Category Archives: Appellate Monitor

Insider stock sales are often used by plaintiffs to establish that the individual defendants had a motive to artificially inflate the company’s stock price. As a general matter, however, courts have held that insider stock sales cannot create an inference of fraudulent intent if the defendants only sold a small percentage of their overall holdings.

In its recent decision in Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226 (9th Cir. 2004), the Ninth Circuit purported to discover an exception to the rule. Larry Ellison, the CEO of Oracle, was alleged to have sold only 2.1% of his holdings during the class period, but that amounted to almost $900 million in proceeds. The court held that “where, as here, stock sales result in a truly astronomical figure, less weight should be given to the fact that they may represent a small portion of the defendant’s holdings.” But is that a sensible exception?

The Delaware Court of Chancery, which addressed the exact same stock sales in its recent summary judgment decision in In re Oracle Corp. Derivative Litigation, C.A. No. 18751 (Del. Ch. Dec. 2, 2004), appears to disagree. The court found that “however wealthy Ellison is and however envious that may make some, the fact remains that Ellison sold only 2% of his Oracle holdings. Ellison remained the person with more equity at stake in Oracle than anyone anywhere. Plaintiffs continually emphasize the nearly $1 billion that he made on the sale, but ignore the roughly $18.9 billion in equity that he lost in the ensuing share price collapse.” In other words, a billion dollars in stock sales may be significant for most people, but not necessarily for everyone.

Addition: The Delaware Court of Chancery’s decision can be found here. Thanks to Adam Savett for the link.

The respondents’ brief has been filed in Dura Pharmaceuticals v. Broudo, the loss causation case currently before the U.S. Supreme Court. Amicus briefs in support of Broudo’s position have been filed by the National Association of Shareholder and Consumer Attorneys, the New Jersey Department of the Treasury and its Division of Investment, and the Regents of the University of California (links will be posted when available).

Oral argument is set for January 12, 2005. The question presented is: “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.”

In Central Bank, the U.S. Supreme Court held that private action under Rule 10b-5 can only be brought against persons who are primary violators and not against those who aid and abet a primary violator. How to tell the difference between a primary violator and an aider and abettor, however, has been the subject of much debate.

The SEC has filed an amicus brief in the Homestore securities litigation currently pending before the U.S. Court of Appeals for the Ninth Circuit that urges the court to adopt a broad test for determining who is a “primary violator.” The lower court dismissed the claims against three companies – AOL Time Warner, Cendant, and L90 (as well as a few of their executives) – that were Homestore’s business partners in transactions whose alleged purpose was to inflate Homestore’s revenues. The lower court reasoned that these business partners could not be primary violators because they did not have a special relationship with Homestore (e.g., accountant or attorney).

The plaintiffs appealed these dismissals. In support of the plaintiffs, the SEC argues that Central Bank did not create a “special relationship” test for a primary violator and that engaging in a transaction whose purpose was to create a false appearance of revenues constitutes a deceptive act that can support primary liability.

Quote of note: “The Commission urges the following test for determining when a person’s conduct as part of a scheme to defraud constitutes a primary violation: Any person who directly or indirectly engages in a manipulative or deceptive act as part of a scheme to defraud can be a primary violator of Section 10(b) and Rule 10b-5; any person who provides assistance to other participants in a scheme but does not himself engage in a manipulative or deceptive act can only be an aider and abettor.”

The “collective scienter” theory is beginning to gain a foothold in securities litigation caselaw, even if courts are not expressly acknowledging the nature of their holdings. As a general matter, whether a defendant corporation has acted with scienter (i.e., fraudulent intent) is determined by looking “to the state of mind of the individual corporate official or officials who make or issue the statement . . . rather than generally to the collective knowledge of all the corporation’s officers and employees acquired in the course of their employment.” Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004). Another way of putting this is that courts recognize corporations only act through their officers and directors, and, therefore, can only be held liable for fraud if one or more of those individuals can be held liable for fraud. A steady trickle of decisions, however, appears to be rejecting this principle in favor of a collective scienter theory.

The U.S. Court of Appeals for the Sixth Circuit recently affirmed the dismissal of a securities class action against Ford based on statements relating to faulty tires, but the manufacturer of those tires has not been as fortunate. In City of Monroe Employees Retirement System v. Bridgestone Corp., No. 03-5505 (6th Cir. 2004), the court found that some of the statements made by Bridgestone and its wholly-owned subsidiary, Firestone, were actionable. On the issue of scienter, the court examined the state of mind of the corporate entities separately from the state of mind of the sole individual defendant (Firestone’s CEO). The court concluded that scienter was adequately plead against Bridgestone and Firestone, even though it failed to identify any individual officers or directors who acted with scienter. Moreover, the court rejected the scienter allegations against Firestone’s CEO and affirmed the dismissal of the claims against him. Leading to the inevitable question: if an officer makes the statement and a janitor knows the statement is false, has the corporation acted with fraudulent intent?

Holding: Affirmed in part and reversed in part.

The first set of briefs have been filed in Dura Pharmaceuticals v. Broudo, the loss causation case currently before the U.S. Supreme Court. Available on the web are Dura’s brief, along with amicus briefs from the Department of Justice and the SEC, the Chamber of Commerce of the United States, the Securities Industry Association and Bond Market Association, the American Institute of Certified Public Accountants, and Technology Network. (The Washington Legal Foundation, Broadcom, and Merrill Lynch also filed amicus briefs and links will be posted when available.)

Dura and its supporters argue that, contrary to the Ninth Circuit’s holding, a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead and prove loss causation. Broudo’s time to respond has been extended until November 17.

Addition: The Merrill Lynch brief can be found here. (Thanks to Adam Savett for the link.)

The battle in the McKesson HBOC securities litigation over whether providing investigatory reports to the SEC and the DOJ constitutes a waiver of attorney-client privilege continues – now in federal court. Last February, the California Court of Appeal held in a case involving McKesson that providing investigatory reports to government entities was a waiver under California law.

Some of McKesson’s former executives have been indicted by the DOJ and also want access to the reports. A federal district court agreed with the California Court of Appeal that the privilege had been waived, but McKesson wants to prevent the reports from going to the shareholder plaintiffs who have brought cases against it in federal court. McKesson appealed the decision and the SEC is supporting the company’s position. The Recorder has an article (via law.com – free regist. req’d) on the recent hearing before the U.S. Court of Appeals for the Ninth Circuit.

Quote of note: “White-collar practitioners are closely watching the case, U.S. v. Bergonzi, 03-10511, because it highlights the collision of civil and criminal prosecutions in cases of alleged corporate wrongdoing. Companies share internal reports in order to win favor with government investigators. But if those reports end up exposing them to liability in securities fraud suits, they may not be as cooperative on the criminal side.”

In the Baxter decision issued in July, the U.S. Court of Appeals for the Seventh Circuit severely limited the application of the PSLRA’s safe harbor by holding that it may be impossible, on a motion to dismiss, to determine whether a company’s cautionary statements are “meaningful.” Baxter may turn out to be influential, but for the moment other appellate courts are continuing to affirm dismissals based on the safe harbor.

In Baron v. Smith, 2004 WL 1847751 (1st Cir. Aug. 18, 2004) the U.S. Court of Appeals for the First Circuit addressed claims based on forward-looking statements in a press release. The court cited the company’s safe harbor language and found that to “the extent that plaintiffs seek to state a claim under the securities laws for a deceptive press release or as an indication that the company omitted material information from its filings, we agree with the district court that the press release contained forward-looking statements, as stated therein, and therefore comes under the protection of the statutory safe harbor.”

Holding: Affirming grant of motion to dismiss.

In a high-profile securities class action brought against Oracle Corp., the U.S. Court of Appeals for the Ninth Circuit has reversed the lower court’s decision to dismiss the case with prejudice. The issue on appeal was whether the plaintiffs had plead a strong inference of scienter (i.e., fraudulent intent) as required by the PSLRA. The decision can be found here and The Recorder has an article (via law.com – free regist. req’d) summarizing the holding.

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 such 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. District courts are split (although the trend appears to be against reviving time-barred claims) and the issue is currently before the U.S. Court of Appeals for the 11th Circuit.

In the midst of this debate, the Wall Street Journal reports (subscrip. req’d) that the SEC has filed an amicus brief in the U.S. Court of Appeals for the Second Circuit arguing that Sarbanes-Oxley did revive time-barred claims. The SEC’s primary argument is that Congress was not required to specifically express its “retroactive intent” and the “natural meaning of the statutory language” supports its position. The underlying case, AIG Asian Infrastructure Fund, L.P. v. Chase Manhattan Asia Limited, et al., alleges Rule 10b-5 violations based on a 1998 purchase of securities.

Addition: In related news, the Legal Intelligencer has an article (via law.com – free regist. req’d) today on a district court decision (from the E.D. of Pa.) that rejects the revival of time-barred claims.

The U.S. Court of Appeals for the Sixth Circuit has upheld the dismissal of a securities class action originally brought against Ford Motor Co. in 2000. The plaintiffs alleged that Ford failed to disclose safety problems with the tires on its Ford Explorer vehicles (prior to a tire recall) and failed to account for the possibility of future recall costs as a loss contingency.

In its decision (In re Ford Motor Co. Sec. Litig., 2004 WL 1873808 (6th Cir. August 23, 2004)), the court found that none of the alleged misrepresentations were actionable. Most of the statements were “either mere corporate puffery or hyperbole” and did not specifically address the safety of Ford Explorers. As for the few statements that did talk about the safety of Ford Explorers, the court held that the plaintiffs failed to establish that these statements were knowingly or recklessly false. Ford also warned investors about potential recall costs and the plaintiffs did not “allege any facts that establish that anyone at Ford thought or anticipated a massive recall of tires was necessary in the United States before the recall was announced.”

Holding: Motion to dismiss with prejudice affirmed.