The 10b-5 Daily

The Sarbanes-Oxley Act of 2002 extends the statute of limitations for federal securities fraud to the earlier of two years after the discovery of the facts constituting the violation or five years after such violation. Although the legislation clearly provides that it “shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002],” left unresolved is whether Congress intended to revive claims that had already expired under the earlier one year/three years statute of limitations.
Courts are beginning to address this issue, with mixed results. In Roberts v. Dean Witter Reynolds Inc., 2003 WL 1936116 (M.D. Fla. March 31, 2003), the district court found that Sarbanes-Oxley revived already time-barred claims because the legislative history demonstrates that Congress intended to achieve that result. The court, however, primarily relied on floor statements made by a single senator and a few sentences in a congressional analysis of the legislation in reaching this conclusion. Perhaps as a result, it certified an interlocutory appeal on the question that is currently pending before the U.S. Court of Appeals for the 11th Circuit.
In the meantime, two other district courts have issued contrary opinions. In Glaser v. Enzo Biochem, Inc., 2003 WL 21960613 (E.D. Va. July 16, 2003), the court concluded that “Congress did not unambiguously provide that the [new] limitations period would apply retroactively.” Last week, in In re Enterprise Mortgage Acceptance Co., LLC Sec. Litig. , 03 Civ. 3752 (S.D.N.Y. Nov. 5, 2003), the court held: (a) “there is no clear language in the statute stating that it applies retroactively or that it operates to revive time-barred claims;” (b) the statute expressly disavows that it is creating any new rights of action; and (c) the legislative history examined by the Roberts court does not support a finding that Congress intended to revive time-barred claims.
Stay tuned.
Addition: The opinion is now available on Westlaw – In re Enterprise Mortgage Acceptance Co., LLC Sec. Litig., 2003 WL 22955925 (S.D.N.Y. Nov. 5, 2003).

The SEC has created an affirmative defense to allegations that a person engaged in insider trading while in possession of material nonpublic information. Rule 10b5-1, put into place in 2000, establishes that a person’s purchase or sale of securities is not “on the basis of” material nonpublic information if, before becoming aware of the information, the person enters into a binding contract, instruction, or trading plan (as defined in the rule) covering the securities transaction at issue. To take advantage of this potential affirmative defense, many executives have been implementing trading plans for their sales of company stock.
Insider trading, of course, is often used by plaintiffs in securities class actions to create an inference of scienter (i.e., fraudulent intent). The plaintiffs allege that the individual corporate defendants profited from the alleged fraud by selling their company stock at an artificially inflated price. Since the implementation of Rule 10b5-1, however, it has been an open question whether this inference can be refuted by the fact that the trading was done pursuant to a previously established trading plan. A partial answer may be found in the decision in Wietschner v. Monterey Pasta Co., No. C 03-0632 (N.D. Cal. Nov. 4, 2003) (will add Westlaw cite and link when available).
In Wietschner, the court held that the individual defendants’ stock sales were not sufficiently unusual or suspicious to raise a strong inference of scienter. In addition to evaluating the size and timing of the transactions, the court noted: “Plaintiffs state that both Defendants sold shares under individual SEC Rule 10b5-1 trading plans, which allows corporate insiders to set a schedule by which to sell shares over a twelve to fifteen month period. This could raise an inference that the sales were pre-scheduled and not suspicious.”
Holding: Motion to dismiss granted.
Addition: The opinion is now available on Westlaw – Weitschner v. Monterey Pasta Company, 2003 WL 22889372 (N.D. Cal. Nov. 4, 2003).

Those who believe that courts, in the post-Enron environment, should be more willing to temper the heightened pleading requirements of the PSLRA will be encouraged by a recent decision from the N.D. of Ill.
In In re Sears, Roebuck and Co. Sec. Litig., 2003 WL 22454021 (Oct. 24, 2003 N.D. Ill.), the court addressed allegations that the defendants made misstatements “about the risk level of balances in accounts in Sears’ credit card portfolio, the delinquencies in those accounts, and the amount of ‘charge-offs’ of unpaid accounts.” The plaintiffs argued that they had established a strong inference of scienter (i.e., fraudulent intent) because the individual defendants were executive officers of Sears and therefore must have known the information that made the alleged misstatements false and misleading. The court agreed, holding: “Officers of a company can be assumed to know of facts ‘critical to a business’s core operations or to an important transaction that would affect a company’s performance.'”
It is difficult to reconcile this decision with the PSLRA. The PSLRA requires plaintiffs to “state with particularity facts giving rise to a strong inference that the defendant acted with the required stated of mind.” The mere pleading of a defendant’s official corporate title and responsibilities would not appear to be sufficient.
Moreover, the case cited (and quoted!) by the court in support of this proposition, Stavros v. Exelon Corp., 266 F. Supp. 2d 833 (N.D. Ill. 2003) says no such thing. Stavros is a case based on allegedly false financial projections and merely notes, after a discussion of the need to plead scienter with particularity, that a “plaintiff might also plead that key officers knew of facts critical to a business’s core operations or to an important transaction that would affect a company’s performance.” There is no suggestion that this knowledge can be assumed based on the officers’ positions with the company. There are cases finding that this assumption is enough to establish a strong inference of scienter (although a significant majority of post-PSLRA cases appear to go the other way – see, e.g., In re Advanta Corp. Sec. Litig., 180 F. 3d 525, 539 (3rd. Cir. 1999)), but Stavros just does not happen to be one of them.
Holding: Motion to dismiss denied.
Quote of note: “Plaintiffs specifically allege that the positions held by each of the individual defendants during the class period gave them knowledge of the specific information in question. . . Logically, defendants in their positions would be expected to have knowledge of the facts regarding the credit card portfolio at the time they were making statements about the portfolio or signing off on SEC filings.”