Category Archives: Appellate Monitor

The U.S. Supreme Court continues to take an interest in securities litigation cases. Earlier today, the Court granted cert in the Erica P. John Fund, Inc. v. Halliburton Co. case.

In Halliburton, the Fifth Circuit declined to certify a class because the plaintiffs had failed to adequately demonstrate loss causation. At issue on appeal is whether the Fifth Circuit’s requirement that plaintiffs establish loss causation at class certification by a preponderance of admissible evidence (but without the benefit of merits discovery) exceeds what is required by Federal Rule of Civil Procedure 23.

The Court asked for the government’s views on the case. In a brief filed early last month, the government urged the Court to take the case and overturn the Fifth Circuit’s decision. Among other things, the government noted that the Seventh Circuit has expressly rejected the Fifth Circuit’s approach.

As always, SCOTUSblog has all of the relevant background materials.

The Apollo Group securities class action has turned out to be far more interesting than anyone could have predicted. The case is based on the company’s alleged failure to disclose the existence of a government report finding that its wholly-owned subsidiary, the University of Phoenix, had violated Department of Education regulations.

After a jury trial, the plaintiffs won a $277.5 million verdict. The trial court, however, held that the plaintiffs had failed to prove loss causation and overturned the verdict. In its decision, the court found that the two analyst reports relied upon by the plaintiffs as “corrective disclosures” that led to a stock price decline “did not provide any new, fraud-revealing analysis.” Instead, the reports merely repeated information about the government report already known to the market or provided information about the University of Phoenix that was factually wrong (and therefore could not have been corrective).

The plaintiffs appealed to the Ninth Circuit and, in a summary, unpublished opinion, the appellate court held that “the jury could have reasonably found that the [analyst] reports following various newspaper articles were ‘corrective disclosures’ providing additional or more authoritative fraud-related information that deflated the stock price.”

So it is on to the Supreme Court, where the question will be whether the justices are ready to revisit the issue of loss causation a mere five years after their Dura decision. Commentators are making a strong argument that the court should grant cert. The Ninth Circuit’s decision appears to suggest that the efficient market hypothesis, which forms the basis for the presumption of reliance in securities class actions, somehow does not really apply when examining loss causation. In other words, the market rapidly absorbs information for the purpose of allowing investors to argue that they relied on false information incorporated into the stock price, but once that information is disclosed, these same investors can argue that it was only when the media or analysts more widely broadcast the information that their loss occurred.

In a New York Law Journal column, the authors discuss the case and the related circuit splits over the necessary timing and nature of a “corrective disclosure.”SCOTUSblog has the cert petition. According to the docket, a number of amicus briefs have already been filed (e.g., a brief from the National Association of Manufacturers supporting the granting of the cert petition).

Oral argument in the Janus case took place this morning. The early verdict is that the U.S. Supreme Court may be headed toward a split decision on whether the investment manager of a fund can be subject to primary liability for securities fraud based on alleged misstatements in the fund’s prospectuses.

A few highlights (based on the transcript):

(1) Petitioner (Janus) conceded that its in-house counsel had drafted the prospectuses on behalf of the fund, but argued that the fund was governed by its trustees who were responsible for the contents and issuance of the prospectuses. The court spent a considerable amount of time exploring the nature of the relationship between an investment advisor and a fund. In particular, various members of the court (J. Breyer, J. Kennedy, J. Sotomayor) probed as to whether an investment advisor should be viewed as the equivalent of a corporate manager who can be held liable for the corporation’s misstatements.

(2) Justice Sotomayor and Justice Ginsburg both suggested that under Petitioner’s theory, a corporate entity could avoid liability by duping another corporate entity into making the misstatements. Petitioner responded that a “dupe case” is addressed in Section 20(b) of the Exchange Act (“the ventriloquist dummy statute”), which makes it unlawful for a person to effect a securities fraud through another person.

(3) Respondent (investors) argued that the Court should adopt the SEC’s interpretation of what it means to “make” a statement, i.e., “to create or compose or to accept as one’s own.” Justice Scalia was skeptical, suggesting that if Respondent was “talking about making heaven and earth, yes, that means to create, but if you’re talking about making a representation, that means presenting the representation to someone, not drafting it for someone else to make.”

(4) As to whether an investment advisor was the equivalent of a corporate manager, despite the fact that it is an independent entity, Respondent asserted that “contractually outsourc[ing] the management function should not alleviate the securities fraud that is alleged here.” Moreover, the investment advisor had “substantive control over the content of the message” and, therefore, was not a mere aider and abettor. In response, Justice Kagan questioned the relevance of “control” given that Respondent had not brought its case under Section 20 of the Exchange Act and presumably could not have done so because of the nature of the relationship between a fund and its investment advisor.

All of the briefs and other background materials can be found here. Bloomberg has coverage of the argument.

Can a plaintiff adequately allege or prove loss causation by pointing to a corrective disclosure that reveals the company’s financial results and condition, even if the disclosure does not directly reveal any alleged misrepresentations? Courts have been reluctant to apply this “true financial condition theory,” especially at the proof stage of a case. The U.S. Court of Appeals for the Ninth Circuit is the latest court to find that an earnings miss, or similar adverse financial result, is by itself insufficient to establish loss causation.

In In re Oracle Corp. Sec. Litig., 2010 WL 4608794 (9th Cir. Nov. 16, 2010), the Ninth Circuit reviewed a grant of summary judgment for the defendants. The district court held that plaintiffs failed to identify sufficient evidence as to loss causation for their non-forecasting claims. In particular, plaintiffs relied on an earning miss rather than any actual disclosure about defects in a key product.

On appeal, the Ninth Circuit agreed that the “overwhelming evidence produced during discovery indicates the market understood Oracle’s earnings miss to be a result of several deals lost in the final weeks of the quarter,” not “that customers did not buy [the product] as a result of defects.” The fact that two analyst reports questioned this explanation for the earnings miss could not overcome the “market’s consensus.” Moreover, Oracle continued to sell large amounts of the product during the following quarter, suggesting that there was no public knowledge of the supposedly concealed defects.

Holding: Grant of summary judgment affirmed.

Quote of note: “Plaintiffs take issue with our opinion in Metzler. Specifically, they assert that they should be able to prove loss causation by showing that the market reacted to the purported ‘impact’ of the alleged fraud—the earnings miss—rather than to the fraudulent acts themselves. We reject that assertion. Loss causation requires more than an earnings miss.”

There is a circuit split on the issue of primary vs. aiding-and-abetting liability. Under the “bright line” test adopted by the Second Circuit, primary liability for securities fraud (as opposed to aiding-and-abetting liability, which is not available in private actions) only exists if the alleged misstatement is attributable on its face to the defendant.

Other circuit courts, however, have applied a more relaxed standard. The Fourth Circuit has found that it is sufficient for a plaintiff to adequately allege that (a) the defendant “participated” in the making of the misstatement, and (b) “interested investors would have known that the defendant was responsible for the statement at the time it was made, even if the statement on its face is not directly attributable to the defendant.” Earlier this year, the Supreme Court granted cert in that case – Janus Capital Group v. First Derivative Traders – and presumably will resolve the circuit split.

In the interim, the Fifth Circuit has issued a decision expressly agreeing with the Second Circuit and adopting the “bright line” test. In Affco Investments 2001 LLC v. Proskauer Rose, L.L.P., 2010 WL 4226685 (5th Cir. Oct. 27, 2010), the court considered whether a law firm could have primary liability based on its provision of tax opinions that were alleged to be part of a fraudulent scheme. The company that promoted the scheme informed investors that “several major national law firms” had vetted the investments. Although plaintiffs claimed to have relied on the tax opinions, the court found that they failed to allege “that they ever saw or heard any Proskauer work product before making their decision, nor do they explicitly allege that the promoters identified Proskauer as one of the ‘major national law firms.'” Accordingly, the plaintiffs “failed to show reliance on Proskauer” and the law firm could not be a primary violator.

Holding: Dismissal affirmed.

Quote of note: “Knowing the identity of the speaker is essential to show reliance because a word of assurance is only as good as its giver. Clients engage ‘name-brand’ law firms at premium prices because of the security that comes from the general reputations of such firms for giving sound advice, or for winning trials. Specific attribution to a reputable source also induces reliance because of the ability to hold such a party responsible should things go awry.”

In the Adelphia securities class action, a law firm that did not act as lead counsel in the case moved for a third (about $17 million) of the aggregate fee award. The law firm argued that it had provided “an independent and substantial benefit” for the class by initiating and preserving the Section 11 and Section 12 claims that ultimately were asserted against two of Adelphia’s underwriters. The district court found no evidence, however, “that the use of those statutes, or their use against [the two underwriters], represents ground-breaking legal or factual analysis.” The law firm was awarded the amount that had been allocated by lead counsel – $155,610, or the time the law firm had invested in the case, at its normal hourly rates, up to the appointment of lead plaintiffs and counsel. The law firm appealed the decision.

In Victor v. Argent Classic Convertible Arbitrage Fund L.P., 2010 WL 4008744 (2d Cir. Oct. 14, 2010), the Second Circuit considered whether the district court had abused its discretion in failing to increase the law firm’s allocation. The court noted that securities class actions “are often an entrepreneurial exercise in which multiple attorneys file complaints” and it is “common practice for lead counsel to borrow legal principles from the complaints filed to the appointment of lead counsel.” While work completed by non-lead counsel can confer substantial benefits upon the class, as it did in this case, a district court has “wide discretion” in determining whether the awarded fee is reasonable. The law firm was requesting a fee amounting to $45,000 an hour. The court found that it was “well within the District Court’s discretion to determine that a fee application containing a lodestar multiplier of 110 is, prima facie, ‘simply not reasonable.'”

Holding: Affirmed.

Quote of note: “Although [lead counsel] were no doubt on the stingy side when it came to compensating their brethern, we have not been convinced that the District Court abused its discretion in approving class counsel’s allocation.”

As the U.S. Supreme Court begins its October term, a securities litigator’s fancy naturally turns to what cases the court might take next. A leading indicator is cert petitions where the Court has asked the government to provide its input. On Monday, the Court made this request in two separate cases: Halliburton (5th Cir.) and Omnicare (6th Cir.).

(1) The question presented in Halliburton is to what extent plaintiffs must demonstrate the existence of loss causation as part of the class certification process. The 10b-5 Daily’s summary of the 5th Circuit’s decision can be found here. SCOTUSblog has all of the cert petition materials.

(2) The question presented in Omnicare is 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 10b-5 Daily’s summary of the Sixth Circuit’s decision can be found here. SCOTUSblog has all of the cert petition materials.

Stay tuned for the governments’ responses.

Disclosure: The author of The 10b-5 Daily’s firm – Dewey & LeBoeuf – represents Omnicare in this case.

It has been several years since the Second Circuit has addressed the scope of the bespeaks caution doctrine. The bespeaks caution doctrine holds that a “forward-looking statement accompanied by sufficient cautionary language is not actionable because no reasonable investor could have found the statement materially misleading.” In Iowa Public Employees’ Retirement System v. MF Global, Ltd., 2010 WL 3547602 (2d Cir. Sept. 14, 2010), the Second Circuit found that the district court had failed to properly sever the forward-looking and non-forward-looking aspects of the alleged misstatements. Accordingly, the case was remanded for further analysis.

Quote of note: “A forward-looking statement (accompanied by cautionary language) expresses the issuer’s inherently contingent prediction of risk or future cash flow; a non-forward-looking statement provides an ascertainable or verifiable basis for the investor to make his own prediction. The line can be hard to draw, and we do not now undertake to draw one. However, a statement specifying the risk of default is distinct from a statement of present or historical financial instability, even though they both bear upon the same risk. And a statement of confidence in a firm’s operations may be forward-looking – and thus insulated by the bespeaks-caution doctrine – even while statements or omissions as to the operations in place (and present intentions as to future operations) are not.”

There was an interesting appellate decision last month in one of the few securities class actions to be tried to a verdict.

In 2005, Thane International won a bench trail in a case concerning the company’s 2002 acquisition of Reliant Interactive Media. A class of Reliant investors brought Securities Act claims seeking recission of the merger. In particular, they alleged that Thane’s pre-merger prospectus contained misrepresentations because it implied that Thane shares would list on the Nasdaq National Market. The company actually commenced trading on the OTCBB.

The Ninth Circuit subsequently found that the district court had erred in holding that the prospectus did not contain material misrepresentations, but remanded so that the district court could address the issue of loss causation. On remand, the district court granted judgment for Thane because the company’s stock price did not decline below the merger price until nineteen days after trading began on the OTCBB. The plaintiffs appealed again.

In Miller v. Thane Int’l, Inc., 2010 WL 3081488 (9th Cir. Aug. 9, 2010), the court found that “stock price evidence may be used in loss causation assessment” even if the market for the stock was inefficient. In the instant case, Thane’s expert demonstrated that that the company’s “stock price could and did impound [i.e., absorb] information about Thane during this nineteen-day period, including the listing on the OTCBB.” Accordingly, the court declined to find that the district court erred in holding that the misrepresentations did not cause any loss.

Holding: Judgment affirmed.

Quote of note: “[T]he materiality inquiry concerns whether a ‘reasonable investor’ would consider a particular misstatement important. It is hypothetical and objective. By contrast, the loss causation inquiry assesses whether a particular misstatement actually resulted in loss. It is historical and context-dependent.”
Thanks to John Letteri for sending in the decision.

He’s back. Judge Easterbrook has authored a new securities litigation decision for the U.S. Court of Appeals for the Seventh Circuit and, as always, it is interesting and contentious.

In Schleicher v. Wendt, 2010 WL 3271964 (7th Cir. Aug. 20, 2010), the court considered to what extent plaintiffs must establish the existence of loss causation before a class can be certified. Defendants argued, based in part on Fifth Circuit precedent (Oscar Private Equity), that the plaintiffs needed to demonstrate that the alleged false statements materially affected the company’s stock price and therefore caused some loss. The court disagreed and held that when and to what extent the alleged false statements affected the stock price are “merits questions” that cannot be resolved as part of the class certification process. Moreover, the Fifth Circuit’s approach would “make certification impossible in many securities suits, because when true and false statements are made together it is often impossible to disentangle the [price] effects with any confidence.”

Holding: Certification of class affirmed.

Quote of note: “Unlike the fifth circuit, we do not understand Basic to license each court of appeals to set up its own criteria for certification of securities class actions or to ‘tighten’ Rule 23’s requirements. Rule 23 allows certification of classes that are fated to lose as well as classes that are sure to win. To the extent it holds that class certification is proper only after the representative plaintiffs establish by a preponderance of the evidence everything necessary to prevail, Oscar Private Equity contradicts the decision, made in 1966, to separate class certification from the decision on the merits.”