Category Archives: All The News That’s Fit To Blog

The Wall Street Journal has an editorial (subscrip. req’d) in today’s edition discussing the Bloomberg/Schumer report. The authors express surprise at Senator Schumer’s apparent support for tort reform, noting that he has not always voted that way in Congress. They also are skeptical whether, as suggested by Senator Schumer in his press conference, the problems associated with securities class actions can be resolved via SEC rulemaking.

Quote of note: “The true costs of [Sarbox’s liability provisions] have yet to be tested for the simple reason that it will take a recession or a stock-market correction to trigger the next round of attempts to turn corporate miscalculations into income redistribution opportunities. So far, this ticking bomb inside Sarbox has received little notice compared to the very real costs of compliance with Section 404 on internal controls. But we can expect to hear more about it after the first wave of Sarbox lawsuits starts hitting the papers. Until that happens, the current consensus that Sarbox is tolerable and the SEC merely has to enforce it more sensibly will remain the conventional wisdom.”

Bruce Carton, the former author of Securities Litigation Watch, has joined Garden City Group and started a new law blog. Readers of The 10b-5 Daily are likely to find Best in Class of interest. Carton also will be hosting a webcast next week on “Emerging Trends in Securities Class Actions.”

Despite the recent downturn in securities class action filings, securities litigation reform is a hot topic. On the heels of the Committee on Capital Markets Regulation’s interim report, Mayor Bloomberg and Senator Schumer have issued “Sustaining New York’s and the US’ Global Financial Services Leadership.” The two reports cover much of the same ground, but there are differences in their securities litigation reform recommendations. After noting that “if economic conditions were to decline in the future, than a strong resurgence in [securities class actions] would likely follow,” the Bloomberg/Schumer report recommends (pp. 102-104):

(1) Limit the liability of foreign companies with U.S. listings to damages that are proportional to their degree of exposure to the U.S. markets. (SEC)

(2) Impose a cap on auditors’ liability. (SEC)

(3) Encourage arbitration as an alternative dispute resolution system for securities grievances. (SEC)

(4) Allow parties in federal securities actions to appeal interlocutory judgments (e.g., the denial of a motion to dismiss) immediately to the circuit courts. (Congress)

Coverage of the report can be found in the Financial Times (subscrip. req’d), Wall Street Journal (subscrip. req’d), and the New York Times. D&O Diary has a comprehensive summary.

In the Jan. 18 edition of the New York Law Journal, Professor John Coffee presents a wish list (subscrip. req’d) of securities litigation reforms. The proposed reforms are:

(1) Congress should impose a cap on auditor liability. To make this reform more politically acceptable, Congress could overturn Central Bank and restore private aiding and abetting liability for securities fraud (at least for accounting firms).

(2) Governor Spitzer should ban, by executive order, “pay to play” practices where lawyers “compete to be selected as class counsel for the public pension funds serving as ‘lead plaintiff’ in securities class actions by making political contributions to state and municipal comptrollers, who in some jurisdictions, including New York, have exclusive control over the pension fund.”

(3) Unlike almost every other state, there is no private right of action for securities fraud under New York law. Attorney General Cuomo should draft new legislation correcting this deficiency.

Quote of note: “Such a ceiling would not protect an audit firm from repetitive litigation resulting in repetitive large settlements – say, ten suits, each for $40 million on average. But a firm forced to settle those many actions at those levels probably does not deserve to survive. It is the prospect of a one-time billion-dollar loss that merits the adoption of a ceiling.”

A few items from around the web:

(1) The Financial Times has an article on the U.S. Supreme Court’s new-found interest in business cases. Although the authors note that many of these cases result in narrow decisions, they cite the Dura decision on loss causation as having had a “big impact.”

(2) The Wall Street Journal Law Blog has a follow-up post on the lead plaintiff dispute in the Merck securities litigation. The lead plaintiffs have asked the court to permit Bernstein Litowitz to act as co-lead counsel.

(3) An op-ed in the Financial Times from earlier this month discusses the negative effects abroad of U.S. shareholder litigation. The author, who works for the British Association of Insurers, advocates the curbing of lawsuits and an increase in shareholder rights. Thanks to Werner Kranenburg for the link.

Just before the holidays, in its Dec. 18 issue, the New York Law Journal ran its annual special section on securities litigation and regulation. It includes articles on: (1) a recent scheme liability decision in the Enron case; and (2) the use of agency and respondeat superior theories by plaintiffs to reach non-speaking defendants.

Earlier this month, the New York Sun ran an interesting feature article on the Time Warner securities litigation. Although the securities class action settled for $2.5 billion last year, some institutional investors who decided to opt-out of the case appear to be doing even better than the class participants. The State of Alaska, for example, recently settled its related state court action against Time Warner for 83% of its estimated damages. Thanks to Point of Law for the link.

Quote of note: “While Alaska may be the most successful opt-out plaintiff thus far, others have also improved their lot by going it alone. A Dutch retirement fund, Stichting Pensioenfonds ABP, won a $20 million settlement from Time Warner earlier this year on what ABP said was $150 million in investment losses. ABP’s chief counsel told a Dutch newspaper, Het Financieele Dagblad, that the fund would have gotten only $1 million to $3 million if it had stayed in the class.”

Addition: Lies, Damn Lies, & Forward-Looking Statements has a post on this article that offers more details and links on the opt-out cases.

The Committee on Capital Markets Regulation has issued its interim report. While there is no call for an abolition of private securities litigation (as had been suggested in the media), the report does contain a number of findings and recommendations regarding securities class actions that are likely to be controversial.

The basic premise of the “Civil Enforcement” section (pp. 74-84) is that the “public value of the securities class action litigation is questionable.” The Committee cites three reasons for this conclusion. First, “virtually all of the costs” of securities class actions fall on the corporation and its insurers, which means they are ultimately borne by the shareholders. Second, securities class actions do a poor job of compensating investors (average settlement of “between two percent and three percent of the investors’ economic losses”) and there are high transactions costs (attorney fees, business disruption, etc.). Finally, any recovery is “largely paid by diversified shareholders to diversified shareholders and thus represents a pocket-shifting wealth transfer that compensates no one in any meaningful sense.”

In keeping with this assessment, the Committee recommends that the SEC: (1) resolve certain judicial conflicts over Rule 10b-5 liability; (2) limit the amount of damages recoverable in private litigation when it has already provided investor compensation; and (3) encourage courts (perhaps with the assistance of new legislation) to stop pay-to-play practices in which plaintiffs’ firms make political contributions in exchange for lead counsel positions. In particular:

Materiality – The SEC should clarify whether a misstatement can be material if its disclosure does not have an “effect on the market,” thereby resolving a circuit split between the 9th Circuit (yes) and the 3rd Circuit (no).

Scienter – The SEC should clarify whether the fraudulent intent (i.e., scienter) element of a securities fraud claim can be demonstrated by “recklessness.” At least, that is what the Committee appears to be suggesting. The discussion of the current state of the law in this section is simply wrong, with the report stating that there is a split between the Second Circuit’s more strenuous “strong inference of fraudulent intent” standard and the Ninth Circuit’s more lenient “deliberate recklessness” standard. The Committee confuses the Second Circuit’s description of the relevant pleading standard for fraudulent intent (which is mandated by the PSLRA and applicable in every circuit) with the court’s substantive standard for fraudulent intent. In fact, every federal circuit court (including the Second Circuit) has found that recklessness is sufficient to establish fraudulent intent. It is the Ninth Circuit’s “deliberate recklessness” standard, i.e., recklessness so severe that it “strongly suggests actual intent,” that is generally believed to be the most strenuous version of this standard in the country. (For more on this issue, the author of The 10b-5 Daily has co-written an article that discusses the differences between the pleading and substantive standards for scienter applied by the various circuits.)

Efficient Market – The SEC should clarify what constitutes an efficient market for purposes of applying the fraud-on-the market theory. The Committee discusses the recent PolyMedica decision in the First Circuit.

Overlap between SEC and Private Lawsuits – The SEC should “prohibit double recoveries against defendants by requiring that private damages awards be offset by any Fair Funds collections [by the SEC] applied for victim compensation.” Interestingly, the Committee suggests that the SEC has the authority to do this pursuant to Section 36 of the Securities Exchange Act, which states that the SEC can “unconditionally exempt any person, security, or transaction from any provision [of the Act].” Although the recommended reform seems like a stretch of the SEC’s authority pursuant to Section 36, the Committee does not offer any further discussion of this point. (The author of The 10b-5 Daily provided his take on the overlap issue in a National Law Journal op-ed published last year.)

Prohibit Pay-To-Play – Either through legislation or SEC advocacy in the courts, lawyers that make political contributions to individuals in charge of a state of municipal pension fund “should not be permitted to represent the fund as a lead plaintiff in a securities class action.” The Committee notes that the Municipal Securities Rulemaking Board has adopted a rule that prevents pay-to-play in municipal underwriting that could serve as a model for successful reform in this area.

Other recommendations in the interim report would impact securities class actions. They include recommendations that Congress should explore protecting auditing firms from catastrophic loss (p. 88), that the SEC should (a) clarify that an outside director’s good-faith reliance on an audited financial statement or auditor report is conclusive evidence of good faith, and (b) reverse its position that indemnification of outside directors for Section 11 damages is against public policy (p. 91), and that public companies should be permitted to contract with their investors to provide for alternative dispute resolutions for securities litigations (p. 109).

There has been plenty of news related to the Paulson Committee and its potential securities litigation recommendations over the past two weeks.

(1) John Thain, the head of the New York Stock Exchange, called class action suits “a tax on all companies and ultimately consumers” and expressed support for the Paulson Committee’s potential tort reform recommendations.

(2) Professor John Coffee used his New York Law Journal column (Nov. 16 – subscrip. req’d) to clarify that he did not recommend to the Paulson Committee (as had been reported) that the SEC dis-imply a private right of action under Rule 10b-5. Instead, his more modest proposal is that the SEC “adopt an exemptive rule under § 36 of the Securities Exchange Act of 1934 that would shield a non-trading public corporation from liability for monetary damages under Rule 10b-5.” In other words, plaintiffs would have to look to corporate officers and agents (e.g., auditors and underwriters) for their securities fraud recovery.

(3) Finally, Treasury Secretary Paulson gave a speech on Monday arguing that excessive regulation and burdensome litigation were prompting companies to choose to list their stock on foreign exchanges rather that U.S. exchanges. According to the New York Times report, Paulson “did not speak about some proposals expected to be made by the two business groups to limit shareholder lawsuits,” but did suggest that he was sympathetic to limiting auditor liability.