Category Archives: Appellate Monitor

Can the announcement of an investigation act as a “corrective disclosure” sufficient to support the existence of loss causation?  Last year, the Eleventh Circuit concluded that investigations do not “in and of themselves, reveal[] to the market that a company’s previous statements were false or fraudulent.”

In Loos v. Immersion Corp., 2014 WL 3866084 (9th Cir. Aug. 7, 2014), the Ninth Circuit has agreed with the Eleventh Circuit’s reasoning.  In particular, the court noted that because the disclosure of an investigation “simply puts investors on notice of a potential future disclosure of fraudulent conduct . . . any decline in a corporation’s share price following the announcement of an investigation can only be attributed to market speculation about whether fraud has occurred.”  Accordingly, “the announcement of an investigation, without more, is insufficient to establish loss causation.”

Holding: Dismissal affirmed.

Addition: Interestingly, this month the Ninth Circuit added a footnote to the decision clarifying that it did not “mean to suggest that the announcement of an investigation can never form the basis of a viable loss causation theory.”  Instead, the court was merely adopting the Eleventh Circuit’s position that the announcement of an investigation “standing alone and without any subsequent disclosure of actual wrongdoing, does not reveal to the market the pertinent truth of anything, and therefore does not qualify as a corrective disclosure.”

Next term, the U.S. Supreme Court will hear argument in the Omnicare case.  The issue in Omnicare is the pleading standard for a claim under Section 11 of the Securities Act alleging a false or misleading opinion.  While the Second, Third, and Ninth Circuits have held that the plaintiff must allege the statement was both objectively and subjectively false – requiring allegations that the speaker’s actual opinion was different from the one expressed – in Omnicare the Sixth Circuit held that if a defendant “discloses information that includes a material misstatement [even if it is an opinion], that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity.”

While Omnicare is pending, the Tenth Circuit has provided its own views on the subject.  In MHC Mutual Conversion Fund, L.P. v. Sandler O’Neill & Partners, L.P., 2014 WL 3765717 (10th Cir. Aug. 1, 2014), the court identified at least three possible conclusions that could be drawn from Section 11 and relevant legal precedent.  First, the court noted that “many common law authorities took a dim view of opinion liability” and one could find that Section 11 liability simply does not extend to opinions (as opposed to misstatements of fact).  Second, “an opinion can qualify as a factual claim by the speaker regarding his current state of mind.”  In that case, the opinion might be actionable if the plaintiff shows “both that the defendant expressed an opinion that wasn’t his real opinion (sometimes called ‘subjective disbelief’) and that the opinion didn’t prove out in the end (sometimes called ‘objective falsity’).”  Finally, there is support in the law for the view that “at least some subset of opinions about future events contain within them an implicit factual warranty that they rest on an objectively reasonable basis – and providing an opinion without an objectively reasonable foundation, at least without disclosing that deficiency, can give rise to a claim for negligent misrepresentation.”

Although the Tenth Circuit – in line with the majority view – appeared inclined to require allegations of both objective and subjective falsity, it found that it did not have to resolve the issue.  Even under the “objectively reasonable basis test,” the plaintiffs had failed to undermine the conclusion that the company had “a reasonable (if not universally shared) basis for the opinion it expressed.”  Moreover, the company had clearly disclosed that its “opinion about the prospects for its securities wasn’t unqualified – that an essential premise of the opinion rested on a judgment about near-term economic trends, a judgement that could well fail to bear out.”

Holding: Dismissal affirmed.

Quote of note:  “For centuries legions accepted Newtonian physics without qualification.  Last year some of us fervently believed the Broncos would win the Super Bowl.  In 2008, no doubt there were those who genuinely thought the market for mortgage backed securities would rebound.  Events have disproved each of these opinions, but that hardly means the opinions were anything other than honestly offered – true opinions at the time made.”

In its Morrison decision, the U.S. Supreme Court addressed the extraterritorial application of Section 10(b) and held that the statute only applies to “transactions in securities listed on our domestic exchanges, and domestic transactions in other securities.” While this formulation clearly excludes foreign transactions, does it conversely mean that any “domestic transaction” in a foreign security can be subject to potential Section 10(b) liability?

The Second Circuit had the opportunity to address this question in a case involving an unusual fact pattern. In Parkcentral Global Hub Ltd. v. Porsche Automobile Holdings SE, 2014 WL 3973877 (2d Cir. August 15, 2014) , the plaintiffs had entered into “securities based-swap agreements pegged to the price of VW [Volkswagen] shares, which trade on European stock exchanges, to bet that VW stock would decline in value.” The plaintiffs alleged that VW “made various fraudulent statements and took various manipulative actions to deny and conceal Porsche’s intention to take over VW.” When it became public that Porsche would take over VW, “the price of VW shares rose dramatically, causing the plaintiffs to suffer large losses.”

While the Second Circuit assumed, for purposes of its decision, that the swap agreements were “executed and performed in the United States,” it found that this was not sufficient under Morrison to justify the application of Section 10(b). First, the Supreme Court “never said that an application of § 10(b) will be deemed domestic whenever such a transaction is present.” Second, applying the statute “to wholly foreign activity clearly subject to regulation by foreign authorities solely because a plaintiff in the United States made a domestic transaction” would “inevitably place § 10(b) in conflict with the regulatory laws of other nations.” As to the VW-related swap agreements, the court held “that the relevant actions in this case are so predominately German as to compel the conclusion that the complaints fail to invoke § 10(b) in a manner consistent with the presumption against extraterritoriality.”

Holding: Dismissal affirmed and case remanded for proceedings consistent with decision.

Quote of note: “We have neither the expertise nor the evidence to allow us to lay down, in the context of the single case before us, a rule that will properly apply the principles of Morrison to every future § 10(b) action involving the regulation of securities-based swap agreements in particular or of more conventional securities generally. Neither do we see anything in Morrison that requires us to adopt a ‘bright-line’ test of extraterritoriality when deciding every § 10(b) case. . . . It is enough to say that we think our decision in this case is compelled by the text of the Exchange Act and the principles underlying the Supreme Court’s decision in Morrison, as applied to our facts.”

In its recent Chadbourne decision, the U.S. Supreme Court held that to be “in connection with” the purchase or sale of a security, an alleged securities fraud must involve “victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintaned an ownership interest in financial instruments that fall within the relevant statutory definition.” Whether that requirement is met, of course, depends heavily on the particular facts at issue.

In Hidalgo-Velez v. San Juan Asset Management, Inc., 2014 WL 3360698 (1st Cir. July 9, 2014) the court addressed whether SLUSA preemption, which applies only to cases involving the purchase or sale of securities traded on a national exchange (“covered securities”), could be invoked if the plaintiffs were investors in a fund that promised to invest at least 75% of its assets “in certain specialized notes offering exposure to North American and European bond indices.” As a threshold matter, the fund shares were not covered securities. The court found, however, that “the analysis does not invariably end there.” To the extent that “the primary intent or effect of purchasing an uncovered security is to take an ownership interest in a covered security,” the “in connection with” requirement could still be met.

The court held that in analyzing this issue, the “relevant questions include (but are not limited to) what the fund represents its primary purpose to be in soliciting investors and whether covered securities predominate in the promised mix of investments.” In the instant case, it was clear the fund was marketed “principally as a vehicle for exposure to uncovered securities” (i.e., the specialized notes). Accordingly, the “in connection with” requirement was not met and SLUSA preemption did not apply.

Holding: Judgment of dismissal vacated, reversal of order denying remand, and remittal of case with instructions to return it to state court.

Quote of note: “As pleaded, the plaintiffs’ case depends on averments that, in substance, the defendants made misrepresentations about uncovered securities (namely, those investments that were supposed to satisfy the 75% promise); that the plaintiffs purchased uncovered securities (shares in the Fund) based on those misrepresentations; and that their primary purpose in doing so was to acquire an interest in uncovered securities. Seen in this light, the connection between the misrepresentations alleged and any covered securities in the Fund’s portfolio is too tangential to justify bringing the SLUSA into play.”

In Spitzberg v. Houston American Energy Corp., 2014 WL 3442515 (5th Cir. July 15, 2014), the Fifth Circuit reversed the dismissal of a securities class action based on alleged false statements concerning oil and gas reserves. The decision contains a few interesting holdings.

(1) Scienter – The district court found, among other things, that the company’s decision to spend $5 million on more testing of one of its wells “would not make sense” if the defendants had believed that no oil or gas would be found. The Fifth Circuit noted, however, that this testing took place after the company had been “heavily criticized” for making optimistic statements regarding its reserves. Accordingly, it was just as plausible that the defendants “may have felt the need to substantiate the allegedly irresponsible statements they had made previously.”

(2) Loss Causation – The district court held that the complaint “warranted dismissal because it did not allege specifically whether the alleged misstatements or omissions were the actual cause of [the plaintiffs’] economic loss as opposed to other explanations, e.g., changed economic circumstances or investor expectations or industry-specific facts.” The Fifth Circuit disagreed with this pleading standard. Instead, the court concluded that “the PSLRA does not obligate a plaintiff to deny affirmatively that other facts affected the stock price in order to defeat a motion to dismiss.”

(3) Forward-looking Statements – The Fifth Circuit joined “the First Circuit, Third Circuit, and Seventh Circuit in concluding that a mixed present/future statement is not entitled to the [PSLRA safe harbor for forward-looking statements] with respect to the part of the statement that refers to the present.” In particular, while the company’s statements concerning the commercial productability of its wells were forward-looking, to the extent that its statements about “reserves” communicated information on past testing of the wells, those statements were actionable.

Holding: Reversed and remanded for further proceedings.

The U.S. Supreme Court has issued a decision in the Halliburton case holding that defendants can rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence of a lack of stock price impact. It is a 9-0 decision authored by Chief Justice Roberts, although Justice Thomas (joined by Justices Alito and Scalia) concurred only in the judgment. As discussed in a February 2010 post on this blog, Halliburton has a long history that now includes two Supreme Court decisions on class certification issues. A summary of the earlier Supreme Court decision can be found here.

Under the fraud-on-the-market presumption, reliance by investors on a misrepresentation is presumed if the misrepresentation is material and the company’s shares were traded on an efficient market that would have incorporated the information into the stock price. The fraud-on-the-market presumption is crucial to pursuing a securities fraud case as a class action – without it, the proposed class of investors would have to provide actual proof of its common reliance on the alleged misrepresentation, a daunting task for classes that can include thousands of investors.

The fraud-on-the-market presumption, however, is not part of the federal securities laws. It was judicially created by the Supreme Court in a 1988 decision (Basic v. Levinson). In Halliburton, the Court agreed to revisit that decision, but ultimately decided that there was an insufficient “special justification” for overturning its own precedent.

The Court rejected the following key arguments. First, Halliburton argued that the fraud-on-the-market presumption was no longer tenable because (a) there is substantial empirical evidence that capital markets are not fundamentally efficient, and (b) investors do not always invest in reliance on the integrity of a stock’s price. The Court found, however, that the Basic decision was not undermined by either of these arguments because it was based “on the fairly modest premise that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.” Accordingly, “[d]ebates about the precise degree to which stock prices accurately reflect public information are . . . largely beside the point” and it is sufficient that most investors do rely, either directly or indirectly, on the accuracy of stock prices.

Second, Halliburton argued that the fraud-on-the-market presumption could not be reconciled with more recent Court decisions making it clear that plaintiffs must prove that their proposed class meets all of the certification requirements imposed by the Federal Rules of Civil Procedure. The Court disagreed, noting that plaintiffs who invoke the fraud-on-the-market presumption must still prove certain prerequisites for that presumption – publicity, market efficiency, and market timing – before class certification.

Finally, Halliburton argued that the fraud-on-the-market presumption, by facilitating securities class actions, “allow[s] plaintiffs to extort large settlements from defendants from meritless claims; punish innocent shareholders, who end up having to pay settlements and judgments; impose excessive costs on businesses; and consume a disproportionately large share of judicial resources.” The Court found that these “concerns are more appropriately addressed to Congress, which has in fact responded, to some extent, to many of the issues raised by Halliburton and its amici.” Moreover, the fact that Congress “may overturn or modify any aspect of our interpretations of the reliance requirement, including the Basic presumption itself” supports the notion that the principle of stare decisis should be applied to the Basic decision.

Although the Court was unwilling to overturn Basic, it did agree with Halliburton that defendants should be able to rebut the fraud-on-the-market presumption with evidence that the alleged misrepresentation did not actually affect the stock price. Notably, price impact evidence is already used at the class certification stage “for the purpose of countering a plaintiff’s showing of market efficiency” by establishing that the stock price did not react to publicly reported events. If it can be used to rebut this prerequisite for the fraud-on-the-market presumption (which is nothing more than “an indirect showing of price impact”), the Court found that it also should be available to directly rebut the presumption as to the specific misrepresentation.

Holding: Vacated judgment and remanded for further proceedings consistent with opinion.

Notes on the Decision:

(1) There are two concurrences, which go in radically opposite directions. A concurrence authored by Justice Ginsburg (joined by Justices Breyer and Sotomayor) simply states that she joins the opinion because she understands that it “should impose no heavy toll on securities-fraud plaintiffs with tenable claims.” In contrast, Justice Thomas (joined by Justices Scalia and Alito) concurs only in the judgment and forcefully argues that the Basic decision should be overturned, noting that “[t]ime and experience have pointed up the error of that decision, making it all too clear that the Court’s attempt to revise securities law to fit the alleged new realities of financial markets should have been left to Congress.”

(2) Missing from the fray is Justice Kennedy, who joined Justice Thomas’ dissent in the recent Amgen decision. In that dissent, Justice Thomas expressed skepticism about the continued vitality of the fraud-on-the-market presumption. A number of commentators therefore assumed that Justice Kennedy was interested in overturning the Basic decision. Apparently not.

Disclosure: The author of The 10b-5 Daily submitted an amicus brief on behalf of the Washington Legal Foundation in support of petitioner. The amicus brief primarily argued that the Court should permit defendants to rebut the fraud-on-the-market presumption with price impact evidence.

In 2003, America Online (AOL) investors brought a securities class action alleging that Credit Suisse First Boston (CSFB) fraudulently withheld relevant information from the market in its reporting on the AOL-Time Warner merger. After many years of litigation, the D. of Mass. granted summary judgment to CSFB, finding that the plaintiffs had failed to raise a triable issue of fact as to loss causation.

The key basis for the district court’s decision was its rejection of the plaintiffs’ expert study. In particular, the district court found that the study improperly (a) cherry-picked days with unusual stock price volatility, (b) overused dummy variables to make it appear that AOL’s stock price was particularly volatile on the days CSFB issued its reports, (c) attributed “volatility in AOL’s stock price to the reports of defendants analysts when, at the time of the inflation or deflation, an efficient market would have already priced in the reports,” and (d) failed to conduct “an intra-day trading analysis for each event day with confounding information (which is, to say, nearly all of them) in order to provide the jury with some basis for discerning the cause of the stock price fluctuation.”

On appeal, the First Circuit affirmed the exclusion of the expert testimony and the grant of summary judgment. See Bricklayers and Trowel Trades Int’l Pension Fund v. Credit Suisse Securities (USA) LLC, 2014 WL 1910961 (1st Cir. May 14, 2014). The appellate court disagreed that the expert’s use of dummy variables was “inconsistent with the methodology or goals of a regression analysis” and concluded that it was a “dispute that should be resolved by the jury.” However, the other three deficiencies identified by the district court were “more than sufficient” to find that the district court had not abused its discretion.

The plaintiffs argued that affirming the district court’s decision was inappropriate because it was uncontested that 5 of the event days identified by the expert as having “statistically significant abnormal returns” (out of a total of 57 days) “did not suffer from any methodological infirmities.” While the appellate court conceded that it could be an abuse of discretion to reject “mostly salvageable expert testimony for narrow flaws,” in this case it “confront[ed] the reverse situation – pervasive problems with [the expert’s] event study that, allegedly, still leave a few dates unaffected.” Under these circumstances, the district court properly treated the entire event study as inadmissible.

Holding: Affirming exclusion of expert testimony and grant of summary judgment to defendants.

Quote of note: “Requiring judges to sort through all inadmissible testimony in order to save the remaining portions, however small, would effectively shift the burden of proof and reward experts who fill their testimony with as much borderline material as possible. We decline to overturn the district court’s ruling on this specious logic.”

In its Morrison decision, the U.S. Supreme Court held that Section 10(b) (the primary federal anti-securities fraud statute) only provides a private cause of action for claims based on “[1] transactions in securities listed on domestic exchanges, and [2] domestic transactions in other securities.” A number of subsequent lower court decisions have explored the scope of those two categories, with most of the decisions taking the view that they should be strictly construed to limit Section 10(b) claims to transactions that take place within the United States.

In the UBS securities litigation, for example, the court dismissed two sets of claims that Morrison arguably precluded. First, the court held that claims asserted by foreign plaintiffs who purchased UBS stock on a foreign exchange (“foreign-cubed claims”) were barred even though UBS common stock is cross-listed on the New York Stock Exchange. Second, the court held that claims asserted by U.S. investors who purchased UBS stock on a foreign exchange (“foreign-squared claims”) were barred even though the orders were placed from the United States.

On appeal, in a case of first impression at the appellate level, the Second Circuit has affirmed that decision. In City of Pontiac Policeman’s and Firemen’s Retirement System v. UBS AG, 2014 WL 1778041 (2d Cir. May 6, 2014), the court found that the plaintiffs’ listing theory “is irreconciliable with Morrison read as a whole,” in which the court “makes clear that the focus of both prongs was domestic transactions of any kind, with the domestic listing acting as a proxy for a domestic transaction.” In addition, the Second Circuit test for whether a transaction is domestic is if “the parties incur irrevocable liability to carry our the transaction within the United States or when title is passed the United States.” The fact that the purchaser is a U.S. entity or placed the order in the U.S. does not establish that it has met this test.

Holding: Dismissal of “foreign-cubed” and “foreign-squared” claims affirmed.

The U.S. Court of Appeals for the Fourth Circuit has issued an opinion – Yates v. Municipal Mortgage & Equity, LLC, 2014 WL 890018 (4th Cir. March 7, 2014) – that clarifies the court’s position on several securities fraud issues.

(1) Core operations (scienter) – Core operations is a scienter theory that infers that facts critical to a business’s ‘core operations’ or an important transaction are known to the company’s key officers. Exactly how and to what extent the theory can be invoked to satisfy a plaintiff’s burden to plead a strong inference of scienter has been the subject of some judicial debate. In Yates, the Fourth Circuit held that “such allegations are relevant to the court’s holistic analysis of scienter,” but without other allegations “establishing the defendant’s actual exposure to the . . . problem, the complaint falls short of the PSLRA’s particularity requirement.”

(2) Rule 10b5-1 trading plans – Two of the individual defendants sold shares pursuant to non-discretionary Rule 10b5-1 trading plans. The court found that the use of these plans “further weakens any inference of fraudulent purpose” caused by the sales, but also noted that because one of the plans was instituted during the class period, it did “less to shield [that defendant] from suspicion.”

(3) Statute of repose for Section 11 claims – The case included Section 11 claims based on an alleged misrepresentation in a registration statement that was declared effective on January 14, 2005. The plaintiffs argued that their Section 11 claims were not barred by the applicable 3-year statute of repose – despite being brought on February 1, 2008 – because the actual offering did not commence until two weeks after the effective date. The court adopted what it described as the majority position: “Section 11 is violated when a registration statement containing misleading information becomes effective.” The fact that the plaintiffs “did not know that the registration statement was effective as of January 14 is of no consequence for statute of repose purposes.”

Holding: Dismissal affirmed.

Securities litigation? Check. Then you are well on your way to getting your cert petition granted by the U.S. Supreme Court. After agreeing just last week to hear Omnicare and resolve a circuit split over the pleading of false opinions in Section 11 claims, the Court has come back this week with yet another grant of cert in a securities case.

Public Employees’ Retirement System of Mississippi v. IndyMac MBS, Inc. presents the question of whether the filing of a securities class action tolls the applicable statute of repose for individual class members. The Second Circuit found that the statute of repose cannot be tolled because it “create[s] a substantive right in those protected to be free from liability after a legislatively-determined period of time” and “[p]ermitting a plaintiff to file a complaint or intervene after the repose period . . . has run would therefore necessarily enlarge or modify a substantive right and violate the Rules Enabling Act.” The Court will hear the case next term.