Category Archives: Appellate Monitor

On Wednesday, the U.S. Supreme Court heard oral argument in the Halliburton v. Erica P. John Fund case, which brings into question the continued viability of the fraud-on-the-market presumption of reliance. 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.

Much of the pre-argument commentary had focused on Chief Justice Roberts as the possible “swing vote” that could create a majority in favor of eliminating the fraud-on-the-market presumption (which was judicially created by a 1988 Supreme Court decision). Based on the questioning at the hearing, however, The 10b-5 Daily’s prediction that Halliburton would be unable to find five justices who are willing to go that far seems more accurate. Indeed, to the extent that the Court is willing to change the current regime, it now appears that they are more likely to embrace the intermediate step of requiring evidence of price impact before a class can be certified (because price impact is a prerequisite of the fraud-on-the-market presumption).

Why read the tea leaves this way? A few highlights:

(1) Petitioner (Halliburton) started off arguing that the fraud-on-the-market presumption should be overruled because at least three things have changed since it was implemented: (a) the Court has consistently construed the private right of action for securities fraud narrowly, (b) the Court has issued decisions making it clear that class-wide issues should be addressed at the class certification stage, and (c) the economic premise that “investors rely in common on the integrity of the market price” is no longer accurate (assuming it ever was). In response, Justice Kagan noted that Petitioner apparently agreed “that market prices generally do respond to new material information,” so in any particular case there will have to be a fact-specific inquiry into “whether there’s an exception to this general rule.” Petitioner responded that “if the Court were inclined to keep the presumption in some sense, it should at least place the burden on the plaintiff to establish that the misrepresentation actually distorted the market price, or to give defendants the full right of rebuttal at the class certification stage to establish the price was not impacted.”

(2) Once the discussion turned to the use of price impact evidence, much of the rest of the hearing focused on that issue. Most notably, Justice Kennedy asked Petitioner to address whether a possible solution to the economic issues it had raised was to require plaintiffs to demonstrate – via an event study at class certification – that the alleged misrepresentation had impacted the market price. Petitioner readily agreed that it made “sense to focus like a laser on the only relevant question, whether the misrepresentation distorted the market price.” In response to questions from Chief Justice Roberts and Justice Alito, Petitioner also argued that the cost of these event studies would not be significant because “plaintiffs are commonly using event studies right now as part of their [overall] market efficiency showing” at class certification and that event studies are “very effective” at determining a misrepresentation’s price effect.

(3) Respondent (investors) and the government also were asked to address the use of price impact evidence at the class certification stage. In response to questioning from Justice Sotomayor and Justice Kennedy, Respondent argued that in a case alleging multiple misrepresentations, conducting event studies would be “very complicated” and “very expensive,” and, moreover, “the idea that there are not significant merits filters that prevent cases from going to trial is simply wrong, both at the pleading stage and at the summary judgment stage.” In contrast, however, the government readily conceded that if the Court were to require proof of price impact at the class certification stage, it “would be a net gain to plaintiffs, because plaintiffs already have to prove price impact at the end of the day.”

Disclosure: The author of The 10b-5 Daily submitted an amicus brief on behalf of the Washington Legal Foundation in support of petitioner.

On the eve of the Halliburton oral argument, there have been two other developments in the U.S. Supreme Court related to securities litigation.

(1) Last week, in the Chadbourne & Parke LLP v. Troice case, the Court held that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) does not preclude state-law class actions unless the alleged misrepresentation “is material to a decision by one or more individuals (other than the fraudster) to buy or sell a ‘covered security.'” The Court went on to find that the state-law class action against the defendants should be allowed to proceed because the alleged ponzi scheme, in which high-interest certificates of deposit (not covered securities) were sold to investors who were falsely told that the proceeds would be invested in liquid securities (at least some of which would be covered securities), did not satisfy this test.

The 7-2 decision authored by Justice Breyer provides an interpretation of the phrase “in connection with the purchase or sale” of a security that is contained both in SLUSA and Section 10(b) of the Securities Exchange Act (the primary statutory basis for federal securities fraud claims). The Court presents the following key arguments in support of its interpretation. First, SLUSA’s language suggests that the requisite connection to the purchase or sale must “matter” and “[i]f the only party who decides to buy or sell a covered security as a result of a lie is the liar, that is not a connection that matters.” Second, “every securities case in which this Court has found a fraud to be ‘in connection with’ a purchase or sale of a security has involved victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition.” Finally, the Court’s reading of SLUSA is consistent with the Securities Exchange Act and the Securities Act because “[n]othing in [those] statutes suggests their object is to protect persons whose connection with the statutorily defined securities is more remote than words such as ‘buy,’ ‘sell,’ and the like, indicate.”

On its surface, of course, the decision is a victory for the plaintiffs’ bar because it narrows the scope of SLUSA preemption. But the split within the Court – Justices Kennedy and Alito filed a vigorous dissent arguing that the new test is inconsistent with the Court’s prior “broad construction” of the “in connection with” language – may be the result of two different forces at play. While the Court’s test narrows the scope of SLUSA preemption, it also appears to narrow the overall scope of Section 10(b), limiting how far the plaintiffs’ bar (and the SEC) can push the definition of a “securities fraud.” This result sheds some light on why, for example, Justice Thomas joins the majority in a short, separate concurrence that applauds the application of “a limiting principle to the phrase ‘in connection with'” – an outcome that no doubt appealed to a justice who has been in dissent in previous cases that arguably espoused a broader view of “in connection with” (e.g., O’Hagan).

(2) Apparently anxious to continue to delve into securities litigation issues, the Court also granted cert on Monday in the Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund case, which will be heard next term. At issue is the scope of Section 11 of the Securities Act, which provides a private remedy for a purchaser of securities issued under a registration statement filed with the SEC if the registration statement contains a material misstatement or omission.

The Court will consider the pleading standard for an allegedly false or misleading opinion (as opposed to statement of fact). While the Second, Third, and Ninth Circuits have held that under Section 11 a plaintiff must allege that 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.” Stay tuned.

The Halliburton case in the U.S. Supreme Court is moving quickly, with oral argument scheduled for March 5, 2014. At issue, at least potentially, is the continued viability of the fraud-on-the-market presumption of reliance. The presumption was judicially created by the Court and is routinely invoked in securities class actions to justify the grant of class certification.

The merits brief for the petitioners (Halliburton and its CEO) and the supporting amicus briefs have been filed with the Court. A listing of the briefs can be found here. The author of The 10b-5 Daily – Lyle Roberts of Cooley LLP – assisted the Washington Legal Foundation (WLF) with the filing of an amicus brief that focuses on the second question presented: Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.

The WLF brief argues that price impact is not dispositive as to either materiality or loss causation for all class members and, as a result, allowing a price impact rebuttal at the class certification stage does not run afoul of the Court’s Amgen decision. In addition, the brief points out that allowing a price impact rebuttal would harmonize the Court’s approach to affirmative misstatement and omissions cases and would better protect the rights of individual investors who can demonstrate actual reliance. The WLF brief is available on the Foundation’s website.

The U.S. Supreme Court has granted certiorari in Halliburton v. Erica P. John Fund, setting up what could be the most important securities litigation decision in the last twenty-five years. At issue is the continued validity of the fraud-on-the market-theory, whereby reliance by investors on a misstatement is presumed if the company’s shares were traded on an efficient market that would have incorporated the information into the stock price. The presumption is routinely invoked in securities class actions to justify the grant of class certification.

In its petition, Halliburton presented the following two questions:

1. Whether this Court should overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory.

2. Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.

In granting review, the Court did not limit its consideration to either question. As a result, SCOTUSBlog notes that the Court presumably “at least will consider the broader plea to cast aside the prior ruling.”

The case will be argued early next year. Reuters and Bloomberg have coverage of the cert grant. For more on the underlying case and the cert petition, see this recent blog post.

Quote of note (Bloomberg): “Four justices — Antonin Scalia, Clarence Thomas, Anthony Kennedy and Samuel Alito — suggested in a ruling in February that they might jettison the ‘Basic presumption,’ as it has become known. The outcome of the case may be in the hands of Chief Justice John Roberts, who usually joins that group in ideologically divisive cases.”

Pursuant to the fraud-on-the-market theory, reliance by investors on a misstatement is presumed if the company’s shares were traded on an efficient market that would have incorporated the information into the stock price. The presumption was judicially-created by the U.S. Supreme Court and is routinely invoked in securities class actions to justify the grant of class certification. In the Court’s recent Amgen decision, however, four justices expressed concerns about the fraud-on-the-market theory’s continuing validity. In particular, the Amgen dissent noted that the Court is not well-equipped to apply economic concepts and there is some disagreement about how market efficiency works. Given that invitation, it was only a matter of time before a securities class action defendant asked the Court to reconsider its current position.

Erica P. John Fund v. Halliburton, a securities class action that has been pending in the N.D. of Texas since 2002, has already been the subject of a Supreme Court decision relating to the fraud-on-the-market theory. In 2011, the Court held that loss causation is not a precondition for invoking the fraud-on-the-market presumption and, therefore, is not necessary to establish that reliance is capable of resolution on a common, classwide basis. On remand, the defendants pursued a related issue. Halliburton argued that it should be allowed to rebut the fraud-on-the-market presumption by establishing that the alleged misstatements did not have a stock price impact. The district court found that price impact evidence did not bear on the critical inquiry of whether common issues predominated under FRCP 23(b)(3) and certified the class. The Fifth Circuit subsequently affirmed, finding that although price impact evidence certainly could be used at trial to refute the presumption of reliance, it was not appropriate to consider this evidence at class certification.

Halliburton is once again seeking certiorari in the Supreme Court, but now it is going after an even bigger prize. In addition to arguing that the Fifth Circuit should have allowed the defendants to rebut the presumption by presenting price impact evidence, Halliburton asserts that the Court should overrule or substantially modify the fraud-on-the-market theory. It takes four justices to grant cert – will the Amgen group decide that the Halliburton case is the right vehicle through which to consider this question? A handful of amici have urged them to do so, including the U.S. Chamber of Commerce, and the issue has caught the attention of the legal press. Stay tuned.

On Monday, the U.S. Supreme Court heard oral argument in three related cases – Chadbourne & Parke v. Samuel Troice, No. 12-79; Willis of Colorado v. Troice, No. 12-86; and Proskauer Rose v. Troice, No. 12-88 – raising the issue of the scope of the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities (“covered securities”).

Observers who were hoping for a lot of discussion about the meaning and import of SLUSA, however, were sorely dissapointed. Instead, oral argument focused on an issue that the Court has considered before: exactly what fact patterns does “in connection with the purchase or sale” (which is taken from Section 10(b) of the Securities Exchange Act of 1934) cover? The three cases related to the Stanford ponzi scheme, in which high-interest certificates of deposit (not covered securities) were sold to investors who were falsely told that the proceeds would be invested in liquid securities (at least some of which would be covered securities).

The justices appeared to struggle with idea that a false statement concerning whether securities have been purchased can satisfy the “in connection with” requirement. Almost immediately, Chief Justice Roberts asked counsel for the petitioners “if I’m trying to get a home loan and they ask you what assets you have and I list a couple of stocks and, in fact, it’s fraudulent, I don’t own them, that’s a covered transaction, that’s a 10(b)(5) violation?” When counsel responded that the scenario would appear to be missing any representation about a purchase or sale, Justice Kagan argued that the problem is “In all of our cases, there’s been something to say when somebody can ask the question: How has this affected a potential purchaser or seller in the market for the relevant securities? And here there’s nothing to say.” For his part, Justice Scalia appeared willing to go even further, noting that the “purpose of the securities laws was to protect the purchasers and sellers of the covered securities. There is no purchaser [] or seller of a covered security involved here.” Ultimately, counsel for the petitioners argued that the “in connection with” standard is satisfied “when there is a misrepresentation and a false promise to purchase covered securities for the benefit of the plaintiffs.”

The government argued in favor of the petitioners’ position, but also ran into stiff questioning, When the government suggested that Justice Kagan’s “market effect” test was satisfied because the Stanford scheme would make investors less likely to trust the financial markets, Justice Kennedy responded that this argument was the equivalent of saying “if you went to church and heard a sermon that there are lots of people that are evil, maybe then you wouldn’t invest.”

Counsel for the respondents argued that the alleged scheme did not involve purchasing covered securities for the benefit of the plaintiffs. The seller of the C.D.’s “was only buying [covered securities] for itself. It did not pledge to sell the assets. It did not give the plaintiffs any interest in them.” Moreover, what the Court’s precedents “have said over and over and over and what has been the dividing line that has prevented 10(b)(5) from swallowing all fraud is these are misrepresentations that affect the regulated market negatively. This fraud did not do that.”

The New York Times and Reuters have coverage of the oral argument.

Securities litigation is at the top of the Supreme Court’s docket this fall. On October 7, the first day of the term, the Court will hear three cases – Chadbourne & Parke v. Troice, Proskauer Rose v. Troice, and Willis v. Troice – that have been consolidated for one hour of argument. The topic is the scope of the Securities Litigation Uniform Standards Act (“SLUSA”).

SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In the three related cases, the Fifth Circuit held that the “best articulation of the ‘coincide’ requirement” is that the fraud allegations must be “more than tangentially related to (real or purported) transactions in covered securities.” The Fifth Circuit then concluded that the relationship between the alleged fraud, which centered around the sale of certificates of deposit, and any transactions in covered securities was too attenuated to trigger SLUSA preclusion. The defendants successfully moved for certification on the grounds that the Fifth Circuit’s “more than tangentially related” standard was in conflict with the standards articulated by other circuits.

The ABA Preview of Supreme Court Cases has all of the briefs, which include amicus briefs from the United States (petitioners), DRI – the Voice of the Defense Bar (petitioners), Occupy the SEC (respondents), and Sixteen Law Professors (respondents). A preview article in The National Law Journal (Sept. 4 issue – subscrip. req’d) focuses on the perceived threat to law firms and other third parties arising from the Fifth Circuit’s decision to allow the state law claims to proceed.

Interestingly, both sides will be represented by prominent Supreme Court advocates: former solicitor general Paul Clement for the defendants (petitioners) and Tom Goldstein for the plaintiffs (respondents).

The federal securities laws have statutes of repose (suit barred after a fixed number of years from the time the defendant acts in some way) and statutes of limitations (establishing a time limit for a suit based on the date when the claim accrued). There is a significant district court split, however, over whether the existence of a class action tolls the statute of repose for a federal securities claim.

Under what is known as American Pipe tolling, “the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action.” American Pipe & Construction Co. v. Utah, 414 U.S. 538, 554 (1974). The Supreme Court found that its rule was “consistent both with the procedures of [Federal Rule of Civil Procedure] 23 and with the proper function of limitations statutes.” Id. at 555. In a later case, however, the Supreme Court also found that federal statutes of repose are not subject to equitable tolling. Lampf, Pleva, Lipkind, Prupis & Pettigrow v. Gilbertson, 501 U.S. 350, 364 (1991). In attempting to reconcile these two cases, the majority of lower courts have concluded that American Pipe tolling applies to the statute of repose for federal securities claims because it is based on FRCP 23 and, therefore, is a type of legal (as opposed to equitable) tolling. Other recent decisions, however, have concluded that because FRCP 23 does not expressly create a class action tolling rule, American Pipe tolling is best understood as a judicially-created rule based on equitable considerations and, as a result, cannot extend a statute of repose.

In Police and Fire Retirement System of City of Detroit v. IndyMac MBS, Inc., 2013 WL 3214588 (2d Cir. June 27, 2013), the Second Circuit has resolved the split by holding that the statue of repose cannot be tolled even if the American Pipe tolling rule is “legal.” The court noted that statutes of repose “create a substantive right in those protected to be free from liability after a legislatively-determined period of time.” Meanwhile, FRCP 23 is a product of the Rules Enabling Act, which specifically states that the rules it authorizes “shall not abridge, enlarge or modify any substantive right.” Accordingly, the court held, “[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.”

Holding: Affirming denial of motions to intervene.

Quote of note: “We are cautioned by some of the proposed intervenors that a failure to extend American Pipe tolling to the statute of repose in Section 13 could burden the courts and disrupt the functioning of class action litigation. We are not persuaded. Given the sophisticated, well-counseled litigants involved in securities fraud class actions, it is not apparent that such adverse consequences will inevitably follow our holding. But even if the decision causes some such problem, it is a problem that only Congress can address; judges may not deploy equity to avert the negative effects of statutes of repose.”

In Massachusetts Retirement Systems v. CVS Caremark Corp., 2013 WL 2278599 (1st Cir. May 24, 2013), the plaintiffs asserted that the company had failed to disclose integration problems following a merger. The district court dismissed on loss causation grounds, holding that the complaint did not plausibly allege that the company’s statements prior to the stock price decline, which related to lost contracts, revealed the supposed fraud. On appeal, the First Circuit provided guidance on how to evaluate loss causation.

(1) “Mirror-image” disclosure not required – The court found that “a corrective disclosure need not be a ‘mirror-image’ disclosure – a direct admission that a previous statement is untrue.” Although the company did not attribute its lost contracts to integration issues, the company’s statements “plausibly revealed to the market that CVS Caremark had problems with service and the integration of its systems.” In particular, the court noted that the strongly negative analyst and stock price reaction “likely reflected an understanding that something systemic had gone wrong.”

(2) Lost contracts v. reason for lost contracts – The defendants argued that CVS Caremark’s loss of certain clients “was public knowledge” well before the disclosures that led to the stock price decline. The court agreed that the market knew about the lost contracts, but concluded that the core allegation in the complaint was that the disclosures revealed “for the first time the real reason for the loss: the failed integration of CVS and Caremark” and “this new information could plausibly have caused [the plaintiffs] losses.”

(3) Use of analyst reports – To support their assertions about the “meaning” of the company’s disclosures, the plaintiffs relied heavily on analyst reports. The court held that “[w]hen a plaintiff alleges corrective disclosures that are not straightforward admissions of a defendant’s previous misrepresentations, it is appropriate to look for indications of the market’s contemporaneous response to those statements.” In this case, the analyst reports plausibly reflected an understanding that “the merger had failed to produce any value for CVS Caremark” and the reports “should have been considered in deciding the motion to dismiss.”

Holding: Dismissal vacated and case remanded for further proceedings.

Section 11 of the ’33 Act creates liability for material misrepresentations in a registration statement. According to the Second Circuit (Fait) and Ninth Circuit (Rubke), however, if the alleged misrepresentation is an opinion, the plaintiff must establish that the opinion was both objectively false and disbelieved by the defendant at the time it was made. In effect, these rulings convert a Section 11 claim based on an opinion from a strict liability (the company) or negligence (the individual defendants) standard to a knowing falsity standard.

The Omnicare securities litigation has generated a number of decisions discussing the pleading standards for Section 11 claims. After the district court dismissed the case, the Sixth Circuit reversed as to the Section 11 claim, finding that the district court had erred by requiring the plaintiffs to plead loss causation. The plaintiffs initially pursued a writ of certiorari on the issue of whether Section 11 claims can be subject to the heightened pleading standard of FRCP 9(b), but then, after the U.S. Supreme Court asked for the government’s view of the cert request, withdrew their petition and went back to the district court. The district court then dismissed the Section 11 claim again, finding that the alleged misrepresentations were opinions and the plaintiffs had failed to sufficiently plead the defendants’ knowledge of falsity.

In Indiana State District Council of Laborers v. Omincare, Inc., 2013 WL 2248970 (6th Cir. May 23, 2013), the court examined the “knowing falsity” rule for opinions. The court found that while it “makes sense that a defendant cannot be liable for a fraudulent misstatement or omission under Section 10(b) and Rule 10b-5 if he did not know the statement was false at the time it was made” that logic does not extend to strict liability claims. Under Section 11, if a defendant “discloses information that includes a material misstatement, that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity.” Nor was the court persuaded by the reasoning of the Second and Ninth Circuits, which had relied on the Supreme Court’s decision in the Virginia Bankshares case interpreting a non-strict-liability securities statute. According to the court, “it would be unwise for this Court to add an element to Section 11 claims based on little more than a tea-leaf reading in a Section 14(a) case.”

Holding: Dismissal reversed in part and affirmed in part.