April 26, 2004 · 11:13 am

Mixed Opinions

The Economist has an interesting article (subscrip. req’d) on the recent court decisions in the research analyst cases. For non-subscribers, the article can be found in the Finance & Economics section of the April 24 edition.

Quote of note: “So far, Merrill Lynch seems to have hit the jackpot. All the litigation against it has been consolidated in New York under Milton Pollack, a federal judge who believes that there is no case to answer. Others have been less lucky: Lehman Brothers suffered a nasty setback last month when another federal judge in the same judicial district in lower Manhattan, Jed Rakoff, allowed litigation against it to proceed. These are, of course, early days; but because the stakes are so high, defendants on the end of adverse rulings are under great pressure to settle. It may well be that none of the civil cases lasts long enough to be decided by a jury.”

Disclosure: The author of The 10b-5 Daily is quoted in the article.

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April 23, 2004 · 3:51 pm

Who’s In Charge Here?

Section 20(a) of the ’34 Act creates a cause of action against defendants alleged to have been “control persons” of those who engaged in securities fraud. In the absence of a scienter pleading requirement for control person liability (a disputed question in the Second Circuit – see this post), all plaintiffs need to show at the pleading stage is: (a) there was a primary violation by a controlled person; and (b) control of the primary violator by the defendant. An unresolved issue is what is necessary to adequately plead the element of control if both the primary violator and the defendant are corporations.

In Schnall v. Annuity and Life Re (Holdings), Ltd., 2004 WL 515150 (D. Conn. March 9, 2004), the court’s answer was: not too much. XL Capital Ltd. had founded Annuity and Life Re (Holdings), Ltd. (“ANR”), the primary corporate defendant in the case, and two of XL Capital’s officers/directors served as ANR directors. In addition, during the class period XL Capital owned between 11% and 12.9% of ANR’s common stock. Based on these facts, the court found “it may reasonably be inferred that defendant XL Capital was in a position to influence and direct the activities of ANR” and therefore the plaintiffs’ Section 20(a) claim against XL Capital could go forward.

Holding: Motion to dismiss denied.

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April 23, 2004 · 2:24 pm

ESI Settles

Electro Scientific Industries, Inc. (Nasdaq: ESIO), a Portland-based manufacturing equipment supplier, has announced the settlement of the securities class action (and a related derivative suit) pending against the company in the D. of Oregon. The suit, originally filed in March 2003, is based on misrepresentations related to the company’s restatment of its financials for the 2002 fiscal year and two subsequent quarters. The settlement is for $9.25 million, of which approximately $3.8 million will be paid by ESI and approximately $5.45 million will be paid by its insurance carrier.

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April 21, 2004 · 7:21 pm

The Goldilocks Problem

How can a court determine what amount of attorneys’ fees is “just right”? DPL, Inc. and their former accountants, PricewaterhouseCooopers, settled the securities class action against them in the S.D. of Ohio (as well as related state court derivative actions) for $145.5 million. The class action portion of the settlement was $110 million and plaintiffs’ counsel requested that the court award them 35%, or $38.5 million, in attorney’s fees and costs.

In a decision issued last month (but only recently appearing online), the court rejected this fees request after members of the class objected. See In re DPL, Inc. Sec. Litig., 2004 WL 473472 (S.D. Ohio March 8, 2004). The court found that plaintiffs’ counsel had achieved an “outstanding” result in the case. According to an affidavit of an economist submitted by plaintiffs’ counsel, $110 million represented “between about 62% and 145% of the losses suffered by the members of the class.” The court also noted that “a review of the Defendants’ motions seeking dismissal of the litigation, motions which were not ruled upon due to the settlement, reveals that it is by no means certain that the claims of the Plaintiffs and the class they represent would have survived rulings on such.” Under these circumstances, the court found that the percentage of fund method for calculating the attorneys’ fees, with its emphasis on rewarding good results, was more appropriate than the lodestar method (which is based on the number of hours reasonably expended, at a reasonable hourly rate, adjusted by a multiplier).

When it came to the actual percentage to award, however, the court balked at 35%. The court determined that plaintiffs’ counsel had done relatively little work to obtain the settlement (primarily briefing the motion to dismiss) and that “an attorney compensated at the hourly rate of $350, an overly generous rate for this part of the world, would have to work 110,000 hours to generate such a fee.” The court then concluded that a reasonable award was 20% of the common fund, or $22 million. Notably, the court offered no rationale for selecting 20% as the right amount, as compared to 19%, 21%, or any other percentage below what was requested.

Holding: Sustaining in part and overruling in part the application for attorneys’ fees.

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April 21, 2004 · 4:27 pm

Service Corp. Int’l Settles

Service Corp. Int’l (NYSE: SRV), a Houston-based funeral and cemetary company, has announced the preliminary settlement of the securities class action pending against the company in the S.D. of Tex. The suit, originally filed in January 1999, alleges that the company made misrepresentations concerning its prearranged funeral business and other financial matters. The settlement is for $65 million, with $30 million of the payment being provided by the company’s insurance carriers.

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April 20, 2004 · 7:01 pm

SEC Files Amicus Brief In WorldCom Appeal

Last Friday, the SEC filed an amicus brief in support of the plaintiffs in the WorldCom securities class action. Two of the defendants, Salomon Smith Barney and its former telecommunications analyst, Jack Grubman, have appealed the district court’s grant of class certification to the United States Court of Appeals for the Second Circuit. At issue is whether the district court properly determined that the fraud on the market theory was applicable to analysts.

The New York Times has an article on the SEC’s brief. The district court held that it “comports with both common sense and probability” to find that Grubman’s analyst reports affected the price of WorldCom securities and therefore to presume that WorldCom investors relied on those statements pursuant to the fraud on the market theory. The SEC reportedly supports this holding. The Second Circuit is scheduled to hear oral argument in the case on May 10.

Quote of note: “There is no reason to believe that Mr. Grubman’s opinions, which relied on WorldCom’s disclosures, had any distinct price impact ‘over and above the price consequences of WorldCom’s massive ongoing fraud,’ Citigroup’s [the parent company of SSB] lawyers said in their brief. As such, each investor should have to prove that he was harmed by Mr. Grubman and Salomon in individual cases, not as a class action. But lawyers at the S.E.C. countered that economic studies showed that analysts’ reports affect securities prices and that their very purpose was to provide information upon which investors base their decisions.”

Addition: The SEC’s amicus brief can be found here (thanks to Bruce Carton for the link) and here (thanks to Paul Mackey for the link).

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April 19, 2004 · 6:47 pm

Infonet Settles

Infonet Services Corp. (NYSE: IN), a California-based provider of managed network communications services, has announced the preliminary settlement of the securities class action pending against the company in the C.D. of Cal. The case, originally filed in December 2001, alleges that the company made misrepresentations as part of an initial public offering of Class B common stock. The settlement is for $18 million ($13 million from insurance coverage and $5 million from the company).

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April 16, 2004 · 12:33 am

The 5th Circuit and the Fraud on the Market Theory

Under the fraud on the market theory, reliance by investors on an alleged misrepresentation is presumed if the company’s shares were traded on an efficient market. The investors are not entitled to the presumption, however, if they are unable to show that the misrepresentation actually affected the market price of the stock.

The U.S. Court of Appeals for the Fifth Circuit issued an opinion this week, Greenberg v. Crossroads Systems, Inc., No. 03-50311 (5th Cir. April 14, 2004), discussing the fraud on the market theory in a case where the plaintiffs failed to establish that the defendants’ falsely positive statements had increased the company’s stock price. Under these circumstances, the determinations of reliance and loss causation essentially merged, with the court holding that the plaintiffs were only entitled to a presumption of reliance for the falsely positive statements that they could connect to the subsequent decline in the company’s stock price when the “truth” was revealed.

Holding: Affirming in part and vacating in part the district court’s grant of summary judgment.

Quote of note: “We are satisfied that plaintiffs cannot trigger the presumption of reliance by simply offering evidence of any decrease in price following the release of negative information. Such evidence does not raise an inference that the stock’s price was actually affected by an earlier release of positive information. To raise an inference through a decline in stock price that an earlier false, positive statement actually affected a stock’s price, the plaintiffs must show that the false statement causing the increase was related to the statement causing the decrease. Without such a showing there is no basis for presuming reliance by the plaintiffs.”

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April 14, 2004 · 11:36 pm

No Damages? No Problem!

Here’s a good law school exam question — does a finding of liability under Rule 10b-5 in a private securities case require a reward of damages? The U.S. Court of Appeals for the Fourth Circuit submitted an essay answer today in the form of an opinion in Miller v. Asensio & Co., Inc., No. 03-1225 (4th Cir. April 14, 2004).

Asensio was a short seller that publicized negative statements about Chromatics Color Sciences Int., Inc. (“CCSI”), a company in which it had a significant short sell interest. Stockholders of CCSI sued Asensio alleging that the statements were material misrepresentations, “which Asensio initiated to defraud the market for its benefit, and which caused their CCSI stock to decline in value resulting in substantial losses to them.” After a trial, the jury returned a verdict finding Asensio liable, but awarding $0.00 in damages. On appeal, the stockholders argued that the finding of liability required the award of damages in some amount.

The Fourth Circuit disagreed (after noting that the issue was one of first impression). Courts “often refer to the fact of proximately caused damage and the amount of proximately caused damage as involving separate, although related, inquiries.” To establish Rule 10b-5 liability, a plaintiff only has to prove that the defendant’s misrepresentation was a “substantial cause of the loss” by showing a “direct or proximate relationship between the loss and the mispresentation.” Accordingly, a jury could find that “(1) the plaintiff proved the defendant’s fraud constituted a substantial cause of plaintiff’s loss and so find the defendant liable but (2) the plaintiff failed to provide a method to discern, by just and reasonable inference, the amount of plaintiff’s loss solely caused by defendant’s fraud, and so refuse to award the plaintiff any damages.”

Applying these principles to the case in hand, the Fourth Circuit found that “the evidence at trial provided the jurors with a sound basis on which to reach the result they did.”

Holding: Affirmed.

Quote of note: “In the vast majority of cases, a finding of the fact of proximately caused loss will result in the award of some amount of damages. However, it would seem contrary to Congress’ mandate that a plaintiff prove that the defendant ’caused the loss,’ 15 U.S.C. § 78u4(b)(4), and that no plaintiff ‘shall recover . . . a total amount in excess of his actual damages on account of the act complained of,’ 15 U.S.C. § 78bb(a), to direct a jury that it must award damages, even if faced, as here, with a record from which it cannot do so.”

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April 13, 2004 · 5:55 pm

Singing Machine Settles

The Singing Machine Co. (AMEX: SMD), a Florida-based maker of consumer-oriented karaoke machines, has announced the preliminary settlement of the securities class action (and a related derivative suit) pending against the company in the S.D. of Fla. The suit, originally filed in July 2003, is based on alleged misrepresentations related to Singing Machine’s restatement of its 2001 and 2002 financials.

The settlement is for a combination of 400,000 shares of common stock and a cash payment of $1.275 million ($800,000 from the company and $475,000 from its former auditor). Singing Machine also is obligated to make certain corporate governance changes, including expanding its board to six members with independent directors comprising at least 2/3 of the total board seats.

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