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

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.

To what extent can a plaintiff protect the identity of his confidential witnesses once discovery in the case has commenced? Courts have tended to be skeptical of claims that the identity of these witnesses are attorney work product or should be kept secret to avoid possible employer retaliation.

In Plumbers and Pipefitters Local Union No. 630 Pension-Annuity Trust Fund v. Arbitron, 2011 WL 5519840 (S.D.N.Y. Nov. 14, 2011), the court addressed these issues in a case where the complaint relied heavily on alleged statements from 11 former Arbitron employees. In discovery, the plaintiffs identified 83 people who were likely to possess discoverable information, but refused to specifically identify the 11 confidential witnesses from among that list. The court concluded that the names of the confidential witnesses were entitled to little, if any, work product protection, noting that “[i]t is difficult to see how syncing up the 11 [confidential witnesses] with these already disclosed names would reveal Plaintiff’s counsel’s mental impressions, opinions, or trial strategy.” Moreover, the plaintiffs had “utilized the [confidential witnesses] offensively” and failing to identify them could require the defendants to take dozens of unnecessary depositions. As for possible retaliation, the court declined to accept any generic assertions that the confidential witnesses faced a risk of retaliation, but did give the plaintiffs’ counsel a week to submit an affidavit setting forth any particularized facts it had on that subject.

Holding: Motion to compel disclosure of confidential witness names granted (subject to review of the requested affidavit).

Quote of note: “On the facts before it, the Court, balancing the relevant considerations, does not believe the work product doctrine compels Arbitron (or, derivatively, its shareholders) to bear these costs. The discovery rules ‘should be construed and administered to secure the just, speedy, and inexpensive determination of every action and proceeding.’ Fed. R. Civ. P. 1. These goals are disserved by forcing a party, in the name of an opponent’s evanescent work product interest, to play a high-cost game of ‘Where’s Waldo?’.”

A few items from around the web.

(1) The first dismissal in the current wave of China-related securities class actions has occured, but it is difficult to read too much into the decision. In In Re China North East Petroleum Holdings Ltd. Sec. Litig., 2011 WL 4801515 (S.D.N.Y. Oct. 6, 2011), the court concluded that the lead plaintiff had not suffered any economic loss. Within a couple of months after the “final allegedly corrective disclosure” was made, the company’s stock price rose above the lead plaintiff’s average purchase price. The court held that a “plaintiff who foregoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure.” The New York Law Journal has an article (subscrip. req’d) on the decision.

(2) The National Law Journal has an interesting interview (free regist. req’d) with the lead defense counsel in a recent civil securities fraud trial. The case was brought by investors against the former CEO of Homestore.com, who had previously plead guilty to related criminal charges. Although the jury found that the former CEO was liable for certain misstatements that caused $46 million in losses, he was not required to pay any damages because other defendants had already paid more than that amount to settle the claims against them.

(3) The D&O Diary has an informative roundup of the U.S. securities class action filing activity through the third quarter of 2011. At the present pace, there will be 205 filings this year, which is just slightly above the post-PSLRA average.

Section 20(b) of the Exchange Act makes it unlawful for a person to effect a securities fraud through another person. Sometimes referred to as the “ventriloquist dummy” statute, it has rarely been invoked in securities cases. In the Supreme Court’s recent Janus decision, however, the Court limited Section 10(b) securities fraud liability to persons who had “ultmate authority” over the alleged false statement. Not surprisingly, Janus has revived interest in Section 20(b) as a potential vehicle for claims against secondary actors.

The New York Law Journal has an interesting column (Sept. 29 – subscrip. req’d) on the potential application of Section 20(b). As a threshold matter, the authors note that “[t]here is so little authority on Section 20(b) that is is not even definitive that it affords a private right of action.” Even assuming that a private right of action exists, plaintiffs will have to demonstrate both the existence of any underlying violation and that “the controlling person ‘knowingly used’ the controlled entity to violate the securities laws.”

The New York Law Journal has two securities litigation columns this week.

(1) In Lower Courts Divided on Standard for Pleading Loss Causation Post-Dura (3/31/11 – subscrip. req’d), the authors discuss the split over whether loss causation is merely subject to notice pleading (FRCP 8(a)(2)) or must be plead with particularity (FRCP 9(b)). The Supreme Court, in its Dura decision, left the issue open and no subsequent judicial consensus has emerged.

(2) In Most ARS Suits Tripped Up By Difficult Pleading Hurdles (3/31/11 – subscrip. req’d), the author examines what has happened to the flurry of securities class actions that were filed in the wake of the 2008 disruption in the market for auction rate securities. Most of the cases have been dismissed for failing to adequately plead various elements of a securities fraud claim, including scienter, loss causation or reliance.

Section 929Y of the Dodd-Frank Act directs the SEC to solicit public comments and thereafter conduct a study to determine the extent to which private rights of action under the antifraud provisions of the federal securities laws should be extended to cover transnational securities fraud. In other words, to what extent is the Supreme Court’s National Australia Bank decision a problem and what, if anything, should Congress do about it?

The SEC solicited comments back in October and the results are now available on the SEC’s website. They make for interesting reading. The commentators include current litigants in cases with extraterritoriality issues, forty-two law professors, the U.S. Chamber of Commerce, the governments of Australia and France, and an individual foreign investor who states that he has “been duped of huge sum of my life long savings by so called private bankers who are affiliates outside USA of US banks.”

Quote of note (Comments by Forty-Two Law Professors): “We differ in our views of private rights of action: some of us have significant doubts about the efficacy of securities class actions, while others believe shareholder litigation rights should be strengthened. Nevertheless, as a group we believe reform efforts should be applied consistently and logically to both domestic and affected foreign issuers, and we therefore support extending the test set forth in Section 929P of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to private plaintiffs.”

A couple of items from around the web.

(1) Professor John Coffee has a New York Law Journal column (Jan. 20 – subscrip. req’d) on the upcoming year in securities litigation. The column discusses the Halliburton and Matrixx cases pending in the U.S. Supreme Court, as well as the New York AG’s suit against E&Y for “allegedly assisting Lehman to cosmetically redecorate its balance sheet.”

Quote of note: “[T]he [Matrixx] case poses the first opportunity in over 20 years for the Court to reconsider or rephrase its basic standard for materiality. Even a modest redefinition of that standard will destroy forests to print the law review articles and practitioner commentaries that will predictably follow. The road to Hell is paved with good intentions and law review articles.”

(2) Whether securities class actions benefit shareholders is a perennial debate. In a recent study published in the Financial Analysts Journal, two professors from Maastricht University (Netherlands) conclude that it is a mixed picture, depending on whether the case is based on a violation of the duty of loyalty (e.g., illegal insider trading) or the duty of care (e.g., known lack of internal controls). While in the short run “the filing of a class-action lawsuit is a materially adverse corporate event,” the authors conclude that cases based on violations of the duty of loyalty are more likely over the long run to lead to positive management and governance changes and a higher stock price.

Quote of note: [Perhaps predictably, commentators chose to read the study’s mixed results in different ways, which led to an amusing post from Bruce Carton.] “I saw the follow headlines about a week apart: 1. ‘Study Shows Benefits of Securities Class Actions’ (January 7, 2011); 2. ‘Securities Class Actions Mostly Punish Shareholders, Study Finds’ (November 30, 2010). Sure, different studies can reasonably reach different conclusions about the benefits or harm of securities class actions … but these articles are about the same study!!! As the fellas say on ESPN’s Monday Night Countdown, ‘C’Mon Man!'”

(1) If you are not willing to walk away, you are not negotiating effectively. Charles Schwab appears to have proven that adage correct in its settlement of the securities class action pending against the company in the N.D. of California. On November 8, Charles Schwab announced that it was terminating the deal because it would allow federal securities class members residing outside of California to bring certain state law claims against the company. On November 18, however, the parties informed the court that the deal was back on. Charles Schwab will continue to pay $235 million, as had been contemplated all along, but the federal securities class members residing outside of California will have to opt out of the settlement if they want to pursue related claims. The court reportedly is close to approving the new deal.

(2) San Diego State may want to issue a revised press release. As it turns out, the university did jump the gun when it announced that it would be the recipient of funds from a cy pres award in the Apple options backdating settlement. Ted Frank, at the Center for Class Action Fairness, has successfully pressured the parties into making those funds available, at least in the first instance, to class members. He is now pushing the court to refuse preliminary approval until the settlement guarantees that the class gets all of the settlement funds.

A couple of cases have taken an unexpected turn.

(1) Last April, Charles Schwab Corporation announced the preliminary settlement of the securities class action pending against the company in the N.D. of California. The case relates to the marketing and sale of a bond fund. Just as the settlement was headed for final approval, however, Schwab has decided to invoke the termination provision in the settlement agreement and proceed to trial. The issue is whether the settlement, despite Schwab’s belief that it provided a global resolution, allows federal securities class members residing outside of California to bring certain state law claims against the company. The D&O Diary has a post with all the details.

(2) Last month, the U.S. Supreme Court asked the government for its views on the Omnicare cert petition. The question presented was whether the heightened pleading standard of FRCP 9(b) should be applied to ’33 Act claims (i.e., strict liability/negligence claims based on misstatements in a prospectus or registration statement) that “sound in fraud.” The plaintiffs, however, did not wait to find out the government’s position. They have dismissed the cert petition and evidently will pursue their remaining claims back in district court.