Category Archives: Appellate Monitor

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.

In a controversial decision, the U.S. Court of Appeals for the Seventh Circuit has held that it may be impossible, on a motion to dismiss, to determine whether a company’s cautionary statements are “meaningful.” In Asher v. Baxter Intern. Inc., 2004 WL 1687885 (7th Cir. July 29, 2004), the court addressed whether Baxter’s published risk factors were sufficient to foreclose liability for its allegedly false financial projections. The court, in an opinion authored by Judge Easterbrook, made three important holdings:

(1) The plaintiffs relied on the fraud-on-the-market theory (i.e., reliance by investors on an alleged misrepresentation is presumed if the company’s shares were traded on an efficient market) in bringing their claims. The court found that an “investor who invokes the fraud-on-the-market theory must acknowledge that all public information is reflected in the price.” Accordingly, a company’s cautionary statements, no matter where found, “must be treated as if attached to every one of its oral and written statements.”

(2) A company does not have to have “prevision.” It is enough for the cautionary statements “to point to the principal contingencies that could cause actual results to depart from the projection.”

(3) Nevertheless, the court found that Baxter’s cautionary statements, though company-specific and not boilerplate, may have fallen short because there “is no reason to think – at least, no reason that a court can accept at the pleading stage, before plaintiffs have access to discovery – that the items mentioned in Baxter’s cautionary language were those thought at the time to be the (or any of the) ‘important’ sources of variance.” The court noted that Baxter’s cautionary language had remained fixed even as the risks faced by the company changed.

Prior to Baxter, numerous courts had dismissed cases pursuant to the first prong of the Safe Harbor (see, e.g., the Blockbuster decision). The Seventh Circuit’s holding cuts sharply against the prevailing judicial trend and weakens the protections of the Safe Harbor. Will other circuit courts adopt the Seventh Circuit’s reasoning?

Quote of note: “What [plaintiffs] do say is that the projections were too rosy, and that Baxter knew it. That charges the defendants with stupidity as much as with knavery, for the truth was bound to come out quickly, but the securities laws forbid foolish frauds along with clever ones.”

Quote of note II: “[A] word such as ‘meaningful’ resists a concrete rendition and thus makes administration of the safe harbor difficult if not impossible. It rules out a caution such as: ‘This is a forward-looking statement: caveat emptor.’ But it does not rule in any particular caution, which always may be challenged as not sufficiently ‘meaningful’ or not pinning down the ‘important factors that could cause actual results to differ materially’–for if it had identified all of those factors, it would not be possible to describe the forward-looking statement itself as materially misleading.”

The Second and Ninth Circuits previously have held that a district court’s decision to remand a case that has been removed under the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) is not appealable. In a decision issued this week, the Seventh Circuit has disagreed.

SLUSA generally prohibits the bringing of a securities class action based on state law in state court. The defendants are permitted to remove the case to federal district court for a determination on whether the case is preempted by the statute. If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.

A remand based on a district court’s decision that it does not have subject-matter jurisdiction over a case cannot be reviewed on appeal. In Kircher v. Putnam Funds Trust, 2004 WL 1470350 (7th Cir. June 29, 2004), however, the Seventh Circuit found that this general proposition is inapplicable to a case removed and remanded under SLUSA. The Supreme Court “has observed that a court lacks ‘subject-matter jurisdiction’ only when Congress has not authorized the federal judiciary to resolve the sort of issue presented by the case (or the Constitution forbids adjudication).” In contrast, SLUSA expressly authorized the district court to accept the removal of the Kircher case and “[o]nly after making the substantive decision that Congress authorized it to make [i.e., whether the case was preempted] did the district court remand.” This means that the district court had “no adjudicatory competence to do more,” the Seventh Circuit concluded, not that it lacked subject-matter jurisdiction. Accordingly, a SLUSA remand may be appealed.

Holding: Appeal will proceed to briefing and a decision on the merits.

Quote of note: “Both the second and ninth circuits were mesmerized by the word ‘jurisdiction’ and did not see the difference between a case that never should have been removed and a case properly removed and remanded only when the federal job is done.”

Quote of note II: “Appellate consideration of what amounts to a venue dispute slows things down to little good end, for the state court is competent to address the merits. SLUSA means, however, that one specific substantive decision in securities litigation must be made by the federal rather than the state judiciary. Appellate review of decisions under [SLUSA] will promote accurate and consistent implementation of that statute, at little cost in delay beyond what the authorized removal itself creates.”

It turns out that the combination of a clear circuit split, the U.S.’s encouragement, and yet another opportunity to overturn the Ninth Circuit, is irresistible. The Associated Press reports that the Supreme Court has granted the cert petition filed by the defendants in the Dura Pharmaceuticals securities litigation, which should lead to a resolution of the circuit split over what is necessary to adequately plead loss causation in a securities fraud case.

A majority of circuit courts hold that a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead loss causation, while a minority of circuit courts hold that a plaintiff merely needs to demonstrate that the alleged misrepresentations artificially inflated the stock price. In Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003), the Ninth Circuit came down squarely in favor of the minority position.

The court found that loss causation “merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause.” Based on this holding, the Ninth Circuit reversed the lower court’s dismissal and remanded the case for further proceedings. The defendants petitioned for a writ of certiorari to the Supreme Court. The U.S. (the SEC and the Solicitor General) later filed an amicus brief in support of the petition, arguing that the case was wrongly decided and the Supreme Court should adopt the majority position. Will it? Stay tuned.

In an unusual opinion, the U.S. Court of Appeals for the Eleventh Circuit has clarified its position on the pleading of scienter (i.e., fraudulent intent) under the PSLRA. The district court in the Scientific-Atlanta securities litigation had denied the defendants’ motion to dismiss, finding that “although individual allegations in the complaint, considered in isolation, may not have given rise to a strong inference of scienter, the allegations created such an inference when viewed collectively.” The defendants petitioned for interlocutory appeal, which the district court certified on the narrow question of whether factual allegations may be aggregated to create the necessary strong inference.

In Phillips v. Scientific-Atlanta, Inc., 2004 WL 1382906 (11th Cir. June 22, 2004) the Eleventh Circuit affirmed the lower court’s ruling. The PSLRA states that the complaint “shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” As a threshold matter, the court noted “the Defendants have largely conceded the narrow, certified question and have attempted to parlay the appeal into a much broader review of the district court.” Under these circumstances, the court had little difficulty joining a number of other circuits in finding that nothing in the PSLRA suggests that scienter may only be inferred from individual facts.

The court also went beyond the certified question and found that scienter must be adequately plead with respect to each defendant and with respect to each alleged violation. In the instant case, however, “Plaintiffs’ complaint sufficiently alleges facts giving rise to a strong inference of scienter on the part of each defendant alleged to have committed each violation of the statute.”

Holding: Denial of motion to dismiss affirmed.

Quote of note: “We believe that the plain meaning of the statutory language compels the conclusion that scienter must be alleged with respect to each alleged violation of the statute. Although the plain language is less compelling with respect to alleging the scienter of each defendant, the statute does use the singular term ‘the defendant,’ and we believe that the most plausible reading in light of congressional intent is that a plaintiff, to proceed beyond the pleading stage, must allege facts sufficiently demonstrating each defendant’s state of mind regarding his or her alleged violations.”

On Tuesday, the U.S. Court of Appeals for the Third Circuit affirmed the dismissal, with prejudice, of the Alpharma securities class action. See In re Alpharma, Inc. Sec. Litig., 2004 WL 1326013 (3rd Cir. June 15, 2004). A few highlights from the opinion:

(1) Collective scienter – The court appeared to reject the idea that a corporate defendant’s scienter (i.e., fraudulent intent) can be properly alleged on the basis of the collective knowledge of all of the corporation’s officers and employees. The plaintiffs alleged that a sales manager in one of Alpharma’s divisions notified employees in the main office of accounting irregularities. The court held that “the mere fact that the information was sent to Alpharma’s headquarters and therefore was available for review by the individual defendants is insufficient to ‘giv[e] rise to a strong inference that [defendants] acted with the required state of mind.'”

(2) Insider stock sales – The court held that the insider stock sales were not unusual in their scope or timing and, therefore, could not support a strong inference of scienter. The allegation that the defendants had not sold any stock during the preceding fifteen months was deemed insufficient. The defendants asserted they were precluded from selling any stock by a blackout period. Although the court could not technically consider this assertion, it found that the “plaintiffs failed to allege the absence of a blackout period or other facts which would demonstrate that the fifteen month period of inactivity was in any way unusual.”

(3) Leave to amend – The court upheld the district court’s denial of leave to amend where the plaintiffs had failed to proffer any proposed amendment. The denial was “further supported by the fact that plaintiffs (1) had already filed previous complaints and (2) were given an extension of time to assemble the amended consolidated complaint currently at issue.”
Holding: Affirm grant of motion to dismiss with prejudice.

As The 10b-5 Daily has frequently discussed (indeed, this is the third post in a row on the topic), there is a circuit split over what is necessary to adequately plead loss causation in a securities fraud case. A majority of the courts hold that a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead loss causation, while a minority of courts hold that a plaintiff merely needs to demonstrate that the alleged misrepresentations artificially inflated the stock price.

In Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003), the Ninth Circuit came down firmly in the minority camp. The court found that loss causation “merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause.” Based on this holding, the court reversed the lower court’s dismissal and remanded the case for further proceedings. (See this postdiscussing the opinion.) The defendants petitioned for a writ of certiorari to the Supreme Court.

On Friday, the U.S. (the SEC and the Solicitor General) filed an amicus brief in support of the defendants’ petition. In the brief, the U.S. argues that there is “an acknowledged circuit conflict regarding the nature and scope of the plaintiff’s burden to plead and prove loss causation in a fraud-on-the-market case under Rule 10b-5; the court of appeals decided that question incorrectly; the question is one of recurring importance; and this case is a suitable vehicle for resolving it.”

Specifically on the issue of whether the case was incorrectly decided, the U.S. makes two main arguments. First, the U.S. argues that measuring the loss in these types of cases “as of the time of the purchase, and not requiring any allegations of a subsequent loss of value attributable to the fraud, would grant a windfall to investors who sold before the reduction or elimination of the artificial inflation, because they would recover the portion of the purchase price attributable to the fraud on resale, and then would be entitled to recover that same amount again in damages.” Second, the U.S. argues that the decision improperly conflated the separate elements of transaction causation (i.e., the alleged misconduct induced the plaintiff to engage in the transaction in question) and loss causation (i.e., the alleged misconduct caused the plaintiff’s economic loss).

The Supreme Court rarely takes on securities litigation issues. But the combination of a clear circuit split, the U.S.’s encouragement, and yet another opportunity to overturn the Ninth Circuit, may well prove irresistible.

In the typical securities class action, the plaintiffs allege the defendant company made material misrepresentations that inflated the value of the company’s stock. But what if the alleged misrepresentations also inflated the value of another company’s stock? Do the purchasers of the second company’s stock have standing to sue the first company?

The U.S. Court of Appeals for the Second Circuit thinks this is stretching the boundaries of Rule 10b-5 too far. In Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks Corp., 2004 WL 1110496 (2d Cir. May 19, 2004), the court addressed whether purchasers of JDS Uniphase stock, which was in the process of selling its laser business to Nortel during the class period, had standing to sue Nortel for alleged misstatements about Nortel’s business prospects that inflated the stock prices of both companies. Based on Supreme Court precedent, the court found that the purchaser-seller requirement for Rule 10b-5 liability limits standing to those who have dealt in the security to which the misrepresentation relates. (The court left open the question, however, of whether a potential merger between two companies, which would create a more direct relationship between the companies’ stock prices, might require a different outcome.)

Holding: Affirming lower court’s dismissal.

Quote of note: “Stockholders do not have standing to sue under Section 10(b) and Rule 10b-5 when the company whose stock they purchased is negatively impacted by the material misstatement of another company, whose stock they do not purchase.”

Under the fraud on the market theory, reliance by investors on an alleged misrepresentation is presumed if the company’s shares were traded on an efficient market. The investors are not entitled to the presumption, however, if they are unable to show that the misrepresentation actually affected the market price of the stock.

The U.S. Court of Appeals for the Fifth Circuit issued an opinion this week, Greenberg v. Crossroads Systems, Inc., No. 03-50311 (5th Cir. April 14, 2004), discussing the fraud on the market theory in a case where the plaintiffs failed to establish that the defendants’ falsely positive statements had increased the company’s stock price. Under these circumstances, the determinations of reliance and loss causation essentially merged, with the court holding that the plaintiffs were only entitled to a presumption of reliance for the falsely positive statements that they could connect to the subsequent decline in the company’s stock price when the “truth” was revealed.

Holding: Affirming in part and vacating in part the district court’s grant of summary judgment.

Quote of note: “We are satisfied that plaintiffs cannot trigger the presumption of reliance by simply offering evidence of any decrease in price following the release of negative information. Such evidence does not raise an inference that the stock’s price was actually affected by an earlier release of positive information. To raise an inference through a decline in stock price that an earlier false, positive statement actually affected a stock’s price, the plaintiffs must show that the false statement causing the increase was related to the statement causing the decrease. Without such a showing there is no basis for presuming reliance by the plaintiffs.”

Here’s a good law school exam question — does a finding of liability under Rule 10b-5 in a private securities case require a reward of damages? The U.S. Court of Appeals for the Fourth Circuit submitted an essay answer today in the form of an opinion in Miller v. Asensio & Co., Inc., No. 03-1225 (4th Cir. April 14, 2004).

Asensio was a short seller that publicized negative statements about Chromatics Color Sciences Int., Inc. (“CCSI”), a company in which it had a significant short sell interest. Stockholders of CCSI sued Asensio alleging that the statements were material misrepresentations, “which Asensio initiated to defraud the market for its benefit, and which caused their CCSI stock to decline in value resulting in substantial losses to them.” After a trial, the jury returned a verdict finding Asensio liable, but awarding $0.00 in damages. On appeal, the stockholders argued that the finding of liability required the award of damages in some amount.

The Fourth Circuit disagreed (after noting that the issue was one of first impression). Courts “often refer to the fact of proximately caused damage and the amount of proximately caused damage as involving separate, although related, inquiries.” To establish Rule 10b-5 liability, a plaintiff only has to prove that the defendant’s misrepresentation was a “substantial cause of the loss” by showing a “direct or proximate relationship between the loss and the mispresentation.” Accordingly, a jury could find that “(1) the plaintiff proved the defendant’s fraud constituted a substantial cause of plaintiff’s loss and so find the defendant liable but (2) the plaintiff failed to provide a method to discern, by just and reasonable inference, the amount of plaintiff’s loss solely caused by defendant’s fraud, and so refuse to award the plaintiff any damages.”

Applying these principles to the case in hand, the Fourth Circuit found that “the evidence at trial provided the jurors with a sound basis on which to reach the result they did.”

Holding: Affirmed.

Quote of note: “In the vast majority of cases, a finding of the fact of proximately caused loss will result in the award of some amount of damages. However, it would seem contrary to Congress’ mandate that a plaintiff prove that the defendant ’caused the loss,’ 15 U.S.C. § 78u4(b)(4), and that no plaintiff ‘shall recover . . . a total amount in excess of his actual damages on account of the act complained of,’ 15 U.S.C. § 78bb(a), to direct a jury that it must award damages, even if faced, as here, with a record from which it cannot do so.”