Category Archives: Motion To Dismiss Monitor

Are two opinions a trend? Last year, The 10b-5 Daily posted about the denial of the motion to dismiss in the Interpublic Group securities litigation in the S.D.N.Y. The court’s opinion in that case was based on the following controversial legal propositions: (1) Section 20(a) claims have no scienter pleading requirement; (2) corporate acquisitions for stock can be a motive for securities fraud; and (3) companies can be personified for scienter purposes (i.e., a finding of fraudulent intent). In a holding that was described here as “the perfect storm that happens when these three strands of questionable law come together,” the Interpublic court found that even though the plaintiffs had failed to establish a strong inference of scienter for any of Interpublic’s officers, the case could proceed against Interpublic and its officers based on the company’s alleged motive to commit fraud and control person liability.

A year later, another court has issued a very similar decision. In In re NUI Sec. Litig., 2004 WL 895846 (D.N.J. April 23, 2004), the court found that the plaintiffs had adequately alleged a strong inference of scienter for the corporate defendant based on two sets of facts applicable to different parts of the class period. First, NUI’s stock-for-stock acquisition of another company allegedly gave it a motive to inflate the price of its stock. Second, NUI’s associate general counsel (who is not a defendant in the case) was alleged to have actual knowledge of the company’s fraudulent conduct. As to the individual defendants (the CEO and CFO of NUI), however, the court held that there were insufficient allegations concerning their motive to commit fraud and knowledge of the alleged fraudulent conduct. Just as in Interpublic, the Rule 10b-5 claims were allowed to continue against NUI, but were dismissed against the individual defendants. The individual defendants were not, however, free to go. Since they controlled NUI and the court had found that a Rule 10b-5 claim was adequately pled against NUI, the Section 20(a) claims against the individual defendants based on control person liability still remain.

The NUI decision, like the Interpublic decision, would appear to eviscerate the PSLRA’s requirement that scienter be adequately plead as to each defendant. Moreover, the NUI court adds a fourth strand of questionable law to the mix. As recently discussed at length in the Fifth Circuit’s decision in Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353 (5th Cir. 2004), in determining whether a corporate defendant has acted with scienter, a court generally looks “to the state of mind of the individual corporate official or official who make or issue the statement (or order or approve it or its making or issuance, or who furnish information or language for inclusions therein, or the like) rather than generally to the collective knowledge of all the corporation’s officers and employees acquired in the course of their employment.” In other words, courts generally reject a “collective scienter” theory – for example, where a plaintiff attempts to impute the knowledge of the associate general counsel, who is not alleged to have made or issued any statements, to the corporation for scienter purposes. The perfect storm keeps going.

Holding: Motion to dismiss granted in part (as to a separate alleged fraudulent scheme and certain statements), and denied in part.

The Washington Post reports that Judge Shirley Wohl Kram has denied most of the motion to dismiss in the AOL Time Warner securities class action pending in the S.D.N.Y. The complaint alleges that the defendants, both before and after the 2001 merger of AOL and Time Warner, improperly inflated results through ’round-trip’ deals that in effect overpaid other companies for goods, services, or equity in exchange for advertising revenue. In 2002, AOL Time Warner restated $190 million in revenue.

Judge Kram threw out some of the plaintiffs’ claims, including those against former AOL chairman Steve Case and various bondholder claims, but found that the allegations in the complaint “established sufficient circumstantial evidence of misbehavior or recklessness for the case to move forward” against the company and various current and former officials. (The 10b-5 Daily has posted frequently about the case, most recently about a discovery decision issued by the court last October.)

The “group pleading” doctrine creates the presumption that the senior officers of a company are collectively responsible for misrepresentations or omissions contained in public statements made by the company (e.g., press releases, SEC filings). The U.S. Court of Appeals for the Fifth Circuit has recently held, in the first circuit court decision to address the issue, that the group pleading doctrine was abolished by the enactment of the PSLRA’s heightened pleading standards.

That decision is beginning to have an impact outside of the Fifth Circuit. In In re Cross Media Marketing Corp. Sec. Litig. 2004 WL 842350 (S.D.N.Y. April 20, 2004), the court found that the PSLRA’s “use of the singular ‘defendant’ counsels against group pleading in actions arising in securities fraud cases since the enactment of the [statute].” The court cited the Fifth Circuit decision and held that group pleading could not be used to establish that the individual defendants made misrepresentations or acted with scienter (i.e., fradulent intent).

Holding: Motion to dismiss granted with leave to replead.

Section 20(a) of the ’34 Act creates a cause of action against defendants alleged to have been “control persons” of those who engaged in securities fraud. In the absence of a scienter pleading requirement for control person liability (a disputed question in the Second Circuit – see this post), all plaintiffs need to show at the pleading stage is: (a) there was a primary violation by a controlled person; and (b) control of the primary violator by the defendant. An unresolved issue is what is necessary to adequately plead the element of control if both the primary violator and the defendant are corporations.

In Schnall v. Annuity and Life Re (Holdings), Ltd., 2004 WL 515150 (D. Conn. March 9, 2004), the court’s answer was: not too much. XL Capital Ltd. had founded Annuity and Life Re (Holdings), Ltd. (“ANR”), the primary corporate defendant in the case, and two of XL Capital’s officers/directors served as ANR directors. In addition, during the class period XL Capital owned between 11% and 12.9% of ANR’s common stock. Based on these facts, the court found “it may reasonably be inferred that defendant XL Capital was in a position to influence and direct the activities of ANR” and therefore the plaintiffs’ Section 20(a) claim against XL Capital could go forward.

Holding: Motion to dismiss denied.

The Copper Mountain securities litigation in the N.D. of Cal. is a font of notable decisions. As reported in The 10b-5 Daily, Judge Vaughn Walker issued a fairly amazing order in February expressing displeasure with both plaintiffs and the 9th Circuit over the lead plaintiff/lead counsel selection process in the case. After questioning whether the mandamus proceeding initiated by one of the lead plaintiff candidates was a “fairy tale” when the successful appellant decided not to pursue the position, the court ended up reappointing the original lead plaintiff.

With the lead plaintiff issue finally settled (after three years), the court was able to turn to the motion to dismiss. Last week, in In re Copper Mountain Sec. Litig., 2004 WL 725204 (N.D. Cal. March 30, 2004), the court granted the motion. The decision’s opening paragraphs present an interesting overview of the particularity requirement in fraud on the market cases (especially for defendants):

It is well-known that the Private Securities Litigation Reform Act (PSLRA) and FRCP 9(b) impose a particularity requirement in the allegation of securities fraud. This is especially important in the case of a complaint alleging open market fraud or fraud on the market, such as the complaint at bar.
The starting point for the particularity analysis is not the allegedly false or misleading statements of the defendants, but the truth that emerges from the market. An open market trades on different points of view of an issuer’s prospects. If all investors thought the same things, there would be no trading except that prompted by the need of investors to re-balance their portfolios among investment alternatives (i.e., cash versus bonds, stocks versus cash, etc). What matters in an open market case is the total mix of information in the market and whether that mix has been altered in some significant way to create a very widely, indeed essentially universal, but wrong view of the value of the security at issue. It is the “truth” that reveals the “error” of the market. The disclosure of this “truth” avulsively changes the price of the security. But disclosure of a market “error” does not make out a case of “fraud on the market.” Starting with the “truth,” the complaint must allege facts to show that the previously settled but false investor expectations can be laid at the feet of defendants. This may seem simple, although it is not easy to do.

A complaint satisfying the particularity requirement does not require rococo factual detail, but it does require specifics. So a plaintiff seeking to allege open market securities fraud does well to begin the analysis with the “truth,” stack it up against what preceded it and then see if acts, omissions or statements of defendants can plausibly be said to be responsible for the “truth” not emerging earlier when plaintiffs traded their securities.
Generally, open market fraud complaints fail to satisfy the required pleading standard in one of several different ways. Most often plaintiffs cannot identify a false statement of defendant that might account for causing a security issue’s price to be distorted. Even if a statement that turns out to be false can be identified, it is usually so laden with cautionary language as to be unactionable as a practical matter. In the more common omissions case, plaintiff may be unable to find a ground upon which to allege that defendant knew the omitted fact or had a duty to disclose it. This complaint illustrates these various shortcomings.

Holding: Motion to dismiss granted (with limited leave to amend).

As a general matter, allegations in an amended complaint relate back to the date of the original filing if they arise out of the same operative facts. What exactly constitutes the operative facts, of course, can be the subject of debate.

In In re American Express Co. Sec. Litig., 2004 WL 632750 (S.D.N.Y. March 31, 2004), the court found that the plaintiffs were on inquiry notice of their claims concerning Amex’s alleged misrepresentations about its investments in high-yield securities as of July 18, 2001. Although the original complaint was filed in a timely manner (i.e., within a year), the amended complaint was not filed until December 10, 2002, and contained new allegations about improper valuation methods, GAAP violations, and a lack of adequate risk controls. The court found that these allegations did not sufficiently relate back to the original complaint, even though they all generally concerned Amex’s investments in high-yield securities, and were therefore time-barred.

Holding: Motion to dismiss granted.

Quote of note: “The initial complaint simply avers that defendants did not disclose management’s failure to ‘fully comprehend’ the risks associated with Amex’s high-yield holdings. The Amended Complaint, on the other hand, claims that ‘the procedures for valuing and evaluating AEFA’s holdings made it impossible to monitor and guage risks accurately, and no such risk analysis was taking place.’ These allegations are therefore distinct from those in the intitial complaint, as they involve different ‘operative facts.'”

Thanks to Adam Savett for sending this case in.

The Associated Press reports that the securities class action pending against Bristol-Myers Squibb Co. (NYSE: BMY) in the S.D.N.Y. has been dismissed with prejudice. The case alleged that Bristol-Myers and certain of its officers had made misrepresentations concerning the company’s accounting practices and its investment in ImClone Systems.

Cable & Wireless plc (NYSE: CWP) has announced the dismissal of the securities class action pending against the company in the E.D. of Va. Plaintiffs originally filed the case in December 2002 and claimed that C&W had misled investors concerning a potential tax liability arising from the sale of its One2One mobile telephone business to Deutsche Telekom. The court apparently has only issued an order at this time, with the memorandum opinion to follow.

Reuters reports that the securities class action pending against Juniper Networks, Inc. (Nasdaq: JNPR) in the N.D. of Cal. has been dismissed with prejudice. The suit was originally filed in 2002 and alleged among its claims that Juniper falsely recognized certain revenues.