Category Archives: Appellate Monitor

The U.S. Supreme Court’s decision to hear a case on the pleading standards for scienter (i.e., fraudulent intent) has received little media attention . . . until today. The New York Times has an article on the SEC’s recent activities related to private securities litigation, including the agency’s decision to file an amicus brief in the Tellabs case in support of the defendants.

In their brief, the SEC/DOJ rejected the “reasonable person” test applied by the U.S. Court of Appeals for the Seventh Circuit in evaluating whether the “strong inference” of scienter pleading standard was met. Instead, “a court should determine whether, taking the alleged facts as true, there is a high likelihood that the conclusion that the defendant possessed scienter follows from those facts.” If the same facts both support and negate an inference of scienter, “the court should consider the relative strength of both inferences, because, where there is a substantial possibility that the defendant acted without scienter, the inference of scienter will not be ‘strong.'”

Quote of note (New York Times): “Critics said that the moves signaled a major retrenchment from the post-Enron changes and showed that a lobbying push by big companies, Wall Street firms and the accounting industry was gaining traction as they seek to roll back what they see as onerous regulation and excessive investor litigation. But Christopher Cox, the chairman of the commission, said in an interview Monday that both efforts were in the best interests of investors because they aimed at preventing the accounting industry from further consolidation and at limiting what he called ‘fraudulent lawsuits,’ including some he said were filed by ‘professional plaintiffs.'”

After eleven years, the PSLRA’s scienter pleading standard finally will be addressed by the U.S. Supreme Court. On Friday, the court granted certiorari in Tellabs, Inc. v. Makor Issues & Rights, Ltd. on appeal from the U.S. Court of Appeals for the Seventh Circuit.

The question presented on appeal is whether, and to what extent, a court must consider or weigh competing inferences in determining whether a complaint has alleged sufficient facts to establish a strong inference of scienter. The Seventh Circuit held that the plaintiff was entitled to more than the most plausible of competing inferences. Instead, a court should “allow the complaint to survive if it alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent.” In their cert petition (via SCOTUSblog), defendants argued that this is the most lenient of the “four meaningfully different interpretations of the strong inference standard” that have been adopted by federal circuit courts and urged the Supreme Court to resolve the circuit split.

Links to the various cert petition briefs can be found on SCOTUSblog, which also notes that the Supreme Court has ordered expedited briefing in the case and may be planning to hear it during the March 2007 session. Thanks to Greg Harris for the tip.

In a decision issued earlier this year in the Qwest securities litigation, the U.S. Court of Appeals for the Tenth Circuit declined to adopt the selective waiver doctrine. Specifically, the court found that Qwest could not withhold documents from the plaintiffs on the grounds of attorney-client privilege or the work-product doctrine if those documents were previously produced to the SEC. On Monday, the U.S. Supreme Court denied cert in the case.

The Denver Business Journal has an article on the decision. Most of the defendants have settled (including Qwest), but the case is continuing against two former officers. The 10b-5 Daily has posted frequently about the settlement.

The Sarbanes-Oxley Act of 2002 (“SOX”) requires the chief executive officer and chief financial officer of a company to certify the accuracy of each periodic report containing financial statements. Plaintiffs often argue that these certifications can support the pleading of scienter (i.e., fraudulent intent) in cases alleging accounting misrepresentations.

In what appears to be the first circuit court opinion to address the issue, the U.S. Court of Appeals for the Eleventh Circuit has held that SOX certifications, by themselves, are not indicative of scienter. In Garfield v. NDC Health Corp., 2006 WL 2883238 (11th Cir. Oct. 12, 2006), the court found that SOX “does not indicate any intent to change the requirements for pleading scienter set forth in the PSLRA [Private Securities Litigation Reform Act of 1995].” Accordingly, a SOX certification “is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.”

Quote of note: “If we were to accept [plaintiff’s] proferred interpretation of Sarbanes-Oxley, scienter would be established in every case were there was an accounting error or auditing mistake made by a publicly traded company, thereby eviscerating the pleading requirements for scienter set forth in the PSLRA.”

The U.S. Court of Appeals for the Fourth Circuit has issued its first post-Dura decision on loss causation. In Glaser v. Enzo Biochem, Inc., 2006 WL 2692848 (4th Cir. Sept. 21, 2006), the court examined whether the plaintiffs had adequately alleged a Virginia common law fraud claim related to the sale of securities. (The federal securities claims had previously been dismissed on statute of limitations grounds.)

The court found that it “is only after the fraudulent conduct is disclosed to the investing public, followed by a drop in the value of the stock, that the . . . investor has suffered a ‘loss’ that is actionable after the Supreme Court’s decision in Dura.” Because the complaint appeared to concede that the plaintiffs had sold their shares before the “alleged truth about Enzo’s science” was “publicly revealed,” any losses they suffered “must have been the result of market factors or other factors, not the revelation of the alleged truth.”

Whether plaintiffs who combine nonfraud and fraud securities claims in the same complaint are subject to the particularity pleading requirement of Fed. R. of Civ. P. 9(b) has been an open issue. Although claims under Section 11 and Section 12(a)(2) of the Securities Act of 1933 do not require the plaintiff to establish fraudulent intent, a number of federal circuits (2nd, 3rd, 5th, 7th, and 9th – with only the 8th disagreeing) have held that these claims must be plead with particularity if they “sound in fraud” based on the existence of a related securities fraud claim.

The U.S. Court of Appeals for the Eleventh Circuit has joined the majority position this week. In Jacobson v. First Horizon Pharm. Corp., 2006 WL 2661652 (11th Cir. Sept. 18, 2006), the court found that a Section 11 or Section 12(a) claim “must be pled with particularity when the facts underlying the misrepresentation at stake in the claim are said to be part of a fraud claim, as alleged elsewhere in the complaint.”

The court also addressed whether the complaint was improperly dismissed pursuant to Fed. R. Civ. P. 12(b)(6) on the basis that it was a “shotgun pleading” that did not clearly link its alleged facts to the causes of action. Interestingly, the district court had granted the dismissal and conditioned any amendment of the complaint “on the [plaintiffs’] payment of the defendants’ costs and fees associated with the motion to dismiss.” On appeal, the court avoided that issue by holding that instead of dismissing the complaint, the district court should have sua sponte ordered a repleading for a more definitive statement of the claim pursuant to Fed. R. Civ. P. 12(e).

Quote of note: “It is not enough to claim that alternative pleading saves the nonfraud claims from making an allegation of fraud because the risk to the defendant’s reputation is not protected. It would strain credulity to claim that Rule 9(b) should not apply in this allegation: The defendant is a no good defrauder, but, even if he is not, the plaintiff can still recover based on the simple untruth of the otherwise fraudulent statement.”

The Sarbanes-Oxley Act of 2002 (“SOX”) extends the statute of limitations for federal securities fraud to the earlier of two years after the discovery of the facts constituting the violation or five years after the violation. Although the legislation clearly provides that it “shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002],” left unresolved is whether Congress intended to revive claims that had already expired under the earlier one year/three years statute of limitations.

In an opinion issued this week – Margolies v. Deason, 2006 WL 259788 (5th Cir. Sept. 11, 2006) – the Fifth Circuit has joined the clear majority of federal appellate courts (including the Second, Third, Fourth, Seventh, and Eighth Circuits) in holding that the new statute of limitations should not be applied retroactively. The Eleventh Circuit remains the only dissenter.

The Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) pre-empts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The “in connection with” requirement has been a continuous source of litigation and was the subject of the Dabit decision by the U.S. Supreme Court earlier this year.

Not to be outdone, the U.S. Court of Appeals for the Seventh Circuit has issued its own opinion discussing the scope of the “in connection with” requirement. In Gavin v. AT&T Corp., 2006 WL 2548238 (7th Cir. Sept. 6, 2006), the court addressed a class action arising out of the merger between MediaOne and AT&T in 2000. The terms of the merger entitled shareholders of MediaOne to obtain, in exchange for their MediaOne shares, a certain amount of AT&T stock plus cash and any accrued but unpaid dividends. After AT&T solicited MediaOne shareholders twice to make this exchange, it hired a shareholder communications company to “clean up” any MediaOne shareholders who had not yet responded. The letter from the shareholder communications company specified a fee of $7 per MediaOne share for the exchange service, without mentioning that MediaOne shareholders could still do the exchange at no cost through AT&T’s exchange agent. The failure to mention the “no cost” option is the fraud charged in the complaint.

In an opinion by Judge Posner, the court was highly critical of the defendants’ position that the case should be pre-empted by SLUSA because the alleged fraud was in connection with the purchase or sale of MediaOne stock. Noting that MediaOne’s shareholders “became the beneficial owners of AT&T stock” when the merger was consummated, the court found that the alleged fraud “happened afterwards and had nothing more to do with the federal securities law than if [the shareholder communication company] had asked the MediaOne shareholders ‘do you want your AT&T shares sent to you by regular mail or by courier?’ and had charged an inflated fee for the courier service.” Accordingly, the court reversed the pre-emption decision and instructed the district court to remand the case back to state court.

Quote of note: “Of course there is a literal sense in which anything that happens that would not have happened but for some prior event is connected to that event. In that sense the fraud of which the plaintiff complains is connected to the merger, without which there would not have been such a fraud against the plaintiff and her class. But in the same sense the fraud is connected to the Big Bang, without which there would never have been a MediaOne or even an AT&T.”

Today’s edition of the New Jersey Law Journal has an interesting article (subscrip. req’d) on an appellate decision upholding an attorneys’ fees award. In In re AT&T Corp. Sec. Litig., 2006 WL 2021033 (3d Cir. July 20, 2006), the Third Circuit found that the upward sliding fee scale (i.e., the fee percentage increased as the size of the settlement increased) agreed to by the lead plaintiff was permissible. Notably, the total fee of $21.25 million was only 1.28 times the lodestar calculation of the reasonable attorney hours expended times their hourly rates.

Quote of note: “St. John’s University Law Professor Michael Perino says, ‘It is a matter of dispute among academics as to whether an upward sliding scale or a downward sliding scale creates the best set of incentives for plaintiffs. Downward is more common.'”

Disclosure: The author of The 10b-5 Daily is quoted in the article.