Category Archives: Motion To Dismiss Monitor

In its Tellabs decision, the U.S. Supreme Court held that a court must assess a plaintiff’s scienter (i.e., fraudulent intent) allegations “holistically” in determining whether the plaintiff has met the requisite “strong inference” pleading standard. The 10b-5 Daily noted that this holding “would appear to alter the evaluation of scienter in the Second Circuit and Third Circuit, both of which have held that a court can examine allegations of motive or knowledge/recklessness separately.” In the intervening years, however, the Second Circuit has not directly addressed this inconsistency, to the benefit of plaintiffs.

George v. China Automotive Systems, Inc., 2012 WL 3205062 (S.D.N.Y. Aug. 8, 2010) is a “Chinese reverse merger” case alleging that the company engaged in accounting fraud. In their motion to dismiss, the defendants argued that the plaintiffs had failed to adequately plead scienter. The court, citing Second Circuit precedent, noted that the “requisite ‘strong inference’ of scienter can be established by alleging facts showing (a) defendants’ ‘motive and opportunity’ to commit the alleged fraud, or (b) strong circumstantial evidence of conscious misbehavior or recklessness.” After examining the complaint, the court held that the plaintiffs’ insider trading allegations, by themselves, were sufficient to establish motive and opportunity. In particular, four of the seven individual defendants “sold over 50% of their CAAS stock during the class period” and the individual defendants collectively made a net profit of nearly $42 million on their class period sales.

The defendants offered two counterarguments, both of which were rejected by the court. First, the defendants noted that the individual defendants had entered into Rule 10b5-1 stock trading plans. As a result “more than two-thirds of [their] sales were made pursuant to the 10b5-1 plans and the remaining sales are too small a fraction of total sales to establish ‘unusual’ trading.” The court held that because the 10b5-1 trading plans were entered into during the class period, they could not be invoked “to disarm any inference of scienter raised by the Individual Defendants’ sales of CAAS stock.” Second, the defendants asserted that “the alleged accounting errors and misstatements regarding internal controls are insufficient to sustain a securities fraud claim.” The court found that this assertion was “immaterial at this stage” because the plaintiffs had “sufficiently plead motive and opportunity.”

It is difficult, in the wake of Tellabs, to see how a lower court can engage in the required weighing of competing inferences of scienter if it stops the exercise after finding that there has been “unusual” insider trading. The Second Circuit needs to sort this out.

Holding: Motion to dismiss denied (except as to an auditor defendant).

Can a plaintiff in a securities class action use information gained through the discovery process to resurrect previously dismissed claims? In In re Constellation Energy Group, Inc. Sec. Litig., 2012 WL 1067651 (D. Md. March 28, 2012), the court dismissed all of the fraud claims (1934 Act), but allowed the non-fraud claims (1933 Act) to proceed. Following discovery, the plaintiff argued that it had found “new evidence of scienter” and moved for lead to amend its complaint to re-plead the fraud claims.

The court held that neither the plain language nor the purpose of the PSLRA would be frustrated by allowing the fraud claims to go forward. The PSLRA’s discovery stay provision (which stays all discovery pending the resolution of a motion to dismiss) was designed to “limit the pressure on innocent defendants to settle cases in lieu of proceeding to expensive discovery” not “to shield all defendants from any adverse evidence that may properly be discovered over the course of litigation.” Moreover, the case was still ongoing against the same defendants, so they would not be prejudiced by having to defend themselves against the new claims. In this instance, however, the court denied the motion for leave to amend as futile, finding that even with the new evidence the plaintiff had failed to satisfy the “strong inference” pleading standard for scienter.

Holding: Motion for leave to amend denied.

A federal court has repelled an attempt to circumvent the Morrison decision through the use of state and foreign law claims. In In re BP P.L.C. Sec. Litig., 2012 WL 432611 (Feb. 13, 2012 S.D. Tex.), the plaintiffs brought claims on behalf of U.S. investors who purchased BP common shares on the London Stock Exchange (“Ordinary Share Purchasers). The claims included federal securities fraud claims, as well as New York common law and English law claims.

The court’s analysis hinged largely on the fact that BP’s common shares are listed, but not traded, on the New York Stock Exchange (to comply with SEC requirements governing the company’s American Depositary Shares program).

(1) Federal securities fraud claims – Following a number of other recent decisions, the court held that the mere fact that BP’s common shares were listed on the NYSE did not allow the Ordinary Share Purchasers to bring a federal securities fraud claim. Moreover, the court rejected plaintiffs’ additional arguments that it should consider both the U.S. residency of the Ordinary Share Purchasers and the fact that the London Stock Exchange rules “allow trades to occur directly through third-party, U.S.-based market makers.” Accepting these arguments would reinstate the old conduct and effect tests and they could not override the key point “that the Ordinary Share Purchasers bought BP ordinary shares on the LSE, the only exchange where BP ordinary shares trade.”

(2) New York common law and English law claims – The fact that BP’s common shares were listed, but not traded, on the NYSE also helped the defendants in the court’s assessment of the state law and foreign law claims, but for an entirely different reason. Under the Securities Litigation Uniform Standards Act of 1998 (SLUSA), a plaintiff cannot bring a class action based on state law fraud claims if the case involves “covered securities.” Covered securities are defined, among other things, as securities “listed, or authorized for listing, on the New York Stock Exchange.” There is no requirement that the securities also be traded on the NYSE and the court declined the plaintiffs’ invitation to read one into the statute. The court therefore held that the New York common law claims involved covered securities and were precluded by SLUSA. Plaintiffs also argued that the court had jurisdiction over the English law claims based on diversity jurisdiction under the Class Action Fairness Act (CAFA). CAFA, however, excludes claims based on “covered securities” and uses the same definition of that term as SLUSA. Accordingly, the court found that it did not have original jurisdiction over the English law claims.

Holding: Dismissed claims of Ordinary Share Purchasers (but other claims in the case were allowed to proceed).

The use (and sometimes abuse) of confidential witnesses in securities cases is a contentious issue. Prior to full discovery, what remedy does the defendant have if a confidential witness was misquoted in the complaint? One possibility, recently approved by the Second Circuit, is to allow the witness to be deposed prior to the filing of a motion to dismiss. A recent decision from the D. of Minn. suggests another possible tactic, although the defendants were ultimately unsuccessful.

In Minneapolis Firefighters Relief Assoc. v. Medtronic, Inc., 2011 WL 6962826 (D. Minn. Dec. 12, 2011), the court considered the issue of class certification prior to the completion of discovery. In opposition to certification, the defendants argued that the plaintiffs could not adequately represent the class “because of alleged misrepresentations counsel made in the Amended Complaint regarding the testimony of the confidential witnesses.” The defendants presented the court with declarations from thirteen of the fifteen confidential witnesses cited in the complaint. In their declarations, the witnesses took issue with how they were quoted, ranging from complaints about the plaintiffs’ interpretation of their statements to an assertion by one witness that the statements attributed to him were “fabrications.”

The court found that “the inquiry Defendants urge the Court to undertake – whether Plaintiffs misrepresented what the confidential witnesses said – is premature.” In particular, the court noted that “[c]ounsel-drafted declarations are not a substitute for deposition testimony” and it declined to come to any conclusion about the conduct of plaintiffs’ counsel until discovery was complete. The court therefore found that the plaintiffs were adequate class representatives and granted class certification.

The Apollo Group, a large private education provider, has been a magnet for securities litigation. In the most recent securities class action brought against Apollo, investors allege that from May 2007 to October 2010 the company made false and misleading statements about its financial condition, business focus, ethics, compensation and recruitment practices, and compliance with federal student loan regulations. In a recent decision – In re Apollo Group, Inc. Sec. Litig., 2011 WL 5101787 (D. Ariz. Oct. 27, 2011) – the court dismissed the claims. The decision has a few interesting holdings:

(1) Internet Postings – The complaint cited certain anonymous internet postings. The court noted that “the only appreciable difference between anonymous internet postings and confidential witness statements is that anonymous internet postings are less reliable.” As a result, “with regard to anonymous internet postings, it is Plaintiffs’ burden to plead reliability and knowledge that are indicative of scienter to at least the same extent as it must when pleading scienter with regard to confidential witness statements.”

(2) Suspicious Stock Trading – There were nine individual defendants in the case. The plaintiffs alleged that four of those defendants sold Apollo stock during the class period (21%, 15%, 34%, and 26% of their holdings respectively). The court found that these stock sales did not support a strong inference of scienter because (a) they were not “large sales amounts,” and (b) there were no “corroborative sales” by the other individual defendants.

(3) SEC Investigation – There is a district court split regarding whether the announcement of an SEC investigation is sufficient to establish loss causation (presuming that the announcement does not otherwise disclose any information about the alleged fraud). In Apollo’s case, the relevant press release stated that the SEC was conducting an informal investigation into the company’s revenue recognition practices. The court found that this disclosure had a sufficient nexus to the alleged fraud, because it could have signaled to a “reasonable investor that there were improprieties in Apollo’s revenue recognition policies.”

Holding: Motion to dismiss granted based on failure to adequately plead scienter.

A variation on the normal securities fraud case occurs when a short seller alleges that a company’s misstatements caused it to cover its short positions at artificially high prices. Although few cases have directly addressed loss causation in the context of short selling, they generally are not favorable for the plaintiffs. That trend continues in the recent decision in Wilamowsky v. Take-Two Interactive Software, Inc., 2011 WL 4542754 (S.D.N.Y. Sept. 30, 2011).

Take-Two previously had settled a securities class action related to options backdating, but the settlement’s plan of allocation excluded short sellers from recovery. Wilamowsky opted out of the settlement and brought his own individual action. On the issue of loss causation, however, the court noted that Wilamowsky’s transactions in Take-Two stock (both short sales and covering purchases) ended “prior to the relevant curative disclosure.” As a result, Wilamowsky could not “plausibly articulate why [his alleged] losses are attributable to Defendants’ misstatements and omissions” as opposed to “legitimate market circumstances and intervening events.” The court found that was “particularly so here, where the in-and-out stock transactions began after the stock price was already inflated, spanned an extended time period punctuated by constant legitimate market stimuli and repeated misstatements, and terminated more than a year prior to the corrective disclosure.”

Holding: Dismissed with prejudice.

Quote of note: “With hindsight, Plaintiff may wish that he either covered immediately at the end of his short-selling period in January 2005, when the stock fell below his average sale price, or waited until after the corrective disclosure, by which point the price declined enough to put him in a position to earn millions of dollars. But allowing him to state a claim under these circumstances would permit a short seller in any standard misrepresentation case to either win big in the marketplace by covering after a corrective disclosure, or win in court by ‘transforming a private securities action into a partial downside insurance policy.'”

At one point, it looked like the UBS securities class action would be a test case on the application of the Morrison decision (in which the U.S. Supreme Court rejected the extraterritorial application of Section 10(b) in private litigation). As it turned out, a number of district court decisions on the issue have been issued while the UBS court considered its ruling. This week, however, the court finally weighed in with a sweeping victory for the defendants. See In re UBS Sec. Litig., 1:07-cv-11225-RJS (S.D.N.Y. Sept. 13, 2011).

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. The court found that Morrison “makes clear that its concern was with respect to the location of the securities transaction and not the location of an exchange where the security may be dually listed.” 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. The court found that neither the location of the buy order nor the place of injury converted the purchase into a “domestic” securities transaction.
Holding: Foreign-cubed and foreign-squared claims dismissed.

As noted by The 10b-5 Daily in its writeup of the Janus decision, a key open question was whether the Supreme Court’s “ultimate authority” requirement for primary liability also applied to corporate insiders. Just a few months later, there is already a district court split on the issue.

In In re Merck & Co., Inc. Sec., Derivative & “ERISA” Litigation, 2011 WL 3444199 (D.N.J. Aug. 8, 2011) the company’s executive vice president for science and technology argued that he did not have “ultimate authority” over the statements attributed to him in Merck’s public filings. (It is the same Merck case that led to the Supreme Court’s recent decision concerning the statute of limitations for securities fraud claims.) The court found that the holding in Janus was limited to cases involving a “separate and independent entity” and could not “be read to restrict liability for Rule 10b-5 claims against corporate officers to instances in which a plaintiff can plead, and ultimately prove, that those officers – as opposed to the corporation itself – had ‘ultimate authority’ over the statement.” Accordingly, the court declined to dismiss the claims against the Merck officer on that basis.

The ink was barely dry on the Merck decision, however, before another district court disagreed with its analysis. In Hawaii Ironworkers Annuity Trust Fund v. Cole, No. 3:10CV371 (N.D. Ohio Sept. 1, 2011), the court found that “nothing in the Court’s decision in Janus limits the key holding – the definition of the phrase ‘to make . . . a statement’ under Rule 10b-5 – to legally separate entities.” Indeed, the dissent in Janus clearly believed that the majority’s holding also applied to corporate insiders. In the instant case, the plaintiffs’ own complaint made it clear that the defendants, who were officers in one of the company’s business units, did not have ultimate authority over the alleged false statements in the company’s filings. The court also noted that the alleged false statements, unlike in the Merck case, were not specifically attributed to the defendants (a fact that might otherwise be sufficient to establish “ultimate authority”). The court therefore dismissed the Rule 10b-5(b) claims against the defendants for making false statements, but declined to dismiss the related Rule 10b-5(a) and (c) claims based on deceptive conduct.

What will the next court to address the issue hold? Stay tuned.

In the wake of the Morrison decision, U.S. courts have proven reluctant to endorse any securities fraud claims by foreign purchasers. And no bonus points for cleverness. In In re Toyota Motor Corp. Securities Litig., 2011 WL 2675395 (C.D. Cal. July 7, 2011), plaintiffs argued that they should be able to bring (a) U.S. securities fraud claims on behalf of ADS purchasers and domestic purchasers of Toyota common stock, and (b) Japanese securities fraud claims on behalf of all purchasers (foreign and domestic) of Toyota common stock. The plaintiffs posited two possible bases for jurisdiction over the Japanese law claims: original jurisdiction under the Class Action Fairness Act (CAFA) and supplemental jurisdiction.

The court disagreed with both. As to CAFA, the court found that Toyota’s common shares are “listed” on the NYSE and, as a result, are “covered securities.” Claims related to “covered securities” are expressly excluded from CAFA. The court also declined to exercise supplemental jurisdiction over the Japanese securities fraud claims for two reasons. First, the Japanese law claims would “substantially predominate over the American law claims” due to the much larger proposed class. Second, the “exceptional circumstance of comity to the Japanese courts.” The National Law Journal and Thomson Reuters have articles on the decision.

Holding: Motion to dismiss granted as to Japanese law claims and certain other claims.

Quote of note: The “respect for foreign law would be completely subverted if foreign claims were allowed to be piggybacked into virtually every American securities fraud case, imposing American procedures, requirements, and interpretations likely never contemplated by the drafters of the foreign law. While there may be instances where it is appropriate to exercise supplemental jurisdiction over foreign securities fraud claims, any reasonable reading of Morrison suggests that those instances will be rare.”