Category Archives: Appellate Monitor

Barred from taking discovery until after a motion to dismiss has been decided, plaintiffs frequently attempt to meet the PSLRA’s heightened pleading standards for securities fraud by citing statements from confidential sources (often former or current employees of the defendant corporation). In its seminal decision in Novak v. Kasaks, the Second Circuit found that it was not necessary to name these confidential sources “provided that they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.”

The Third Circuit has now weighed in on the issue. In California Public Employees’ Retirement System v. The Chubb Corp., 2004 WL 3015578 (3rd Cir. Dec. 30, 2004), the court adopted the Novak standard, but also stated that this standard requires “an examination of the detail provided by the confidential sources, the sources’ basis of knowledge, the reliability of the sources, the corrobative nature of other facts alleged, including from other sources, the coherence and plausibility of the allegations, and similar indicia.” After engaging in this rigorous examination, the court rejected most of the allegations based on confidential sources contained in the complaint. The opinion is notable for its in-depth discussion of different types of confidential sources, including former employees at various levels within Chubb’s corporate organization, and what knowledge reasonably can be imputed to them.

Holding: Dismissal affirmed.

Quote of note: “Citing to a large number of varied sources may in some instance help provide particularity, as when the accounts supplied by the sources corroborate and reinforce one another. In this case, however, the underlying prerequisite – that each source is described sufficiently to support the probability that the source possesses the information alleged – is not met with respect to the overwhelming majority of Plaintiffs’ sources. Cobbling together a litany of inadequate allegations does not render those allegations particularized in accordance with Rule 9(b) or the PSLRA.”

The U.S. Court of Appeals for the Seventh Circuit is the latest court to hold that the Sarbanes-Oxley Act of 2002, which extended the statute of limitations for federal securities fraud actions, did not revive previously time-barred claims. In Foss v. Bear, Stearns & Co., Inc., 2005 WL 43724 (7th Cir. Jan 11, 2005), the court found the Second Circuit’s recent decision in the Enterprise Mortgage case “persuasive” on this issue and noted that it had “nothing to add.”

Oral argument in the Dura Pharmaceuticals v. Broudo case took place in the U.S. Supreme Court this morning (links to all of the main briefs can be found here). The question presented was: “Whether a securities fraud plaintiff invoking the fraud-on-the-market theory must demonstrate loss causation by pleading and proving a causal connection between the alleged fraud and the investment’s subsequent decline in price.”

Chief Justice Rehnquist did not attend the hearing, but reserved his right to participate in the decision. Argument was heard from counsel for Dura Pharmaceuticals, the U.S. government (in support of Dura’s position), and Broudo. Here are a few notes on the main issues that were discussed:

Overall Impressions – Predicting how the Supreme Court will rule based on oral argument is a tricky business. That said, the Court appeared likely to reject the 9th Circuit’s price inflation theory of loss causation. Whether the Court will attempt to lay out what a plaintiff in a fraud-on-the-market case must plead as to loss causation to survive a motion to dismiss, however, was unclear.

Dura’s Position – Consistent with their briefs, Dura’s counsel argued that a loss only occurs when a corrective disclosure is made. Justice Breyer posed the following hypothetical – a company says it has found gold and its stock price is $60; the company later discloses that no gold has been discovered and the stock price declines to $10; the loss is clearly $50. But what if the gold never existed but the company finds platinum and the stock price rises to $200? Are plaintiffs permitted to show that the stock price would have been $250 if the company had also found gold? Dura’s counsel did not disagree that it might be possible to demonstrate loss causation under these circumstances, but argued that there would need to be a disclosure about the absence of gold.

Difference Between Dura And Government? – Justice Ginsburg, in particular, noted that there appeared to be a difference between Dura’s position and the one put forward by the government, because the government allowed for the possibility that something other than a corrective disclosure might be sufficient to establish loss causation. Justice Scalia emphasized that plaintiffs simply need to show that the market knows the truth, however that truth comes to be revealed.

Government’s Position – The government’s counsel then argued that to establish loss causation, plaintiffs must demonstrate that the price inflation caused by any misrepresentation was removed or reduced by the dissemination of corrective information (but there is no need for a formal disclosure from the company).

Rule 8 vs. Rule 9(b) – Having established its basic position, the government’s counsel found himself in the awkward position of spending most of his time defending a proposition of law that was not really briefed in the case. At least two justices, Ginsburg and Stevens, appeared to feel strongly that the pleading of loss causation is only subject to the notice pleading requirements of Fed. R. Civ. P. 8. The government’s counsel countered that, as an element of fraud, loss causation must be plead with particularity pursuant to Fed. R. Civ. P. 9(b) and it was important to make an assessment about loss causation at the pleading stage of a case before defendants are forced to pay millions in discovery costs or settlement of the claims.

Need A Viable Theory of Loss? – Even if Broudo was only required to engage in notice pleading on the issue of loss causation, Justice Breyer questioned whether the complaint still needed to articulate a viable theory of loss. Broudo’s counsel conceded that the complaint could have contained more on this point, but later noted that the pleading was in conformity with 9th Circuit law at the time it was filed.

When Does Loss Occur? – As expected, a large portion of the argument concerned whether the 9th Circuit’s price inflation theory of loss causation (i.e., that the loss occurs, and a viable claim exists, at the time the purchaser buys the stock at an artificially inflated price) is correct. Broudo’s counsel argued in favor of the 9th Circuit’s position, but conceded that to show recoverable damages the plaintiffs would eventually have to establish that the inflation in the stock price was reduced or eliminated. A number of justices expressed skepticism that there could be any cause of action for fraud prior to actual damages having been suffered. Justices Souter and Scalia suggested that the inflation in the stock price simply established the limit of the potential loss, not that any loss had occurred. Justice Scalia also wondered whether the entire case was simply a “great misunderstanding,” since the parties both agreed that plaintiffs would eventually have to establish that the inflation in the stock price was reduced or eliminated. Broudo’s counsel noted, however, that there was also an issue over what plaintiffs needed to plead in their complaint on this issue and it may be possible for “lowered expectations” to result in stock price drops that are related to the fraud, even though the fraud is not revealed.

The PSLRA created a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. Under the first prong of the safe harbor, a defendant is not liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by “meaningful cautionary statements” that alert investors to the factors that could cause actual results to differ.

As discussed in a post in The 10b-5 Daily from last August entitled “The Safe Harbor May Just Be A Safe Puddle,” the U.S. Court of Appeals for the Seventh Circuit has weakened the protection afforded by the safe harbor. In Asher v. Baxter International, the court found that may be impossible, on a motion to dismiss, to determine whether a company’s cautionary statements are “meaningful.”

The New York Law Journal has an article (via law.com – free regist. req’d) discussing the Seventh Circuit’s decision and comparing it to a contrary decision issued by the Second Circuit last year. Baxter International apparently has indicated that it will appeal to the U.S. Supreme Court and the article suggests that this could be the next securities litigation issue, after loss causation in the Dura case, that the Court hears.

The National Law Journal has a solid preview (via law.com – free regist. req’d) of the Supreme Court argument in Dura Pharmaceuticals v. Broudo. Counsel for both parties in the case, which addresses the issue of loss causation, are quoted extensively. The argument will take place next Wednesday.

Securities litigators eagerly awaiting oral argument in Dura Pharmaceuticals v. Broudo, the loss causation case currently before the U.S. Supreme Court, will want to take a look at Dura’s reply brief (this post has links to the earlier briefs). The argument will take place on January 12, 2005. Thanks to SecuritiesLawblog for the link.

The chief executive officer (“CEO”) of MCG Capital Corp. (“MCG”) misled his company into believing that he had an undergraduate degree in economics from Syracuse University. MCG repeated this false statement in its SEC filings. Once the CEO admitted the truth, MCG corrected its public statements and the company’s stock price declined. A securities class action suit filed in the E.D. of Va. soon followed. The district court dismissed the case, finding that the CEO’s educational background was immaterial as a matter of law. Plaintiffs appealed.

In Greenhouse v. MCG Capital Corp., 2004 WL 2940871 (4th Cir. Dec. 21, 2004), the U.S. Court of Appeals for the Fourth Circuit has affirmed the district court’s decision. The court held that an action brought pursuant to Rule 10b-5 must “allege a fact that is both untrue and material.” It follows that Rule 10b-5 “does not prohibit any misrepresentation – no matter how willful, objectionable, or flatly false – of immaterial facts, even if it induces reactions from investors that, in hindsight or otherwise, might make the misrepresentation appear material.” The court went on to find that although the statements made about the CEO’s educational background were clearly false, they were immaterial because there was no credible basis for believing that the CEO’s lack of an undergraduate degree would have altered the “total mix” of information available to investors about the company.

Holding: Affirming dismissal.

Quote of note: “In conclusion, while we acknowledge that [the CEO’s] lie is indefensible, it does not follow invariably that it is illegal. We hold that, viewed properly, it is not substantially likely that reasonable investors would devalue the stock knowing that [the CEO] skipped out on his last year at Syracuse. That is, if one imagines a parallel universe of affairs where the one and only thing different was that MCG’s filings made no mention of [the CEO’s] education (or, instead, said simply that he ‘attended’ Syracuse or ‘studied economics’ there), we find it incredible to believe that MCG’s stock would be worth even a penny more to a reasonable investor.”

The U.S. Court of Appeals for the Third Circuit has issued an interesting decision on the tolling of the statute of limitations for class claims. In Yang v. Odom, No. 03-2951 (3rd Cir. Dec. 15, 2004), the court found that “where class certification has been denied solely on the basis of the lead plaintiffs’ deficiencies as class representatives, and not because of the suitability of the claims for class treatment,” the statute of limitations is tolled for subsequent class claims from the commencement of the earlier case until there is a final adverse determination of the earlier class claims. As a result of this holding, the plaintiffs will be able to proceed with their securities class action brought in the D. of N.J. even though a “substantively identical” securities class action brought in the N.D. of Ga. had previously had been denied class certification. (Note that there appears to be a circuit split on this issue that is discussed in the opinion.)

Quote of note: “Drawing the line arbitrarily to allow tolling to apply to individual claims but not to class claims would deny many plaintiffs with small, potentially meritorious claims the opportunity for redress simply because they were unlucky enough to rely upon an inappropriate lead plaintiff. For many, this would be the end result, while others would file duplicative protective actions in order to preserve their rights lest the class representative be found deficient under [F.R.C.P.] 23.”

Thanks to Adam Savett for sending in the case.

The Sarbanes-Oxley Act of 2002 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.

A growing majority of district courts has held that these claims must be dismissed. The U.S. Court of Appeals for the Second Circuit agrees. In In re Enterprise Mortgage Acceptance Co., LLC, Sec. Litig., 2004 WL 2785776 (2nd Cir. Dec. 6, 2004), the court, which combined a number of cases presenting this issue into one decision, held that Congress did not clearly provide or intend for retroactive application of the new statute of limitations. Accordingly, the court declined to revive any previously time-barred claims. (Note that this issue is also currently before the Eleventh Circuit.)

Holding: Dismissals affirmed.

Addition: In reaching its decision, the Second Circuit took judicial notice of the amicus brief filed by the SEC in the AIG Asian Infrastructure case, which urged the court to hold that Sarbanes-Oxley revived previously time-barred claims. The court rejected the SEC’s position and noted that the SEC was not entitled to any deference on the issue given that the new statute of limitations is only applicable to private actions, and not to SEC enforcement actions.

Two circuit court opinions were issued last week affirming dismissals based on the plaintiffs’ failure to adequately plead that any false or misleading statements were made.

In the 8th Circuit case, In re Amdocs Ltd. Sec. Litig., 2004 WL 2735530 (8th Cir. Dec. 2, 2004), the court held that the “bespeaks caution” doctrine rendered Amdocs’ statements about its customer demand immaterial as a matter of law because the statements were accompanied by warnings of market erosion.

In the 4th Circuit case, Nolte v. Capital One Financial Corp., 2004 WL 2749867 (4th Cir. Dec. 2, 2004), the court held that the plaintiffs had failed to adequately allege that Capital One’s management did not believe its stated opinions about the sufficiency of the company’s reserves and computer infrastructure. Moreover, the plaintiffs could not rely on a memorandum of understanding with federal regulators that required Capital One to make prospective changes to its business to establish that the company’s past practices were deficient.