June 3, 2004 · 10:55 pm

The Perfect Storm Redux

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.

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June 2, 2004 · 9:07 pm

Class Action Reform Tabled

As predicted, Senate Majority Leader Bill Frist has been forced to table the Class Action Fairness Act until after the completion of the 2005 Department of Defense authorization bill. The Hill has this report.

Quote of note: “With several of the class-action bill’s co-sponsors opposing the cloture vote, Frist probably lacked the votes yesterday to limit debate on the defense bill. Frist said he remains committed to bringing the class-action bill to the floor and said he would move ‘immediately’ to it after the defense bill was complete.”

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June 1, 2004 · 10:01 pm

U.S. Urges Supreme Court to Resolve Circuit Split on Loss Causation

As The 10b-5 Daily has frequently discussed (indeed, this is the third post in a row on the topic), there is a circuit split over what is necessary to adequately plead loss causation in a securities fraud case. A majority of the courts hold that a plaintiff must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead loss causation, while a minority of courts hold that a plaintiff merely needs to demonstrate that the alleged misrepresentations artificially inflated the stock price.

In Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003), the Ninth Circuit came down firmly in the minority camp. The court found that loss causation “merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause.” Based on this holding, the court reversed the lower court’s dismissal and remanded the case for further proceedings. (See this postdiscussing the opinion.) The defendants petitioned for a writ of certiorari to the Supreme Court.

On Friday, the U.S. (the SEC and the Solicitor General) filed an amicus brief in support of the defendants’ petition. In the brief, the U.S. argues that there is “an acknowledged circuit conflict regarding the nature and scope of the plaintiff’s burden to plead and prove loss causation in a fraud-on-the-market case under Rule 10b-5; the court of appeals decided that question incorrectly; the question is one of recurring importance; and this case is a suitable vehicle for resolving it.”

Specifically on the issue of whether the case was incorrectly decided, the U.S. makes two main arguments. First, the U.S. argues that measuring the loss in these types of cases “as of the time of the purchase, and not requiring any allegations of a subsequent loss of value attributable to the fraud, would grant a windfall to investors who sold before the reduction or elimination of the artificial inflation, because they would recover the portion of the purchase price attributable to the fraud on resale, and then would be entitled to recover that same amount again in damages.” Second, the U.S. argues that the decision improperly conflated the separate elements of transaction causation (i.e., the alleged misconduct induced the plaintiff to engage in the transaction in question) and loss causation (i.e., the alleged misconduct caused the plaintiff’s economic loss).

The Supreme Court rarely takes on securities litigation issues. But the combination of a clear circuit split, the U.S.’s encouragement, and yet another opportunity to overturn the Ninth Circuit, may well prove irresistible.

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May 28, 2004 · 7:15 pm

PLI Teleseminar On Loss Causation

Regular readers of The 10b-5 Daily know that the past year has seen a series of notable court opinions on the pleading of loss causation (the requirement that a plaintiff demonstrate that the economic harm it suffered occurred as a result of the alleged securities fraud). Is loss causation becoming a significant barrier to bringing a securities fraud claim?

The author of The 10b-5 Daily, Lyle Roberts (Wilson, Sonsini, Goodrich & Rosati), will be chairing a PLI teleseminar on this topic on Wednesday, June 9 at 1 p.m. ET. The panelists are Alfred Lechner (Morgan Lewis & Bockius – former U.S. District Judge) and Sherrie Savett (Berger & Montague). The program will also be webcast and CLE credit is available.

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May 28, 2004 · 6:05 pm

Two Steps To Tango

NERA Economic Consulting has published an interesting working paper entitled “Loss Causation and Damages in Shareholder Class Actions: When It Takes Two Steps To Tango.” The author, Dr. David Tabak, discusses the circuit court split between courts that believe plaintiffs must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to adequately plead loss causation (e.g., Emergent Capital Investment Management, LLC v. Stonepath Group, Inc., 343 F.3d 189 (2d Cir. 2003)) and courts that believe plaintiffs merely need to demonstrate that the alleged misrepresentations artificially inflated the stock price (e.g., Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003)).

Dr. Tabak finds that “if plaintiffs have to plead either only a purchase inflation or only a later price decline, some investors will ‘successfully’ plead loss causation without having suffered a loss.” Accordingly, there is a logical argument that plaintiffs should have to plead both a purchase inflation and a later price decline related to the fraud to survive a motion to dismiss. The article also discusses how the different loss causation pleading requirements impact the calculation of damages.

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May 27, 2004 · 10:40 pm

Class Action Reform May Be Delayed Again

The Class Action Fairness Act applies some of the reform concepts in the PSLRA and SLUSA to all class actions. Notably, class actions meeting certain jurisdictional criteria would have to be heard in federal court. It is believed that Republicans have enough votes in the Senate to pass the bill, but Reuters reports that there is a disagreement over when it will reach the floor. The House passed its own version of the legislation almost a year ago.

Quote of note: “Republicans seeking curbs on what they call runaway litigation against business want to start debating the class action measure on June 1, when Senate Majority Leader Bill Frist has scheduled a vote on a motion to bring up the bill. . . . But Democratic aides predict Frist will not be able to get the 60 votes he needs to bring up the bill next Tuesday, because of the desire to resume debate on defense.”

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May 26, 2004 · 9:22 pm

PWC Settles Raytheon Suit

In the wake of Raytheon’s settlement of the securities class action pending against the company in the D. of Mass. for $410 million in cash and securities, its co-defendant and former auditor, PricewaterhouseCoopers LLP, also has decided to avoid a trial. The Boston Globe has a lengthy article on PwC’s agreement to pay $50 million to settle its portion of the suit, which alleged that the auditor helped Raytheon hide cost overruns. Taken together, the Raytheon settlements are the fifth-largest ever in a securities class action.

Quote of note: “The settlement allows Raytheon and PwC to put the dark days of 1999 behind them. But the biggest winners in the case may be the jurors who faced the prospect of sifting through complex and highly technical evidence for six weeks or longer. Instead, just after the jury was led in yesterday morning, Judge Saris disclosed the settlement before lightheartedly admonishing the jurors: ‘Don’t look so happy!'”

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May 24, 2004 · 11:18 pm

Defining The Outer Limits

In the typical securities class action, the plaintiffs allege the defendant company made material misrepresentations that inflated the value of the company’s stock. But what if the alleged misrepresentations also inflated the value of another company’s stock? Do the purchasers of the second company’s stock have standing to sue the first company?

The U.S. Court of Appeals for the Second Circuit thinks this is stretching the boundaries of Rule 10b-5 too far. In Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks Corp., 2004 WL 1110496 (2d Cir. May 19, 2004), the court addressed whether purchasers of JDS Uniphase stock, which was in the process of selling its laser business to Nortel during the class period, had standing to sue Nortel for alleged misstatements about Nortel’s business prospects that inflated the stock prices of both companies. Based on Supreme Court precedent, the court found that the purchaser-seller requirement for Rule 10b-5 liability limits standing to those who have dealt in the security to which the misrepresentation relates. (The court left open the question, however, of whether a potential merger between two companies, which would create a more direct relationship between the companies’ stock prices, might require a different outcome.)

Holding: Affirming lower court’s dismissal.

Quote of note: “Stockholders do not have standing to sue under Section 10(b) and Rule 10b-5 when the company whose stock they purchased is negatively impacted by the material misstatement of another company, whose stock they do not purchase.”

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May 21, 2004 · 8:42 pm

Monday Morning Settling (Another Look At Citigroup)

In settling a case, timing is important. Citigroup’s settlement of the WorldCom litigation for $2.65 billion was the subject of a handshake agreement as of Thursday, May 6. According to press reports, Citigroup told analysts that the timing was influenced by the Second Circuit argument in the case scheduled for the following Monday.

At issue in that appeal was whether the district court had properly granted class certification for the claims against Citigroup based on analyst statements about WorldCom’s securities. The district court had applied the fraud-on-the-market doctrine (i.e., reliance by investors on an alleged misrepresentation is presumed if the company’s shares were traded on an efficient market) to help establish that common issues predominated over individual ones for the class members. Citigroup argued on appeal that the fraud-on-the-market doctrine could not be applied to claims based on analyst statements. Meanwhile, the SEC submitted an amicus brief to the court opposing Citigroup’s position. Citigroup, in discussing its decision to settle the case before the appeal was heard, stated “to have the SEC come out against that obviously worsened the odds against us.” But, with the benefit of hindsight, were the odds better than they appeared?

Although the Second Circuit had agreed to hear Citigroup’s appeal, as of May 6 (the date of the handshake agreement) it had not issued an opinion explaining its ruling. That would come the next day, May 7, and the opinion certainly suggested that Citigroup’s arguments would be considered carefully.

In Hevesi v. Citigroup Inc., 2004 WL 1008439 (2d Cir. May 7, 2004), the court explained that it had agreed to hear the appeal because the certification order “implicates a legal question about which there is a compelling need for immediate resolution.” The question was “whether a district court may certify a class in a suit against a research analyst and his employer, based on the fraud-on-the-market doctrine, without a finding that the analyst’s opinions affected the market prices of the relevant securities.” In discussing its decision to address that question, the court expressed skepticism about the lower court’s ruling. Among other indications that it might be favorably disposed to Citigroup’s position, the court: (1) discussed a Seventh Circuit case in which the court had declined to apply the fraud-on-the-market doctrine on class certification; (2) noted that “the application of the fraud-on-the-market doctrine to opinions expressed by research analysts would extend the potentially coercive effect of securities class actions to a new group of corporate and individual defendants – namely, to research analysts and their employers;” and (3) cited a prominent Columbia Law School professor on the point that analyst opinions should be treated differently from issuer statements.

If that were not enough, just five days later the Fourth Circuit issued an opinion establishing that a district court must make a factual finding that the fraud-on-the-market doctrine is applicable before it can be used to support class certification. In Gariety v. Grant Thornton, LLP, 2004 WL 1066331 (4th Cir. May 12, 2004), the court addressed whether a district court could accept “at face value the plaintiffs’ allegations that the reliance element of their fraud claims could be presumed under a ‘fraud-on-the-market’ theory.” At issue was whether the relevant securities had been traded on an efficient market (one of the requirements for the application of the theory). The court concluded that because “the district court concededly failed to look beyond the pleadings and conduct a rigorous analysis of whether Keystone’s shares traded in an efficient market, we must remand the case to permit the district court to conduct the analysis and make the findings required by Rule 23(b)(3).”

While there are undoubtedly many other factors that go into a settlement (especially one of this magnitude), would the Citigroup settlement have looked different just a week later based on these judicial developments? Maybe not, but it’s interesting to speculate.

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Filed under Appellate Monitor, Settlement, WorldCom

May 19, 2004 · 11:04 pm

Predicting The Future

The Associated Press has an article discussing whether the market should expect another set of corporate scandals in the future. Although human nature is unlikely to change, the article reviews the legal environment and concludes “[i]n sheer numbers, the legal activity of recent years – both government action and investor litigation – should be enough to give any would-be wrongdoer some immediate cause for pause.”

Quote of note: “‘I don’t think there’s a clear connection’ between legal risks and improper behavior, said Bruce Carton, executive director for Securities Class Action Services at ISS. ‘When the misdeeds are going on, people aren’t thinking years down the road, ‘Will this cost me in a class action suit?’ My sense is that (the legal risk) generally won’t deter the bad guys, but it may spur the bad guys’ employers to put safeguards in place that may catch or deter somebody down the line.'”

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