Category Archives: Appellate Monitor

Determining whether a pharmaceutical company has made a false statement about a clinical trial can raise technical issues. In In re Rigel Pharmaceuticals, Inc. Sec. Litig., 2012 WL 3858112 (9th Cir. Sept. 6, 2012), the plaintiffs alleged that the company misstated the results of a clinical trial for a drug designed to treat rheumatoid arthritis. The district court found that the plaintiffs “had failed to adequately plead a false statement regarding efficacy [of the drug] because disagreements over statistical methodology and study design are insufficient to allege a materially false statement.”

On appeal, the Ninth Circuit agreed with that analysis. The court found that the plaintiffs were really “alleging that Defendants should have used different statistical methodologies, not that Defendants misrepresented the results they obtained from the methodologies they employed.” Even if another statistical methodology would have been better or more accurate, accepting the plaintiffs’ argument “would suggest that a company should announce statistical results that are obtained using a statistical methodology that is adopted after the study data is made available to the researchers and that is different from the methodology used as part of the clinical trial.” Any company that took this approach “could raise concerns regarding reliability, biased scientific methods, or even fraud.”

Holding: Dismissal affirmed (both on falsity and scienter grounds).

What evidence is necessary to establish loss causation and economic damages? Two recent circuit court decisions address this issue, albeit at different stages of a securities fraud case.

(1) In Aciticon AG v. China North East Petroleum Holdings, Ltd., 2012 WL 3104589 (2d Cir. Aug. 1, 2012), the lower court dismissed the case based on the plaintiffs’ failure to adequately plead economic damages. 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 lower 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.”

On appeal, the Second Circuit rejected this economic-loss rule as “inconsistent with the traditional out-of-pocket measure of damages, which calculates economic loss based on the value of the time of the security at the time that the fraud became known.” The court noted that “a share of stock that has regained its value after a period of decline is not functionally equivalent to an inflated share that has never lost value.” To hold otherwise, would allow defendants to improperly “offset gains that that plaintiff recovers after the fraud becomes known against losses caused by the revelation of the fraud if the stock recovers value for completely unrelated reasons.” Accordingly, the court held, “the [stock price] recovery does not negate the inference that [the lead plaintiff] has suffered an economic loss.”

Holding: Dismissal reversed and case remanded.

(2) In Hubbard v. BankAtlantic Bancorp, Inc., 2012 WL 2985112 (11th Cir. July 23, 2012), the plaintiffs alleged that BankAtlantic fraudulently concealed the poor credit quality of its commercial real estate portfolio. The plaintiff’s only evidence of loss causation was the testimony of its expert. After a trial, the court granted judgment as a matter of law to the defendants based on the plaintiffs’ failure to establish loss causation.

On appeal, the Eleventh Circuit agreed with the lower court (albeit on a slightly different basis). The court found that a plaintiff must “offer evidence sufficient to allow the jury to separate portions of the price decline attributable to causes unrelated to the fraud, leaving only the part of the price decline attributed to the dissipation of the fraud-induced inflation.” The study conducted by the plaintiffs’ expert was supposed to isolate which part of the stock price drop was caused by the materialization of the risk concealed by BankAtlantic. But it failed to adequately take into account that BankAtlantic’s assets were concentrated in loans tied to Florida real estate. The court noted that there was a general downturn in the Florida real estate market at the relevant time, which may have been a substantial cause of the stock price drop. Because the plaintiffs’ evidence failed to exclude this possibility, the court affirmed the lower court’s decision.

Holding: Judgment affirmed.

The U.S. Court of Appeals for the Second Circuit has reversed a summary judgment grant in favor of Grant Thornton (outside auditor) in a securities class action related to the collapse of Winstar Communications. The case was originally filed in 2001 and, due to intervening settlements, Grant Thornton is the sole remaining defendant. The district court found that Grant Thornton had engaged in “dubious accounting practices” and had “failed to uncover the accounting fraud” being perpetrated by Winstar. Nevertheless, the district court concluded that there was no genuine issue of material fact as to whether Grant Thornton had acted intentionally or recklessly (i.e., with scienter) in issuing its unqualified audit opinion for FY1999.

The Second Circuit disagreed. In Gould v. Winstar Communications, Inc., 2012 WL 2924254 (2d Cir. July 19, 2012), the court held that at least some evidence existed to support the plaintiffs’ assertion “that in the course of its audit GT learned of and advised against the use of indisputably deceptive accounting schemes, but eventually acquiesced in the schemes by issuing an unqualified audit opinion.” While the district court had placed “particular emphasis on the magnitude of GT’s audit work, both in time spent and documents reviewed” in granting summary judgment, the court noted that “[t]he number of hours spent on an audit cannot, standing alone, immunize an accountant from charges it has violated the securities laws.” In regard to two other issues raised on appeal – reliance by certain plaintiffs who brought a Section 18 claim and loss causation – the court found that there was sufficient evidence to allow a jury to reasonably infer that those elements were satisfied.

Holding: Grant of summary judgment vacated and case remanded.

The U.S. Court of Appeals for the First Circuit has issued a short, interesting decision discussing the “holistic” evaluation of scienter allegations. In In re Boston Scientific Corp. Sec. Litig., 2012 WL 2849660 (1st Cir. July 12, 2012), the company allegedly failed to disclose that it had fired ten sales personnel, who ended up going to a competitor and taking business with them. The district court found it was a material omission, but dismissed the claim based on the plaintiffs’ failure to adequately plead a strong inference of scienter (i.e., fraudulent intent).

On appeal, the plaintiffs argued that the district court had failed to consider their scienter allegations holistically, as required by the Supreme Court in its Tellabs decision. The First Circuit noted that it was true that “allegations that are individually insufficient can sometimes combine together to make the necessary showing.” In the instant case, however, “a single central risk existed – that sales personnel might leave and perhaps take some of their business with them.” While that risk became greater over time, to the point where the district court decided that failure to disclose it was a material omission, the potential lost business was “extremely modest in relation to revenues.” Accordingly, the court held that there was no basis for concluding that the defendants “were dishonest or at least reckless in failing to mention” something so marginally material.

Holding: Dismissal affirmed.

Rules 10b-5(a) and (c) establish securities fraud liability for deceptive devices, schemes, and acts. One issue courts have considered is whether “scheme liability” requires a defendant to have engaged in fraudulent conduct beyond the making of material misrepresentations or omissions (which is specifically prohibited by Rule 10b-5(b)).

In Public Pension Group v. KV Pharmaceutical Co., 2012 WL 1970226 (8th Cir. June 4, 2012), the court found that the only non-conclusory “scheme liability” allegations were based on the defendants’ supposed knowledge of misstatements concerning the company’s FDA compliance and earnings. The court held that these allegations were deficient, “join[ing] the Second and Ninth Circuits in recognizing a scheme liability claim must be based on conduct beyond misrepresentations or omissions actionable under Rule 10b-5(b).”

Holding: Dismissal affirmed in part and reversed in part.

The Second Circuit and Seventh Circuit have issued recent notable decisions.

(1) Item 303(a) of Regulation S-K requires issuers to disclose known trends or uncertainties “reasonably likely” to have a material effect on operations, capital, and liquidity. While it has been referred to as the “sleeping tiger” of securities litigation, it may soon be the star of the circus. In Panther Partners Inc. v. Ikanos Communications, Inc., 2012 WL 1889622 (2nd Cir. May 25, 2012), the Second Circuit added to its Item 303(a) jurisprudence, finding that the plaintiffs had plausibly alleged that the company, at the time of its securities offering, “was aware of the ‘uncertainty’ that it might have to accept returns of a substantial volume, if not all, of the chips it had delivered to its major customers.”

Holding: Denial of leave to file an amended complaint (based on futility) reversed.

(2) He’s back and so soon! Following up on last month’s decision, Judge Easterbrook of the Seventh Circuit has authored another securities litigation opinion. In Plumbers and Pipefitters Local Union 719 Pension Fund v. Zimmer Holdings, Inc., 2012 WL 1813700 (7th Cir. May 21, 2012) (Easterbrook, J.), the court addressed whether the plaintiffs had adequately plead scienter (i.e., fraudulent intent) in a case alleging that the company downplayed the significance of product problems. Among other things, the plaintiffs pointed to the CEO’s failure, in response to a question posed during an analyst call, to reveal that the company had received verbal notice from an FDA inspector of “significant objectionable conditions” at one of its plants. The court concluded that the CEO’s answer was technically accurate and the “worst one could say about [the] answer is that it was evasive, which is short of fraudulent.”

Holding: Dismissal affirmed.

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.”

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.

(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.