Citigroup Inc. (NYSE: C), a leading global bank, has agreed to settle a securities class action pending against the company in the S.D.N.Y. The case, which was originally filed in 2008, alleges that Citibank misrepresented its exposure to collaterialized debt obligations. The court preliminarily approved the settlement on August 29, 2012, and has scheduled a hearing for final approval on January 13, 2013.
The settlement is for $590 million, which the company says will be covered by existing legal reserves. It is the third-largest settlement of a credit crisis case, trailing only Wachovia ($627 million) and Countrywide ($624 million). Bloomberg and Reuters have articles on the settlement.
Citigroup Settles
Filed under Settlement
Defining Domestic
The New York Law Journal has a column (Aug. 17 edition – subscrip. req’d) on the application of the Morrison decision. In Morrison, the Supreme Court held that Section 10(b) liability for securities fraud is limited to “transactions in securities listed on our domestic exchanges, and domestic transactions in other securities.” What constitutes a “domestic transaction,” however, was not clarified.
As a result, the authors note, lower courts have adopted at least three different approaches for determining whether a non-exchange transaction is “domestic.” Some courts have looked at whether the “critical steps of the transaction,” including the offer and acceptance, occurred in the United States. Other courts limit potential liability to transactions in which the parties agreed to be bound to each other in the United States. The strictest approach is to insist that the actual transfer of the securities must have taken place in the United States. The authors argue that all of these approaches are broader than what the Supreme Court intended.
Quote of note: “When any of these approaches is applied to Morrison, it becomes clear that the lower courts’ applications of Morrison are inconsistent with the Supreme Court’s ruling and do not end extraterritorial application of the 34 Act. If [the Morrison corporate defendant] had hypothetically transferred its stocks to the investors in New York, for example, the 34 Act arguably would have applied under all three approaches. Ironically, under the prior conduct and effects tests, the same hypothetical would likely not have triggered the application of the 34 Act.”
Filed under All The News That's Fit To Blog
Made In America
While the Morrison decision limits Section 10(b) liability to securities transactions that take place in the United States, the complexity of the global securities market can lead to transactions that are difficult to define geographically. As a result, lower courts have struggled to consistently apply Morrison to different fact patterns.
In Phelps v. Stomber, 2012 WL 3276969 (D.D.C. Aug. 13, 2012), the court addressed whether there could be Section 10(b) liability for “Class B Shares” and “Restricted Depositary Shares (RDS)” issued by a closed-end investment fund. The Class B Shares were sold only outside the U.S. to foreign investors. The RDSs were sold to investors in the U.S.
As to the Class B Shares, the court held it was of no significance that Euronext, the exchange upon which the shares were traded, is owned by a Delaware company. Euronext was still a “foreign exchange” for purposes of the Morrison analysis and there could be no Section 10(b) liability. In contrast, the RDSs were clearly bought and sold in the U.S., but the defendants argued that the purchase of a RDS also should be considered a foreign transaction because it represented the shareholder’s ownership of a Class B Share traded on Euronext. Among other precedent, the defendants cited the Societe Generale decision, which held that American Depository Receipts were the “functional equivalent” of trading a company’s shares on a foreign exchange. The court rejected this view, finding that while the contention that “an investor could not purchase an RDS in the United States without a corresponding overseas transaction may be true, it does not change the fact that a purchase in the United States still took place.” Accordingly, Morrison did not bar the RDS claims.
Holding: Motion to dismiss granted (on other grounds as to the RDS claims).
Quote of note: “[P]laintiffs’ efforts to label everything “Made in America” to get around Morrison requires the Court to ignore allegations in the complaint and information contained in the Offering documents referenced in the complaint.”
Filed under Motion To Dismiss Monitor
What Does “Holistic” Mean?
In its Tellabs decision, the U.S. Supreme Court held that a court must assess a plaintiff’s scienter (i.e., fraudulent intent) allegations “holistically” in determining whether the plaintiff has met the requisite “strong inference” pleading standard. The 10b-5 Daily noted that this holding “would appear to alter the evaluation of scienter in the Second Circuit and Third Circuit, both of which have held that a court can examine allegations of motive or knowledge/recklessness separately.” In the intervening years, however, the Second Circuit has not directly addressed this inconsistency, to the benefit of plaintiffs.
George v. China Automotive Systems, Inc., 2012 WL 3205062 (S.D.N.Y. Aug. 8, 2010) is a “Chinese reverse merger” case alleging that the company engaged in accounting fraud. In their motion to dismiss, the defendants argued that the plaintiffs had failed to adequately plead scienter. The court, citing Second Circuit precedent, noted that the “requisite ‘strong inference’ of scienter can be established by alleging facts showing (a) defendants’ ‘motive and opportunity’ to commit the alleged fraud, or (b) strong circumstantial evidence of conscious misbehavior or recklessness.” After examining the complaint, the court held that the plaintiffs’ insider trading allegations, by themselves, were sufficient to establish motive and opportunity. In particular, four of the seven individual defendants “sold over 50% of their CAAS stock during the class period” and the individual defendants collectively made a net profit of nearly $42 million on their class period sales.
The defendants offered two counterarguments, both of which were rejected by the court. First, the defendants noted that the individual defendants had entered into Rule 10b5-1 stock trading plans. As a result “more than two-thirds of [their] sales were made pursuant to the 10b5-1 plans and the remaining sales are too small a fraction of total sales to establish ‘unusual’ trading.” The court held that because the 10b5-1 trading plans were entered into during the class period, they could not be invoked “to disarm any inference of scienter raised by the Individual Defendants’ sales of CAAS stock.” Second, the defendants asserted that “the alleged accounting errors and misstatements regarding internal controls are insufficient to sustain a securities fraud claim.” The court found that this assertion was “immaterial at this stage” because the plaintiffs had “sufficiently plead motive and opportunity.”
It is difficult, in the wake of Tellabs, to see how a lower court can engage in the required weighing of competing inferences of scienter if it stops the exercise after finding that there has been “unusual” insider trading. The Second Circuit needs to sort this out.
Holding: Motion to dismiss denied (except as to an auditor defendant).
Filed under Motion To Dismiss Monitor
Offsetting Gains and Attributing Losses
What evidence is necessary to establish loss causation and economic damages? Two recent circuit court decisions address this issue, albeit at different stages of a securities fraud case.
(1) In Aciticon AG v. China North East Petroleum Holdings, Ltd., 2012 WL 3104589 (2d Cir. Aug. 1, 2012), the lower court dismissed the case based on the plaintiffs’ failure to adequately plead economic damages. Within a couple of months after the “final allegedly corrective disclosure” was made, the company’s stock price rose above the lead plaintiff’s average purchase price. The lower court held that a “plaintiff who foregoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure.”
On appeal, the Second Circuit rejected this economic-loss rule as “inconsistent with the traditional out-of-pocket measure of damages, which calculates economic loss based on the value of the time of the security at the time that the fraud became known.” The court noted that “a share of stock that has regained its value after a period of decline is not functionally equivalent to an inflated share that has never lost value.” To hold otherwise, would allow defendants to improperly “offset gains that that plaintiff recovers after the fraud becomes known against losses caused by the revelation of the fraud if the stock recovers value for completely unrelated reasons.” Accordingly, the court held, “the [stock price] recovery does not negate the inference that [the lead plaintiff] has suffered an economic loss.”
Holding: Dismissal reversed and case remanded.
(2) In Hubbard v. BankAtlantic Bancorp, Inc., 2012 WL 2985112 (11th Cir. July 23, 2012), the plaintiffs alleged that BankAtlantic fraudulently concealed the poor credit quality of its commercial real estate portfolio. The plaintiff’s only evidence of loss causation was the testimony of its expert. After a trial, the court granted judgment as a matter of law to the defendants based on the plaintiffs’ failure to establish loss causation.
On appeal, the Eleventh Circuit agreed with the lower court (albeit on a slightly different basis). The court found that a plaintiff must “offer evidence sufficient to allow the jury to separate portions of the price decline attributable to causes unrelated to the fraud, leaving only the part of the price decline attributed to the dissipation of the fraud-induced inflation.” The study conducted by the plaintiffs’ expert was supposed to isolate which part of the stock price drop was caused by the materialization of the risk concealed by BankAtlantic. But it failed to adequately take into account that BankAtlantic’s assets were concentrated in loans tied to Florida real estate. The court noted that there was a general downturn in the Florida real estate market at the relevant time, which may have been a substantial cause of the stock price drop. Because the plaintiffs’ evidence failed to exclude this possibility, the court affirmed the lower court’s decision.
Holding: Judgment affirmed.
Filed under Appellate Monitor
Compare and Contrast
NERA Economic Consulting and Cornerstone Research (in conjunction with the Stanford Securities Class Action Clearinghouse) have released their 2012 midyear reports on securities class action filings. As usual, the different methodologies employed by the two organizations have led to different numbers, although they generally agree that the number of filings is holding steady.
The findings for the first half of 2012 include:
(1) NERA counts 116 filings and Cornerstone counts 88 filings (NERA treats actions filed in different circuits, but against the same defendant, as separate filings – see FN 2 of the report). Cornerstone views this as a slight decrease in total filings, down 6 percent from both the first half and second half of 2011, while NERA finds it in line with historical averages.
(2) Both NERA and Cornerstone agree that there has been a decline in M&A-related filings and, correspondingly, an increase in “standard” misstatement cases alleging violations of Rule 10b-5, Section 11, and/or Section 12. According to NERA, there have been 83 “standard” filings in the first half of 2012. If that pace continues, it will lead to the most “standard” filings since 2008.
(3) The number of cases against foreign-domiciled companies is decreasing, largely due to a decline in Chinese reverse merger filings.
(4) NERA’s report contains an interesting analysis of the motions practice in securities class actions that were filed and settled between 2000 and 2012. The findings include that in 22% of cases where a motion to dismiss was filed, and in 46% of cases were a motion for class certification was filed, the cases were settled before the court issued a decision on the pending motion.
(5) NERA also examines the settlement activity so far this year and concludes (a) the overall number of settlements is lower than usual (a projected 98 settlements in 2012 vs. 123 settlements in 2011), but (b) the median settlement amount ($7.9 million) is about the same as last year and consistent with pre-credit crisis levels.
Quote of Note (Professor Grundfest – Stanford): “Looking over the horizon, the Libor-litigation industry is clearly a sector to watch for years to come. The magnitude of the potential exposures and the complexity of the underlying damages claims will likely generate large amounts of litigation activity in many geographies.”
Filed under Lies, Damn Lies, And Statistics
When Working Hard Is Not Enough
The U.S. Court of Appeals for the Second Circuit has reversed a summary judgment grant in favor of Grant Thornton (outside auditor) in a securities class action related to the collapse of Winstar Communications. The case was originally filed in 2001 and, due to intervening settlements, Grant Thornton is the sole remaining defendant. The district court found that Grant Thornton had engaged in “dubious accounting practices” and had “failed to uncover the accounting fraud” being perpetrated by Winstar. Nevertheless, the district court concluded that there was no genuine issue of material fact as to whether Grant Thornton had acted intentionally or recklessly (i.e., with scienter) in issuing its unqualified audit opinion for FY1999.
The Second Circuit disagreed. In Gould v. Winstar Communications, Inc., 2012 WL 2924254 (2d Cir. July 19, 2012), the court held that at least some evidence existed to support the plaintiffs’ assertion “that in the course of its audit GT learned of and advised against the use of indisputably deceptive accounting schemes, but eventually acquiesced in the schemes by issuing an unqualified audit opinion.” While the district court had placed “particular emphasis on the magnitude of GT’s audit work, both in time spent and documents reviewed” in granting summary judgment, the court noted that “[t]he number of hours spent on an audit cannot, standing alone, immunize an accountant from charges it has violated the securities laws.” In regard to two other issues raised on appeal – reliance by certain plaintiffs who brought a Section 18 claim and loss causation – the court found that there was sufficient evidence to allow a jury to reasonably infer that those elements were satisfied.
Holding: Grant of summary judgment vacated and case remanded.
Filed under Appellate Monitor
Single Central Risk
The U.S. Court of Appeals for the First Circuit has issued a short, interesting decision discussing the “holistic” evaluation of scienter allegations. In In re Boston Scientific Corp. Sec. Litig., 2012 WL 2849660 (1st Cir. July 12, 2012), the company allegedly failed to disclose that it had fired ten sales personnel, who ended up going to a competitor and taking business with them. The district court found it was a material omission, but dismissed the claim based on the plaintiffs’ failure to adequately plead a strong inference of scienter (i.e., fraudulent intent).
On appeal, the plaintiffs argued that the district court had failed to consider their scienter allegations holistically, as required by the Supreme Court in its Tellabs decision. The First Circuit noted that it was true that “allegations that are individually insufficient can sometimes combine together to make the necessary showing.” In the instant case, however, “a single central risk existed – that sales personnel might leave and perhaps take some of their business with them.” While that risk became greater over time, to the point where the district court decided that failure to disclose it was a material omission, the potential lost business was “extremely modest in relation to revenues.” Accordingly, the court held that there was no basis for concluding that the defendants “were dishonest or at least reckless in failing to mention” something so marginally material.
Holding: Dismissal affirmed.
Filed under Appellate Monitor
Something More
Rules 10b-5(a) and (c) establish securities fraud liability for deceptive devices, schemes, and acts. One issue courts have considered is whether “scheme liability” requires a defendant to have engaged in fraudulent conduct beyond the making of material misrepresentations or omissions (which is specifically prohibited by Rule 10b-5(b)).
In Public Pension Group v. KV Pharmaceutical Co., 2012 WL 1970226 (8th Cir. June 4, 2012), the court found that the only non-conclusory “scheme liability” allegations were based on the defendants’ supposed knowledge of misstatements concerning the company’s FDA compliance and earnings. The court held that these allegations were deficient, “join[ing] the Second and Ninth Circuits in recognizing a scheme liability claim must be based on conduct beyond misrepresentations or omissions actionable under Rule 10b-5(b).”
Holding: Dismissal affirmed in part and reversed in part.
Filed under Appellate Monitor
Supreme Court To Address Fraud-On-The-Market Theory
A key development this week was the Supreme Court’s decision to hear the Amgen Inc. v. Connecticut Retirement Plans and Trust Funds case on appeal from the Ninth Circuit. Pursuant to the fraud-on-the-market theory, reliance by investors on a misstatement is presumed if the company’s shares were traded on an efficient market that would have incorporated the information into the stock price. The fraud-on-the-market presumption is routinely invoked in securities class actions to justify the grant of class certification because it removes the potential need for individual evaluations of reliance.
At issue in the Amgen case is a circuit split over whether a plaintiff must prove that the misstatement was material to invoke the fraud-on-the-market theory in support of class certification. Three circuit courts (Second, Fifth and, to a lesser extent, the Third) previously have held that this is a required part of the fraud-on-the-market analysis when evaluating whether a class should be certified. The Ninth Circuit joined a decision from the Seventh Circuit, however, in rejecting that position. The court held that materiality is a merits question that does not affect whether class certification is appropriate.
The Amgen case picks up threads from two other recent Supreme Court decisions. In Matrixx, the Court addressed the issue of materiality, but only in the context of what must be plead to survive a motion to dismiss. Meanwhile, in Halliburton, the Court found that a plaintiff does not have to prove loss causation to invoke the fraud-on-the-market presumption, but left open the question of whether the plaintiff must demonstrate that the misstatement had a stock “price impact” (which is often used as a proxy for determining whether the misstatement was material). As a practical matter, if the Court were to find that lower courts should be evaluating whether the misstatement was material in determining whether to grant class certification, it obviously would reinvigorate class certification as a meaningful hurdle in prosecuting securities class actions.
Scotusblog has all of the relevant links, including to the amicus briefs filed in conjunction with the cert petition. The case will be heard next term.
The 10b-5 Daily 
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