Category Archives: Motion To Dismiss Monitor

The PSLRA’s Safe Harbor for forward-looking statements is designed to encourage companies to provide investors with information about future plans and prospects by limiting their potential liability for these statements. Under the first prong of the Safe Harbor, a defendant is not liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by “meaningful cautionary statements” that alert investors to the factors that could cause actual results to differ.

In the case of oral forward-looking statements, the PSLRA specifically provides that the meaningful cautionary statements can be incorporated by reference in a readily available written document. The statute is silent, however, about whether this is also true for written forward-looking statements. A surprisingly small number of courts have addressed this issue, but the trend appears to be in favor of finding that a company’s incorporation by reference is sufficient.

In Yellen v. Hake, 2006 WL 1881205 (S.D. Iowa July 7, 2006), the court addressed a securities class action brought against Maytag Corp. The court found that “[w]hile the Safe Harbor provision does not explicitly provide for incorporation by reference for written forward-looking statements” it is implicit in Congress’ direction that courts consider “all information and documents relevant to a determination of whether a defendant has given adequate warnings.” Accordingly, the court agreed to consider warnings contained in Maytag’s 2004 Annual Report that were incorporated by reference in the press release and investor presentations that allegedly contained false or misleading forward-looking statements.

The role of Rule 10b5-1 stock trading plans in assessing the adequacy of a plaintiff’s scienter (i.e., fraudulent intent) allegations is becoming a more frequent issue in securities class actions as the use of these plans increases. A recent decision in the N.D. of Texas – relying on the Netflix opinion – will certainly encourage that trend.

In Fener v. Belo Corp., 425 F.Supp.2d 788 (N.D. Tex. 2006), the court held that at the pleading stage it is the burden of the plaintiff to place any allegedly suspicious stock trading in context. Accordingly, the plaintiffs needed to address “in their complaint whether [the defendant officer] sold his stock pursuant to a Rule 10b-5(1) trading plan formulated before the alleged fraudulent scheme and why, if he did, this does not undercut a strong inference of scienter.”

Holding: Motion to dismiss granted with leave to amend.

Whether selling company stock under a Rule 10b5-1 trading plan can help shield corporate executives from securities fraud liability is an open question. Although some courts have considered the existence of a trading plan in finding that an executive’s stock sales did not create a strong inference of scienter (i.e., fraudulent intent), a recent decision goes the other way. In In re Cardinal Health Inc. Sec. Litig., 2006 WL 932017 (S.D. Ohio April 12, 2006), the court held that it was “premature” to evaluate the impact of a trading plan at the motion to dismiss stage because it is an affirmative defense to insider trading allegations.

The content of the disclosure that led to a stock price decline is an important part of post-Dura loss causation analyses. One particular fact pattern that has proven difficult for defendants is when a company announces a SEC investigation without specifying exactly what conduct is under investigation.

In In re Bradley Pharmaceuticals, Inc. Sec. Litig., 2006 WL 740793 (D.N.J. March 23, 2006), the company disclosed that the SEC was conducting an informal inquiry and had asked for information “with respect to revenue recognition and capitalization of certain payments.” The stock price fell 26%. A subsequent announcement by the company revealed that it would have to restate its financial results for an earlier quarter due to improper revenue recognition on a particular transaction. The stock price went up slightly.

In their motion to dismiss, the defendants argued that the plaintiffs had failed to allege a loss following a “corrective disclosure” because the original press release was “simply a disclosure of a non-specific SEC inquiry” and did not say anything about the particular transaction at issue. The court disagreed, finding that the revelation of the truth “occurred through a series of disclosing events” and that by the time the company announced its restatement “the market had already incorporated that the previously released financial statements could not be relied upon.”

Holding: Motion to dismiss denied.

Addition: For a similar holding, see Brumbaugh v. Wave Systems Corp., 2006 WL 52751 (D. Mass. 2006).

In its Dura decision, the Supreme Court left open the question of whether loss causation is subject to a heightened pleading standard. The court assumed, without deciding, “that neither the [Federal Rules of Civil Procedure] nor the securities statutes impose any special further requirements in respect to the pleading of proximate causation or economic loss,” and applied the notice pleading requirements of F.R.C.P. 8(a)(2). Following Dura, several courts have concluded that notice pleading is sufficient (see, e.g., Greater Penn. Carpenters Pension Fund v. Whitehall Jewellers, Inc., 2005 WL 1563206 (N.D. Ill. June 30, 2005)).

A contrary view can be found in the recent decision in In re The First Union Corp. Sec. Litig., 2006 WL 163616 (W.D.N.C. Jan. 20, 2006). The court noted that the Supreme Court had “expressly declined to consider whether loss causation must be pled with particularity.” Based on pre-Dura circuit court decisions finding that F.R.C.P. 9(b)’s particularity standard is applicable to loss causation and the fact that “the Fourth Circuit has held that every element of a common law fraud action must be plead with particularity,” the court decided that the plaintiffs needed to satisfy the heightened pleading standard.

Motions for reconsideration are rarely successful, but loss causation issues may be an exception given the need to interpret the Supreme Court’s recent Dura decision. In In re Royal Dutch/Shell Transport Sec. Litig., 2005 WL 3359695 (D.N.J. Dec. 12, 2005), the court had held, based on Dura, that investors who purchased securities during the class period, but did not subsequently sell the securities, could not adequately plead loss causation. Therefore, those investors could not join the putative class.

On reconsideration (and after the case was reassigned to another judge), the court found that Dura “neither expressly nor implicitly mandates that the subject securities be sold in order for a plaintiff to have suffered cognizable loss.” The court also found that the PSLRA did not require such a sale to bring a securities fraud action and that it would be against public policy to judicially create this requirement.

Holding: Motion for reconsideration granted.

Quote of note: “Nothing in Dura indicates that the Supreme Court intended to overrule the established precedent permitting holding plaintiffs to maintain actions for securities fraud, to call into question the statutory scheme by creating a sell- to-sue requirement, or to undermine relevant policy concerns without any analysis. Moreover, Dura‘s holding was limited to rejecting the Court of Appeals for the Ninth Circuit’s standard for pleading loss causation and economic loss in a securities fraud action, which had required only an allegation of inflated purchase price because of a misrepresentation; the Supreme Court expressly stated that it did not ‘consider other proximate cause or loss-related questions.’ Accordingly, Dura cannot be read to require both purchase and sale of the subject securities.”

Section 304 of the Sarbanes-Oxley Act of 2002 provides that a company’s CEO and CFO must disgorge certain bonuses, equity-based compensation, and trading profits if the company is required “to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws.” Although Congress did not create an express private right of action in the statute, recent securities class actions and derivative suits often include a tag-along Section 304 claim.

As reported by The 10b-5 Daily, at least one court has found in a derivative case that the legislation did not create a private right of action and dismissed the claim. Courts that are inclined to do the same thing in a securities class action, however, may choose to rely on the plain language of the statute. In In re Qwest Communications Int’l, Inc. Sec. Litig., 387 F. Supp. 2d 1130 (D. Col. 2005), the court found that Section 304 expressly requires an officer to “reimburse the issuer.” Under these circumstances, Qwest’s investors did not have standing to bring the claim because they were “not entitled to the relief authorized by the statute.”

Holding: Motion to dismiss Section 304 claim granted.

The content of the disclosure that led to a stock price drop continues to be the focal point of post-Dura loss causation analyses. In Sekuk Global Enterprises v. KVH Industries, Inc., 2005 WL 1924202 (D.R.I. Aug. 11, 2005), the plaintiffs claimed that the company engaged in improper accounting practices related to the sales of a key product. The plaintiffs’ alleged losses occurred after the company issued a press release announcing reduced quarterly revenue based on lower than expected sales.

In their motion to dismiss, the defendants argued that “the press release and the resulting drop in the price of KVH common stock fails to establish loss caustion because the press release does not attribute the declining revenue to the sales of the [key product].” The court found, however, that the key product was a possible contributor to the lower than expected sales, even if it was not expressly discussed in the press release. Accordingly, the plaintiffs adequately plead loss causation.

Holding: Motion to dismiss denied (except for the claims based on a limited number of inactionable statements).