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Longtop Financial Technologies, a Chinese financial software company, was a notorious financial fraud (see here for a NYT column on the discovery of the fraud).  Both its outside auditors, Deloitte Touche Tohmatsu, and its Canada-based CFO, Derek Palaschuk, were apparently taken in by the company’s scheme to exaggerate its cash balances and revenue, under-report bank loan balances, and hide employee costs in an off-balance-sheet entity.  Last year, a securities class action brought on behalf of investors in Longtop’s American Depositary Shares obtained an $882.3 million default judgment against Longtop and its CEO, but Palaschuk decided to take the claims against him to trial.

On Friday, after a short trial in New York federal court, a jury found Palaschuk liable for securities fraud based on his failure to act despite the presence of “red flags” indicating that the company’s accounting might be fraudulent.  According to press reports, the inability to compel the presence of Chinese witnesses meant that Palaschuk was the only fact witness to testify.  Because Palaschuk’s liability was based on recklessness (rather than actual knowledge of the fraud), however, he presumably was subject to the PSLRA’s proportionate liability provisions.  Under these provisions, he only could be liable “for the portion of the judgment that corresponds to [his] percentage of responsibility.”  In an interesting twist, the jury reconvened today and found that Palaschuk was only 1% responsible for the fraud, assigning the other 99% of the responsiblity to Longtop and its CEO.  According to the plaintiffs, that still means Palaschuk will owe at least $5 million.  Palaschuk plans to challenge the verdict.  Stay tuned.

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An interesting motion to dismiss decision in the S.D.N.Y. – Dobina v. Weatherford Int’l Ltd., 2012 WL 5458148 (S.D.N.Y. Nov. 7, 2012) – touches upon several scienter pleading issues.

(1) Corporate Acquisitions – Does the artificial inflation of the company’s stock price to facilitate acquisitions establish a “motive” that can contribute to a demonstration of scienter (i.e., fraudulent intent)? The Second Circuit has held that there must be a “unique connection between the fraud and the acquisition,” but has “provided little guidance as to what this ‘unique connection’ must be.” The court found that, at a minimum, this requirement “demands more than alleging simply that the Company acquired companies during the class period with the use of stock.” Moreover, it is arguable that “any such motive to raise the stock price in order to fund acquisitions more cheaply would inure to the benefit of all shareholders, and thus would not demonstrate intent to defraud.”

(2) Core Operations Theory – Should knowledge of the falsity of statements about the “core operations” of a company be imputed to its key officers? The court noted that “it remains an open question whether the theory has survived the passage of the PSLRA.” Even if it applied the core operations theory, however, the court found that because it “may make such an inference does not mean that such an inference necessarily would be the most compelling [as required by the S. Ct.’s Tellabs decision].” As to the Weatherford defendants, the more compelling inference of scienter was “that the Company made an error in its tax accounting treatment in 2007 that persisted on its books, compounding over time, and leading to incorrect financial reporting that propagated up to management.”

(3) Auditor Scienter – Auditor scienter in the Second Circuit “turns on alleging that the auditor repeatedly failed to scrutinize serious signs of fraud” (i.e., ignored red flags). The court found that the plaintiffs’ allegations about what E&Y (Weatherford’s auditor) ignored, however, were either “not red flags at all” or “not sufficiently colorful.” In particular, the mere “size and nature of the fraud” could not establish that “E&Y should have found it.”

Holding: Complaint dismissed, except for claims against two officers based on statements about the quality of internal controls (and related control claims).

One of the first decisions in the Facebook securities litigation addresses a Securities Litigation Uniform Standards Act of 1998 (SLUSA) issue that has been the subject of a longstanding district court split.

Private actions under the Securities Act of 1933 (’33 Act) may be brought in federal or state court. SLUSA was designed, however, to prohibit the bringing of securities class actions based on misrepresentations or deception in state court and provides for the removal of these cases to federal court. In doing so, however, SLUSA specifically limits itself to class actions “based upon the statutory or common law of any State.” Which leaves open the question: can plaintiffs bring a ’33 Act class action in state court and prevent its removal?

In Lapin v. Facebook, Inc., 2012 WL 3647409 (N.D. Cal. Aug. 23, 2012), the court held that ’33 Act class actions are removable. The court found that SLUSA amended the jurisdiction section of the ’33 Act by inserting an “except as provided in” SLUSA provision that exempts covered class actions from concurrent jurisdiction (presumably even though ’33 Act class actions are brought under federal, not state or common, law). Moreover, this interpretation of the amendment to the jurisdiction section is supported by SLUSA’s legislative history, which broadly states that SLUSA’s purpose “is to prevent plaintiffs from seeking to evade the protections that Federal law provides against abusive litigation by filing suit in State, rather than in Federal, court.”

Holding: Motion to remand denied.

The Morrison decision limiting the extraterritorial application of the U.S. securities laws continues to be the subject of extensive judicial, practicioner, and academic commentary. Recent items include:

(1) Professor Hannah Buxbaum has published a paper entitled “Remedies for Foreign Investors Under U.S. Federal Securities Law,” in which she discusses Morrison‘s transaction-based test and explores the possibility of foreign investors suing under U.S. law or participating in the SEC’s Fair Funds program.

(2) The American Lawyer describes Morrison as “The Global Securities Case of the Decade (So Far)” (Jan. 20 – subscrip. req’d). The article summarizes the widespread impact of Morrison to date and notes that seven Morrison-related cases are currently on appeal in the Second Circuit alone.

(3) NERA has issued a report, in response to an SEC comment request, on “Cross-Border Shareholder Class Actions Before and After Morrison” (Dec. 2011). The authors conclude that by “reducing expected litigation costs, Morrison eases a deterrent to US listing by foreign issuers and thereby makes the US a more competitive venue for cross-listings, as well as for the volume in cross-listed stocks.”

(4) The Harvard Law School Forum on Corporate Governance and Financial Regulation has a post entitled “A New Playbook for Global Securities Litigation and Regulation.” The author discusses the rise of alternative forums to the U.S. for global securities litigation.

(5) A Reuters article (Feb. 1) discusses a recent decision in the Vivendi securities litigation confirming that Morrison applies to claims under both the Securities Exchange Act of 1934 (market activity) and the Securities Act of 1933 (offering and sale of securities).

A few months ago, this blog noted an unusual lead plaintiff decision. A S.D.N.Y. court dismissed the lead plaintiff from a securities class action brought against Smith Barney Fund Management and Citigroup Global Markets because, after six years of litigation, it was revealed that the entity had not actually purchased the securities at issue. So what happened to the case?

All is revealed in the court’s most recent order (In re Smith Barney Transfer Agent Litig., 2011 WL 6318988 (S.D.N.Y. Dec. 15, 2011)), along with some new twists and turns. The court decided to reopen the lead plaintiff selection process. The applicants included a new proposed lead plaintiff group associated with the former lead counsel for the case, as well as one of the unsucessful lead plaintiff applicants from back in 2005. As a group, the applicants associated with the former lead counsel had the largest financial interest in the relief sought. The court found, however, that “[p]laintiffs who moved for lead plaintiff appointment within sixty days of the original notice are entitled to priority over plaintiffs who only moved within sixty days of the order dismissing the prior lead plaintiff.” Accordingly, the court selected the original applicant to handle the case.

Quote of note: “In appointing new lead counsel, this Court is mindful that [former lead counsel] served . . . for over six years. But it is investors – and not their lawyers – who are the focus under the PSLRA. And the Court would not have been confronted with this situation if [former lead counsel] had investigated their client’s holdings in 2005. In any event, this Court has every confidence that [former lead counsel] will provide ample assistance to new lead counsel consistent with their professional responsibilities to their clients and their obligations as officers of the Court.”

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