Category Archives: Appellate Monitor

In its Morrison decision, the Supreme Court limited the scope of Section 10(b) claims to “transactions in securities listed on our domestic exchanges, and domestic transactions in other securities.” While determining whether a security is listed on a domestic exchange is a relatively straightforward question (although some plaintiffs have unsuccessfully attempted to complicate it), the Court offered little guidance on what constitutes a “domestic transaction.”

The Second Circuit has tried to provide some clarity. In Absolute Activist Value Master Fund Ltd. v. Ficeto, 2012 WL 661771 (2d Cir. March 1, 2012), the court evaluated “whether foreign funds’ purchases and sales of securities issued by U.S. companies brokered through a U.S. broker-dealer constitute ‘domestic transactions.'” The court concluded that there are two related tests for determining domesticity.

As a threshold matter, the court noted that the purchase or sale of a security normally takes place when the parties become bound to effectuate the transaction. The court held that the same test can be used to determine the locus of the purchase or sale. Based on this reasoning, “it is sufficient for a plaintiff to allege facts leading to the plausible inference that the parties incurred irrevocable liability within the United States: that is, that the purchaser incurred irrevocable liability within the United States to take and pay for a security, or that the seller incurred irrevocable liability within the United States to deliver a security.” Alternatively, a “sale” is defined as a transfer of title and it also is sufficient for a plaintiff to adequately allege that title was transferred within the United States.

In the instant case, the plaintiffs merely had alleged that the transactions took place within the United States. The court found that more factual allegations related to irrevocable liability and/or transfer of title were necessary and could include “facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money.” Because the complaint had been filed pre-Morrison, and based on the plaintiffs’ representations that they could provide such factual allegations if required, the court granted them leave to amend.

Holding: Dismissal affirmed in part and reversed in part.

Quote of note: “[R]ather than looking to the identity of the parties, the type of security at issue, or whether each individual defendant engaged in conduct within the United States, we hold that a securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States.”

The scope of the Securities Litigation Uniform Standards Act (“SLUSA”), which precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities, continues to be fertile ground for litigation more than 13 years after the legislation’s adoption. A persistent issue is to what extent a plaintiff can disclaim that his case is based on an alleged misrepresentation, even if the nature of the case suggests otherwise, and thereby avoid SLUSA preclusion.

In Brown v. Calamos, 2011 WL 5505375 (7th Cir. Nov. 10, 2011), the U.S. Court of Appeals for the Seventh Circuit reviewed a SLUSA dismissal in a case about a fund’s issuance of “auction market preferred stock.” Although it was a “suit for breach of fiduciary obligation and not securities fraud,” the complaint included allegations that the fund had falsely stated the term of the security “was perpetual” and omitted to disclose a material conflict of interest. Judge Posner found that SLUSA preclusion was appropriate under either (a) the Sixth Circuit’s “literalist approach,” because the complaint could be interpreted as alleging a misrepresentation; or (b) the Third Circuit’s “looser approach,” because the allegations of the complaint made “it likely that an issue of fraud will arise in the course of the litigation.”

Holding: Dismissal affirmed.

Quote of note: “[I]t can be argued that a dismissal with prejudice is too severe a sanction for what might be an irrelevancy added to the complaint out of an anxious desire to leave no stone unturned – a desire that had induced momentary forgetfulness of SLUSA. But a lawyer who files a securities suit should know about SLUSA and ought to be able to control the impulse to embellish his securities suit with a charge of fraud.”

What must a plaintiff do to invoke the fraud-on-the-market theory (pursuant to which reliance by investors on a misrepresentation is presumed if the company’s shares were traded on an efficient market) in support of class certification? According to the U.S. Court of Appeals for the Ninth Circuit, nothing more than show (a) the security was traded on an efficient market, and (b) the alleged misrepresentations were public.

In Connecticut Retirement Plans and Trust Funds v. Amgen, Inc., 2011 WL 5341285 (9th Cir. Nov. 8, 2011), the court addressed whether a plaintiff also must prove that the alleged misrepresentations were material. Three circuit courts (Second, Fifth, and, to a lesser extent, Third) previously have held that this is a required part of the fraud-on-the-market analysis when evaluating whether a class should be certified. The Ninth Circuit joined a recent decision from the Seventh Circuit, however, in rejecting that position. The court held that materiality is a merits question that does not affect whether class certification is appropriate.

Holding: Affirming grant of class certification.

Quote of note: “If the misrepresentations turn out to be material, then the fraud-on-the-market presumption makes the reliance issue common to the class, and class treatment is appropriate. If the misrepresentations turn out to be immaterial, then every plaintiff’s claim fails on the merits (materiality being a standalone merits element), and there would be no need for a trial on each plaintiff’s individual reliance. Either way, the plaintiffs’ claims stand or fall together – the critical question in the Rule 23 inquiry.”

Is it necessary for the alleged false statements to have artificially inflated the company’s stock price to establish loss causation? The Eleventh Circuit recently considered this question in a case where the plaintiffs’ expert found that the company’s stock price was artificially inflated both before and during the class period by the same amount. The district court granted summary judgment for the defendants, concluding that because the stock price inflation predated the class period, the alleged false statements made during the class period could not have caused the inflation or any subsequent losses.

On appeal – FindWhat Investor Group v. FindWhat.com, 2011 WL 4506180 (11th Cir. Sept. 30, 2011) – the Eleventh Circuit disagreed. The court concluded that false statements “that prevent a stock price from falling can cause harm by prolonging the period during which the stock is traded at inflated prices.” Accordingly, “defendants can be liable for knowingly and intentionally causing a stock price to remain inflated by preventing preexisting inflation from dissipating from the stock price.”

Holding: Vacating dismissal of claims based on failure to establish loss causation (but affirming the dismissal of certain other claims)

Quote of note: “Defendants whose fraud prevents preexisting inflation in a stock price from dissipating are just as liable as defendants whose fraud introduces inflation into the stock price in the first instance. We decline to erect a per se rule that, once a market is already misinformed about a particular truth, corporations are free to knowingly and intentionally reinforce material misconceptions by repeating falsehoods with impunity.”

The scope of the Securities Litigation Uniform Standards Act (“SLUSA”), which precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities, continues to be the subject of litigation. In Atkinson v. Morgan Asset Mgmt., Inc., 2011 WL 3926376 (6th Cir. Sept. 8, 2011), the court considered whether SLUSA preempted claims brought by the holders of mutual fund shares, who were entitled to redeem their shares at any time for their “proportionate share of the issuer’s current net assets.”

The plaintiffs argued that as the holders of mutual fund shares, their claims were covered by what is known as the “first Delaware carve-out” to SLUSA, which preserves state-law class actions that involve “the purchase or sale of securities by the issuer or an affiliate of the issuer exclusively from or to holders of equity securities of the issuer.” The first Delaware carve-out generally applies to cases challenging corporate transactions, such as tender offers and mergers, or share buybacks directed exclusively to existing shareholders. The plaintiffs claimed that it also should apply to the holders of mutual fund shares, because the “funds’ obligation to redeem Plaintiffs’ shares amounts to an ongoing contract to purchase them.”

The Sixth Circuit rejected the plaintiffs’ argument, holding that the redemption obligation did not convert the holders of mutual fund shares into continuous purchasers or sellers. Moreover, the U.S. Supreme Court, in its Dabit decision, has held that holder claims are precluded under SLUSA. Permitting the plaintiffs’ construction of the first Delaware carveout would create an impermissible exception for mutual fund shareholders. The court also held that for purposes of SLUSA preclusion it was sufficient that the plaintiffs’ claims included allegations of misrepresentations in connection with the buying and selling of securities; it was not necessary for fraud to be an element of the claims.

Holding: Dismissal affirmed.

Quote of note: “Plaintiffs’ construction of the carve-out invites us to pull the rug out from under Dabit‘s holding, creating an exemption for a large set of the very holder claims over which Dabit extended SLUSA’s bar. Indeed, Plaintiffs ask us to shield from PSLRA’s federal protections nearly every class action involving shareholders in open-end mutual funds. In the absence of clear language, precedent, or policy supporting this exemption, we decline to extend the carve-out so far.”

Are financial estimates like goodwill and loan loss reserves statements of fact or opinion? The answer is significant, especially for claims brought under Section 11 and Section 12 of the ’33 Act based on alleged misrepresentations in a registration statement. If these financial estimates are statements of fact, then a plaintiff is only required to establish that they were objectively false. If these financial estimates are statements of opinion, then a plaintiff must establish that they were objectively false and disbelieved by the defendant at the time they were made. In effect, it converts the cause of action from one based on strict liability (the company) or negligence (the individual defendants), to one based on knowing falsity.

In Fait v. Regions Financing Trust, No. 10-2311-cv (2d Cir. August 23, 2011), the plaintiffs alleged that despite adverse trends in the mortgage and housing markets, particularly in areas where the mortgage loans issued by a company previously acquired by Regions were concentrated, Regions failed to write down goodwill and to sufficiently increase its loan loss reserves. The lower court held that these financial estimates were matters of opinion and dismissed the Section 11 and Section 12 claims brought by purchasers of Region’s trust preferred securities.

On appeal, the Second Circuit affirmed the lower court’s ruling. Estimating goodwill “depend[s] on management’s determination of the ‘fair value’ of the assets acquired and liabilities assumed, which are not matters of objective fact.” Similarly, loss reserves “reflect management’s opinion or judgment about what, if any, portion of amounts due on the loans ultimately might not be collectible.” As a result, plaintiffs were required to plausibly allege that defendants did not believe their statements regarding goodwill and loan loss reserves at the time they made them. In the absence of these allegations, the plaintiffs’ claims were subject to dismissal.

Holding: Dismissal affirmed.

The Janus opinion, which holds that primary liability for securities fraud is limited to the person or entity with ultimate authority over the alleged false statements, has had its first impact. Earlier this week, the U.S. Supreme Court denied cert in a case alleging that a law firm and one of its former partners were liable for false statements made by Refco in its public filings. The Second Circuit had dismissed the claims, finding that under its “bright line” test the attorneys could not be liable because they were not identified to investors as the makers of the statements. In the wake of Janus, the Court left the Second Circuit’s decision undisturbed. Law360 has an article on the cert denial.

In the Janus Capital Group v. First Derivative Traders case, the U.S. Supreme Court has held that for purposes of primary liability under Rule 10b-5, the “maker” of a statement is the person or entity with ultimate authority over the statement. The 5-4 decision authored by Justice Thomas rejects the government’s proposed “creation” test, which would have extended primary liability to a person who provides false or misleading information that another person puts into a statement. Justice Breyer penned a vigorous dissent.

Oral argument does not always point the way to the ultimate decision in a case. Here, however, the justices split along the same lines, and for the same reasons, as publicly discussed back in December. At issue in Janus was whether a fund’s investment advisor had “made” the alleged misstatements in the prospectuses issued by the fund. The Court concluded that “the maker of a statement is the entity with authority over the content of the statement and whether and how to communicate it.” Because the fund (and not its investment advisor, which was a separate corporate entity) possessed the “ultimate authority” to determine what would go into its prospectuses, it was the “maker” of the alleged misstatements.

Although the Court recognized that an investment advisor acts as the manager of a fund and exercises significant influence over the contents of any prospectus, it concluded that “[a]ny reapportionment of liability in the securities industry in light of the close relationship between investment advisers and mutual funds is properly the responsibility of Congress and not the courts.” Moreover, the Court found that its bright-line definition of “maker” was consistent with its past rejections of secondary liability in private securities fraud suits.

Holding: Judgment reversed.

Quote of note: “[T]he maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it. Without control, a person or entity can merely suggest what to say, not ‘make’ a statement in its own right. One who prepares or publishes a statement on behalf of another is not its maker. And in the ordinary case, attribution within a statement or implicit from surrounding circumstances is strong evidence that a statement was made by—and only by—the party to whom it is attributed. This rule might best be exemplified by the relationship between a speechwriter and a speaker. Even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit—or blame—for what is ultimately said.”

Notes on the Decision:

(1) In dissent, Justice Breyer argues that the “English language does not impose upon the word ‘make’ boundaries of the kind the majority finds determinative.” It is more reasonable to conclude that several different individuals or entities can “‘make’ a statement that each has a hand in producing.” Here, according to the dissent, the “special relationships” alleged between the fund, its investment advisor, and the prospectus statements “warrant the conclusion that [the investment advisor] did ‘make’ those statements.”

(2) The Court is notably silent on the exact scope of its decision. Is it limited to cases involving separate corporate entities or does it also extend to disputes over who, within a corporation, can be said to have “made” an alleged misstatement? The dissent appears to suggest that it covers both situations, noting (as part of its criticism of the decision) that “[e]very day, hosts of corporate officials make statements with content that more senior officials or the board of directors have ‘ultimate authority’ to control.”

(3) One of the key issues at the oral argument was whether a limited interpretation of “make a statement” would allow a corporate entity to avoid liability by duping another corporate entity into making misstatements. A possible solution is the application of Section 20(b) of the Exchange Act, which makes it unlawful for a person to effect a securities fraud through another person. The Court declined to address the issue (see Note 10), but will we now see an increase in Section 20(b) claims as plaintiffs attempt to limit the impact of the decision?