Category Archives: Appellate Monitor

In a famous market manipulation that lead to multiple criminal convictions, the A.R. Baron brokerage engaged in a pump-and-dump scheme to induce customers to purchase the securities of small companies at artificially inflated prices. Among many others, investors sued an individual whose acts allegedly facilitated Baron’s frauds in violation of Section 10(b). The district court dismissed the Section 10(b) claim.

On appeal, the Second Circuit addressed this dismissal (Fezzani v. Bear Stearns & Co., Inc., 2013 WL 1876534 (2d Cir. May 7, 2013) (Lohier, J. dissenting). The court found that manipulation violates Section 10(b) “when an artificial or phony price of a security is communicated to persons who, in reliance upon a misrepresentation that the price was set by market forces, purchase the securities.” The Supreme Court, in its decisions in Stoneridge and Janus, has held that in a Section 10(b) claim involving a misrepresentation there can only be primary liability for entities or individuals who actually communicated the misrepresentation to the injured investors. Applying that principle in the instant case, the court found that because there was no allegation that the individual defendant actually communicated the artificial price information to the investors (as opposed to assisting Baron in its fraud), there could be no Section 10(b) primary liability.

In a vigorous dissent, however, one of the panel members challenged whether Stoneridge and Janus are applicable in a case alleging market manipulation. The dissent noted that a “market manipulation claim permits the plaintiff to plead that it relied on an assumption of an efficient market free of manipulation, whereas a misrepresentation claim requires the plaintiff to allege reliance upon a misrepresentation or omission.” As a result, a plaintiff alleging market manipulation is entitled to use a fraud-on-the-market theory to establish reliance (i.e., the defendant engaged in a transaction that sent a fale pricing signal to the market, which was then communicated by the market to the investor). Accordingly, the dissent concluded, the fact that the individual defendant was a key participant in the transactions that sent a false pricing signal was sufficient to establish Section 10(b) primary liability.

Holding: Dismissal affirmed.

Quote of note (dissent): “I fear that every market manipulator . . . will be cheered by the extra shelter for stock manipulation under the federal securities laws that the majority opinion unnecessarily provides them. If I thought that Stoneridge or Janus required that result, I would shrug, concur, and move on. Because I conclude that neither case forecloses the federal claim of market manipulation against Dweck, I respectfully dissent.”

Based on the Supreme Court’s recent decisions, a plaintiff is not required to prove the existence of loss causation (Halliburton) or materiality (Amgen) to certify an investor class. In the Halliburton case, however, the defendants pursued a related issue on remand. Halliburton argued that it should be allowed to rebut the fraud-on-the-market presumption of reliance by establishing that the alleged misrepresentations 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. Halliburton appealed.

In Erica P. John Fund, Inc. v. Halliburton Company, 2013 WL 1809760 (5th Cir. April 30, 2013), the Fifth Circuit found that “Halliburton’s price impact evidence potentially demonstrates that despite the presence of the necessary conditions for market price incorporation of fraudulent information (fraud-on-the-market reliance), no such incorporation occurred in fact.” Although this evidence certainly could be used at trial to refute the presumption of reliance, the court questioned whether it was appropriate to consider it at class certification.

Under Amgen, the court held, price impact evidence should not be considered if it is “common to the class” and if there is no risk “that a later failure of proof on the common question of price impact will result in individual questions predominating.” The court found that both criteria were met and the district court did not err in declining to consider Halliburton’s price impact evidence. First, “price impact is ordinarily established by expert evaluation of a stock’s market price following a specific event and it inherently applies to everyone in the class.” Second, although defeating the presumption of reliance would presumably still leave open the possibility of individual claims, “[i]f Halliburton were to successfully show that the price did not drop when the truth was revealed, then no plaintiff could establish loss causation.” Accordingly, the claims of all individual plaintiffs would fail.

Holding: Affirming grant of class certification.

Addition: As detailed in a February 2010 post, the Halliburton case has a remarkable procedural history that now includes a Supreme Court decision and two Fifth Circuit decisions on class certification. What next?

The Boeing securities class action related to its development of its 787-8 Dreamliner plane continues to provide some drama. In 2011, as noted on this blog, the district court granted the company’s motion to dismiss (on a motion for reconsideration) after it was determined that a key confidential witness denied being the source of the allegations attributed to him in the complaint, denied having worked for Boeing, and claimed to have never met plaintiffs’ counsel until his deposition. The plaintiffs appealed this decision to the U.S. Court of Appeals for the Seventh Circuit.

In City of Livonia Employees’ Retirement System and Local 295/Local 851, IBT v. Boeing Company, 2013 WL 1197791 (7th Cir. March 26, 2013), the court affirmed the dismissal based on the complaint’s failure to establish a strong inference of scienter. The opinion, authored by Judge Posner, contains some interesting commentary.

(1) Motive – The plaintiffs alleged Boeing had failed to disclose in a timely manner that the Dreamliner’s first test flight would be cancelled. The court noted that the law does not require the disclosure of the mere risk of failure. Indeed, “[n]o prediction – even a prediction that the sun will rise tomorrow – has a 100 percent probability of being correct . . . If a mistaken prediction is deemed a fraud, there will be few predictions, including ones that are well-grounded, as no one wants to be held hostage to an unknown future.” Moreover, it was unclear what motive Boeing would have had to put off the announcement, with the court wryly concluding that the main effect would be to “undermine Boeing’s credibility with its customers and expose the company to a multi-hundred million dollar lawsuit for securities fraud.”

(2) Confidential Witness – The court found that the recantation of the key confidential witness was fatal to the plaintiffs’ claims, because his supposed evidence provided the only basis for concluding that the company knew (at an earlier date) that the first flight test would be cancelled. Moreover, the confidential witness would no longer be useful because “[e]ither he had told the investigator the same thing he said in his deposition, which would be of no help to the plaintiffs and would expose the investigator as a liar, or he had had made the opposite assertions on the two occasions, in which event he was the liar, which wouldn’t help the plaintiffs either.”

(3) Sanctions – The defendants had cross-appealed for sanctions. The court strongly suggested that sanctions were appropriate in the case, noting that the plaintiffs’ lawyers “failure to inquire further [about the supposed evidence from the confidential witness] puts one in mind of ostrich tactics – of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing.” Nevertheless, the court remanded the case to the lower court to determine whether sanctions should be imposed.

Holding: Dismissal affirmed, but case remanded for consideration of whether to impose Rule 11 sanctions.

The Eleventh Circuit has issued an opinion that provides some clear exposition on the issue of loss causation. In Meyer v. Greene, 2013 WL 656500 (11th Cir. Feb. 25, 2013), the court considered whether the plaintiffs had adequately plead loss causation in a securities class action brought against St. Joe Company (a Florida real estate development corporation). The two key disclosures cited by the plaintiffs were (1) a presentation by a prominent short seller, and (2) the company’s announcement of an SEC investigation. The district court found that neither disclosure revealed to the market the supposed falsity of the company’s prior statements and dismissed the complaint.

On appeal, the Eleventh Circuit examined the two key disclosures:

(1) Short Seller Presentation – The court found that the presentation was based (by its own admission) on “publicly available sources.” As a result, it did not provide any new facts to the market that could act as a corrective disclosure. Indeed, the plaintiffs “cannot contend that the market is efficient for purposes of reliance and then cast the theory aside when it no longer suits their needs for purposes of loss causation.” Having conceded that the market was efficient and St. Joe’s stock price reflected all public information, the plaintiffs “must take the bitter with the sweet.”

Nor could the plaintiffs claim that that the presentation qualified as a corrective disclosure because it provided “expert analysis of the source material.” The court held that “the mere repackaging of already-public information by an analyst or short-seller is simply insufficient” because “the only thing actually disclosed to the market when the opinion is released is the opinion itself, and such opinion, standing alone, cannot reveal to the market the falsity of a company’s prior factual representations.”

(2) SEC Investigation – Although the company’s disclosure of an SEC investigation lead to a decline in its stock price, the court noted that “the SEC never issued any finding of wrongdoing or in any way indicated that the Company had violated the federal securities laws.” Under these circumstances, an “investigation can be seen to portend an added risk of future corrective action” but it does not mean that SEC investigations “in and of themselves, reveal[] to the market that a company’s previous statements were false or fraudulent.”

Holding: Dismissal affirmed.

Quote of Note: “Put another way, though Sec. 10(b) is designed to protect against fraud, it is not a prophylaxis against the normal risks attendant to speculation and investment in the financial markets, and loss causation therefore ensures that private securities actions remain a scalpel for defending against the former, while not becoming a meat axe exploited to achieve the latter.”

The U.S. Supreme Court has issued a decision in the Amgen case holding that proof of materiality is not a prerequisite to certification of a securities fraud class action. It is a 6-3 decision authored by Justice Ginsburg, with dissents from Justice Thomas (main) and Justice Scalia.

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. At issue in Amgen was whether a class action plaintiff, to take advantage of this presumption for purposes of class certification, is required to prove that the misrepresentation was material. As foreshadowed by the oral argument, the key issue for the Court was whether the fact that materiality is both a predicate for the use of the fraud-on-the-market presumption and a substantive element of the securities fraud claim means that it should be treated differently than the other fraud-on-the-market predicates (market efficiency, misrepresentation was public, transaction took place between time when misrepresentation was made and truth was revealed).

The majority opinion held that proof of materiality is not needed to ensure, as required by FRCP 23(b), that the questions of law or fact common to the class will predominate over any questions affecting only individual members. First, materiality is determined using an objective test and is therefore a common question as to every class member. Second, if the plaintiff were unable to establish materiality at summary judgment or trial, that failure would end the case for every class member leaving no individual reliance questions. This result is in contrast to the other fraud-on-the-market predicates – e.g., market efficiency – where a failure to prove that the market was efficient would still leave an individual plaintiff capable of establishing reliance by other means and proceeding with his case. The Court also rejected the notion that policy considerations militated in favor of requiring precertification proof of materiality. Notably, the Court found that Congress had previously “rejected calls to undo the fraud-on-the-market presumption of classwide reliance” and had not decreed “that securities-fraud plaintiffs prove each element of their claim before obtaining class certification.”

The main dissent presented a starkly different view of the importance of addressing materiality at the class certification stage. According to the dissent, “nothing in logic or precedent justifies ignoring at certification whether reliance is susceptible to Rule 23(b)(3) classwide proof simply because one predicate of reliance – materiality – will be resolved, if at all, much later in the litigation on an independent merits element.” Indeed, a recent Court decision (Wal-Mart) “expressly held that a court at certification may inquire into questions that also have later relevance on the merits.” The judicial history of the fraud-on-the-market presumption also shows that materiality “has been the driving force behind the theory from the outset” and “further supports the need to prove materiality at the time the fraud-on-the-market theory is invoked.”

Holding: Judgment of Ninth Circuit upholding grant of class certification affirmed.

Notes on the Decision:

(1) The decision does not “revisit” the fraud-on-the-market presumption. That said, it would appear that at least four justices have some concerns about its continuing validity. The dissent notes that the Court is not well-equipped to apply economic concepts and there is some disagreement about how market efficiency works. In a separate concurrence, Justice Alito references that part of the dissent and suggests reconsideration could be appropriate because the presumption “may rest on a faulty economic premise.”

(2) The majority’s eagerness to establish there can be no individual questions of reliance if a class action plaintiff fails to prove materiality leads to some interesting language. Notably, the Court states that “there can be no actionable reliance, individually or collectively, on immaterial information.” The Court also concludes that an individual’s reliance on immaterial information would be “objectively unreasonable.” In the context of the entire opinion, it is not clear whether the Court is suggesting that (a) any class member’s claim will fail in the absence of materiality (therefore rendering the question of reliance moot), or (b) materiality is a necessary predicate for a finding of reliance under any circumstances. There is no doubt that there is close relationship between the concepts of materiality and reliance, but for an individual investor the reliance question is typically whether he actually saw the misrepresentation and acted upon it (i.e., transaction causation), with materiality as a separate inquiry.

Just because the government says a case is not a good cert candidate, does not mean the U.S. Supreme Court will agree. On Friday, in a somewhat surprising decision, the Court granted cert in three related cases that raise an issue about 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 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 government, at the invitation of the Court, filed an amicus brief arguing that cert should not be granted because (a) the circuit standards are substantially similar and (b) the unusual fact pattern in the cases would render any holding that SLUSA applies (or does not apply) of little assistance to lower courts in future cases. But the Court evidently did not find the government’s arguments persuasive.

The official question presented is: Whether SLUSA precludes a state-law class action alleging a scheme of fraud that involves misrepresentations about transactions In SLUSA-covered securities. Bloomberg has coverage of the Court’s decision.

Back in October, this blog speculated that the Supreme Court might grant cert in three related cases that raised an issue related to the Securities Litigation Uniform Standards Act (“SLUSA”). The Court had asked for the government to weigh in on the cert petition, which can be an indicator that the Court is inclined to take the case. The government has finally expressed its view and it is a frustrating one for the defendants: the lower court’s decision was wrong, but the Court should not grant cert.

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 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 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.

In its amicus brief, the government concluded that the Fifth Circuit had reached the wrong result because “the purported existence of covered securities transactions was far from ‘tangential’ to the fraudulent scheme and the misrepresentations that supported it.” Nevertheless, it urged the Court to deny cert for two reasons. First, the Fifth Circuit’s “more than tangentially related” standard is substantially similar to those used by other circuits and any variation in word choice “does not mean that the courts of appeals have applied substantively different understandings of the “in connection with” requirement.” Second, the unusual fact pattern in these cases would render any holding that SLUSA applies (or does not apply) of little assistance to lower courts in future cases.

Does this mean that the Supreme Court will deny cert? More likely than not, but stay tuned.

Oral argument took place in the Amgen case in the U.S. Supreme Court this morning. The case involves the issue of whether, to obtain class certification, a plaintiff must prove that an alleged misstatement was material and therefore can support a fraud-on-the-market presumption (reliance by investors on the misstatement is presumed if the misstatement is material and the company’s shares were traded on an efficient market that would have incorporated the information into the stock price).

The argument focused heavily on whether it was appropriate to decide the issue of materiality at the class certification stage given that it is both a predicate for the use of the fraud-on-the-market presumption and a substantive element of the securities fraud claim.

A few highlights:

(1) The parties agreed that materiality was a “common issue” for all the class members, but not on whether that fact should preclude it being examined at the class certification stage of the case. Petitioner (Amgen) had some difficulty persuading the Court that a distinction could be drawn between determining materiality at the class certification stage for purposes of the fraud-on-the-market presumption and determining materiality on the merits. A few justices pressed whether it was Petitioner’s position, as Justice Kagan put it, “that a judge who has just ruled that a statement is immaterial is going to keep the case in his court litigated by an individual plaintiff, even though he’s just ruled that the statement is immaterial?” Petitioner insisted that this was possible, because the judge would not be able to resolve disputed facts at the summary judgment stage of a case brought by an individual plaintiff. Justice Breyer questioned whether this established too much, because why not “try out everything [at class certification], because we could always think of a few examples where, despite the fact that, you know, it’s only a common issue 99 percent of the time, we can dream up a situtation where it’s not a common issue.”

(2) More broadly, Petitioner argued that the purpose of FRCP 23 “is for a court to determine whether all of the preconditions for forcing everyone into a class action are present before you certify.” Because materiality is “an essential predicate of the fraud-on-the-market theory” and that theory is necessary to certify a securities fraud class, it follows that the court must determine the existence of materiality at class certification.

(3) In turn, Respondent (investors) was asked numerous questions about why the Court should draw a distinction between market efficiency (another predicate for the fraud-on-the-market presumption that can be rebutted at the class certification stage) and materiality. Justice Scalia noted that market efficiency also is a common issue that, if decided by the judge at class certification, might preclude individual investors from bringing a suit because they could not say “that’s why I got cheated, because the market reflected this false statement and I paid more money for the stock than I should have.” Respondent – with some assistance from Justice Breyer – argued that the difference was that market efficiency is merely a “gate-keeping function[] to determine whether or not the answer for indirect reliance on the market is a common question,” while materiality is a traditional element of a fraud.

(4) For its part, the government argued in support of Respondent, stating that “materiality in a fraud-on-the-market case serves two purposes . . . . And what Petitioners would have this Court do is isolate the two inquiries when they’re really the same question.” Justice Scalia’s response: “If you have the same question, then maybe we shouldn’t have this fraud-on-the-market theory . . . . So maybe we should overrule Basic [the Supreme Court case endorsing the fraud-on-the-market presumption] because it was certainly based upon a theory that simply collapses once you remove the materiality element.”

All of the briefs and other background materials can be found here. Reuters has an article on the argument.

On Monday, the Supreme Court will hear oral argument in the Amgen case. The official questions presented are:

1. Whether, in a misrepresentation case under SEC Rule 10b-5, the district court must require proof of materiality before certifying a plaintiff class based on the fraud-on-the-market theory.

2. Whether, in such a case, the district court must allow the defendant to present evidence rebutting the applicability of the fraud-on-the-market theory before certifying a plaintiff class based on that theory.

The court will be addressing a circuit split on these issues. Three circuit courts (Second, Fifth and, to a lesser extent, the Third) previously have held that materiality is a required part of the fraud-on-the-market analysis when evaluating whether a class should be certified. The Ninth Circuit joined a decision from the Seventh Circuit, however, in rejecting that position and holding that materiality is a merits question that does not affect whether class certification is appropriate.

Scotusblog has links to all of the relevant background materials, including the merits and amicus briefs, and an argument preview. Thomson Reuters and Forbes also have columns on the case.

As the U.S. Supreme Court begins its October term, a securities litigator’s thoughts turn to what cases the court might take next. A leading indicator (although far from a guarantee) is a cert petition where the Court asks the government to provide its input. On Monday, the Court made this request in three related cases arising out of an alleged Ponzi scheme.

The Securities Litigation Uniform Standards Act (“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 determining what is meant by “in connection with,” the Supreme Court has held that it is sufficient that the alleged misrepresentation “coincide” with a covered securities transaction. The circuit courts have had difficulty, however, in expanding upon this requirement to form a consistent standard (see, e.g., decisions from the Second Circuit, Sixth Circuit, and Seventh Circuit).

In the Ponzi scheme 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 court concluded that the relationship between the alleged Ponzi scheme, which centered around the sale of certificates of deposit, and any transactions in covered securities was too attenuated to trigger SLUSA preclusion.

Will the Supreme Court revisit SLUSA? Stay tuned.

Addition: Bloomberg has an article on the Supreme Court’s request.