S. investors and the U.S. securities market. From the allegations in the complaint, however, I cannot determine that the effect was 'substantial.' Plaintiffs bear the burden of demonstrating that subject matter jurisdiction exists, and these plaintiffs have not met that burden."

Posted by Lyle Roberts at 9:42 PM | TrackBack

July 24, 2009

Indicators of Risk

The extent to which an alleged "corrective disclosure" needs to have revealed the fraud to investors - thereby establishing the existence of loss causation based on a related stock price decline - continues to bedevil courts. One particular fact pattern that has proven difficult to analyze is when an SEC investigation is announced. Although some post-Dura cases found that loss causation had been adequately plead based on the disclosure of an SEC investigation, a couple of recent cases have gone the other way.

In Maxim Integrated Products, Inc. Sec. Litig., 2009 WL 2136939 (N.D. Cal. July 16, 2009), the court considered whether the company's "disclosures regarding compliance with an SEC investigation, subpoenas from the United States Attorney's office, and the formation of its own Special Committee to investigate options granting practices" were corrective disclosures for the purposes of pleading loss causation. The court concluded that these disclosures were "indicators of risk," but did not adequately reveal the alleged fraud. See also In re Hansen Natural Corp. Sec. Litig., 527 F. Supp. 2d 1142, 1162 (C.D. Cal. 2007).

Holding: Motion to dismiss granted in part and denied in part.

Quote of note: "A reasonable investor may view these disclosures as indicators of risk because they reveal the potential existence of future corrective information. However, they do not themselves indicate anything more than a 'risk' or 'potential' that Defendants engaged in widespread fraudulent conduct. Thus, the court finds that these statements are not corrective disclosures for which Plaintiffs can plead loss causation."

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June 19, 2009

The Safe Harbor At Work

The PSLRA's safe harbor for forward-looking statements has a checkered history in the courts, with some judges refusing to apply it as written. It is therefore worth noting a decision that relies entirely on the safe harbor to dismiss the plaintiffs' securities fraud claims.

In In re Aetna, Inc. Sec. Litig., 2009 WL 1619636 (E.D. Pa. June 9, 2009), the plaintiffs alleged that the health care company told investors it practiced "disciplined pricing" when, in fact, it was aggressively underpricing to bring in new business. The court found that "'disciplined pricing' means that Aetna expects that its pricing will be in line with its projected medical cost trend, a specific measurement of future performance." Accordingly, the statements concerning "disciplined pricing" were forward-looking as defined by the PSLRA.

The court then applied the safe harbor and held that the statements were protected from liability. First, Aenta's statements concerning its commitment to "disciplined pricing" were immaterial corporate puffery. Second, the company's risk factors specifically warned investors "that profitability could be affected by Aetna's 'ability to forecast . . . costs' and 'there can be no assurance regarding the accuracy of medical cost projections assumed for pricing purposes." The court found this was meaningful cautionary language that rendered the statements inactionable. Finally, the court noted that "there is still uncertainty" as to whether a forward-looking statement is protected by the safe harbor based on immateriality or meaningful cautionary language if a plaintiff adequately pleads that the defendant had actual knowledge of the falsity of the statements (see the Third Circuit's recent Avaya decision). In this case, however, the plaintiffs failed to meet that pleading burden.

Holding: Dismissed with prejudice.

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June 5, 2009

Intervening Events and Phantom Stocks

The U.S. Court of Appeals for the Second Circuit has held that where there has been a market-wide downturn in a particular industry, a plaintiff must plead facts which, if proven, would show that its loss was caused by the alleged misstatements as opposed to intervening events. How to determine the existence of a "market-wide downturn," however, is an open question.

In In re Moody's Corp. Sec. Litig., 2009 WL 435323 (S.D.N.Y. Feb. 23, 2009), the defendants argued that the plaintiffs' losses were caused by the subprime crisis, not Moody's alleged misstatements concerning its credit ratings. However, the court found that there was no market-wide downturn in the credit-ratings industry. Although Moody's stock price declined by 28.8% during the class period, the stock price of McGraw-Hill (the parent company of Standard & Poor's, Moody's biggest competitor) fell only 1.7%. The court also found that Standard & Poor's stock price rose 2.5% during the same period - which was strange, because Standard & Poor's is not a publicly traded entity and has no published share price.

Not surprisingly, the defendants moved for reconsideration, citing two factual errors related to the court's "market-wide downturn" analysis. First, the defendants noted that the court had apparently confused the Standard & Poor's 500 Financials Index with the company itself, leading to the erroneous conclusion that Standard & Poor's stock price had not declined. Second, the defendants argued that the court should have examined the comparative decline in stock prices from the date of the first corrective disclosure, rather than the entire class period. When measured in that manner, the stock price for Moody's dropped by 38%, while the stock price for McGraw-Hill dropped by 28%.

The court, however, declined to change its decision (see In re Moody's Corp. Sec. Litig., 2009 WL 1150281 (S.D.N.Y. April 29, 2009)). McGraw-Hill's stock price, which had been the basis for the court's original determination that there was no market-wide downturn, suddenly came under more judicial scrutiny. While not appearing to disagree with the defendants' contention that the decline should be measured from the first corrective disclosure, the court found that it was unclear whether the drop in McGraw-Hill's stock price was actually related to the performance of its Standard & Poor's subsidiary. In addition, the court noted that Moody's "other primary competitors are both private companies with no published stock price," which left the court without a basis for comparison. The court concluded that "the question of causation is reserved for trial."

Posted by Lyle Roberts at 11:58 PM | TrackBack

April 13, 2009

Get Your Own Little Birdy

A plaintiff can rely on an anonymous source to plead securities fraud, but can he rely on someone else's anonymous source? In Vladimir v. Bioenvision Inc., 2009 WL 857552 (S.D.N.Y. March 31, 2009), the plaintiffs alleged that Bioenvision had entered into a merger agreement as of January 2007, but failed to disclose it to the market. The factual basis for the allegation was a state employment action brought by a former Bioenvision officer. In his complaint, the former officer alleged that he had "been informed that the merger was agreed to at a January 2007 secret meeting. The court found that the plaintiffs in the securities class action could not rely upon allegations from the former officer's anonymous source to satisfy their pleading obligations.

Holding: Motion to dismiss granted.

Quote of note: "Plaintiffs have not alleged anything at all about [the former officer's] alleged anonymous source, let alone describing him with any particularity whatsoever, and the Court is wholly unable to determine whether this source was in a position to know what he is alleged to have told [the former officer], or, in fact, whether or not this alleged anonymous source even exists. The Court therefore cannot credit any of these allegations that come from an alleged anonymous source of [the former officer's], which were adopted wholesale and relied upon by plaintiffs here to make serious charges of fraud."

Posted by Lyle Roberts at 10:06 PM | TrackBack

March 20, 2009

Being Myopic

It is going to take a unique set of facts to establish the existence of scheme liability in the wake of the Stoneridge decision. Earlier this week, in the Refco securities class action, a S.D.N.Y. court dismissed the securities fraud claims against Refco's outside counsel. In its decision, the court found the plaintiffs adequately alleged that the law firm facilitated Refco's fraudulent transactions, but not that the company's investors relied on any misstatements by the law firm in purchasing their securities.

The court may have been forced to apply Stoneridge, but it was not happy about it. In an interesting footnote, the court suggested that "a bright line between principals and accomplices may not be appropriate" and offered its own policy solution: "Perhaps a provision authorizing the SEC not only to bring actions in its own right but also to permit private plaintiffs to proceed against accomplices after some form of agency review would provide the necessary flexibility without involving the courts in standardless and difficult-to-administer line drawing exercises." Do all judges secretly long to be legislators?

Press coverage of the decision can be found in the WSJ Law Blog and the American Lawyer.

Holding: Motion to dismiss granted.

Quote of note: "The nub of plaintiffs' contention is that as Refco's primary counsel, the . . . defendants could not be 'remote' within the meaning of Stoneridge, because they were directly involved in creating and executing the fraudulent scheme, including the drafting of misleading communications to Refco investors. Plaintiffs' reading of 'remote' is myopic. The issue is not the distance between the issuer and the defendant, but rather the distance between the defendants' conduct and the investor."

Posted by Lyle Roberts at 10:01 PM | TrackBack

September 4, 2008

Stoneridge And Non-Speakers

Following the Stoneridge decision on scheme liability, the lower courts continue to explore what conduct is sufficient to induce reliance by investors. In In re Bristol Myers Squib Co. Sec. Litig., 2008 WL 3884384 (S.D.N.Y. Aug. 20, 2008), a corporate officer negotiated a settlement agreement in a patent infringement case, the terms of which were misstated by the company in its disclosures. Even though the corporate officer did not participate in the making of the disclosures, the court considered whether investors relied on his allegedly deceptive conduct in failing to correct the misstatements. In determining that reliance was adequately plead, the court found that the "investors relied on [the corporate officer's] good faith in negotiating the Apotex settlement agreement and committing the Company to its terms." In addition, unlike in Stoneridge, the corporate officer's deceptive conduct was communicated to the public.

Holding: Motion to dismiss denied.

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June 18, 2008

Global Fraud On The Market

The jurisdictional issues surrounding "foreign cubed" cases - i.e., an action 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 - continue to be a hot topic. In In re Astrazeneca Sec. Lit., 2008 WL 2332325 (S.D.N.Y. June 3, 2008), the court addressed a proposed class in which 90% of the members were foreigners who purchased on foreign exchanges.

Under the conduct test for subject matter jurisdiction, the plaintiffs needed to adequately allege that (a) the defendants' conduct in the U.S. was more than merely preparatory to the fraud, and (b) the defendants' actions in the U.S. "directly caused losses to foreign investors abroad." Although the court held that the plaintiffs adequately alleged "several of the fraudulent misrepresentations took place in the United States," the court was unwilling to apply a global fraud on the market presumption and find that the foreign purchasers relied on the U.S.-based conduct when deciding to acquire the stock. Accordingly, the court dismissed the action as to foreign purchasers on foreign exchanges.

Holding: Motion to dismiss granted (both on jurisdictional and, more generally, pleading grounds).

Quote of note: "The Securities Exchange Act does not address the question of extraterritorial reach. The Second Circuit has not yet given guidance on whether the fraud-on-the-market theory should apply to foreign countries. In the absence of clear authority in favor of a global fraud-on-the-market theory, this Court declines to adopt such a theory."

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May 15, 2008

Law Firm Excused

The application of the Stoneridge decision is likely to develop slowly, as relatively few cases raise the issue of scheme liability. That said, the early returns look positive for defendants. In In re DVI Inc. Sec. Litig., 2008 WL 1900384 (E.D. Pa. April 28, 2008), the plaintiffs alleged that the company's law firm "initiated and masterminded a 'workaround' that allowed DVI to fraudulently misstate . . . that its internal controls were adequate." In evaluating class certification, the court found that under Stoneridge the proposed class could not show reliance on the law firm's deceptive acts. The law firm had neither "made any public misstatements that affected the market for DVI securities" nor "owed [any] duty of disclosure to DVI's investors."

Holding: Class certification granted, except as to the claims against DVI's law firm.

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April 25, 2008

No Reason To Make A Federal Case Out Of It

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.

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April 16, 2008

Aim For The Heart

In its Tellabs decision, the U.S. Supreme Court created an "at least as compelling" standard for weighing competing inferences of scienter in securities fraud cases. The fact that a draw goes to the plaintiff was criticized by Justice Scalia in his concurrence, although he noted that his preferred "more plausible" standard would be unlikely to have much of a practical effect because "[h]ow often is it that inferences are precisely in equipoise?" Beware of rhetorical questions.

In In Re Paincare Holdings Sec. Litig., 2008 WL 348781 (M.D. Fla. Feb. 7, 2008), the court considered an amended complaint filed after a dismissal without prejudice. The magistrate judge (whose order was adopted by the court), found that scienter had been adequately plead because "the inference of scienter is equal to the inference of non-fraudulent intent." In support of its holding, the decision noted the sheer magnitude of the financial restatement, the company's ambitious acquisition strategy, and the company's alleged false rationalization for the financial restatement.

Quote of note: "To the extent the reason offered to the public [for the financial restatement] was not true, one can infer that the Company had a reason not to delve too deeply in presenting its mea culpa to the public. While fecklessness is not recklessness, when truly falling on your sword, you aim for the heart."

Posted by Lyle Roberts at 7:22 PM | TrackBack

March 7, 2008

Fees and Bloggers

A couple of notable recent decisions:

(1) In In re Cardinal Health Inc. Sec. Litig., 528 F. Supp. 2d 752 (S.D. Ohio 2007), the court considered a requested attorney fee award of $145 million (24% of the $600 million settlement). The court found that the absence of an ex-ante fee arrangement between the lead plaintiff group and lead counsel required it to "undertake an independent analysis to determine reasonable attorneys' fees." The court ultimately awarded an 18% fee award, with a high lodestar multiplier of 6, based on the "excellent recovery, considerable effort and time, and high quality of lawyering."

Quote of note: "[T]his court would . . . recommend that courts, in addition to the established requirements, look favorably on the presence of an ex-ante fee arrangement in its [sic] decision to approve lead plaintiff and lead counsel. Alternatively, Congress could amend the PSLRA to mandate lead plaintiffs to enter into a fee arrangement with lead counsel before the court formally approves lead counsel. Under this approach, sophisticated parties would be encouraged to negotiate fee arrangements without the bias of hindsight, and they could reach presumptively reasonable results that the court can review."

(2) In In re Pfizer, Inc. Sec. Litig., 2008 WL 540120 (S.D.N.Y. Feb. 28, 2008), the court considered whether an anonymous blog post could provide reliable factual allegations. The plaintiffs asserted that the blogger was actually a former Pfizer officer. The court found that there was insufficient information about the blogger's identity and, even accepting that he had been employed at Pfizer, it was unclear whether the blogger "would have been likely to know the relevant facts."

Quote of note: The blogger's "allegation does not claim to be based on personal knowledge and lacks detail that might suggest personal knowledge. For example, the blog post does not describe when, how, on what basis, by whom, or to whom the alleged warning was communicated."

Posted by Lyle Roberts at 8:48 PM | TrackBack

September 6, 2007

Suspicious Trading

Motive is in the eye of the beholder. Many courts have found that the sale of stock by corporate insiders just before the announcement of bad news is "suspicious" and can contribute to an inference of scienter (i.e., fraudulent intent). In a decision from earlier this summer, however, a federal district court came to the exact opposite conclusion. The court's apparent theory was that if the defendants had committed a fraud, they surely would have done it better.

In In re Hutchinson Technology Inc. Sec. Litig., 2007 WL 1620805 (D. Minn. June 4, 2007), three of the individual defendants sold stock a month before dramatically lowering the company's finanical projections. The court found that "it would have been in [the defendants] interests to put off the disclosure of that bad news as long as possible, because the closer the release of the bad news followed on the heels of their stock sales, the more suspicious those sales would have appeared." The fact that the defendants did not delay the release of the news, according the the court's reasoning, removed any suspicion from the stock sales.

Holding: Motion to dismiss granted (with prejudice).

Posted by Lyle Roberts at 10:43 AM | TrackBack

May 4, 2007

License Revoked

There are two prongs to the PSLRA's safe harbor for forward-looking statements. First, a defendant shall not be 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. Second, a defendant shall not be liable with respect to any forward-looking statement, even in the absence of meaningful cautionary statements, if the plaintiff cannot establish that the statement was made with "actual knowledge" that it was false or misleading.

Although the two prongs are written in the alternative, courts frequently have rebelled against the plain language of the statute because it appears to provide defendants with a "license to defraud" investors about a company's future prospects so long as the statement is accompanied by meaningful cautionary language.

In a decision issued this week, In re Nash Finch Co. Sec. Litig., 2007 WL 1266658 (D.Minn. May 1, 2007), the court noted that the Eighth Circuit had not yet addressed the question of "whether allegations of actual knowledge defeat the safe harbor when cautionary language is present." The defendants argued that their knowledge of the truth or falsity of the forward-looking statements was irrelevant under the first prong of the safe harbor. The court held, however, that "cautionary language can not be 'meaningful' when defendants know that the potential risks they have identified have in fact already occurred, and that the positive statements they are making are false." (For a similar holding from the C.D. of Cal., see this post.)

Posted by Lyle Roberts at 2:35 PM | TrackBack

December 22, 2006

I'll Bet You Won't Print This

The fee-shifting imposed by the Enron court - related to claims brought against Alliance Capital - continues to make news. At the time of the decision, the Wall Street Journal (subscrip. req'd) published an editorial lauding the result. In today's edition, the plaintiff's attorney fights back with a letter that he challenges the paper to print (a bet he happily loses), while the newspaper's editorial board defends its analysis. The WSJ Law Blog has the blow-by-blow (free content).

Posted by Lyle Roberts at 5:19 PM | TrackBack

December 20, 2006

Truth On The Market

If the market were aware during the class period of the allegedly omitted information, could the investors later argue that they were defrauded? Some courts have declined to consider a "truth on the market" defense raised as part of a motion to dismiss because it presents factual issues. Other courts, however, have been willing to examine public documents available to investors and conclude that any failure on the part of the defendants to disclose material information was excused by its availability from other sources. Two recent decisions have taken the latter approach and dismissed securities fraud claims.

In Ley v. Visteon Corp., 2006 WL 2559795 (E.D. Mich. Aug. 31, 2006), the court considered whether claims based on "Visteon's Ford-related operational issues" should be dismissed because these issues were discussed in analyst reports and newspaper articles during the class period. Although the plaintiffs argued that a truth on the market defense would be premature at the motion to dismiss stage of the case, the court disagreed, finding that it could "consider publications by market analysts in determining if the market had sufficient knowledge of Defendants' various deficiencies." The court concluded that it was clear from these publications that the market was aware of "Visteon's inability to shed unprofitable business lines inherited from Ford, high labor costs, price reductions owed to Ford, and general reliance upon Ford."

Similarly, in In re Discovery Laboratories Sec. Litig., 2006 WL 3227767 (E.D. Pa. Nov. 1, 2006), the court examined whether certain statements related to the FDA-approval process for a drug product were materially misleading in light of the public information available to the market. The court held that the "'truth on the market' defense does not require that any investor should be capable of finding the information and understanding its significance based on a single click for a simple Web search." Instead, the standard is "reasonable investors, those who we can assume exercise due investment diligence." Based on public reports of facility problems and the widely known fact that the company would need to comply with FDA regulations to obtain approval for the drug, the court found that the alleged misstatements related to those issues were inactionable.

Posted by Lyle Roberts at 9:51 PM | TrackBack

October 25, 2006

Defining Corporate Scienter

Courts continue to struggle with the question of how to determine the scienter (i.e., fraudulent intent) of a defendant corporation. Should a court examine the collective knowledge of the corporation's employees (collective scienter theory) or should it look to the state of mind of the individual corporate official or officials who made the false or misleading statement (which some courts have found is required under the common law of agency)? As The 10b-5 Daily has noted, between these two positions is a weaker version of the collective scienter theory that allows a plaintiff to establish the scienter of a defendant corporation by showing that a management-level employee of the corporation acted with knowledge or recklessness, even if that employee was not an individual defendant and did not make any alleged false statements.

The weaker version of the collective scienter theory, however, suffers from a lack of judicial uniformity as to exactly which employees can have their state of mind imputed to the corporation. One possible definition can be found in a recent decision - Hill v. The Tribune Co., 2006 WL 2861016 (N.D. Ill. Sept. 29, 2006) - dismissing a securities class action. The court found that a "corporation's scienter is generally limited to being based on knowledge or scienter of a senior officer or director of the corporation, or an employee involved in issuing the alleged misrepresentation." Because the plaintiffs were unable to "adequately allege that those responsible for [Tribune's] SEC filings and press releases recklessly relied on the circulation figures that were provided" by lower-level employees, the court held that the defendant corporation's scienter was not adequately alleged.

Posted by Lyle Roberts at 10:04 PM | TrackBack

August 22, 2006

The Officer And The Janitor

Whether a plaintiff can establish the scienter (i.e., fraudulent intent) 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 has been simmering in the courts for a number of years. When The 10b-5 Daily last checked in on the status of the issue back in 2004, the Sixth Circuit had issued an opinion in the Bridgestone securities litigation that appeared to apply a collective scienter theory. Although the opinion did not specifically discuss the issue, the court's holding clearly was incompatible with the Fifth and Ninth Circuits' previous rulings that a defendant corporation only can be deemed to have acted with scienter if the individual officer making the alleged false statement acted with scienter.

Fast forward a couple of years and the collective scienter theory is gaining traction in certain district courts. There are two distinct versions of the theory being applied.

Under the weaker version, it is sufficient for a plaintiff to establish that a management-level employee of the corporation acted with fraudulent intent, even if that employee is not a defendant and did not make any alleged false statement. Two recent decisions from the D. of Mass. and the S.D.N.Y. have adopted this version. In re Sonus Networks, Inc. Sec. Litig., 2006 WL 1308165 (D. Mass. May 10, 2006) (scienter of former controller attributable to corporation); In re Marsh & McLennan Companies, Inc. Sec. Litig., 2006 WL 2057194 (S.D.N.Y. July 20, 2006) (scienter of "particular management-level employees identified in the Complaint" attributable to corporation).

Under the stronger version, a plaintiff can establish that the corporation acted with fraudulent intent without any reference to a particular employee. Not only has this version been adopted by a court in the S.D.N.Y., but that court has certified the issue for interlocutory appeal to the Second Circuit. In re Dynex Capital, Inc. Sec. Litig., 2006 WL 1517580 (S.D.N.Y. June 2, 2006) (finding that relevant prior decisions from Second Circuit do not clearly decide issue).

So stay tuned. The Second Circuit will have the opportunity to decide a question that The 10b-5 Daily posited years ago: if an officer makes the statement and a janitor knows the statement is false, has the corporation acted with fraudulent intent? If the answer is "yes," there will be an open circuit split on corporate scienter.

Posted by Lyle Roberts at 2:52 PM | TrackBack

August 16, 2006

Mutual Fund Fees

The New York Law Journal has an article (via law.com) in its August 14 edition discussing the dismissal of the federal securities claims in the Salomon Smith Barney mutual fund fees litigation. The plaintiffs had "accused the investment firm of offering undisclosed incentives to brokers and financial advisers, extracting improper fees from investors in its proprietary funds and encouraging its propriety funds to invest in poorly performing companies because of their status as Smith Barney investment banking clients." In its decision - In re Salomon Smith Barney Mut. Fund Fees Litigation, 2006 WL 2085979 (S.D.N.Y. July 26, 2006) - the court dismissed both the '34 Act (Rule 10b-5) and '33 Act (Sections 11 and 12) claims based on the failure to adequately plead loss causation.

Quote of note (opinion): "Here, Plaintiffs have not only not alleged why they lost money on their purchase of the mutual fund stock, they have not alleged even that they in fact lost money on their purchase of the mutual fund stock (i.e., that the mutual fund share price dropped and that it dropped for the precise reason complained of)."

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August 10, 2006

A Little Of This, A Little Of That

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."

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July 18, 2006

Incorporation By Reference

The PSLRA's Safe Harbor for forward-looking statements is designed to encourage companies to provide investors with information about future plans and prospects by limiting their potential liability for these statements. 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 the case of oral forward-looking statements, the PSLRA specifically provides that the meaningful cautionary statements can be incorporated by reference in a readily available written document. The statute is silent, however, about whether this is also true for written forward-looking statements. A surprisingly small number of courts have addressed this issue, but the trend appears to be in favor of finding that a company's incorporation by reference is sufficient.

In Yellen v. Hake, 2006 WL 1881205 (S.D. Iowa July 7, 2006), the court addressed a securities class action brought against Maytag Corp. The court found that "[w]hile the Safe Harbor provision does not explicitly provide for incorporation by reference for written forward-looking statements" it is implicit in Congress' direction that courts consider "all information and documents relevant to a determination of whether a defendant has given adequate warnings." Accordingly, the court agreed to consider warnings contained in Maytag's 2004 Annual Report that were incorporated by reference in the press release and investor presentations that allegedly contained false or misleading forward-looking statements.

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June 9, 2006

More On The Impact Of Stock Trading Plans

The role of Rule 10b5-1 stock trading plans in assessing the adequacy of a plaintiff's scienter (i.e., fraudulent intent) allegations is becoming a more frequent issue in securities class actions as the use of these plans increases. A recent decision in the N.D. of Texas - relying on the Netflix opinion discussed in this post - will certainly encourage that trend.

In Fener v. Belo Corp., 425 F.Supp.2d 788 (N.D. Tex. 2006), the court held that at the pleading stage it is the burden of the plaintiff to place any allegedly suspicious stock trading in context. Accordingly, the plaintiffs needed to address "in their complaint whether [the defendant officer] sold his stock pursuant to a Rule 10b-5(1) trading plan formulated before the alleged fraudulent scheme and why, if he did, this does not undercut a strong inference of scienter." (A contradictory decision is discussed here.)

Holding: Motion to dismiss granted with leave to amend.

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May 9, 2006

The Impact of Stock Trading Plans

Whether selling company stock under a Rule 10b5-1 trading plan can help shield corporate executives from securities fraud liability is an open question. Although some courts have considered the existence of a trading plan in finding that an executive's stock sales did not create a strong inference of scienter (i.e., fraudulent intent), a recent decision goes the other way. In In re Cardinal Health Inc. Sec. Litig., 2006 WL 932017 (S.D. Ohio April 12, 2006), the court held that it was "premature" to evaluate the impact of a trading plan at the motion to dismiss stage because it is an affirmative defense to insider trading allegations.

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May 5, 2006

What's In Your Press Release?

The content of the disclosure that led to a stock price decline is an important part of post-Dura loss causation analyses. One particular fact pattern that has proven difficult for defendants is when a company announces a SEC investigation without specifying exactly what conduct is under investigation.

In In re Bradley Pharmaceuticals, Inc. Sec. Litig., 2006 WL 740793 (D.N.J. March 23, 2006), the company disclosed that the SEC was conducting an informal inquiry and had asked for information "with respect to revenue recognition and capitalization of certain payments." The stock price fell 26%. A subsequent announcement by the company revealed that it would have to restate its financial results for an earlier quarter due to improper revenue recognition on a particular transaction. The stock price went up slightly.

In their motion to dismiss, the defendants argued that the plaintiffs had failed to allege a loss following a "corrective disclosure" because the original press release was "simply a disclosure of a non-specific SEC inquiry" and did not say anything about the particular transaction at issue. The court disagreed, finding that the revelation of the truth "occurred through a series of disclosing events" and that by the time the company announced its restatement "the market had already incorporated that the previously released financial statements could not be relied upon."

Holding: Motion to dismiss denied.

Addition: For a similar holding, see Brumbaugh v. Wave Systems Corp., 2006 WL 52751 (D. Mass. 2006).

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March 8, 2006

Pleading Loss Causation

In its Dura decision, the Supreme Court left open the question of whether loss causation is subject to a heightened pleading standard. 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," and applied the notice pleading requirements of F.R.C.P. 8(a)(2). Following Dura, several courts have concluded that notice pleading is sufficient (see, e.g., Greater Penn. Carpenters Pension Fund v. Whitehall Jewellers, Inc., 2005 WL 1563206 (N.D. Ill. June 30, 2005)).

A contrary view can be found in the recent decision in In re The First Union Corp. Sec. Litig., 2006 WL 163616 (W.D.N.C. Jan. 20, 2006). The court noted that the Supreme Court had "expressly declined to consider whether loss causation must be pled with particularity." Based on pre-Dura circuit court decisions finding that F.R.C.P. 9(b)'s particularity standard is applicable to loss causation and the fact that "the Fourth Circuit has held that every element of a common law fraud action must be plead with particularity," the court decided that the plaintiffs needed to satisfy the heightened pleading standard.

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January 17, 2006

On Second Thought

Motions for reconsideration are rarely successful, but loss causation issues may be an exception given the need to interpret the Supreme Court's recent Dura decision. In In re Royal Dutch/Shell Transport Sec. Litig., 2005 WL 3359695 (D.N.J. Dec. 12, 2005), the court had held, based on Dura, that investors who purchased securities during the class period, but did not subsequently sell the securities, could not adequately plead loss causation. Therefore, those investors could not join the putative class.

On reconsideration (and after the case was reassigned to another judge), the court found that Dura "neither expressly nor implicitly mandates that the subject securities be sold in order for a plaintiff to have suffered cognizable loss." The court also found that the PSLRA did not require such a sale to bring a securities fraud action and that it would be against public policy to judicially create this requirement.

Holding: Motion for reconsideration granted.

Quote of note: "Nothing in Dura indicates that the Supreme Court intended to overrule the established precedent permitting holding plaintiffs to maintain actions for securities fraud, to call into question the statutory scheme by creating a sell- to-sue requirement, or to undermine relevant policy concerns without any analysis. Moreover, Dura's holding was limited to rejecting the Court of Appeals for the Ninth Circuit's standard for pleading loss causation and economic loss in a securities fraud action, which had required only an allegation of inflated purchase price because of a misrepresentation; the Supreme Court expressly stated that it did not 'consider other proximate cause or loss-related questions.' Accordingly, Dura cannot be read to require both purchase and sale of the subject securities."

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November 30, 2005

Reimbursing The Issuer

Section 304 of the Sarbanes-Oxley Act of 2002 provides that a company's CEO and CFO must disgorge certain bonuses, equity-based compensation, and trading profits if the company is required "to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws." Although Congress did not create an express private right of action in the statute, recent securities class actions and derivative suits often include a tag-along Section 304 claim.

As reported by The 10b-5 Daily, at least one court has found in a derivative case that the legislation did not create a private right of action and dismissed the claim. Courts that are inclined to do the same thing in a securities class action, however, may choose to rely on the plain language of the statute. In In re Qwest Communications Int'l, Inc. Sec. Litig., 387 F. Supp. 2d 1130 (D. Col. 2005), the court found that Section 304 expressly requires an officer to "reimburse the issuer." Under these circumstances, Qwest's investors did not have standing to bring the claim because they were "not entitled to the relief authorized by the statute."

Holding: Motion to dismiss Section 304 claim granted.

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October 3, 2005

For SEC Use Only

Section 304 of the Sarbanes-Oxley Act of 2002 provides that a company's CEO and CFO must disgorge certain bonuses, equity-based compensation, and trading profits if the company is required "to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws." Although Congress did not create an express private right of action in the statute, recent securities class actions and derivative suits often include a tag-along Section 304 claim.

The Legal Intelligencer reports (via law.com - free regist. req'd) that a federal judge finally has had the opportunity to address whether private litigants, as opposed to the SEC, can bring a Section 304 claim. In a derivative suit brought against Stonepath Group in the E.D. of Pa., Judge Dalzell has ruled that Congress did not intend to create an implied private right of action. The court found that another Sarbanes-Oxley provision expressly creates a private right of action, leading to the conclusion that Section 304's silence should be interpreted as restricting enforcement of the statute to the SEC. The case is Neer v. Pelino - a Westlaw cite will be added to this post when available.

Addition: Neer v. Pelino, 389 F.Supp.2d 648 (E.D.Pa. 2005).

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August 17, 2005

What's In Your Press Release?

The content of the disclosure that led to a stock price drop continues to be the focal point of post-Dura loss causation analyses. In Sekuk Global Enterprises v. KVH Industries, Inc., 2005 WL 1924202 (D.R.I. Aug. 11, 2005), the plaintiffs claimed that the company engaged in improper accounting practices related to the sales of a key product. The plaintiffs' alleged losses occurred after the company issued a press release announcing reduced quarterly revenue based on lower than expected sales.

In their motion to dismiss, the defendants argued that "the press release and the resulting drop in the price of KVH common stock fails to establish loss caustion because the press release does not attribute the declining revenue to the sales of the [key product]." The court found, however, that the key product was a possible contributor to the lower than expected sales, even if it was not expressly discussed in the press release. Accordingly, the plaintiffs adequately plead loss causation.

Holding: Motion to dismiss denied (except for the claims based on a limited number of inactionable statements).

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August 12, 2005

The Content Of The Disclosure

Following the Dura decision by the Supreme Court, lower courts continue to grapple with what constitutes a sufficient pleading of loss causation. In In re Cree, Inc. Sec. Litig., 2005 WL 1847004 (M.D.N.C. Aug. 2, 2005), Cree's stock price dropped after its former CEO filed an individual lawsuit generally alleging that the company had engaged in securities fraud. The court found: (a) the individual lawsuit "did not disclose anything about transactions with five of the six companies Plaintiffs now claim were the subject of numerous misstatements and omissions;" and (b) as to the one transaction it did address, the complaint "merely attribute[d] an improper purpose to the previously disclosed facts." In the absence of the disclosure of new facts, the court found that the transaction could not be the "proximate cause of the complained-of loss."

Holding: Dismissed with prejudice. (The court also adopted the rigorous First Circuit standard for evaluating confidential witness statements and held that the plaintiffs failed to plead falsity with sufficient particularity.)

Quote of note: "It is doubtful that a general averment of fraud with no specific factual allegations could be deemed a 'disclosure' for purposes of determining whether some act or omission, previously concealed by a false representation, caused, upon revelation, a shareholder's loss. While it is clear that a disclosure need not conform to any prescribed format, in must nevertheless satisfy at least a minimum standard of content. A disclosure must reveal new facts; a bald assertion of fraud is not sufficient."

Disclosure: The author of The 10b-5 Daily represents the defendants in the Cree securities litigation.

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August 4, 2005

When A Promotion Is Not Enough

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.

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July 13, 2005

Upside Surprises

Judge Scheindlin (S.D.N.Y.) has issued two loss causation decisions in an offshoot of the IPO allocation cases.

In the case in question, the plaintiffs alleged a scheme by an investment bank and several issuers to systematically set the issuers' announced earnings forecasts below internal forecasts. When earnings consistently beat the announced forecasts, the resulting excitement in the market allegedly drove the issuers stock prices up. According to the complaint, the scheme was ultimately revealed to the market through a series of announcements disclosing that earnings were below expectations or warning that future earnings would not meet expectations. These announcements allegedly ended "the fraudulently induced expectation of continuing upside surprises."

In In re Initial Public Offering Sec. Litig., No. MDL 1554(SAS), 2005 WL 1162445 (S.D.N.Y. May 13, 2005), the court responded to a motion for reconsideration of an earlier dismissal of the claims by rejecting the plaintiffs' reliance on the announcements because they were not "corrective disclosures." The court explained that "[t]o allege loss causation, plaintiffs must allege that, at some point, the concealed scheme was disclosed to the market." None of the disclosures relied on by the plaintiffs, however, implied that there had been a fraudulent scheme.

In response to a second motion for reconsideration, Judge Scheindlin issued another decision. In In re Initial Public Offering Sec. Litig., 2005 WL 1529659 (S.D.N.Y. June 28, 2005), the court noted that the Supreme Court's Dura opinion "did not disturb Second Circuit precedent regarding loss causation." After a lengthy discussion of how to reconcile this sometimes contradictory Second Circuit precedent, the court again found that loss causation had not been adequately plead.

The June 28 decision is the subject of a New York Law Journal article (via law.com - free regist. req'd).

Posted by Lyle Roberts at 11:21 PM | TrackBack

July 8, 2005

Scienter and Rule 10b5-1 Trading Plans

Whether trading under a Rule 10b5-1 trading plan can help shield corporate executives from securities fraud liability is a topic that courts continue to explore.

Rule 10b5-1, put into place in 2000, establishes that a person's purchase or sale of securities is not "on the basis of" material nonpublic information if, before becoming aware of the information, the person enters into a binding contract, instruction, or trading plan (as defined in the rule) covering the securities transaction at issue. To take advantage of this potential affirmative defense, many executives have implemented trading plans for their sales of company stock.

Insider trading, of course, is often used by plaintiffs in securities class actions to create an inference of scienter (i.e., fraudulent intent). The plaintiffs allege that the individual corporate defendants profited from the alleged fraud by selling their company stock at an artificially inflated price. In the latest decision to consider the impact of Rule 10b5-1 trading plans on insider trading scienter allegations, the court in In re Netflix, Inc. Sec. Litig., 2005 WL 1562858 (N.D. Cal. June 28, 2005) found that the fact that the trading in question took place pursuant to a trading plan mitigated against a finding of an inference of scienter.

The author of The 10b-5 Daily has written an article (with one of his colleagues) on this topic.

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June 29, 2005

Parmalat's Auditors

In an interesting opinion released yesterday in the Parmalat securities class action, Judge Kaplan (S.D.N.Y.) addresses some important topics.

(1) Parmalat's primary auditors were the Italian affiliates of two multinational accounting firms - Grant Thornton and Deloitte & Touche. The court found that the plaintiffs sufficiently alleged an agency relationship between the global umbrella organizations, Grant Thornton International ("GTI") and Deloitte Touche Tohmatsu ("DTT"), and their Italian member firms so as to allow the claims against the global entities to go forward.

(2) GTI and DTT argued that the plaintiffs had failed to adequately plead loss causation "because they do not allege that any misrepresentation by them was the proximate cause of the decline in the value of the price of Parmalat securities or that a corrective disclosure about their prior misrepresentations caused the company's collapse." The court disagreed, holding that under Second Circuit precedent the plaintiffs' allegations that the risks concealed by Parmalat and its auditors caused the decline in investor value were sufficient.

(3) Section 20(a) of the '34 Act creates a cause of action against defendants alleged to have been "control persons" of those who engaged in securities fraud. There is a split within the Second Circuit over whether a plaintiff must allege culpable participation to state a legally sufficient claim under this provision. The court found that allegations of culpable participation are not necessary.

(4) The defendants evidently also moved to dismiss the 368-page complaint as failing to comply with F.R.C.P. 8 ("short and plain statement" of the claim). The court noted that it was in "substantial sympathy" with this position: "The requirement of pleading fraud with particularity does not justify a complaint longer than some of the greatest works of literature." Nevertheless, the court declined to dismiss the complaint on this basis.

Posted by Lyle Roberts at 11:22 PM | TrackBack

May 9, 2005

Chubb In Action

Speaking of confidential sources, it has not taken long for the Third Circuit's decision in Chubb to have an effect in the lower courts. In Freed v. Universal Health Services, Inc., 2005 WL 1030195 (E.D.Pa. May 3, 2005), the plaintiffs relied on confidential sources in alleging that UHS improperly accounted for its receivables and deliberately understated its bad debt reserves.

The confidential sources included numerous unnamed former employees of UHS, but all of them worked in individual hospitals owned by the corporation. The court, citing the Chubb decision, found that the statements could not be relied upon because "the Amended Complaint fails to allege how [the confidential sources] would have access to information regarding UHS's operations nationwide." The Legal Intelligencer has an article (via law.com - free regist. req'd) on the decision.

Holding: Dismissed with leave to amend.

Quote of note: "[C]omplaints that rely heavily on confidential sources to establish the 'true facts' must contain information describing the time period during which the confidential sources were employed by the defendant corporation, the dates on which they acquired the information they purportedly possess, and the manner in which they had access to such information."


Posted by Lyle Roberts at 10:56 PM | TrackBack

March 15, 2005

Paying Analysts

Is it fraudulent to pay analysts to promote your company's stock? In a break from the run-of-the-mill securities class action, investors in Diomed Holdings, Inc. alleged that, in 2002, the company and its chairman "devised a plan to artificially inflate the price of Diomed's stock by secretly paying stock analysts to tout Diomed to unsuspecting investors." The plaintiffs argued that this was part of a "pump and dump" scheme and and unlawful pursuant to Rule 10b-5.

The court disagreed. In Garvey v. Arkoosh, 2005 WL 273135 (D. Mass. Feb. 4, 2005), the court held that "nothing in the securities laws bars the issuer of a regulated security from paying an analyst for a stock recommendation." While the applicable regulatory scheme requires the person who publishes the report to disclose a conflict of interest (see Section 17(b) of the '33 Act), there is no similar duty imposed on the issuer who paid for the promotion. Moreover, the analysts had clearly stated in their reports that they were being paid to tout the stock, even if the disclosures did not directly connect Diomed to the payments.

Holding: Motion to dismiss granted.

Quote of note: "Any reasonable investor told that the publisher of an investment report had received $700,000, $100,000, or even $50,000 to tout a particular stock would give the analyst's recommendation the proverbial grain of salt regardless of the source of the funds."

Posted by Lyle Roberts at 7:27 PM | TrackBack

November 1, 2004

Sarbanes-Oxley And The Revival Of Time-Barred Claims

The 11th Circuit and 2nd Circuit are continuing to ponder whether the Sarbanes-Oxley Act of 2002, which extended the statute of limitations for securities fraud claims, revived claims that were time-barred prior to the Act's passage. Meanwhile, a growing majority of district courts are holding that these time-barred claims must be dismissed. In the past two months, three courts have come to this conclusion: Zurich Capital Mkts. v. Coglianese, 2004 WL 2191596 (N.D. Ill. Sept. 23, 2004); Zouras v. Hallman, 2004 WL 2191031 (D.N.H. Sept. 30, 2004); Milano v. Perot Systems Corp., 2004 WL 2360031 (N.D. Tex. Oct. 19, 2004). Given that the frequency of these cases is bound to decrease over time, the appellate courts better act quickly if they plan to reverse the tide.

Posted by Lyle Roberts at 8:17 PM | TrackBack

October 11, 2004

Loss Causation And Stock Price Declines

As the U.S. Supreme Court prepares to take on the issue of loss causation in securities fraud cases, the lower court split continues. In Swack v. Credit Suisse First Boston, 2004 WL 2203482 (D. Mass. Sept. 21, 2004), a case alleging that the defendants committed fraud by disseminating research reports that they knew to be overly optimistic, the court held that loss causation could be adequately plead even though the corrective disclosure did not lead to a stock price decline.

The court noted that "stock prices sometimes self-correct in advance of the final overt disclosure." In the case of a misleading analyst report, data that is inconsistent with the rating may lead the market to devalue the rating to the point that the corrective disclosure fails to move the stock price. As a result, the court found that it could not resolve the issue of loss causation on a motion to dismiss. (Note that the court's decision is similar to the Fogarazzo opinion from earlier this year, which is discussed here.)

Holding: Motion to dismiss denied.

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September 29, 2004

Then Again, We Might Fire Them

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.

Posted by Lyle Roberts at 6:09 PM | TrackBack

September 22, 2004

Collective Scienter And The PSLRA

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). In other words, courts reject a "collective scienter" theory.

Eager to get at corporate wrongdoing, however, some courts have been ignoring this principle. In In re NUI Sec. Litig., 314 F.Supp.2d 388 (D.N.J. 2004), the court found that the plaintiffs had adequately alleged a strong inference of scienter for the corporate defendant because NUI's associate general counsel (who was not a defendant in the case and made none of the alleged misstatements) was alleged to have actual knowledge of the company's fraudulent conduct. As to the individual defendants (the CEO and CFO of NUI), however, the court held that there were insufficient allegations concerning their motive to commit fraud and knowledge of the alleged fraudulent conduct. (See this post for a discussion of the case.)

Similarly, in the recent decision in In re Motorola Sec. Litig., 2004 WL 2032769 (N.D. Ill. Sept. 9, 2004), the court held that the plaintiffs had alleged a strong inference that Motorola "through its various officials, sought to mislead the investing public" about its vendor financing to a Turkish company. The direct fraud claims against the individual defendants (the CEO, CFO, and COO of Motorola) were dismissed, however, because the plaintiffs made no allegations that the individual defendants "had specific knowledge of the details concerning Motorola's loan" and the plaintiffs' motive allegations were insufficient.

In both cases, the claims against the individual defendants were not fully dismissed. Since the individual defendants controlled NUI and Motorola, and the courts found that a Rule 10b-5 claim was adequately pled against these companies, the Section 20(a) claims against the individual defendants based on control person liability for fraud still remained. By analyzing the scienter of NIU and Motorola separately, the courts, in essence, held that the companies acted with fraudulent intent, but their controlling officers or directors did not. This result both defies common sense (after all, a corporation can only act through its officers and directors) and, given that the individual defendants still have potential Section 20(a) liability, provides an end run around the PSLRA's requirement that scienter be adequately plead as to each defendant.

Posted by Lyle Roberts at 10:47 PM | TrackBack

August 16, 2004

Citigroup Case Dismissed

Following its enormous settlement in the WorldCom case, Citigroup received a bit of relief last week when Judge Swain (S.D.N.Y.) dismissed a related securities class action against the company. In In re Citigroup, Inc. Sec. Litig., 2004 WL 1794465 (S.D.N.Y. August 10, 2004), the court addressed claims that Citigroup had failed, with respect to transactions with Enron, Dynegy, and WorldCom, to conduct its business in accordance with its risk management policies. The plaintiffs also alleged that Citigroup had permitted Solomon Smith Barney (a Citigroup subsidiary) analysts to color their public assessments of those companies to aid Citigroup's investment banking business.

In its decision, the court found that the claims regarding the transactions with Enron, Dynegy, and WorldCom merely alleged "that Citigroup's business would have been conducted differently had the company adhered to the management principles disclosed in its public filings." The court held that under established law, "allegations of mismanagement, even where a plaintiff claims that it would not have invested in the an entity had it known of the management issues, are insufficient to support a securities fraud claim under section 10(b)."

As to the claims based on analyst statements, the court noted that the plaintiffs had failed to allege that any misleading statements were made "in connection with the market for Citigroup's own securities." The allegation that Citigroup's failure to disclose the false nature of the analyst statements had the effect of misleading investors concerning the profitability of Citigroup's investment banking activities was summarily rejected. First, the court found the "securities laws do not require a company to accuse itself of wrongdoing." Second, the court found that to the extent the claims were "premised on the assertion that Citigroup breached a duty to disclose that its revenues were 'unsustainable," no such duty existed in the absence of any projections concerning those revenues.

Holding: Motion to dismiss granted with leave to amend.

The New York Law Journal has an article (via law.com - free regist. req'd) on the decision.

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August 9, 2004

"The Truth Was All Over The Market"

One way to rebut the fraud-on-the-market theory is to demonstrate that the alleged misrepresentations could not have affected the market price of the stock because the truth of the matter was already known to investors. The "truth-on-the-market" defense is fact-specific, and courts have only rarely found it to be an appropriate basis for dismissing a securities fraud complaint for failure to adequately plead that the alleged misrepresentations were material.

As the court in White v. H.R. Block, Inc., 2004 WL 1698628 (S.D.N.Y. July 28, 2004) recently noted, however, "'rarely appropriate' is not the same as 'never appropriate.'" In that case, the plaintiffs alleged that H.R. Block had concealed important facts about more than 20 class action lawsuits filed against the company over its refund anticipation loan program. The court found that the "litigation involved public lawsuits brought by public filings in public courts, and the litigation was the subject of extensive press coverage . . . as well as press releases and SEC filings from Block itself." Not surprisingly, the court rejected the plaintiffs' argument that this information did not enter the market with sufficient intensity to counter-balance any alleged misrepresentations. "In short, the truth was all over the market."

Holding: Motion to dismiss granted with prejudice.

Quote of note: "Plaintiffs claim that investors should not be obligated to 'scour county court houses across the country.' But, as defendants point out, the market is comprised of more than ordinary investors; it is also comprised of market professionals, such as Avalon, and Avalon apparently had little trouble scouring those courthouses to gather information for its report on the RAL litigation which sparked this lawsuit against Block."

Posted by Lyle Roberts at 7:39 PM | TrackBack

July 26, 2004

Waiting On The Eleventh Circuit

While the U.S. Court of Appeals for the Eleventh Circuit continues to consider whether the new statute of limitations in the Sarbanes-Oxley Act of 2002 revives time-barred claims, the district court split on the issue remains unresolved. Two recent decisions from the S.D.N.Y., in prominent cases, come to different conclusions.

In In re Worldcom, Inc. Sec. Litig., 2004 WL 1435356 (S.D.N.Y. June 28, 2004), Judge Cote found that "there is no explicit language in the statute" that would operate to revive time-barred claims and lengthening the statute of limitations in this manner "would affect the substantive rights of the defendants by depriving them of a defense on which they were entitled to rely." Accordingly, the court held that "Sarbanes-Oxley does not revive previously time-barred private securities fraud claims" and dismissed certain claims in the case that had expired in June 2002 (a month before Sarbanes-Oxley was passed).

In In re AOL Time Warner, Inc. Sec. and "ERISA" Litig., 2004 WL 992991 (S.D.N.Y. May 5, 2004), Judge Kram went in another direction. In that case, the first class action was filed on July 18, 2002 (two weeks before Sarbanes-Oxley was passed). The court held that the plaintiffs' otherwise time-barred claims would have been revived if the plaintiffs had filed after the passage of Sarbanes-Oxley. Although "in most cases, class actions or otherwise, the date of the first filing is the operative one for statute of limitations purposes," the court decided that the filing date of the consolidated complaint, September 16, 2002, should be the operative date in the instant case. As a result, the longer statute of limitations in Sarbanes-Oxley applied and the otherwise time-barred claims could proceed. The court justified this rather extraordinary decision by arguing that any other result would punish the plaintiffs for filing too early and lead to a mass opt-out from the class.

Posted by Lyle Roberts at 10:29 PM | TrackBack

July 23, 2004

How Deep Is The 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.

In the case of oral forward-looking statements, the PSLRA specifically provides that the meaningful cautionary statements can be incorporated by reference in a readily available written document. The statute is silent, however, about whether this is also true for written forward-looking statements. Surprisingly, only a few courts have addressed this issue.

In In re Blockbuster Inc., Sec. Litig., 2004 WL 884308 (N.D. Tex. April 24, 2004), the court noted that the PSLRA's safe harbor is based on the judicially-created bespeaks caution doctrine, which provides that statements must be analyzed in context. The court therefore concluded that "as long as the reference is clear and explicit so that the referenced cautionary language can fairly be viewed as part of the 'context' surrounding the written forward-looking statement, the PSLRA safe harbor for written forward-looking statements can be satisfied by meaningful cautionary language that is incorporated by reference." The court found that its holding was supported by the "illogic" of allowing incorporation by reference for oral statements, where the location of the cautionary statements is likely to be misheard or forgotten, but not allowing it for easily followed written statements.

Holding: Motion to dismiss granted.

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July 20, 2004

In-And-Out Traders As Lead Plaintiffs

Matria Healthcare has announced the dismissal of the securities class action pending against the company in the N.D. of Ga. The court's opinion addresses the issue of whether in-and-out traders (i.e., investors who both bought and sold their shares during the class period) can be effective lead plaintiffs.

Only one person filed suit against Matria on a class action basis and he was subsequently named lead plaintiff. The proposed class period extended from October 24, 2000 to June 25, 2002, when the company disclosed problems with its information technology capabilities, but the lead plaintiff had sold all of his Matria shares on February 6, 2002.

In its opinion (Barr v. Matria Healthcare, Inc., 2004 WL 1551566 (N.D. Ga. July 7, 2004)), the court found that it was "undisputed that the Plaintiff sold his stock in response to an adverse market reaction to the Defendants' January 30, 2002 press release." The January 30 press release, however, made no mention of Matria's information technology problems. As a result, the court found that the lead plaintiff could not demonstrate loss causation because the relevant misrepresentations "were not disclosed until well after the Plaintiff had sold his stock at the still artificially inflated price."

Holding: Motion to dismiss granted with prejudice (also on other grounds).

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July 15, 2004

Applying The Fraud-On-The-Market Theory To Research Analysts

Whether and how to apply 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) to research analyst statements is a controversial issue. It was the subject of a recent appeal by Citigroup in the WorldCom litigation, but the appeal was mooted by the settlement of the case just before the scheduled oral argument.

The 10b-5 Daily has argued that the Second Circuit, in its opinion granting Citigroup's request for interlocutory appeal, appeared favorably disposed to finding that the fraud-on-the-market theory was not generally applicable to research analyst statements. Judge Rakoff of the S.D.N.Y. apparently agrees with this reading of the opinion.

In DeMarco v. Lehman Brothers, 2004 WL 1506242 (S.D.N.Y. July 6, 2004), a case alleging that a Lehman analyst made buy recommendations for RealNetworks, Inc. stock while secretly holding negative views of the stock, the court has denied the motion for class certification. The court noted that there is a "qualitative difference" between a statement of fact from an issuer and a statement of opinion by a research analyst. In particular, a "well-developed efficient market can reasonably be presumed to translate the former into an effect on price, whereas no such presumption attaches to the latter." As a result, the court held that the fraud-on-the-market doctrine can apply to a case based on research analyst statements "only where the plaintiff can make a prima facie showing that the analyst's statements materially impacted the market price in a reasonably quantifiable respect."

The plaintiffs relied on Lehman Brothers' promotional materials touting its analyst's abilities and influence and an expert report (largely based on general studies of the effect of analyst recommendations on stock prices) in arguing that the analyst's statements inflated the market price for RealNetworks' stock. The court found that this evidence was insufficient to "warrant invocation of the fraud-on-the-market presumption."

Holding: Motion for class certification denied.

Quote of note: "[A] statement of opinion emanating from a research analyst is far more subjective and far less certain, and often appears in tandem with conflicting opinions from other analysts as well as new statements from the issuer. As a result, no automatic impact on the price of a security can be presumed and instead must be proven and measured before the statement can be said to have 'defrauded the market' in any material way that is not simply speculative."

The New York Law Journal has an article (via law.com - free regist. req'd) on the decision. Thanks to Adam Savett for sending in a copy of Judge Rakoff's opinion.

Posted by Lyle Roberts at 9:15 PM | TrackBack

June 21, 2004

Fogarazzo Revisited

The decision in the Fogarazzo research analyst case in the S.D.N.Y. (previously posted about in The 10b-5 Daily here) is controversial on a number of pleading issues. Not only does the court apply a loss causation standard that, in contravention of the Second Circuit, appears to remove the need to draw any actual connection between the misrepresentations and the loss, it also runs roughshod over other S.D.N.Y. decisions on how to analyze the falsity and scienter (i.e., fraudulent intent) requirements for securities fraud claims based on statements of opinion.

In the research analyst cases, the issue is whether the defendants deliberately misrepresented their truly held opinion that the stock was not a good investment. Judges in the S.D.N.Y. (e.g., Judge Lynch in the Podany decision discussed here) have found that under these circumstances the falsity and scienter requirements are essentially identical. Since the statement (unlike a statement of fact) cannot be false at all unless the speaker is knowingly misstating his truly held opinion, the plaintiffs must allege inconsistent statements or actions by the defendants from which a factfinder could infer that a knowing misstatement was made. For example, the plaintiffs might allege that the defendants' made statements to others that the stock was overvalued or engaged in personal sales of the stock.

In Forgarazzo, Judge Scheindlin rejected this approach. After finding that falsity must be examined separately from scienter, the court held that the falsity of the analysts' buy recommendations was adequately plead based on allegations that the defendants: (1) wanted to obtain investment banking business from the underlying company; (2) had analysts that were subject to financial conflicts of interest; and (3) failed to maintain adequate controls to protect the objectivity of their public research. None of these allegations, however, suggests that the analyst reports were false (i.e., that the defendants actually regarded the underlying stock as a poor investment). In essence, the court found that the existence of a motive to commit fraud is enough to demonstrate that the opinions were false.

Holding: Motion to dismiss denied.

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June 14, 2004

Running Loss Causation Out Of Town

The argument that loss causation must be plead by showing a stock price decline related to the alleged fraud, articulated in the Second Circuit by the Emergent Capital decision, is meeting with increased resistance by the S.D.N.Y. judges handling the research analyst cases. Judges have argued that the stock market crash that occured between the issuance of the allegedly biased research and the revelation of the analysts' conflicts of interest (and, therefore, arguably caused any loss) was irrelevant, either because of allegations that the research analyst directly participated in a fraudulent scheme perpetrated by the issuer of the underlying stock or because the revelation of the analysts' conduct caused a subsequent stock price drop. (See these posts on the WorldCom and Robertson Stephens cases).

In Fogarazzo v. Lehman Brothers, Inc., 2004 WL 1151542 (S.D.N.Y. May 21, 2004), however, the entire concept of the price decline approach to pleading loss causation comes under attack. The complaint, brought by shareholders of RSL Communications, Inc. (RSL), alleged that analysts at three firms had falsified their opinions of RSL. Specifically, while RSL issued a series of negative announcements in 1999 and 2000 and its stock price dropped the analysts continued to provide RSL with positive ratings. Ultimately, RSLs stock declined to the point that it was delisted, and each of the three firms then dropped analyst coverage. The court was careful to note that there were no allegations that the defendants concealed any facts concerning RSL. Instead, the plaintiffs merely alleged that despite publicly available negative information, the analysts expressed falsely positive opinions.

Although the facts are similar to those in the Merrill Lynch cases, Judge Scheindlin appears to create a new loss causation standard and concludes that loss causation was adequately plead. The court explained that loss causation is shown when "(1) the misrepresentation artificially inflated the value of the security, or otherwise misrepresented its investment quality, and (2) the subject of the misrepresentation caused the decline in the value of the security." Here, the subject of the misrepresentations was "the financial health and future prospects of RSL," and though no facts were concealed, that subject still caused plaintiffs' losses. "[E]ven though the true facts were available to the world to see, by affirmatively opining on the meaning of those facts, the Banks obscured the logical conclusion that RSL was failing." This standard would appear to remove the need to draw any actual connection between the misrepresentations and the loss; the mere fact that the company's stock price declined creates liability for anyone who issued false statements about the company into the market.

Moreover, although Judge Scheindlin expressed uncertainty as to whether the Second Circuits price decline approach requires a corrective disclosure, the court concluded that dropping analyst coverage of RSL was a corrective disclosure. "[W]hen the Banks dropped coverage, they essentially conceded (in the eyes of the investing public) that their previous recommendations were mistaken." Even accepting this characterization of the banks' actions (and it is hard to see how dropping coverage can be equated with a disclosure about the previous recommendations), the court did not find that there was a price decline after coverage was dropped.

As noted previously, clarification of these issues may come in the near future. The Second Circuit is scheduled to hear the appeal of the first few Merrill Lynch decisions on August 12, 2004.

Holding: Motion to dismiss denied. (The 10b-5 Daily may do an additional post about the other holdings in the opinion.)

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June 9, 2004

Using Stock As Currency

As noted in The 10b-5 Daily's discussions of the Intergroup and NUI decisions, the idea that corporate acquisitions for stock are a sufficient motive for securities fraud is controversial. A contrary view can be found in the recent decision in In re Corning Sec. Litig., 2004 WL 1056063 (W.D.N.Y. April 9, 2004).

In the Corning case, the plaintiffs alleged that the defendants were motivated to artificially inflate the company's stock price so that they could use it as currency for the acquisition of Tropel Corporation. The court found that "[p]aying a smaller price for the acquisition of Tropel [by using inflated stock] benefited Corning's common shareholders." Moreover, the desire to have a high stock price to be used in the purchase of Tropel "is a motive that could be attributed to virtually every company seeking to acquire another through the use of its own stock as part of the purchase." As a result, the court held that the acquisition failed to create a strong inference of scienter.

Holding: Motion to dismiss granted.

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June 3, 2004

The Perfect Storm Redux

Are two opinions a trend? Last year, The 10b-5 Daily posted about the denial of the motion to dismiss in the Interpublic Group securities litigation in the S.D.N.Y. The court's opinion in that case was based on the following controversial legal propositions: (1) Section 20(a) claims have no scienter pleading requirement; (2) corporate acquisitions for stock can be a motive for securities fraud; and (3) companies can be personified for scienter purposes (i.e., a finding of fraudulent intent). In a holding that was described here as "the perfect storm that happens when these three strands of questionable law come together," the Interpublic court found that even though the plaintiffs had failed to establish a strong inference of scienter for any of Interpublic's officers, the case could proceed against Interpublic and its officers based on the company's alleged motive to commit fraud and control person liability.

A year later, another court has issued a very similar decision. In In re NUI Sec. Litig., 2004 WL 895846 (D.N.J. April 23, 2004), the court found that the plaintiffs had adequately alleged a strong inference of scienter for the corporate defendant based on two sets of facts applicable to different parts of the class period. First, NUI's stock-for-stock acquisition of another company allegedly gave it a motive to inflate the price of its stock. Second, NUI's associate general counsel (who is not a defendant in the case) was alleged to have actual knowledge of the company's fraudulent conduct. As to the individual defendants (the CEO and CFO of NUI), however, the court held that there were insufficient allegations concerning their motive to commit fraud and knowledge of the alleged fraudulent conduct. Just as in Interpublic, the Rule 10b-5 claims were allowed to continue against NUI, but were dismissed against the individual defendants. The individual defendants were not, however, free to go. Since they controlled NUI and the court had found that a Rule 10b-5 claim was adequately pled against NUI, the Section 20(a) claims against the individual defendants based on control person liability still remain.

The NUI decision, like the Interpublic decision, would appear to eviscerate the PSLRA's requirement that scienter be adequately plead as to each defendant (see the post on the Interpublic decision for a fuller discussion). Moreover, the NUI court adds a fourth strand of questionable law to the mix. As recently discussed at length in the Fifth Circuit's decision in Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004) (see this post on the decision's group pleading holding), in determining whether a corporate defendant has acted with scienter, a court generally looks "to the state of mind of the individual corporate official or official who make or issue the statement (or order or approve it or its making or issuance, or who furnish information or language for inclusions therein, or the like) rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment." In other words, courts generally reject a "collective scienter" theory - for example, where a plaintiff attempts to impute the knowledge of the associate general counsel, who is not alleged to have made or issued any statements, to the corporation for scienter purposes. The perfect storm keeps going.

Holding: Motion to dismiss granted in part (as to a separate alleged fraudulent scheme and certain statements), and denied in part.

Posted by Lyle Roberts at 10:55 PM | TrackBack

May 6, 2004

Motion To Dismiss Denied In AOL Time Warner Case

The Washington Post reports that Judge Shirley Wohl Kram has denied most of the motion to dismiss in the AOL Time Warner securities class action pending in the S.D.N.Y. The complaint alleges that the defendants, both before and after the 2001 merger of AOL and Time Warner, improperly inflated results through 'round-trip' deals that in effect overpaid other companies for goods, services, or equity in exchange for advertising revenue. In 2002, AOL Time Warner restated $190 million in revenue.

Judge Kram threw out some of the plaintiffs' claims, including those against former AOL chairman Steve Case and various bondholder claims, but found that the allegations in the complaint "established sufficient circumstantial evidence of misbehavior or recklessness for the case to move forward" against the company and various current and former officials. (The 10b-5 Daily has posted frequently about the case, most recently about a discovery decision issued by the court last October.)

Posted by Lyle Roberts at 5:54 PM | TrackBack

May 5, 2004

Group Pleading Takes Another Blow

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). The U.S. Court of Appeals for the Fifth Circuit has recently held, in the first circuit court decision to address the issue, that the group pleading doctrine was abolished by the enactment of the PSLRA's heightened pleading standards.

That decision is beginning to have an impact outside of the Fifth Circuit. In In re Cross Media Marketing Corp. Sec. Litig. 2004 WL 842350 (S.D.N.Y. April 20, 2004), the court found that the PSLRA's "use of the singular 'defendant' counsels against group pleading in actions arising in securities fraud cases since the enactment of the [statute]." The court cited the Fifth Circuit decision and held that group pleading could not be used to establish that the individual defendants made misrepresentations or acted with scienter (i.e., fradulent intent).

Holding: Motion to dismiss granted with leave to replead.

Posted by Lyle Roberts at 10:35 PM | TrackBack

April 23, 2004

Who's In Charge Here?

Section 20(a) of the '34 Act creates a cause of action against defendants alleged to have been "control persons" of those who engaged in securities fraud. In the absence of a scienter pleading requirement for control person liability (a disputed question in the Second Circuit - see this post), all plaintiffs need to show at the pleading stage is: (a) there was a primary violation by a controlled person; and (b) control of the primary violator by the defendant. An unresolved issue is what is necessary to adequately plead the element of control if both the primary violator and the defendant are corporations.

In Schnall v. Annuity and Life Re (Holdings), Ltd., 2004 WL 515150 (D. Conn. March 9, 2004), the court's answer was: not too much. XL Capital Ltd. had founded Annuity and Life Re (Holdings), Ltd. ("ANR"), the primary corporate defendant in the case, and two of XL Capital's officers/directors served as ANR directors. In addition, during the class period XL Capital owned between 11% and 12.9% of ANR's common stock. Based on these facts, the court found "it may reasonably be inferred that defendant XL Capital was in a position to influence and direct the activities of ANR" and therefore the plaintiffs' Section 20(a) claim against XL Capital could go forward.

Holding: Motion to dismiss denied.

Posted by Lyle Roberts at 3:51 PM | TrackBack

April 9, 2004

The Fairy Tale May Be Over

The Copper Mountain securities litigation in the N.D. of Cal. is a font of notable decisions. As reported in The 10b-5 Daily, Judge Vaughn Walker issued a fairly amazing order in February expressing displeasure with both plaintiffs and the 9th Circuit over the lead plaintiff/lead counsel selection process in the case. After questioning whether the mandamus proceeding initiated by one of the lead plaintiff candidates was a "fairy tale" when the successful appellant decided not to pursue the position, the court ended up reappointing the original lead plaintiff.

With the lead plaintiff issue finally settled (after three years), the court was able to turn to the motion to dismiss. Last week, in In re Copper Mountain Sec. Litig., 2004 WL 725204 (N.D. Cal. March 30, 2004), the court granted the motion. The decision's opening paragraphs present an interesting overview of the particularity requirement in fraud on the market cases (especially for defendants):

It is well-known that the Private Securities Litigation Reform Act (PSLRA) and FRCP 9(b) impose a particularity requirement in the allegation of securities fraud. This is especially important in the case of a complaint alleging open market fraud or fraud on the market, such as the complaint at bar.

The starting point for the particularity analysis is not the allegedly false or misleading statements of the defendants, but the truth that emerges from the market. An open market trades on different points of view of an issuer's prospects. If all investors thought the same things, there would be no trading except that prompted by the need of investors to re-balance their portfolios among investment alternatives (i.e., cash versus bonds, stocks versus cash, etc). What matters in an open market case is the total mix of information in the market and whether that mix has been altered in some significant way to create a very widely, indeed essentially universal, but wrong view of the value of the security at issue. It is the "truth" that reveals the "error" of the market. The disclosure of this "truth" avulsively changes the price of the security. But disclosure of a market "error" does not make out a case of "fraud on the market." Starting with the "truth," the complaint must allege facts to show that the previously settled but false investor expectations can be laid at the feet of defendants. This may seem simple, although it is not easy to do. A complaint satisfying the particularity requirement does not require rococo factual detail, but it does require specifics. So a plaintiff seeking to allege open market securities fraud does well to begin the analysis with the "truth," stack it up against what preceded it and then see if acts, omissions or statements of defendants can plausibly be said to be responsible for the "truth" not emerging earlier when plaintiffs traded their securities.

Generally, open market fraud complaints fail to satisfy the required pleading standard in one of several different ways. Most often plaintiffs cannot identify a false statement of defendant that might account for causing a security issue's price to be distorted. Even if a statement that turns out to be false can be identified, it is usually so laden with cautionary language as to be unactionable as a practical matter. In the more common omissions case, plaintiff may be unable to find a ground upon which to allege that defendant knew the omitted fact or had a duty to disclose it. This complaint illustrates these various shortcomings.

Holding: Motion to dismiss granted (with limited leave to amend).

Posted by Lyle Roberts at 5:40 PM | TrackBack

April 7, 2004

Relating Back

As a general matter, allegations in an amended complaint relate back to the date of the original filing if they arise out of the same operative facts. What exactly constitutes the operative facts, of course, can be the subject of debate.

In In re American Express Co. Sec. Litig., 2004 WL 632750 (S.D.N.Y. March 31, 2004), the court found that the plaintiffs were on inquiry notice of their claims concerning Amex's alleged misrepresentations about its investments in high-yield securities as of July 18, 2001. Although the original complaint was filed in a timely manner (i.e., within a year), the amended complaint was not filed until December 10, 2002, and contained new allegations about improper valuation methods, GAAP violations, and a lack of adequate risk controls. The court found that these allegations did not sufficiently relate back to the original complaint, even though they all generally concerned Amex's investments in high-yield securities, and were therefore time-barred.

Holding: Motion to dismiss granted.

Quote of note: "The initial complaint simply avers that defendants did not disclose management's failure to 'fully comprehend' the risks associated with Amex's high-yield holdings. The Amended Complaint, on the other hand, claims that 'the procedures for valuing and evaluating AEFA's holdings made it impossible to monitor and guage risks accurately, and no such risk analysis was taking place.' These allegations are therefore distinct from those in the intitial complaint, as they involve different 'operative facts.'"

Thanks to Adam Savett for sending this case in.

Posted by Lyle Roberts at 10:20 PM | TrackBack

April 6, 2004

Bristol-Myers Dismissed

The Associated Press reports that the securities class action pending against Bristol-Myers Squibb Co. (NYSE: BMY) in the S.D.N.Y. has been dismissed with prejudice. The case alleged that Bristol-Myers and certain of its officers had made misrepresentations concerning the company's accounting practices and its investment in ImClone Systems.

Posted by Lyle Roberts at 10:36 PM | TrackBack

April 1, 2004

Things Are Getting Interesting

The issue of loss causation is proving to be difficult for the S.D.N.Y. as it addresses the numerous research analyst cases. The general theme of the cases is straightforward: the defendants 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 the Merrill Lynch decision, the court found that there was no alleged connection between the research reports and the companies' financial troubles or the collapse of the overall market. (See this post.) In distinguishing that case, other S.D.N.Y. judges have pointed to additional facts linking the research reports to the alleged loss. In the Robertson Stephens decision, for example, the court noted that there was "evidence that disclosure of defendants' scheme caused a further decline in the price of [the] stock, even after the overall bubble had burst." (See this post.) While in the WorldCom decision, the plaintiffs had alleged that the analyst was aware of and concealed the accounting irregularities that led to the loss. (See this post.)

This week has seen the issuance of another research analyst decision from the S.D.N.Y., with what appears to be a new take on loss causation. In DeMarco v. Lehman Brothers, Inc., 2004 WL 602668 (S.D.N.Y. March 29, 2004), the plaintiffs allege that a Lehman analyst made buy recommendations for RealNetworks, Inc. stock during the class period (July 11, 2000 to July 18, 2001) while secretly holding negative views of the stock. In October 2000, the stock price declined, allegedly causing plaintiffs' losses. Investors did not discover that the Lehman analyst had misled them about his opinion on RealNetworks until the release of certain e-mails by the SEC in April 2003.

On the issue of loss causation the court made the following holding:

"[A]ssuming arguendo that plaintiffs must plead that their losses proximately resulted from the marketplace's reaction to the revelation of the truth that defendant's actionable statements concealed (as contrasted to independent market forces), the Complaint adequately alleges that in or around October 2000, the market was finally apprised of the negative information concerning RealNetworks that had earlier led [the Lehman analyst] to take a secretly negative view of the stock and that, as a result of these revelations, the stock declined, causing the losses on which plaintiff here sues."

The decision leaves a number of questions unanswered:

(1) Did the plaintiffs allege any facts demonstrating that the analyst knew about negative information that was not available to the market? (This factual scenario is suggested by the holding, but there is nothing in the decision to support it.)

(2) If the answer to Question 1 is no, what about the Merrill Lynch decision, which would appear to have reached the opposite conclusion on loss causation (but is not discussed by the court)?

(3) If the loss occurred in or around October 2000, how can the class period extend until July 18, 2001?

Things are getting interesting. Here's a final question: what is the Second Circuit going to say about all of this and when?

Holding: Motion to dismiss denied.

Addition: As to when the Second Circuit is going to deal with the issue of loss causation and the research analyst cases, a good guess is as part of the Merrill Lynch appeal. The scheduling order for the appeal states that briefing will be completed on May 24, with argument to be heard as early as the week of July 12. Thanks to Adam Savett for passing along this information.

Posted by Lyle Roberts at 9:18 PM | TrackBack

March 23, 2004

Cable & Wireless Dismissed

Cable & Wireless plc (NYSE: CWP) has announced the dismissal of the securities class action pending against the company in the E.D. of Va. Plaintiffs originally filed the case in December 2002 and claimed that C&W had misled investors concerning a potential tax liability arising from the sale of its One2One mobile telephone business to Deutsche Telekom. The court apparently has only issued an order at this time, with the memorandum opinion to follow.

Posted by Lyle Roberts at 3:17 PM | TrackBack

March 15, 2004

Juniper Case Dismissed

Reuters reports that the securities class action pending against Juniper Networks, Inc. (Nasdaq: JNPR) in the N.D. of Cal. has been dismissed with prejudice. The suit was originally filed in 2002 and alleged among its claims that Juniper falsely recognized certain revenues.

Posted by Lyle Roberts at 7:16 PM | TrackBack

March 11, 2004

It Doesn't Walk Like A Duck

In 2001, more than 300 securities class actions were filed against companies and underwriters who engaged in initial public offerings in the high-tech boom years. The cases, known as the "IPO Allocation" cases, alleged that the underwriters gained increased trading commissions in exchange for access to IPO shares and that investors who were allocated IPO shares were required to buy shares in the after-market to help push up the share price.

An offshoot of this litigation is the class actions that have been brought on behalf of the companies who did IPOs alleging that the underwriters engaged in breaches of contract or fiduciary duty by engaging in these activities. An example is the case brought by Xpedior Creditor Trust against Donaldson Lufkin & Jenrette ("DLJ" - now owned by CSFB) on behalf of companies whose initial public offerings were underwritten by DLJ. On Tuesday, Judge Scheindlin denied the defendant's motion to dismiss. Most notably, the court determined that the plaintiffs' claims were not subject to preemption under the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), which generally requires the dismissal of class actions for securities fraud that are based on state law.

The court held that, based on the Second Circuit's recent decision in Spielman, it was not enough to rely on the plaintiffs' characterization of their claims. Instead, the court needed to examine whether the state law claims in the case relied on misstatements or omissions made in connection with the sale or purchase of a security as a "necessary component" of the claims. "To make this determination the simple inquiry is whether plaintiff is pleading fraud in words or substance." The court found, however, that none of the state law claims asserted by the plaintiffs - breach of contract, breach of the implied convenants of good faith and fair dealing, breach of fiduciary duty, or unjust enrichment - required misrepresentations as a necessary element and they did not sound in fraud.

Holding: Motion to dismiss denied (except as to the unjust enrichment claim on different grounds).

The Associated Press has an article on the decision, but gets the basis for the claims wrong. The decision makes it clear that Xpedior did not allege that DLJ "deliberately underpriced initial public offerings during the Internet boom," precisely because that would have led to the likely dismissal of the case due to SLUSA preemption.

Posted by Lyle Roberts at 8:39 PM | TrackBack

March 9, 2004

What Were They Thinking?

The research analyst cases continue to generate interesting judicial opinions. Judge Gerard Lynch of the S.D.N.Y. recently denied the motion to dismiss in the DeMarco case, which involved allegedly fraudulent buy recommendations for Corvis Corp. stock made by Robertson Stephens. (The loss causation holding in that decision was discussed in this post.) Last month, however, Judge Lynch came to the opposite conclusion in two facially similar cases against Robertson Stephens over buy recommendations for Redback Networks and Sycamore Networks stock. See Podany/Finazzo v. Robertson Stephens, Inc., 2004 WL 307296 (S.D.N.Y. Feb. 17, 2004). Why the difference?

In all of the cases, the issue was whether the defendants deliberately misrepresented a truly held opinion (i.e., that the stock was not a good investment). The court framed the inquiry in this manner:

"While in a misstatement of fact case the falsity and scienter requirements present separate inquiries, in false statement of opinion cases such as these, the falsity and scienter requirements are essentially identical . . . . [A] material misstatement of opinion is by its nature a false statement, not about the objective world, but about the defendant's own belief. Essentially, proving the falsity of the statement 'I believe this investment is sound' is the same as proving scienter, since the statement (unlike a statement of fact) cannot be false at all unless the speaker is knowingly misstating his truly held opinion."

In the DeMarco case, the court found, the complaint "described acts and statements inconsistent with the defendants' published opinions about the value of Corvis stock," including the defendants' statements to others that Corvis stock was overvalued and their personal sales of Corvis stock. In contrast, the Podany and Finazzo complaints pointed "to no inconsistent statements or actions by defendants from which a factfinder could infer that the published opinions were not truly held." Plaintiffs' arguments that the opinions were not objectively reasonable, that the analyst had a motive to lie because he owned shares in companies that were being acquired by Redback and Sycamore, and that defendants had engaged in similar schemes (e.g., the Corvis allegations) were insufficient to establish any misstatements of opinion.

Holding: Motions to dismiss granted.

Quote of note: "While the commission of similar fraudulent schemes may be admissible evidence of defendants' state of mind under Federal Rule of Evidence 404(b), alleging the existence of such other schemes does not sufficiently plead that the opinions in these cases were fraudulent."

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February 3, 2004

Titan Pharmaceuticals Dismissed

Titan Pharmaceuticals, Inc. (Amex: TTP) has announced that the plaintiffs in the derivative and securities class action litigation brought against the Company have voluntarily dismissed their claims without prejudice. The securities class actions, intitially filed in the N.D. of Cal. last November, had alleged that Titan made false statements regarding the development of a new drug for treating schizophrenia.

Posted by Lyle Roberts at 11:09 PM | TrackBack

January 15, 2004

EDS Motion To Dismiss Denied

A court in the E.D. of Tex. has denied the motion to dismiss in the securities class action against Electronic Data Systems Corp. ("EDS"). The suit alleges that EDS misrepresented company earnings and facts related to its multibillion-dollar Navy/Marine Corps Intranet contract. According to an article in Computerworld, the court found that the plaintiffs had established a "strong inference that defendants were extremely reckless in continuing to recognize any revenue on the project when they were allegedly pursuing a tactic of intentionally providing goods that did not meet contract specifications."

Quote of note: "Lawyers for the shareholders presented a significant number of documents that the court upheld as evidence supporting the allegations against EDS. Among the documents was a May 6, 2002, e-mail from the N/MCI transition manager at the Naval Air Systems Command that outlined various software problems, a failure to provide remote access for 61% of the users that were testing the new intranet, and a lack of secure Web access and help desk support."

Addition: The opinion is now available on Westlaw - In re Electronic Data Systems Corp. Securities and "ERISA" Litigation, 2004 WL 52088 (E.D. Tex. Jan. 13, 2004).

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January 13, 2004

Loss Causation In The S.D.N.Y.

What is necessary to adequately plead loss causation in a securities fraud case continues to be the subject of contention in the S.D.N.Y., with a number of decisions addressing the issue over the past year. (The 10b-5 Daily discusses the recent loss causation decision in the IPO Allocation cases here.) The New York Law Journal has an article (via law.com - free regist. req'd) on yet another loss causation decision in DeMarco v. Robertson Stephens, Inc., 2004 WL 512232 (S.D.N.Y. Jan. 9, 2004), the securities class action against Robertson Stephens over its Corvis Corp. stock recommendations.

The suit alleges that Robertson Stephens' analysts made buy recommendations for Corvis stock to prop up the price until the firm and some of its executives could sell off their pre-IPO shares in the company (i.e., a variation on a "pump-and-dump" stock manipulation). The alleged scheme was revealed to the market when a May 2001 article in the New York Times reported the discrepancy between Robertson Stephens' public recommendations and the sales by its executives. In his opinion, District Judge Lynch notes that the price of Corvis stock dropped 16% within a few days of the article.

On the issue of loss causation, the defendants argued that the plaintiffs' loss was due to the general market downturn in telecommunications stock, not any alleged misrepresentations. The court agreed that the plaintiffs could not merely allege that the price of Corvis shares had been inflated to establish loss causation (there is a circuit split on this issue, see this post), holding that "it is unlikely that loss causation could be adequately alleged in every fraud-on-the-market case that successfully pleads transaction causation because in cases where an unforseeable intervening event causes the plaintiffs' loss, there is no causal nexus between the loss and the misrepresentation." In the instant case, however, the court found that "the bursting of the Corvis stock bubble could reasonable be construed, at least in part, as the market's correction of an inflated stock price, pumped up in part by defendants' false statements about its opinions."

The court took pains to distinguish the case from the facially similar cases against Merrill Lynch that have been dismissed by Judge Pollack. (The 10b-5 Daily's summary of the initial Merrill Lynch decision can be found here.) On the issue of loss causation, Judge Lynch noted that, in contrast to the Merrill Lynch cases, "in this case there is evidence that disclosure of defendants' scheme caused a further decline in the price of Corvis stock, even after the overall bubble had burst."

Holding: Motion to dismiss Rule 10b-5 claim denied. A motion to dismiss the insider trading claim against a Robertson Stephens executive, however, was granted.

Quote of note: "On the facts in this case, the Court must conclude that plaintiffs have adequately alleged loss causation because the decline in stock price was a forseeable consequence of defendants' fraudulent statements that allegedly inflated the price, because in an efficient market, revelation of the misrepresentations will lead inexorably to a price correction."

Posted by Lyle Roberts at 11:30 PM | TrackBack

January 5, 2004

Discovery Of Wells Submissions, Loss Causation, And The IPO Allocation Cases

The WorldCom and Initial Public Offering securities litigations in the S.D.N.Y. are generating judicial opinions on a wide variety of topics, with the plaintiffs frequently getting the better of the argument. Two more opinions have come down from Judge Scheindlin in the IPO allocation cases over the holidays.

Discovery of Wells Submissions

On December 24, the court issued an opinion and order addressing whether "Wells submissions" to the SEC are discoverable in subsequent litigations. The target of a SEC investigation is permitted to file a written submission, known as a Wells submission, with the agency to respond to contemplated charges. The plaintiffs were seeking discovery of Wells submissions made by the underwriter defendants in connection with the SEC's investigation of the same IPO allocation practices at issue in the current litigation. Although the Wells submissions contained offers of settlement, the court found that they are not "settlement material" and, in any event, they are relevant to the current litigation and therefore discoverable.

Quote of note: "Offers of settlement, however, are not intrinsically part of Wells submissions, which were intended to be 'memoranda to the SEC presenting arguments why an enforcement proceeding should not be brought.' To the extent that a respondent may make a settlement offer, that offer is typically clearly identified and thus easily severable from the remainder of the submission."

Holding: The underwriter defendants are ordered to produce their Wells submissions to plaintiffs on or before January 20, 2004.

The New York Law Journal has an article (via law.com - free regist. req'd) on the decision and the Securities Litigation Watch has a post.

Loss Causation

On December 31, the court issued an order and opinion addressing a motion for judgment on the pleadings by the underwriter defendants. The underwriter defendants argued that the Rule 10b-5 claims against them should be dismissed in light of the Second Circuit's recent decision on the pleading of loss causation in securities fraud cases. In Emergent Capital, the Second Circuit held that allegations of artificial price inflation, without more, do not suffice to plead loss causation. (The 10b-5 Daily has posted about the decision and the current circuit split on this issue.)

In the IPO allocation cases, the underwriter defendants "allegedly required or induced their customers to buy shares of stock in the aftermarket as a condition of receiving initial public offerings stock allocations." This conduct allegedly caused the plaintiffs to purchase the stock at an artificially inflated price. The plaintiffs have brought claims, based on different provisions of Rule 10b-5, for (1) market manipulation and (2) material misstatements and omissions.

Although the Emergent Capital decision requires more than price inflation to adequately plead loss causation (e.g., a corrective disclosure revealing the fraud and causing a stock price decline), the court noted that it is a material misstatements and omissions case. Market manipulation, the court argued, is simply different.

"A market manipulation is a discrete act that influences stock price. Once the manipulation ceases, however, the information available to the market is the same as before, and the stock price gradually returns to its true value. . . In market manipulation cases, therefore, it may be permissible to infer that the artificial inflation will inevitably dissipate. That being so, plaintiffs' allegations of artificial inflation are sufficient to plead loss causation because it is fair to infer that the inflationary effect must inevitably diminish over time. It is that dissipation -- and not the inflation itself -- that caused plaintiffs' loss."

The court offers no citations for this analysis and it certainly reaches some broad (and potentially controversial) conclusions. As for the remaining misstatements and omission claims, the court concedes that Emergent Capital is directly on point, but simply bootstraps the claims into its earlier loss causation analysis: "The content of Underwriters' misstatements was, in essence: 'this is a fair, efficient market, unaffected by manipulation.' In fact (according to plaintiffs), the market was manipulated. For the reasons discussed [] above, that market manipulation was a cause of plaintiffs' loss. Therefore, the misstatements that concealed that manipulation also were a cause of plaintiffs' loss." But if the plaintiffs have brought separate fraud claims based on alleged misstatements, don't they need to establish that the alleged misstatements, separate and apart from the market manipulation, caused a loss? Apparently not.

Holding: Motion for judgment on the pleadings denied.

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December 10, 2003

Maxim Pharmaceuticals Case Dismissed

Maxim Pharmaceuticals, Inc. (Nasdaq: MAXM) has announced the dismissal, with prejudice, of the securities class action pending against the company in the S.D. of Cal. The plaintiffs had alleged that Maxim made false and misleading statements in 1999 and 2000 concerning the efficacy and clinical trial results of a cancer drug it was developing. The court had already dismissed two earlier complaints and based this dismissal on the failure to adequately plead scienter. The Securities Litigation Watch has a post on the case and has linked to the court's order.

Posted by Lyle Roberts at 8:28 PM | TrackBack

December 2, 2003

Amdocs Case Dismissed

Amdocs, Ltd. (NYSE: DOX), a St. Louis-based supplier of billing and customer relationship management software to the telecommunications industry, has announced the dismissal, with prejudice, of the securities class action pending against the company in the E.D. of Missouri. Plaintiffs had alleged that "Amdocs and the individual defendants had made false or misleading statements about Amdocs business and future prospects during a putative class period between July 18, 2000 and June 20, 2002."

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WorldCom & The Statute of Limitations

The WorldCom securities litigation continues to generate judicial decisions at an impressive rate. The past ten days have turned up two opinions addressing the application of the statute of limitations for securities fraud to various claims.

1) In State of Alaska Dept. of Revenue v. Ebbers, 2003 WL 22738546 (S.D.N.Y. Nov. 21, 2003), one of the forty-seven individual actions brought on behalf of public pension funds, the court addressed whether the extended statute of limitations created by the Sarbanes-Oxley Act of 2002 is applicable to claims brought under Section 11 of the '33 Act. (Click here for a recent post on The 10b-5 Daily describing the new statute of limitations.)

Section 11 creates liability for false or misleading statements in registration statements. To avoid the heightened pleading standards for pleading fraud, the State of Alaska plaintiffs expressly disavowed that their claims were based on a theory of fraud, instead styling them as pure negligence or strict liability claims. By its terms, however, the extended Sarbanes-Oxley statute of limitations only applies to claims that involve "fraud, deceit, manipulation, or contrivance" in contravention of the "securities laws."

The court explained the results of the plaintiffs' Faustian bargain: "There are advantages to bringing solely strict liability and negligence claims: the pleading and proof thresholds are far lower than for claims asserting securities fraud, and liability is 'extensive.' One of the disadvantages of bringing negligence claims, however, is a more narrow window of time in which to sue. Because Section 13 [of the '33 Act] and not Section 804 [of Sarbanes-Oxley], applies to the Section 11 claim arising from the 1998 Offering, that claim expired in August 2001 and is time-barred."

Having found that the extended Sarbanes-Oxley statute of limitations did not apply, the court noted "it is unnecessary to consider whether the statute could be retroactively applied." It also made additional statute of limitations rulings on other claims in the case.

2) Statute of limitations arguments based on inquiry notice (i.e., plaintiffs were aware of the probability of fraud but failed to bring their claim in a timely manner) are often difficult for defendants because there is a fine, but distinct, line between arguing that plaintiffs were aware of the probability of fraud and conceding that a fraud was committed. In a different individual action in the Worldcom securities litigation, Public Employees Retirement System of Ohio v. Ebbers, No. 03 Civ. 338 (S.D.N.Y. November 25, 2003), the court addressed a statute of limitations defense raised by Salomon Smith Barney ("SSB") and its telecommunications analyst, Jack Grubman. (The 10b-5 Daily has posted previously about the defenses raised by the SSB defendants at the class certification for the main securities class action.)

The court found that the plaintiffs were not put on inquiry notice of the alleged fraud because the cited press reports were "simply too vauge" to support a conclusion that an illicit relationship between SSB and WorldCom was tainting Grubman's reports. In a rather unfair bit of piling on, however, the court also stated that it was "ironic" that the SSB defendants "now contend that the conflicts of interest that they have so vigorously argued are insufficient to sustain fraud allegations were sufficiently reported in the business press to put plaintiffs on notice of their fraud claims as early as 2000." No arguing in the alternative allowed?

The New York Law Journal has an article (via law.com - free regist. req.) on the Ohio decision.

Posted by Lyle Roberts at 6:30 PM | TrackBack

November 13, 2003

Does The New Statute Of Limitations 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 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.

Courts are beginning to address this issue, with mixed results. In Roberts v. Dean Witter Reynolds Inc., 2003 WL 1936116 (M.D. Fla. March 31, 2003), the district court found that Sarbanes-Oxley revived already time-barred claims because the legislative history demonstrates that Congress intended to achieve that result. 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. Perhaps as a result, it certified an interlocutory appeal on the question that is currently pending before the U.S. Court of Appeals for the 11th Circuit.

In the meantime, two other district courts have issued contrary opinions. In Glaser v. Enzo Biochem, Inc., 2003 WL 21960613 (E.D. Va. July 16, 2003), the court concluded that "Congress did not unambiguously provide that the [new] limitations period would apply retroactively." Last week, in In re Enterprise Mortgage Acceptance Co., LLC Sec. Litig. , 03 Civ. 3752 (S.D.N.Y. Nov. 5, 2003), the court held: (a) "there is no clear language in the statute stating that it applies retroactively or that it operates to revive time-barred claims;" (b) the statute expressly disavows that it is creating any new rights of action; and (c) the legislative history examined by the Roberts court does not support a finding that Congress intended to revive time-barred claims.

Stay tuned.

Addition: The opinion is now available on Westlaw - In re Enterprise Mortgage Acceptance Co., LLC Sec. Litig., 2003 WL 22955925 (S.D.N.Y. Nov. 5, 2003).

Posted by Lyle Roberts at 5:32 PM | TrackBack

November 7, 2003

Rule 10b5-1 To The Rescue

The SEC has created an affirmative defense to allegations that a person engaged in insider trading while in possession of material nonpublic information. Rule 10b5-1, put into place in 2000, establishes that a person's purchase or sale of securities is not "on the basis of" material nonpublic information if, before becoming aware of the information, the person enters into a binding contract, instruction, or trading plan (as defined in the rule) covering the securities transaction at issue. To take advantage of this potential affirmative defense, many executives have been implementing trading plans for their sales of company stock.

Insider trading, of course, is often used by plaintiffs in securities class actions to create an inference of scienter (i.e., fraudulent intent). The plaintiffs allege that the individual corporate defendants profited from the alleged fraud by selling their company stock at an artificially inflated price. Since the implementation of Rule 10b5-1, however, it has been an open question whether this inference can be refuted by the fact that the trading was done pursuant to a previously established trading plan. A partial answer may be found in the decision in Wietschner v. Monterey Pasta Co., No. C 03-0632 (N.D. Cal. Nov. 4, 2003) (will add Westlaw cite and link when available).

In Wietschner, the court held that the individual defendants' stock sales were not sufficiently unusual or suspicious to raise a strong inference of scienter. In addition to evaluating the size and timing of the transactions, the court noted: "Plaintiffs state that both Defendants sold shares under individual SEC Rule 10b5-1 trading plans, which allows corporate insiders to set a schedule by which to sell shares over a twelve to fifteen month period. This could raise an inference that the sales were pre-scheduled and not suspicious."

Holding: Motion to dismiss granted.

Addition: The opinion is now available on Westlaw - Weitschner v. Monterey Pasta Company, 2003 WL 22889372 (N.D. Cal. Nov. 4, 2003).

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November 6, 2003

Is Being A Corporate Executive Sufficient To Establish Fraudulent Intent?

Those who believe that courts, in the post-Enron environment, should be more willing to temper the heightened pleading requirements of the PSLRA will be encouraged by a recent decision from the N.D. of Ill.

In In re Sears, Roebuck and Co. Sec. Litig., 2003 WL 22454021 (Oct. 24, 2003 N.D. Ill.) (thanks to Adam Savett for the link), the court addressed allegations that the defendants made misstatements "about the risk level of balances in accounts in Sears' credit card portfolio, the delinquencies in those accounts, and the amount of 'charge-offs' of unpaid accounts." The plaintiffs argued that they had established a strong inference of scienter (i.e., fraudulent intent) because the individual defendants were executive officers of Sears and therefore must have known the information that made the alleged misstatements false and misleading. The court agreed, holding: "Officers of a company can be assumed to know of facts 'critical to a business's core operations or to an important transaction that would affect a company's performance.'"

It is difficult to reconcile this decision with the PSLRA. The PSLRA requires plaintiffs to "state with particularity facts giving rise to a strong inference that the defendant acted with the required stated of mind." The mere pleading of a defendant's official corporate title and responsibilities would not appear to be sufficient.

Moreover, the case cited (and quoted!) by the court in support of this proposition, Stavros v. Exelon Corp., 266 F. Supp. 2d 833 (N.D. Ill. 2003) says no such thing. Stavros is a case based on allegedly false financial projections and merely notes, after a discussion of the need to plead scienter with particularity, that a "plaintiff might also plead that key officers knew of facts critical to a business's core operations or to an important transaction that would affect a company's performance." There is no suggestion that this knowledge can be assumed based on the officers' positions with the company. There are cases finding that this assumption is enough to establish a strong inference of scienter (although a significant majority of post-PSLRA cases appear to go the other way - see, e.g., In re Advanta Corp. Sec. Litig., 180 F. 3d 525, 539 (3rd. Cir. 1999)), but Stavros just does not happen to be one of them.

Holding: Motion to dismiss denied.

Quote of note: "Plaintiffs specifically allege that the positions held by each of the individual defendants during the class period gave them knowledge of the specific information in question. . . Logically, defendants in their positions would be expected to have knowledge of the facts regarding the credit card portfolio at the time they were making statements about the portfolio or signing off on SEC filings."

Posted by Lyle Roberts at 1:23 PM | TrackBack

November 3, 2003

IPO Suits Alleging Price-Fixing Dismissed

The Associated Press reports that District Judge Pauley of the S.D.N.Y. has dismissed two class actions alleging price-fixing in connection with high-tech initial public offerings. The anti-trust cases, brought in 2001 against ten investment banks, addressed the same claims of stock price manipulation and commission kickbacks as in the related IPO allocation cases. The article states "Pauley ruled Monday that the charges made by investors in the suits are immune from antitrust law and fall to federal securities regulators to decide."

Addition: Judge Pauley's decision can be found here.

Posted by Lyle Roberts at 9:21 PM | TrackBack

October 31, 2003

Plaintiffs Voluntarily Dismiss Pediatrix Suits

Pediatrix Medical Group, Inc. (NYSE: PDX) announced yesterday that the plaintiffs have voluntarily dismissed, without prejudice, the securities class actions currently pending against the company in the S.D. of Fla.

Pediatrix is a Fort Lauderdale-based provider of maternal-fetal and newborn physician services. The suits were brought following Pediatrix's June 24 announcement that a U.S. attorney's office is conducting an investigation into the company's nationwide Medicaid billing practices. In 2002, Pediatrix settled an earlier securities class action, also based on allegedly fraudulent billing practices, for $12 million.

Posted by Lyle Roberts at 11:49 PM | TrackBack

Eight More Analyst Research Cases Dismisssed

Judge Pollack of the S.D.N.Y. has dismissed, with prejudice, an additional eight class actions against Merrill Lynch alleging the brokerage committed securities fraud by publishing overly optimistic research reports. The companies discussed in the relevant reports include eToys Inc., Homestore.com, and Pets.com Inc. The decision follows the reasoning laid down in Judge Pollack's earlier ruling on two related cases a few months ago. The court focuses on the plaintiffs' inability to adequately plead loss causation because of the absence of an alleged connection between the analyst reports and the companies' financial troubles or the collapse of the overall market. As has become expected, Judge Pollack also manages to provide some colorful turns of phrase.

As of July, there were 27 similar consolidated class actions, each involving a different company's stock, pending in the S.D.N.Y. It appears likely that none will survive the motion to dismiss stage. The Associated Press has a story on the new decision and the Securities Litigation Watch has this post.

Quote of note: Loss causation - "The burst of the bubble and the attendant market chaos are not chargeable to the defendants and represent intervening causes for which defendants are not responsible in the sequence of responsible causation."

Quote of note II: Statute of limitations - On the issue of whether plaintiffs were on inquiry notice of their fraud claims, thus triggering the statute of limitations, the court concludes that "[t]he plethora of public information would have required even a blind, deaf, or indifferent investor to take notice of the purported alleged 'fraud.'"

Quote of note III: Scienter - "Often lost in the enormous muddle of securities litigation is this most basic of facts: not every knowing misrepresentation creates a legal cause of action under the securities laws. The requisite state of mind, or scienter, in an action under Section 10(b) and Rule 10b-5, that the plaintiff must allege is a purpose to harm by intentionally deceiving, manipulating or defrauding."

Posted by Lyle Roberts at 11:19 PM | TrackBack

October 2, 2003

Hiding The Ball

When a court grants a motion to dismiss a securitites class action based on the failure to meet the heightened pleading standards of the PSLRA, the plaintiffs often seek to file an amended complaint addressing the identified deficiences. At least one court has found, however, that plaintiffs cannot take a wait-and-see-what-happens approach if they are aware of additional facts.

In In re Stone & Webster, Inc. Sec. Litig., 217 F.R.D. 96 (D. Mass. 2003), the court addressed whether to grant a motion for leave to file a second consolidated and amended complaint after dismissing most of the claims in the case because they were not plead with the required specificity. The plaintiffs premised their motion "on the theory that the facts that would allegedly remedy the pleading defects identified in the [court's] order were 'newly discovered,' [but] conceded at the scheduling conference that much of this information was in fact available to them during the pendency of the motions to dismiss." The court found that the plaintiffs' failure to provide these additional facts while the court considered the motion to dismiss was "precisely the sort of 'undue delay' that should result in a denial of leave to amend."

Holding: Motion for leave to amend denied.

Quote of note: "The fact that the plaintiffs chose to oppose the motions to dismiss on the grounds that their complaint was, in their view, sufficiently pleaded, rather than providing the additional information known to them during the necessarily lengthy period during which the motions to dismiss were being considered, smacks of gamesmanship bordering on bad faith."

Posted by Lyle Roberts at 7:45 PM | TrackBack

September 29, 2003

One More For The Road

Securities Litigation Watch notes that the recent decision in the K-Mart case (see this post) addresses loss causation and appears to follow the line of cases holding that merely alleging the stock was purchased at an artificially inflated price does not adequately plead a "causal nexus" between the misstatement and any economic harm. The 10b-5 Daily recently summarized the current split of appellate authority on this issue.

Posted by Lyle Roberts at 3:09 PM | TrackBack

September 26, 2003

Materiality = Economic Impact

According to Second Circuit precedent, for a court to determine on a motion to dismiss in a securities fraud case that the alleged misstatement or omission is immaterial, it must be "so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of [its] importance." Judges in the S.D.N.Y. recently have been exploring what "obviously unimportant" means, with favorable results for defendants. (See this post in The 10b-5 Daily for a discussion of the Allied Capital case.)

In re Duke Energy Corp. Sec. Litig., 2003 WL 22170716 (S.D.N.Y. September 17, 2003), involved allegations that Duke Energy had failed adequately to disclose that its revenues were overstated due to "round trip" or "wash transactions," involving simultaneous sales and purchases of energy at the same prices and in the same amounts. The stock price dropped over the time period that the company made announcements concerning the discovery of these trades. Finally, in August 2002, the company confirmed that it had engaged in $217 million of these transactions.

The court found that the concealment of these transactions could not have been material. An inflation of $217 million in Duke Energy's revenues over a two-year period amounted to about 0.3% of the company's total revenues -- a total that the court found immaterial as a matter of law. The plaintiffs made two counterarguments that were rejected by the court as insufficient.

First, the plaintiffs argued that the fall in share price after the announcement of the discovery of these transactions demonstrated that they were material to investors. The court found: (a) the plaintiffs' allegations of a connection between the company's disclosures and the stock price decline were too vague (really a loss causation argument); and (b) "bare allegations of stock price declines cannot cure the immateriality of an overstatement as small as the one here at issue."

Second, the plaintiffs argued that the nondisclosure was qualitatively material because it involved illegal activity. The court found that even assuming that the transactions were illegal, the failure to disclose them did "not give rise to a securities claims if their only effect in terms of what was disclosed to the public was a miniscule 0.3% inflation of revenues."

Holding: Motion to dismiss with prejudice granted.

Quote of note: "Plaintiffs are vague about what constituted this underlying 'illegality,' as 'wash sales' and 'round-trip trading' are not necessarily illegal per se. But even assuming they were, illegality of a financial nature (as opposed, say, to rape or murder) must still be assessed, for disclosure purposes, by its economic impact. Otherwise, every time a giant corporation failed to disclose a petty theft in its mailroom, it would be liable under the securities laws."

Posted by Lyle Roberts at 3:28 PM | TrackBack

September 22, 2003

Kmart Case Dismissed

The E.D. of Mich. has dismissed the securities class action against several former Kmart executives and PricewaterhouseCoopers. The complaint alleged that the defendants misled Kmart investors in 2000 and 2001 prior to the company's bankruptcy.

According to an article in yesterday's Detroit News, the case was dismissed by Judge Gerald Rosen on pleading grounds, despite his determination that the plaintiffs had established a strong inference of fradulent intent for two of the individual defendants. The article also reports that a related ERISA class action on behalf of former Kmart employees has survived a motion to dismiss.

Quote of note: "Rosen said he dismissed the lawsuit strictly on technical legal grounds. Congress may have set 'a virtually unreachable' standard for lawsuits that charge private companies with securities fraud, he said. But his decision 'by no means should be construed as giving defendants a completely clean bill of health,' Rosen wrote in the 65-page opinion issued Friday."

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September 19, 2003

Intervoice Case Dismissed

Intervoice, Inc. (Nasdaq: INTV) has announced the dismissal, with prejudice, of the securities class action pending against the company in the N.D. of Tex. Intervoice is a Dallas-based maker of call automation systems.

According to the Dallas Business Journal, the suit was filed in June 2001 and alleged "some of Intervoice's executives issued false and misleading statements concerning the financial condition of the company, the results of the company's merger with Brite Voice Systems Inc. in 1999 and the company's business projections." The suit was originally dismissed a year ago, but the plaintiffs were given leave to amend.

Posted by Lyle Roberts at 3:46 PM | TrackBack

September 12, 2003

Restating Your CEO's Resume

MCG Capital Corp. (Nasdaq: MCGC) has announced the dismissal, with prejudice, of the securities class action filed against the company in the E.D. of Va.

Even without the benefit of reading an opinion, the "with prejudice" part of the decision does not seem surprising. The suit was based on alleged misstatements made by MCG Capital regarding the academic background of the company's chief executive. Last November, the company revealed that its CEO did not, in fact, have an undergraduate degree from Syracuse University. The announcement caused a stock price decline.

Posted by Lyle Roberts at 7:44 PM | TrackBack

September 9, 2003

"Honey-Loving Bear" Case Dismissed

The Walt Disney Co. has obtained the dismissal of a securities class action against the company. The case, filed in the C.D. of Cal., alleged that Disney had failed until May 2002 to disclose in its SEC filings the potential damages at stake in a separate legal dispute with Stephen Slesinger Inc., which holds the U.S. merchandising rights for Winnie-the-Pooh.

Reuters reports that Judge Mariana Pfaelzer was critical of the plaintiffs' arguments, noting that events in a case can suddenly change lawyers' views of the outcome (leading to Disney's decision to make its May 2002 disclosure) and that "everybody is on notice that this [the Slesinger suit] could be a big case." Nevertheless, the plaintiffs were given 30 days to amend their complaint if they want to try again.

Posted by Lyle Roberts at 1:32 PM | TrackBack

September 4, 2003

Foundry Case Dismissed

Foundry Networks (Nasdaq: FDRY) has obtained a dismissal, with prejudice, of the securities class action against the company in the N.D. of Cal. The case was originally filed in January 2001.

Securities Litigation Watch reports that it was the fifth amended complaint in the case and "the Court found that plaintiffs had, at most, alleged facts giving rise to a 'reasonable inference' (rather than the required 'strong inference') that defendants knew the challenged statements were false when made." A copy of the order can be found here.

Posted by Lyle Roberts at 9:32 PM | TrackBack

September 2, 2003

Infonet Case Dismissed

Infonet Services Corporation (NYSE: IN), a California communication services provider, has announced the dismissal, without prejudice, of the securities class action against the company. The plaintiffs have until October 2, 2003 to refile.

Posted by Lyle Roberts at 10:45 PM | TrackBack

August 18, 2003

Qwest Cites Merrill Lynch Decision (And So It Begins)

There is little doubt that Judge Pollack's decision in the Merrill Lynch research class actions is destined to be widely cited by securities litigation defendants -- it certainly has caused attorneys to give more consideration to loss causation as a defense. Exhibit A: Qwest Communications International, Inc.

The Rocky Mountain News reported over the weekend that Qwest has filed a motion to dismiss the securities class action against the company citing the Merrill Lynch decision and arguing that plaintiffs have not adequately alleged that the supposed misconduct, rather than a general market decline, caused their losses. Predictably (especially if you regularly read The 10b-5 Daily), plaintiffs have responded that the Merrill Lynch case isn't relevant, in part, because none of the plaintiffs in that case bought their stock from Merrill Lynch. The Qwest suit is before the U.S. District Court for the District of Colorado.

Quote of note: "In its court brief, Qwest cited the Merrill Lynch decision this summer. The class-action claim was dismissed, Qwest said, because the plaintiffs didn't adequately prove that the conduct of the analysts, rather than a general market decline, caused their losses. Qwest attorneys argue that Qwest's stock price too 'generally rose and fell' in a pattern corresponding to the broader Nasdaq telecommunications index."

Posted by Lyle Roberts at 9:11 PM | TrackBack

August 14, 2003

Alliant Energy Case Dismissed

The Milwaukee Business Journal reports that the securities class action against Alliant Energy, filed in the U.S. District Court for the Western District of Wisconsin, has been dismissed without prejudice. The case was based on Alliant's alleged misrepresentations concerning its expected financial performance.

Posted by Lyle Roberts at 11:53 PM | TrackBack

August 12, 2003

Intel Order

The recent unpublished order granting Intel Corp.'s motion to dismiss the securities class action against the company has been posted by The Securities Law Beacon. (The 10b-5 Daily has previously noted the decision.)

Posted by Lyle Roberts at 7:00 PM | TrackBack

Judge Pollack Declines To Rehear Merrill Lynch Cases

Reuters reports that Judge Pollack of the S.D.N.Y. has declined to reconsider his ruling, or allow the plaintiffs to file an amended complaint, in the Merrill Lynch research class actions he recently dismissed. (The 10b-5 Daily has posted extensively about the original decision, starting here.)

Quote of note: "Pollack said on Tuesday that the plaintiffs had done 'nothing to change the unalterable, judicially-noticeable facts relating to the widespread public dissemination, years prior to the filing of the cases at bar, of information regarding analyst conflicts of interest and the service of investment banking business.'"

Posted by Lyle Roberts at 6:08 PM | TrackBack

August 11, 2003

SuperGen Obtains Voluntary Dismissal

SuperGen, Inc. (NASDAQ: SUPG) has announced the voluntary dismissal of the securities class action against the pharmaceutical company. The suit, originally filed in April in the U.S. District Court for the Northern District of California, alleged that the company sold shares while failing to disclose material information about one of its drugs.

Posted by Lyle Roberts at 6:07 PM | TrackBack

July 31, 2003

Dismissal Of Suit Against Two WorldCom Executives Upheld

The Jackson Clarion Ledger reports that the U.S. Court of Appeals for the Fifth Circuit has upheld the dismissal of a securities class action against WorldCom former executives Bernie Ebbers and Scott Sullivan. The decision can be found here.

It is important to note, however, that this suit was not based on the accounting irregularties that led to WorldCom's recent bankruptcy. Instead, it was based on the failure of WorldCom to write-off certain receivables in 2000.

Quote of note: "In the original complaint, shareholders claimed Ebbers and Sullivan withheld information about $685 million in write-offs of uncollectible receivables. The ruling said, 'the plaintiffs simply ignore evidence that WorldCom frequently took large write-offs and that, indeed, a $768 million write-off had been taken in 1999.'"

Posted by Lyle Roberts at 9:31 PM | TrackBack

July 29, 2003

Baxter Suit Dismissed

Apparently, it's a good day to be a defendant. Baxter International, Inc. , a medical products maker, has announced the dismissal of the securities class action filed against it in Illinois federal court. The suit was based on earnings forecasts Baxter had made for FY2002.

Posted by Lyle Roberts at 7:07 PM | TrackBack

July 18, 2003

Read Judge Pollack's Opinion For Yourself

The conventional wisdom on Judge Pollack's decision in the Merrill Lynch analyst research cases is that he dismissed the cases because the plaintiffs were not Merrill Lynch clients, and therefore could not demonstrate that they reasonably relied on the brokerage's research. Columnists for Forbes and Bloomberg continue to provide a forum for this incorrect reading of the case, which is being promoted vociferously by (surprise) attorneys representing individual Merrill Lynch clients in arbitration claims against the brokerage.

In fact, as discussed in The 10b-5 Daily here and here, Judge Pollack dismissed the cases because plaintiffs failed to establish any connection between the analyst research and the companies' financial troubles or the collapse of the overall market. In Judge Pollack's view, that is what actually caused plaintiffs' losses. But as Chico Marx once said, "who are you going to believe, me or your own eyes?" Here's the opinion again -- whether you agree with Judge Pollack or not, it's fascinating reading.

Posted by Lyle Roberts at 6:59 PM | TrackBack

July 15, 2003

Motion To Dismiss Filed In The AOL Time Warner Case

The New York Times is keeping on top of the AOL Time Warner securities class action. In a followup to its July 7 overview of the case (posted on The 10b-5 Daily), the paper has an article on the recently filed motion to dismiss. Among other things, AOL Time Warner argues that its restatement of $190 million is just 1% of its revenue over the period in question and that it disclosed all of its two-way deals with customers.

Quote of note: "The company's motion to dismiss the suit is an expected part of the proceedings, and legal scholars consider it unlikely to succeed. But the relative strength of AOL Time Warner's legal defense will help determine how costly it is for the company to resolve the suit, most likely through a settlement payment."

Posted by Lyle Roberts at 7:16 PM | TrackBack

July 9, 2003

Who Sold The Hard Cheese?

The securities class action (along with another securities fraud case) against the former executives of Suprema Specialties, a bankrupt cheese manufacturer, have been dismissed by Judge William Walls of the D. of N.J. The Newark Star-Ledger reports that testimony and evidence in the related bankruptcy case raised questions about the validity of the company's "hard cheese" sales, but Judge Walls held that the allegations of fictitious sales in the securities fraud cases lacked details and failed to meet the applicable pleading standards.

Quote of note: "'The complaints certainly paint a picture of a company which was troubled and ultimately failed, a picture where, perhaps, something smelled a little funny,' Walls wrote in his June 25 decision. 'But the complaints lack the factual specificity demanded by (securities fraud law) and may not be so maintained.'"

Posted by Lyle Roberts at 11:56 PM | TrackBack

July 7, 2003

Status Of The AOL Time Warner Case

The The New York Times has a lengthy article in today's edition on the securities class action against AOL Time Warner. The author concludes that a dismissal of the case appears unlikely.

Quote of note: "In what one legal scholar called 'the judicial equivalent of a Freudian slip,' Judge Shirley Wohl Kram of United States District Court in Manhattan responded to a preliminary letter from shareholders' lawyers by ordering AOL Time Warner to turn over millions of pages of documents before the lawyers filed a formal motion or the company had a chance to respond. When AOL Time Warner's lawyers complained, she quickly rescinded the order."

Quote of note II: "[L]egal experts say that the settlement in this case may well exceed previous benchmarks and formulas because of the political impetus among judges and regulators these days to crack down on corporate fraud. 'There has been a regime change,' said Joseph A. Grundfest, a law professor at Stanford and a former member of the S.E.C., adding that 'settlements are more difficult for companies to negotiate in the post- Enron environment.'"

Posted by Lyle Roberts at 1:00 AM | TrackBack

July 6, 2003

NYT On The Merrill Lynch Case

On Friday, the New York Times ran a news analysis on Judge Pollack's decision in the Merrill Lynch case. Unfortunately, the author misstates the central holding in the case, leading to a number of erroneous conclusions. In support of the proposition that the decision has little precedential value, the article conflates two elements of a Rule 10b-5 claim that Judge Pollack took great pains to separate: reasonable reliance and loss causation. The article states: "The judge's point, instead, was that even if the research was fraudulent, the plaintiffs could not prove that their losses were tied to the research because they were not Merrill Lynch clients."

Wrong. Instead, as discussed in The 10b-5 Daily here, Judge Pollack held that the plaintiffs must "allege facts which, if accepted as true, would establish that the decline in the prices of 24/7 and Interliant stock (their claimed losses) was caused by any or all of the alleged omissions from the analyst reports." Finding that there was no alleged connection between the analyst reports and the companies' financial troubles or the collapse of the overall market, the court held that the plaintiffs failed to meet their pleading burden.

In other words, Judge Pollack's ruling is much broader than the New York Times suggests. The key was not whether the plaintiffs were Merrill Lynch clients and therefore could establish that they reasonably relied on Merrill Lynch's research. Judge Pollack notes in his decision that in a fraud-on-the-market class action, price inflation is typically used as a surrogate for reliance. Instead, the court focused on loss causation and whether the plaintiffs, presumably regardless of their status as Merrill Lynch clients, had adequately alleged that their investment losses were caused by the analyst reports. And that, as they say, is a bird of a different feather.

Addition: The 10b-5 Daily should note that the article's overall theme, that Judge Pollack's decision does not necessarily prevent Merrill Lynch clients from successfully bringing individual arbitration claims against the brokerage, is correct. It's simply correct for a different reason. Judge Pollack's decision addresses a fraud-on-the-market class action based on Rule 10b-5, it does not address every type of individual claim that might be brought against Merrill Lynch by a client (including breach of fiduciary duty, breach of contract, etc.).

Posted by Lyle Roberts at 11:37 PM | TrackBack

July 3, 2003

Merrill Lynch Optimistic That Remaining Suits Will Be Dismissed

Having gone three-for-three in front of Judge Pollack of the S.D.N.Y. this week, Merrill Lynch is apparently optimistic that the remaining 24 securities class actions against the company based on allegedly biased research reports will be dismissed. According to a Reuters article, the general counsel of Merrill Lynch sent an e-mail to employees stating: "Although the dismissals apply only to these three class actions, we believe the reasoning of the decisions is equally applicable to other research-related class actions as well."

Posted by Lyle Roberts at 6:56 PM | TrackBack

July 2, 2003

Judge Pollack Strikes Again

For the second time in as many days, Judge Pollack of the S.D.N.Y. has dismissed a securities class action against Merrill Lynch. According to Reuters, the plaintiffs, investors in Merrill Lynch's Global Technology Fund, had alleged "they were duped in part because the fund invested in the stock of companies that Merrill Lynch investment bankers were doing business with."

Quote of note: "'She (the lead plaintiff) was suing on the same general theme of having bought some shares in a fund and that Merrill Lynch was responsible for the decline in the value of the funds,' Pollack told Reuters. 'I tossed her out.'"

Addition: The opinion in the Global Technology Fund case can be found here. (Thanks to the Securities Law Beacon for the link.)

Posted by Lyle Roberts at 7:18 PM | TrackBack

Investor Suits Based On Research Reports Dismissed

The Washington Post has a comprehensive article on the decisions by Judges Pollack and Baer of the S.D.N.Y. dismissing securities class actions against Merrill Lynch and other brokerages that were based on the dissemination of allegedly biased research reports about 24/7 Real Media Inc., Interliant Inc., and Covad Communications Group. The cases are part of 27 similar consolidated actions involving different stocks.

Judge Pollack's decision in the Merrill Lynch case is sweeping in its scope, with the court finding that "plaintiffs were among the high-risk speculators who, knowing full well or being properly chargeable with appreciation of the unjustifiable risks they were undertaking in the extremely volatile and highly untested stocks at issue, now hope to twist the federal securities laws into a scheme of cost-free speculators' insurance." (CorpLawBlog has a post discussing the rhetoric in the decision.) The court held that the plaintiffs had failed to adequately plead their Section 10(b) claims and that the claims were, in any event, barred by the statute of limitations.

Note that when it rains loss causation cases, it pours loss causation cases. In direct contrast to the Eighth Circuit's holding in ConAgra (discussed below), Judge Pollack found that merely alleging that the stock price was artificially inflated is not sufficient to satisfy loss causation. (Indeed, he states that to allow this "would undoubtedly lead to speculative claims and procedural intractability.") The plaintiffs needed "to allege facts which, if accepted as true, would establish that the decline in the prices of 24/7 and Interliant stock (their claimed losses) was caused by any or all of the alleged omissions from the analyst reports." Finding that there was no alleged connection between the analyst reports and the companies' financial troubles or the collapse of the overall market, the court held that the plaintiffs failed to meet their pleading burden.

Quote of note (Washington Post): "'This was something of a test case for [lawsuits] involving similar facts,' Pollack said. 'The question is, are the facts similar?" Pollack said he did not believe the case was a close one. "Anybody who goes out to Las Vegas and loses can't sue the croupier,' he said."

Quote of note II (Washington Post): "Columbia University law professor John C. Coffee Jr. called Pollack's decision 'a huge victory for Merrill Lynch' because the judge ruled that the losses were caused by the bursting of a bubble rather than the allegedly false research. 'That's the part of his decision that has the greatest application to other cases. It's [also] the most debatable. He doesn't have much factual evidence.'"

Posted by Lyle Roberts at 11:29 AM | TrackBack

June 30, 2003

C.D. of Cal. On Safe Harbor

The PSLRA creates a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. There are two prongs to the safe harbor. First, a defendant shall not be 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. Second, a defendant shall not be liable with respect to any forward-looking statement, even in the absence of meaningful cautionary statements, if the plaintiff cannot establish that the statement was made with "actual knowledge" that it was false or misleading.

As noted by numerous commentators, the statutory scheme arguably gives companies a license to lie. If a company uses appropriate cautionary language, it can make a forward-looking statement that it knows to be false without fear of liability. Accordingly, courts have struggled with how to apply the first prong of the safe harbor where the plaintiffs allege that the defendants knew their forward-looking statements were false and merely offered cautionary language to create a smoke screen for their fraud.

In In re Seebeyond Technologies Corp. Sec. Litig., 2003 WL 21262498 (C.D. Cal. May 28, 2003), the court disagreed that the safe harbor permits knowing falsities. The key is the requirement that the cautionary language be "meaningful." The court found that "[i]f the forward-looking statement is made with actual knowledge that it is false or misleading, the accompanying cautionary language can only be meaningful if it either states the belief that it is false or misleading or, at the very least, clearly articulates the reasons why it is false or misleading."

This reading of the statute is subject to a number of objections, some of which the court itself raises. First, it appears to require a court to determine whether the statement was made with actual knowledge of falsity as a prerequisite for determining whether the cautionary language was meaningful. Congress did not impose a state of mind requirement in the first prong of the safe harbor; leaving that examination for forward-looking statements that are not accompanied by cautionary language. Second, other courts have held that to take advantage of the safe harbor, a defendant is not required to have identified the exact factor that ultimately rendered the statement untrue. It is enough to have cautionary language that reasonably alerted investors to the risks. The court's holding would appear to severely weaken this principle - as long as the plaintiff adequately alleges actual knowledge, the defendant's disclosure is never sufficient unless the exact factor that ultimately rendered the statement untrue is revealed. The bottom line: Congress is going need to solve this one.

Holding: Motion to dismiss granted in part and denied in part (plaintiffs were allowed to proceed with their claims based on forward-looking statements).

Quote of note: "Subsection (A) may still provide safe harbor where cautionary language is used, even if the defendant has actual knowledge that the statement is false or misleading. The idea that sufficient cautionary language may be used when the defendant has actual knowledge that a statement is somehow misleading (for instance, where the company is engaging in 'puffery' of some sort) is not so far-fetched."

Posted by Lyle Roberts at 11:37 PM | TrackBack

June 25, 2003

Class Action Against Arthur Anderson May Proceed

Reuters reports that the S.D.N.Y. has denied Arthur Anderson's motion to dismiss a WorldCom-related securities class action pending against the defunct accounting firm. The suit "accuses Andersen of failing to properly review and investigate WorldCom's adjustments and journal entries in its books and argues the firm should have discovered the $11 billion accounting fraud at the telephone company."

Posted by Lyle Roberts at 9:20 PM | TrackBack

June 19, 2003

The Perfect Storm

The opinion in the Interpublic Group case (In re Interpublic Securities Litigation, 2003 WL 21250682, (S.D.N.Y. May 29, 2003)) is a must-read because it brings three strands of questionable law together to eviscerate the PSLRA's scienter (i.e., fraudulent intent) pleading requirement. It has taken The 10b-5 Daily a while to get around to addressing the opinion, but only because there is so much to say!

A little background is in order. Interpublic (IPG) is a New York holding company that ranks as the second-largest owner of advertising agencies in the world. The case is the result of a restatement IPG announced last August for the five years from 1997 to 2001, which corrected inter-company charges that had been wrongly declared as income for the European offices of one of IPG's agencies.

The three strands of questionable law are:

1) Section 20(a) liability has no scienter element- Section 20(a) of the '34 Act creates a cause of action against defendants alleged to have been "control persons" of those who engaged in securities fraud. Good faith may be asserted as an affirmative defense. Six circuit courts have held that plaintiffs do not have to show that the control persons acted with scienter (the 5th, 7th, 8th, 9th, 10th, and 11th Circuits); two have held that such a showing is required (the 3rd and 4th Circuits). The Second Circuit has not definitively answered the question, but has stated that to prove a Section 20(a) claim a plaintiff must show, inter alia, "that the controlling person was in some meaningful sense a culpable participant." Although some district courts in the Second Circuit have found that this creates a scienter pleading requirement, others have disagreed. The effect of no scienter requirement, however, is that the heightened pleading standards of the PSLRA do not apply. All plaintiffs need to show at the pleading stage is: (a) there was a primary violation by a controlled person; and (b) control of the primary violator by the defendant.

2) Corporate acquisitions for stock can be a motive for securities fraud - There is a line of cases, especially in the Second Circuit, which hold that a desire to acquire other companies through the use of stock as consideration may be a sufficient allegation that defendants had a motive to make misstatements for the purpose of artificially inflating the stock price. (Note that the question of whether the motive and opportunity to commit fraud is sufficient, on its own, to establish scienter for a Rule 10b-5 claim is a whole separate debate. The Second Circuit has held that it is, but other circuit courts have disagreed.) The relatively unexplored question is: motive for whom? The company may benefit from obtaining another entity at a cheap price, but the concrete benefit for the individual defendants (i.e., officers or directors) is in the value of their stock. So in the absence of stock sales by the individual defendants at an inflated price (with the acquisition presumably included), are corporate acquisitions really a motive for individual defendants to commit fraud?

3) Personifying the company - It is generally understood that a company acts through its officers and directors. As a result, courts uniformly hold that allegations of scienter as to the individual defendants in a securities fraud case can be used to plead a claim against the company. In other words, the scienter of the individual defendants is imputed to the company. But is the reverse true? Can a securities fraud case continue against a company if there are insufficient allegations of scienter as to the individual defendants? For some courts, the corporate acquisitions motive appears to be the answer to this question. In In re IPO Securities Litigation, 241 F.Supp.2d 281 (S.D.N.Y. 2003), for example, the court separately examined the motive allegations against the companies and the individual defendants that had been sued. For the companies, the court considered whether there had been stock-based acquisitions or add-on offerings during the class period. For the individual defendants, the court looked at stock sales during the class period. In other words, the motive of a company to commit fraud was evaluated without reference to the motive of the company's officers or directors.

All of which leads to the holdings in the IPG opinion, the perfect storm that happens when these three strands of questionable law come together. As to the Rule 10b-5 claims in the case, the court made the following rulings: (a) the series of stock-for-stock acquisitions made by IPG during the class period created a strong inference that IPG had acted with scienter; and (b) there were insufficient allegations concerning the individual defendants' stock sales and knowledge of the accounting problems to create a strong inference that the individual defendants had acted with scienter. As a result, the Rule 10b-5 claims were allowed to continue against IPG, but were dismissed against the individual defendants.

The individual defendants were not, however, free to go. Since they controlled IPG and the court had found that a Rule 10b-5 claim was adequately pled against IPG, the Section 20(a) claims for controlling person liability against the individual defendants still remain.

This is a troubling result on two levels. By analyzing the scienter of IPG separately, the court, in essence, ends up holding that IPG acted with fraudulent intent, but its officers and directors did not. How can a company do anything if not through its officers and directors? Moreover, the PSLRA was designed to protect individuals from unsubstantiated securities fraud claims. By applying Section 20(a) in this manner, the court allowed the plaintiffs to bypass the heightened pleading requirements for scienter in the PSLRA. Based on the IPG holding, plaintiffs merely have to establish that the company had a motive for fraud (or, one supposes, that some unnamed person at the company knew of the misstatements or was reckless with respect to them), and can then continue to bring their securities fraud claims against both the company and its officers and directors (in the form of Section 20(a) claims) without having to make any specific scienter allegations concerning the individual defendants. That does not comport with the PSLRAs requirement that scienter be sufficiently alleged as to each defendant.

This post covers a lot of ground. Readers comments, as always, are welcome.

Posted by Lyle Roberts at 3:15 PM | TrackBack

June 16, 2003

The Martha Stewart Watch III

Well, it's not exactly about Martha Stewart, but it's related. Judge Owen of the S.D.N.Y. apparently has denied the motions to dismiss in the two securities class actions against ImClone Systems, Inc. (Nasdaq: IMCLE).

Posted by Lyle Roberts at 11:51 AM | TrackBack

June 12, 2003

Certification Granted In DaimlerChrysler Suit

Of course, there are always exceptions to the rule. The class certification appeal provision in the Class Action Fairness Act of 2003 (see below) might have played a role in the case by Chrysler Corp.'s former shareholders against DaimlerChrysler AG. The investors allege that Daimler-Benz AG misrepresented the acquisition of Chrysler as a "merger of equals" to avoid paying Chrysler shareholders a takeover premium for their shares. Bloomberg reports that District Judge Farnan of the D. of Del. has certified a class, over the defendants' objections, that includes both U.S. shareholders who exchanged their shares in the transaction and U.S. shareholders who purchased or acquired DaimlerChyrsler shares after the merger through November 2000 (when the fraud was allegedly revealed).

Posted by Lyle Roberts at 12:42 AM | TrackBack

June 9, 2003

Amended Complaint In Dynegy Case

The Houston Chronicle reports (in last Friday's edition) that an amended complaint has been filed in the securities class action against Dynegy, Inc. (NYSE: DYN). The amended complaint alleges that Dynegy hid an $850 million loan from Citicorp, known as the "Black Thunder" transaction, in an off-balance-sheet company in 2000 to avoid a downgrade of Dynegy's debt. The Black Thunder loan is one of two transactions cited in the suit.

Quote of note: "The deadline for filing the amended complaint against Dynegy had been extended numerous times to enable the company and plaintiffs time to negotiate a settlement. A spokesman for the University of California [the lead plaintiff in the case] would not confirm whether those talks were still under way but said the school remains open to settlement talks."

Posted by Lyle Roberts at 5:15 PM | TrackBack

Interpublic Decision

The 10b-5 Daily previously noted that there has been a decision in the Interpublic Group case. The opinion (In re Interpublic Securities Litigation, 2003 WL 21250682, (S.D.N.Y. May 29, 2003)) turns out to be a must-read for a number of reasons. More on this later in the week.

Posted by Lyle Roberts at 1:00 PM | TrackBack

June 3, 2003

Interpublic Case to Proceed

The New York Law Journal reports that Judge Cote of the S.D.N.Y. (who is also the judge in the Worldcom case) has denied most of the motion to dismiss in the securities class action against Interpublic Group of Cos. Interpublic is a New York holding company that ranks as the second-largest owner of advertising agencies in the world. The case is the result of a restatement Interpublic announced last August for the five years from 1997 to 2001, which corrected inter-company charges that had been wrongly declared as income for the European offices of one of Interpublic's agencies. (Thanks to the Securities Law Beacon for the link.)

Posted by Lyle Roberts at 1:45 PM | TrackBack

May 28, 2003

Rambus Suit Dismissed

Rambus, Inc. just announced that the securities class action pending against it in the N.D. of Cal. has been dismissed with prejudice -- apparently with the approval of the lead plaintiff.

Posted by Lyle Roberts at 12:56 PM | TrackBack

N.D. Of Ill. On Group Pleading

In Johnson v. Tellabs, Inc., 2003 WL 21183390, (N.D. Ill. May 19, 2003), the court addressed the viability of group pleading following the passage of the PSLRA. Tellabs is one of the numerous securities class actions that arose out of the severe downturn in the telecommunications industry in 2001 and 2002. The court granted defendants' motion to dismiss on multiple grounds. Of particular interest, however, is the court's discussion of group pleading.

The "group pleading" doctrine creates the presumption that senior executives of a company may be held liable for misrepresentations or omissions contained in the public statements made by the company (e.g., press releases, SEC filings, etc.). Courts are divided (including a clear split within the N.D. of Ill.) over whether a plaintiff's ability to plead in this manner has survived the enactment of the PSLRA. The Tellabs court strongly suggested that it has not.

First, the court held that even if the group pleading doctrine continues to be viable in "some form," plaintiffs must allege facts "relating to an individual defendant's duties or legal obligations that create a presumption that the company's statement was somehow caused by or attributable to an individual defendant." Merely alleging an individual defendant's title is not enough. Second, the court concluded that group pleading can never be used to establish scienter, because the PSLRA expressly requires that scienter be plead with particularity as to each defendant.

Holding: Motion to dismiss granted, with leave to replead.

Posted by Lyle Roberts at 12:37 AM | TrackBack

May 27, 2003

Examining Cisco

Over Memorial Day weekend, the Los Angeles Times ran a critical two-part story on Cisco Systems Inc. The first article focused on Cisco's loans to financially-troubled customers. The second article focused on Cisco's acquisitions of companies backed by Sequoia Capital. The author noted that last month Judge Ware of the N.D. of Cal. refused to dismiss the consolidated securities class action against the company, its auditor, and top executives.

Quote of note (first article): "Ware wrote that the allegations contained in the 198-page complaint, including a claim that Cisco artificially inflated its revenue through its lending operation, were 'sufficient to support a strong inference' of wrongdoing. His ruling clears the way for investor attorneys, who are seeking billions of dollars in damages, to collect internal documents and conduct sworn interviews with Chief Executive John Chambers and other executives."

Posted by Lyle Roberts at 12:01 PM | TrackBack

May 23, 2003

S.D.N.Y. On Statute Of Limitations

In Bond Opportunity Fund v. Unilab Corp., 2003 WL 21058251 (S.D.N.Y. May 9, 2003), the court addressed the issue of inquiry notice and the statute of limitations. The statute of limitations for Section 14(a) claims (misleading statements in proxies) is one year from discovery or three years from the occurrence that gives rise to the action, whichever is less (Sarbanes-Oxley arguably has not changed this standard because Section 14(a) does not sound in fraud). The Second Circuit has stated that discovery of the claim occurs when the plaintiff obtains actual knowledge of the facts giving rise to the action or notice of the facts, which in the exercise of reasonable diligence, would have led to actual knowledge. In other words, inquiry notice is sufficient to trigger the statue of limitations.

If the court determines that inquiry notice existed and the plaintiffs concede they engaged in no investigation, dismissing the claim based on the statute of limitations is straightforward. More difficult is the case where the plaintiffs claim that they did engage in an investigation after being put on inquiry notice, but were unable to obtain sufficient facts to bring the claim until more than a year later.

In Unilab, plaintiffs claimed that BT Alex.Brown aided and abetted in the alleged Section 14(a) violation committed by the company. Plaintiffs argued that because they began to make inquiry immediately upon issuance of the proxy, in late October/early November 1999, knowledge of BT Alex.Browns role should not be imputed until they actually learned all the facts in November 2000 [less than a year before BT Alex Brown was added to the case in September 2001]. The court disagreed. Noting that BT Alex.Browns role as a key player in the transaction was disclosed in the proxy statement, the court found it incomprehensible how Plaintiffs can claim that they were not sufficiently aware of BT Alex.Browns involvement in this transaction to name it as a defendant in this action prior to its deposition in November 2000.

Holding: Securities claims against BT Alex.Brown dismissed as time-barred. The opinion also addressed other claims not discussed in this summary.

Quote of note: A minimal or lackadaisical investigation will not serve to extend the statute of limitations until the plaintiff actually learns facts that could have been discovered much earlier had a diligent investigation taken place.

Posted by Lyle Roberts at 11:19 PM | TrackBack

May 20, 2003

The Martha Stewart Watch

Let no one say that The 10b-5 Daily avoids hot topics in favor of long dissertations on statutory construction (see post below). The Southern District of New York has denied the motion to dismiss in the securities class action against Martha Stewart Living Omnimedia Inc.

Posted by Lyle Roberts at 1:32 PM | TrackBack

SLUSA and the '33 Act . . . Not So Perfect Together

In Alkow v. TXU Corp., 2003 WL 21056750 (N.D. Tex. May 8, 2003), the court addressed a conflict in the provisions of the '33 Act. Stay with me, because this gets a little tricky. Private actions under the '33 Act may be brought in federal or state court. The Securities Litigation Uniform Standards Act of 1998 ("SLUSA"), however, was designed to prohibit the bringing of securities class actions in state court and provides for their removal to federal court. In doing so, however, SLUSA specifically limits itself to class actions "based upon the statutory or common law of any State." The drafters were focused on plaintiffs who wanted to avoid the heightened pleading standards of the PSLRA by bringing the equivalent of Rule 10b-5 claims (for which federal courts have exclusive jurisdiction) in state court under state law. All of which leaves the question addressed in Alkow: can plaintiffs bring a class action pursuant to the '33 Act in state court?

The N.D. of Texas doesn't think so. The court noted that the jurisdiction section of the '33 Act "prohibits removal of cases 'arising under' the 1933 Act, '[e]xcept as provided in section 77p(c).'" Section 77p is the SLUSA section. As a result, the court held, it is clear that Congress intended to prevent the filing of class actions pursuant to the '33 Act in state court, despite the specific reference to state law in SLUSA. Moreover, any other result would create a loophole in SLUSA. Still there? Hello?

Holding: Motions to remand denied.

Quote of note: "In short, Congress intended SLUSA to prevent the exact maneuver used by the Alkows here. If sec. 77p(c) does not permit removal of claims arising under the 1933 Act, then SLUSA did not counteract the shift in cases to state courts that Congress determined had frustrated the intent of PSLRA."

Posted by Lyle Roberts at 1:05 PM | TrackBack

May 9, 2003

S.D.N.Y. On Materiality

Only one recent case to report on, but it is fairly interesting:

In re Allied Capital Corp. Sec. Litig., 2003 WL 19641843 (S.D.N.Y. April 25, 2003) involved allegations that Allied Capital's "flawed valuation policy" caused it to overvalue its investments in nine companies and materially misstate those values in its public filings. An outside hedge manager publicly questioned Allied's valuation practices, resulting in a stock price decline from $25.99 to $23.20. Within a week, however, the stock had regained most of that loss.

The court found that plaintiffs had failed to adequately plead that defendants made fraudulent or misleading statements because: (1) "plaintiffs have not sufficiently pled that Allied's valuation policies resulted in its overvaluing of some investments;" and (2) "plaintiffs do not allege that Allied followed different valuation policies than those that it described in its public filings, or that Allied concealed any relevant information about the companies in which it invested."

More interestingly, the court determined that the alleged misstatements were immaterial. (According to 2d Cir. precedent, for a court to determine on a motion to dismiss that the alleged misstatement or omission is immaterial it must be "so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of [its] importance.") The court gave three reasons for its ruling.

First, the investments in the nine companies represented just over 10% of Allied's portfolio. Given that Allied's public disclosures clearly stated that the valuation process was inexact, "no reasonable investor could consider the fact that a small proportion of Allied's holdings might have values that were debatable (which is all the Complaint alleges) to be material."

Second, the stock price declined less than 10%, and then quickly rebounded, negating any inference of materiality.

Finally, "any number of factors unrelated to the alleged overstatements could have contributed to the decline in price on May 16," including the statements from the hedge fund manager, which might be untrue.

Holding: Motion to dismiss granted.

Quote of note: "In addition, the stock price's recovery, in the face of a general decline in the market, negates any inference of materiality, because it indicates that investors quickly determined that the 'new' information was not material to their investment decisions." Does that mean that a quick recovery in the stock price will always lead to the conclusion that the alleged misstatements are immaterial?

Posted by Lyle Roberts at 3:45 PM | TrackBack