January 5, 2004 · 1:12 am

Discovery Of Wells Submissions, Loss Causation, And The IPO Allocation Cases

The WorldCom and Initial Public Offering securities litigations in the S.D.N.Y. are generating judicial opinions on a wide variety of topics, with the plaintiffs frequently getting the better of the argument. Two more opinions have come down from Judge Scheindlin in the IPO allocation cases over the holidays.

Discovery of Wells Submissions

On December 24, the court issued an opinion and order addressing whether “Wells submissions” to the SEC are discoverable in subsequent litigations. The target of a SEC investigation is permitted to file a written submission, known as a Wells submission, with the agency to respond to contemplated charges. The plaintiffs were seeking discovery of Wells submissions made by the underwriter defendants in connection with the SEC’s investigation of the same IPO allocation practices at issue in the current litigation. Although the Wells submissions contained offers of settlement, the court found that they are not “settlement material” and, in any event, they are relevant to the current litigation and therefore discoverable.

Quote of note: “Offers of settlement, however, are not intrinsically part of Wells submissions, which were intended to be ‘memoranda to the SEC presenting arguments why an enforcement proceeding should not be brought.’ To the extent that a respondent may make a settlement offer, that offer is typically clearly identified and thus easily severable from the remainder of the submission.”

Holding: The underwriter defendants are ordered to produce their Wells submissions to plaintiffs on or before January 20, 2004.

The New York Law Journal has an article (via law.com – free regist. req’d) on the decision and the Securities Litigation Watch has a post.

Loss Causation

On December 31, the court issued an order and opinion addressing a motion for judgment on the pleadings by the underwriter defendants. The underwriter defendants argued that the Rule 10b-5 claims against them should be dismissed in light of the Second Circuit’s recent decision on the pleading of loss causation in securities fraud cases. In Emergent Capital, the Second Circuit held that allegations of artificial price inflation, without more, do not suffice to plead loss causation. (The 10b-5 Daily has posted about the decision and the current circuit split on this issue.)

In the IPO allocation cases, the underwriter defendants “allegedly required or induced their customers to buy shares of stock in the aftermarket as a condition of receiving initial public offerings stock allocations.” This conduct allegedly caused the plaintiffs to purchase the stock at an artificially inflated price. The plaintiffs have brought claims, based on different provisions of Rule 10b-5, for (1) market manipulation and (2) material misstatements and omissions.

Although the Emergent Capital decision requires more than price inflation to adequately plead loss causation (e.g., a corrective disclosure revealing the fraud and causing a stock price decline), the court noted that it is a material misstatements and omissions case. Market manipulation, the court argued, is simply different.

“A market manipulation is a discrete act that influences stock price. Once the manipulation ceases, however, the information available to the market is the same as before, and the stock price gradually returns to its true value. . . In market manipulation cases, therefore, it may be permissible to infer that the artificial inflation will inevitably dissipate. That being so, plaintiffs’ allegations of artificial inflation are sufficient to plead loss causation because it is fair to infer that the inflationary effect must inevitably diminish over time. It is that dissipation — and not the inflation itself — that caused plaintiffs’ loss.”

The court offers no citations for this analysis and it certainly reaches some broad (and potentially controversial) conclusions. As for the remaining misstatements and omission claims, the court concedes that Emergent Capital is directly on point, but simply bootstraps the claims into its earlier loss causation analysis: “The content of Underwriters’ misstatements was, in essence: ‘this is a fair, efficient market, unaffected by manipulation.’ In fact (according to plaintiffs), the market was manipulated. For the reasons discussed [] above, that market manipulation was a cause of plaintiffs’ loss. Therefore, the misstatements that concealed that manipulation also were a cause of plaintiffs’ loss.” But if the plaintiffs have brought separate fraud claims based on alleged misstatements, don’t they need to establish that the alleged misstatements, separate and apart from the market manipulation, caused a loss? Apparently not.

Holding: Motion for judgment on the pleadings denied.

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January 2, 2004 · 7:50 pm

Fourth Circuit Breaks Silence On Scienter

To survive a motion to dismiss, the PSLRA requires plaintiffs bringing a securities fraud claim to plead facts establishing a “strong inference” that the defendants acted with scienter (i.e., fraudulent intent). There are two components to this analysis: (1) what is the substantive standard for scienter; and (2) what must a plaintiff allege to meet the “strong inference” pleading requirement. Until last week, the U.S. Court of Appeals for the Fourth Circuit had declined to take a position on either of these issues. Not anymore.

In Ottmann v. Hanger Orthopedic Group, 2003 WL 22992292 (4th Cir. Dec. 22, 2003), the court joined every other circuit in holding that scienter may be established by pleading not only intentional misconduct, but also recklessness (although it must be “severe recklessness [that] is, in essence, a slightly lesser species of intentional misconduct”). Having established the substantive standard, the court turned to what a plaintiff must plead to meet the PSLRA’s “strong inference” pleading requirement.

The court found that “Congress ultimately chose not to specify particular types of facts that would or would not show a strong inference of scienter [as part of the PSLRA].” As a result, the court concluded that a “flexible, case-specific analysis is appropriate in examining scienter pleadings.” Although facts establishing “motive and opportunity to commit fraud (or lack of such facts) may be relevant to the scienter inquiry, the weight accorded to those facts should depend on the circumstances of each case.”

In applying this flexible analysis to the instant case, the court found that there were insufficient facts demonstrating that any of the alleged misstatements were the product of reckless or intentional conduct (as opposed to negligence). Moreover, the court noted that the plaintiffs failed to allege that the individual defendants had any personal motive to make the alleged misstatements, “such as to facilitate personal sales of Hanger stock.” Instead, plaintiffs argued that the defendants were motivated to misrepresent Hanger’s financial situation so as to maintain the company’s positive relationships with its creditors, avoid additional interest payments, and promote future acquisitions. The court concluded that other courts “have repeatedly rejected these types of generalized motives — which are shared by all companies — as insufficient to plead scienter under the PSLRA.”

Holding: Affirm the dismissal of complaint.

Quote of note: “We therefore conclude that courts should not restrict their scienter inquiry by focusing on specific categories of facts, such as those relating to motive and opportunity, but instead should examine all of the allegations in each case to determine whether they collectively establish a strong inference of scienter.”

Addition: Note that the facts of the case do not allow the Fourth Circuit to address an important issue. Based on the analysis in the opinion, it appears clear that the court could have affirmed the dismissal of the complaint based on the lenient Second Circuit pleading standard, as it has in other cases. See Phillips v. LCI Int., Inc. 190 F.3d 609 (4th Cir. 1999). Instead, the court chose to adopt and apply a new pleading standard in a case where the plaintiffs did not allege any personal motive to commit securities fraud (e.g., stock sales by the individual defendants). District courts in the Fourth Circuit are left with no practical guidance on what “weight” the appellate court thinks should be given to those types of allegations in determining whether a strong inference of scienter has been plead.

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December 31, 2003 · 6:19 pm

Gaming Lottery Settles

The securities class action against Gaming Lottery Corp., pending in the S.D.N.Y. since 1996, has been preliminarily settled for $1 million (or about 7 cents per damaged share before the deduction of litigation expenses). Plaintiffs allege that the company engaged in misrepresentations concerning its acquisition and operation of Special Manufacturing Inc. In the spirit of the holiday season, the notice of proposed settlement states that plaintiffs’ counsel have declined to apply for any attorneys’ fees.

Quote of note: “Plaintiffs’ Counsel are NOT applying for any attorneys’ fees. Plaintiffs’ Counsel do intend to request the Court to approve a payment to Plaintiffs’ Counsel of $90,000 for reimbursement of expenses incurred in connection with the prosecution of this Action, which is less than 23% of the over $400,000 of expenses actually incurred.”

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December 29, 2003 · 11:37 pm

South Korea Passes Securities Class Action Legislation

After two years of debate, the South Korean legislature has finally passed a bill establishing a private securities class action system. The Korea Times reports, however, that the bill contains phase-in and standing requirements that may limit its effectiveness. (The 10b-5 Daily has posted frequently about the debate over this legislation, most recently here.)

Initially (commencing in Jan. 2005), suits will be limited to companies with assets of more than 2 trillion won ($1.67 billion). Only about 80 of the 1500 publicly-traded South Korean companies meet this benchmark. Smaller companies can be sued starting in July 2007. Also, a suit will only be permissible if more than 50 shareholders, owning at least 0.01% of the outstanding shares of the company, agree to bring the case.

Quote of note: “Civic organizations described the revised bill as a ‘toothless tiger,’ pointing out it completely blocks the possibility for suits against big business conglomerates. For example, they said, shareholders might need to amass stocks worth more than 7 billion won to meet the 0.01 percent requirement in a file against Samsung Electronics.”

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December 24, 2003 · 12:29 pm

Lucent Fees Dispute

Two weeks ago, the D. of N.J. approved the settlement of the Lucent Technologies, Inc. securities litigation for over $600 million, the third-largest securities settlement ever. The settlement calls for claimants to receive $315 million in stock; $24 million in the stock of Lucent spin-off Avaya Inc.; $148 million in cash from the Lucent’s directors-and-officers insurance; and 200 million warrants. Now comes the battle over attorneys fees.

Co-lead counsel for the main securities class action on behalf of Lucent’s common shareholders (there are four other cases on behalf of other classes of investors that are also being settled) are asking for 17% of the $517 million those investors will be awarded: about $88 million. They also seek $3.5 million in expenses for the case, which was litigated for almost four years.

The New Jersey Law Journal has a lengthy article (via law.com – free regist. req’d) exploring the arguments for and against this fee award. The objectors suggest that the fees are excessive compared with the payout to investors, which amounts to no more than 15 cents a share. Plaintiffs’ counsel, however, notes that the warrants may make the value of the settlement increase dramatically if Lucent’s stock price rises (thereby lowering the percentage of the recovery going to attorneys fees). To bolster their fee request, plaintiffs’ counsel retained Columbia Law School Professor John Coffee to submit a supporting certification to the court.

Quote of note: “Typical was T. Tucker Hobgood, who bought 100 shares at $74 a week before it dove to the mid-50s, at which point he bought another 50 shares. All told, Lucent dropped from almost $80 in 1999 to 55 cents by the fall of 2002 after disclosures of inflated revenue reports and accounting shenanigans. ‘I’ll get $15, with the plaintiffs’ lawyers making about $4.50 off me and getting reimbursed another $1.50. Not to unduly hammer only one side of the equation. The company I still own part of paid untold sums to its lawyers to grind the plaintiffs under their feet,’ Hobgood wrote to [District Judge] Pisano. ‘I lost virtually my entire investment of $10,000. There is nothing fair about this process or this settlement to me. It is a complete waste of time to recover less than one-fifth of one percent of a loss,’ he continued.”

Quote of note: “[Professor Coffee] listed the 22 largest fee awards for class actions, which showed that 17 were above the 17 percent being sought in the Lucent case, with only five falling below that figure. However, most of those cases that garnered more than 17 percent were significantly smaller than the Lucent payout. Five of the class actions produced fees amounting to 30 percent, but those settlements ranged from $104 million to $185 million. The closest settlement in size to Lucent’s, the $687 million in the Washington Public Power Supply Systems case in 1990, resulted in a fee award of just 7.3 percent. Moreover, the $457 million settlement in this year’s Waste Management Inc. class action generated a fee amounting to only 7.9 percent. Another so-called megafund class action, brought against Bankamerica Corp., led to a $490 million settlement along with a fee of 18 percent for lead counsel.”

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December 22, 2003 · 2:22 pm

The Big Breakup In Action

The future is now for Milberg Weiss, which has been in the process of splitting into two separate firms for the past six months. (For the latest on the split, see this recent post.) Milberg’s New York and San Diego offices are about to face off over lead plaintiff/lead counsel status in the securities class actions filed against the NYSE specialist trading firms.

As reported in The Recorder (via law.com – free regist. req’d), in October Milberg’s New York office filed suit on behalf of Generic Trading of Philadelphia against the specialist trading firms, while last Tuesday Milberg’s San Diego office filed suit on behalf of CalPERS against the same firms and added the NYSE as a defendant. (The 10b-5 Daily has posted about the CalPERS suit.) A spokesman for CalPERS stated that the timing of the state’s suit was intended to meet the 60-day deadline for moving for lead plaintiff status triggered by the original suit. Both Generic Trading and CalPERS have filed motions to be appointed lead plaintiff — putting the two Milberg offices into an adversarial position even before the split is official.

Quote of note: “There are signs that the divorce has been completed in spirit, if not on paper. East Coast and West Coast partners are already competing for clients, said a lawyer who did not wish to be named. Also, the New York office recently filed a securities fraud class action in San Francisco, leaving any mention of the firm’s San Francisco office off their filings.”

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December 18, 2003 · 8:28 pm

Adding Exceptions To The Discovery Stay

The mandatory discovery stay in the PSLRA is often the subject of contention in securities class actions. The PSLRA provides that “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.”

A minor district court split has developed over whether this provision allows for the discovery, prior to a decision on a motion to dismiss, of documents that have been produced to governmental entities. Compare, e.g., In re Enron Corp. Securities, Derivative & ERISA Litig., 2002 WL 31845114 (S.D. Tex. Aug. 16, 2002) (permitting partial lifting of discovery stay for documents made available to government entities because burden would be slight and the documents had already been made available outside of securities case) with In re Vivendi Universal, S.A. Sec. Litig., 2003 WL 21035383 (S.D.N.Y. May 6, 2003) (statute does not create exception for documents previously produced to governmental agencies and plaintiffs failed to establish the need to preserve evidence or undue prejudice). The 10b-5 Daily has previously posted about the Vivendi decision.

The N.D. of Alabama has now weighed in on the issue. In In re HealthSouth Securities Litigation, CV-03-BE-1500-S (N.D. Ala. Dec. 8, 2003), relevant documents had been produced to Congress and to the parties in a derivative lawsuit filed against HealthSouth in Delaware state court. Plaintiffs argued that “adherence to the two exceptions enumerated in the [PSLRA’s mandatory discovery stay] would create absurd results in a case like this one of admitted securities fraud and where a discovery stay would not effectuate Congress’ goals in enacting the statute.” The court, however, found that allowing plaintiffs to use documents produced to Congress “is not only inconsistent with the statute’s plain language, but creates an absurd result in direct contravention of Congress’ intent to protect defendants from the possibility that documents produced to governmental entities may by used by the plaintiffs in formulating a complaint or in opposing a motion to dismiss.”

Holding: Motion to partially lift discovery stay denied.

Thanks to Matt Herrington for pointing The 10b-5 Daily to this decision.

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December 17, 2003 · 12:12 pm

The Big Breakup Is Moving Slow

The National Law Journal has an article (via law.com – free subscrip. req’d) on the status of the previously announced breakup of Milberg Weiss, widely recognized as the leading plaintiffs’ securities class action firm, into two separate law firms. (See this post for background information on the split.)

Quote of note: “According to attorneys inside the firm as well as attorneys who have left, Milberg Weiss had hoped to finalize the restructuring by the end of 2003, with an outside date of February. ‘We are 85 percent of the way through,’ a lawyer close to the negotiations said. ‘We just need more time to reconcile the accounting, and we are now looking at March.'”

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December 16, 2003 · 6:21 pm

CalPERS Sues NYSE And Seven Specialist Firms

The 10b-5 Daily does not normally post about the initial filing of a securities class action (or that’s all it would have time to do), but sometimes an exception is warranted. The Associated Press reports that the California Public Employees Retirement System (CalPERS) has brought a class action suit against the New York Stock Exchange and seven specialist trading firms (who make a market in NYSE stock assigned to them by matching buyers and sellers). The suit alleges that the specialists failed “to fill outstanding buy-and-sell orders at the best prices and routinely and unnecessarily intervened in trades, earning fees for themselves and the exchange at the expense of investors” and that “stock exchange officials hid the extent of the practices from investors.”

CalPERS has issued a press release and posted the complaint on its website. The complaint alleges violations of Sections 10(b) and 20(a) of the Exchange Act and breach of fiduciary duty against all of the defendants and violation of Section 6(b) of the Exchange Act against the NYSE. CalPERS appears to rely heavily on information from a November 3, 2003 Wall Street Journal article discussing a confidential SEC report about NYSE trading practices and exchange oversight.

Quote of note (Associated Press): “‘We’re convinced, and we will seek to prove in court, that the New York Stock Exchange not only knew of these rampant problems, and knew they existed, but also perpetuated them,’ [Sean Harrigan, President of CalPERS] said. Officials said they decided to sue, rather than rely on the U.S. Securities and Exchange Commission, which is conducting its own investigation into floor-trading, because the SEC has not done its job.”

Addition: The Recorder has an article (via law.com – free regist. req’d) discussing CalPERS decision to hire Milberg Weiss to bring the suit.

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December 15, 2003 · 7:18 pm

Lucent Settlement Receives Final Court Approval

Reuters reports that Lucent Technologies, Inc. (NYSE: LU) has received final court approval for the roughly $600 million settlement of the securities litigation pending against the company in the D. of N.J. The settlement was originally announced last March and is one of the largest ever.

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