The 10b-5 Daily

Balancing Act

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

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

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

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

Holding: Dismissal affirmed.

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

Public Red Flags

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

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

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

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

Holding: Dismissal affirmed.

Mr. Roberts Heads Across Town

On a personal note, Lyle Roberts (the author of The 10b-5 Daily) has joined the Washington, DC office of Cooley LLP. The firm's press release can be found here. Posting has been correspondingly light, but will pick up shortly.

Medtronic Settles

Medtronic, Inc. (NYSE: MDT), a Minneapolis-based medical technology company, has announced the preliminary settlement of the securities class action pending against the company in the D. of Minnesota. The case, originally filed in 2008, stems from allegations that the company and certain of its officers made materially false statements regarding the extent to which revenue from one of its products, the Infuse bone graft, depended on applications not approved by the FDA (i.e., "off-label" uses).

The settlement is for $85 million. Reuters has an article. The 10b-5 Daily previously has posted about the court's decision to certify the proposed class over the defendants' objection 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."

A CLE Program You Will Definitely Want To Attend

With that bold claim, do you have some availability on Thursday, April 26 to participate in a continuing legal education (CLE) program in New York or view a live webcast? It is not too late to sign up for PLI's Handling a Securities Case: From Investigation to Trial and Everything in Between. All of the details can be found here.

Lyle Roberts of Dewey & LeBoeuf (the author of The 10b-5 Daily) is co-chairing the program. The outstanding faculty will cover a wide range of topics, all while following a hypothetical case from the initial investigation through trial. There will even be a panel on ethical issues, for those in need of ethics credits.

Hope to see you there.

The SEC Speaks (About Private Litigation and Transnational Securities Frauds)

As part of the Dodd-Frank Act, the Securities and Exchange Commission (SEC) was asked to solicit public comment and evaluate whether private litigants should be permitted to bring actions in the United States based on transnational securities frauds. In practical terms, the SEC was charged with examining whether the Supreme Court's Morrison decision, which limits Section 10(b) claims to domestic securities transactions, should be legislatively overturned or modified.

The SEC's study has been released and it contains a number of interesting items, including an analysis of the post-Morrison case law, a detailed review of the public comments, and a summary of the studies that have examined the capital markets impact of the Morrison decision. The SEC's overall conclusion, perhaps not surprisingly, is that the position it took in Morrison was correct as a matter of public policy (even if the Court rejected it on legal grounds). In Morrison, the SEC argued that the court should retain the preexisting conduct and effects tests for extending Section 10(b) private actions to transnational securities frauds, but limit the conduct test to situations where the plaintiff can demonstrate "that the plaintiff’s injury resulted directly from conduct within the United States." The SEC's approach arguably would have the benefit of "serv[ing] as a filter to exclude those claims that have a closer connection to another jurisdiction and, thus, are more appropriately pursued elsewhere." That said, the SEC also concedes that a more limited "conduct test" would still have the disadvantages of permitting "foreign investors [to] receive remedies that their governments have determined not to provide" and possibly "requiring a fact-intensive inquiry involving burdensome discovery. . . to determine if the alleged U.S. conduct constituted a direct cause of the overseas injury."

In response to these concerns, the SEC proposes a tweak and suggests alternatives for Congress to consider. The tweak is to make the conduct and effects tests available only to U.S. investors. While that still might require costly discovery to determine the scope and impact of the U.S. conduct, it alleviates some of the international comity problems created by allowing foreign investors, who engaged in foreign securities transactions, to bring suit in the U.S.

Alternatively, the SEC proposes that Congress "supplement and clarify" the Supreme Court's domestic transaction test in one or more of the following ways:

(1) Permit investors to bring Section 10(b) private actions based on transactions in any security that is of the same class of securities as those registered in the U.S., irrespective as to where the transaction took place. The idea is that companies who have registered shares in the U.S. have chosen to expose themselves to Section 10(b) liability, although the proposal also would have the obvious effect "of a return to U.S. courts of so-called “foreign-cubed” class actions – i.e., private class actions brought by foreign investors suing foreign issuers involving transactions on foreign exchanges."

(2) Create a Section 10(b) right of private action that can be brought "against: (i) securities intermediaries located within the United States when they defraud a client in connection with any securities transaction (i.e., foreign or domestic); and (ii) foreign securities intermediaries when they are reaching into the United States to provide securities investment services for a U.S. client and commit fraud against that client in connection with any securities transaction." The proposal is designed to close a "void" created by the domestic transaction test, wherein investment advisors can defraud their clients in connection with foreign securities transactions without fear of Section 10(b) liability.

(3) Create a "fraud-in-the-inducement" exception to the domestic transaction test, wherein investors can bring a Section 10(b) private action if they can demonstrate they were in the U.S. at the time they were induced to purchase or sell securities in reliance on a false or misleading statement, even if the transaction took place outside of the U.S. This proposal is another version of limiting the conduct test to U.S. investors, although the SEC suggests that it is narrower because the investors would need to demonstrate actual reliance, as opposed to basing their claims on a presumption of reliance created by the "fraud-on-the-market" theory.

(4) The Second Circuit recently clarified that a domestic securities transaction is one where "irrevocable liability was incurred or title was transferred within the United States." The SEC criticizes that approach, arguing that it may "serve as a roadmap for overseas fraudsters to structure transactions to avoid Section 10(b) private liability" by ensuring that key actions are taken outside of the country. Instead, the SEC suggests, Congress could "clarify that, in the case of off-exchange transactions, a domestic securities transaction occurs if a party to the transaction is in the United States either at the time that party made the offer to sell or purchase, or accepted the offer to sell or purchase."

But will Congress have any interest in pursuing a legislative reversal or modification of the domestic transaction test for Section 10(b) private action liability? Stay tuned.

Appellate Roundup

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

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

Cornerstone Releases Report on Settlements

Cornerstone Research has released its annual report on securities class action settlements. The notable findings include:

(1) There were 65 settlements in 2011, involving $1.4 billion in total settlement funds. These numbers represent a significant decline as compared to 2010 (86 settlements; $3.2 billion in funds) and are the lowest number of approved settlements and total settlement dollars in more than 10 years.

(2) The average reported settlement amount decreased from $36.3 million in 2010 to $21 million in 2011, substantially below the average of $55.2 million for all post-PSLRA settlements. Among the factors identified by Cornerstone as possibly responsible for the decrease are: (a) the overall drop in filings of traditional securities class actions that began in 2006; (b) a decline in very large settlements (only three over $100 million); (c) a lower average estimated damages in the settled cases; and (d) fewer cases involving accounting allegations or accompanied by SEC actions/derivative actions.

(3) Robbins Geller was the most active firm in 2011, having been involved in 35% of the settled cases.

Quote of Note: "[C]onsidering that the $725 million partial settlement approved in February 2012 in the American International Group, Inc., Securities Litigation matter exceeds 50 percent of the total value of 2011 settlements and that other tentative mega-settlements have settlement approval dates in 2012, it appears likely that the total dollar amount for settlements will return to more typical levels in 2012."

CIT Settles

CIT Group, Inc. (NYSE: CIT), a New York-based bank holding company that provides commercial financing and leasing products and other services to small and middle market businesses, has agreed to settle the securities class action pending against the company in the S.D. of New York. The case, originally filed in 2008, stems from allegations that CIT and certain of its directors and officers made materially false statements and omissions regarding CIT’s subprime home loans and certain non-guaranteed, private student loans. The settlement is for $75 million. Reuters has an article.

Clear Incentives

Two items on the relationship between investors and their counsel.

(1) The battle over the attorneys' fees award in the Tyco securities litigation continues. At the heart of the dispute is whether lead counsel was bound by its contractual fee arrangement with the lead plaintiff, which provided for a much lower fee award, or could seek whatever level of fees the court would approve. Forbes has a column on the latest filings in the case.

(2) Judge Jed Rakoff is no stranger to securities litigation and is not known for holding back on his opinions. In City of Pontiac General Employees' Retirement System v. Lockheed Martin Corp., 2012 WL 546475 (S.D.N.Y. Feb. 21, 2012), the judge took on the common practice of plaintiffs' firms entering into "monitoring" agreements with institutional investors. Under these agreements, the plaintiffs' firm (without charge) monitors the investments made by the institution to see if any securities class actions should be brought. If the plaintiffs' firm recommends that a case be brought and the institution agrees, the plaintiffs' firm will be the institution's presumptive choice as counsel. Judge Rakoff noted that the practice "creates a clear incentive for the monitoring firm to discover 'fraud' in the investments it monitors," which would appear to undermine the PSLRA's goal of discouraging lawyer-driven litigation. Nevertheless, the court approved the proposed lead plaintiff and lead counsel, finding that it appeared that the institution had "the ability to properly exercise [its] role as lead plaintiff" and had affirmed at a hearing on the matter that it would play an active part in the litigation going forward.