The 10b-5 Daily

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.