Fervent Beliefs

Next term, the U.S. Supreme Court will hear argument in the Omnicare case.  The issue in Omnicare is the pleading standard for a claim under Section 11 of the Securities Act alleging a false or misleading opinion.  While the Second, Third, and Ninth Circuits have held that the plaintiff must allege the statement was both objectively and subjectively false – requiring allegations that the speaker’s actual opinion was different from the one expressed – in Omnicare the Sixth Circuit held that if a defendant “discloses information that includes a material misstatement [even if it is an opinion], that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity.”

While Omnicare is pending, the Tenth Circuit has provided its own views on the subject.  In MHC Mutual Conversion Fund, L.P. v. Sandler O’Neill & Partners, L.P., 2014 WL 3765717 (10th Cir. Aug. 1, 2014), the court identified at least three possible conclusions that could be drawn from Section 11 and relevant legal precedent.  First, the court noted that “many common law authorities took a dim view of opinion liability” and one could find that Section 11 liability simply does not extend to opinions (as opposed to misstatements of fact).  Second, “an opinion can qualify as a factual claim by the speaker regarding his current state of mind.”  In that case, the opinion might be actionable if the plaintiff shows “both that the defendant expressed an opinion that wasn’t his real opinion (sometimes called ‘subjective disbelief’) and that the opinion didn’t prove out in the end (sometimes called ‘objective falsity’).”  Finally, there is support in the law for the view that “at least some subset of opinions about future events contain within them an implicit factual warranty that they rest on an objectively reasonable basis – and providing an opinion without an objectively reasonable foundation, at least without disclosing that deficiency, can give rise to a claim for negligent misrepresentation.”

Although the Tenth Circuit – in line with the majority view – appeared inclined to require allegations of both objective and subjective falsity, it found that it did not have to resolve the issue.  Even under the “objectively reasonable basis test,” the plaintiffs had failed to undermine the conclusion that the company had “a reasonable (if not universally shared) basis for the opinion it expressed.”  Moreover, the company had clearly disclosed that its “opinion about the prospects for its securities wasn’t unqualified – that an essential premise of the opinion rested on a judgment about near-term economic trends, a judgement that could well fail to bear out.”

Holding: Dismissal affirmed.

Quote of note:  “For centuries legions accepted Newtonian physics without qualification.  Last year some of us fervently believed the Broncos would win the Super Bowl.  In 2008, no doubt there were those who genuinely thought the market for mortgage backed securities would rebound.  Events have disproved each of these opinions, but that hardly means the opinions were anything other than honestly offered – true opinions at the time made.”

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Freshening Up

Regular visitors to The 10b-5 Daily will notice that the look and format of the blog has undergone a change.  A few items of note:

(1) To receive e-mail notifications of new posts (even if you have previously “subscribed” to The 10b-5 Daily), you will need to submit your e-mail address under “Follow by Email.”

(2) Links to various relevant materials can be found by clicking on About The Blog, The Law, The Facts, and Recent Supreme Court Cases.

(3) The search functions for the blog remain the same (word searches, category searches, and monthly archives).

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Ostrich Tactics

The long-running saga of the Boeing securities litigation is apparently coming to a close. In 2011, the district court granted the company’s motion to dismiss (on a motion for reconsideration) after it was determined that the key confidential witness denied being the source of the allegations attributed to him in the complaint, denied having worked for Boeing, and claimed to have never met plaintiffs’ counsel until his deposition.

The plaintiffs appealed this decision to the U.S. Court of Appeals for the Seventh Circuit. Not only did the Seventh Circuit affirm the dismissal, but it also strongly suggested that sanctions were appropriate in the case, noting that the “failure to inquire further [about the supposed evidence from the confidential witness] puts one in mind of ostrich tactics – of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing.” The appellate court remanded the case to the district court to determine whether sanctions should be imposed.

In City of Livonia Employees’ Retirement System v. The Boeing Company, 2014 WL 4199136 (N.D. Ill. August 21, 2014), the district court examined the conduct at issue. First, the court found that the plaintiffs’ counsel should have interviewed the confidential witness before the filing of the initial complaint and that not doing so constituted “a failure to conduct a reasonable pre-filing investigation as required by the PSLRA.” Second, once the confidential witness had been interviewed by an investigator, the court concluded that it should have been clear to the plaintiffs’ counsel that it “did not have reasonable cause to trust the accuracy of the information obtained by the investigator because the investigator herself noted in her report that some of the information [the confidential witness] provided was unreliable.” Finally, even after the confidential witness told the investigator that “he no longer wished to cooperate with Plaintiffs,” the plaintiffs’ counsel filed a second amended complaint attributing key allegations to the confidential witness and “repeatedly made assurances to the court as to the truth of the allegations.” The court also noted that this was not the first time that the plaintiffs’ counsel had engaged in this type of misconduct. Under these circumstances, the court held that the imposition of sanctions was warranted.

Holding: Imposing Rule 11 sanctions and encouraging the parties to mediate and settle the issue of what constituted “reasonable attorneys’ fees and other expenses incurred in defending the lawsuit.”

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No Bright Line

In its Morrison decision, the U.S. Supreme Court addressed the extraterritorial application of Section 10(b) and held that the statute only applies to “transactions in securities listed on our domestic exchanges, and domestic transactions in other securities.” While this formulation clearly excludes foreign transactions, does it conversely mean that any “domestic transaction” in a foreign security can be subject to potential Section 10(b) liability?

The Second Circuit had the opportunity to address this question in a case involving an unusual fact pattern. In Parkcentral Global Hub Ltd. v. Porsche Automobile Holdings SE, 2014 WL 3973877 (2d Cir. August 15, 2014) , the plaintiffs had entered into “securities based-swap agreements pegged to the price of VW [Volkswagen] shares, which trade on European stock exchanges, to bet that VW stock would decline in value.” The plaintiffs alleged that VW “made various fraudulent statements and took various manipulative actions to deny and conceal Porsche’s intention to take over VW.” When it became public that Porsche would take over VW, “the price of VW shares rose dramatically, causing the plaintiffs to suffer large losses.”

While the Second Circuit assumed, for purposes of its decision, that the swap agreements were “executed and performed in the United States,” it found that this was not sufficient under Morrison to justify the application of Section 10(b). First, the Supreme Court “never said that an application of § 10(b) will be deemed domestic whenever such a transaction is present.” Second, applying the statute “to wholly foreign activity clearly subject to regulation by foreign authorities solely because a plaintiff in the United States made a domestic transaction” would “inevitably place § 10(b) in conflict with the regulatory laws of other nations.” As to the VW-related swap agreements, the court held “that the relevant actions in this case are so predominately German as to compel the conclusion that the complaints fail to invoke § 10(b) in a manner consistent with the presumption against extraterritoriality.”

Holding: Dismissal affirmed and case remanded for proceedings consistent with decision.

Quote of note: “We have neither the expertise nor the evidence to allow us to lay down, in the context of the single case before us, a rule that will properly apply the principles of Morrison to every future § 10(b) action involving the regulation of securities-based swap agreements in particular or of more conventional securities generally. Neither do we see anything in Morrison that requires us to adopt a ‘bright-line’ test of extraterritoriality when deciding every § 10(b) case. . . . It is enough to say that we think our decision in this case is compelled by the text of the Exchange Act and the principles underlying the Supreme Court’s decision in Morrison, as applied to our facts.”

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Cornerstone Releases Midyear Report

Cornerstone Research (in conjunction with the Stanford Securities Class Action Clearinghouse) has released its 2014 midyear report on federal securities class action filings.

The findings for the first half of 2014 include:

(1) There were 78 filings, which closely matches the pace of the first half of 2013. Approximately one in sixty companies listed on a major exchange were sued.

(2) Healthcare, biotechnology, and pharmaceutical companies were the most frequent targets for securities class actions, accounting for 21% of the filings.

(3) The number of filings in the Sixth, Eighth, and Tenth Circuits was up sharply, already equaling or eclipsing the full year totals for 2013.

Quote of note (Professor Grundfest – Stanford): “The most intriguing new trend in the market concerns high-frequency trading and allegations related to Michael Lewis’s Flash Boys. There lawsuits are very much in the early stages, and raise issues with a degree of economic complexity that far surpass the challenges encountered in the typical class action securities fraud case as we know it.”

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Too Tangential

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

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

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

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

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

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Doubling Down

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

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

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

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

Holding: Reversed and remanded for further proceedings.

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