January 6, 2012 · 10:16 pm

Improper Use

Does the fact that an individual defendant’s stock trading took place pursuant to a pre-determined Rule 10b5-1 trading plan undermine any inference that the trades were “suspicious”? Courts continue to grapple with this issue in evaluating the existence of scienter (i.e., fraudulent intent) in securities fraud cases.

(1) In In re Novatel Wireless Sec. Litig,, 2011 WL 5873113 (S.D. Cal. Nov. 23, 2011), the court reviewed insider trading claims brought as a part of a securities class action. Defendants argued that several of the challenged trades were inactionable because they had been made pursuant to Rule 10b5-1 trading plans. The court noted, however, that “each defendant entered new or amended 10b5-1 plans . . . that contained accelerator clauses that called for immediate sales.” Because the “improper use of 10b5-1 trading is evidence of scienter,” the court found that a genuine issue of material fact precluded summary judgment on the insider trading claims.

(2) In The Mannkind Sec. Actions, 2011 WL 6327089 (C.D. Cal. Dec. 16, 2011), the court evaluated whether the plaintiffs had adequately pled motive based on a “suspicious” stock sale by one of the individual defendants. The defendant pointed out that the sale was only 10.5% of his holdings and “was made pursuant to a pre-determined 10b5-1 trading plan, and was identical to another 10b5-1 trading sale made 11 months earlier.” The court concluded that the timing of the sale “appears suspicious.” The plaintiffs’ failure to rebut the contention that the sale had been made pursuant to a Rule 10b5-1 trading plan, however, meant that the sale could not “provide support for Plaintiffs’ pleading of scienter.”

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December 28, 2011 · 4:45 pm

Where’s Waldo?

To what extent can a plaintiff protect the identity of his confidential witnesses once discovery in the case has commenced? Courts have tended to be skeptical of claims that the identity of these witnesses are attorney work product or should be kept secret to avoid possible employer retaliation.

In Plumbers and Pipefitters Local Union No. 630 Pension-Annuity Trust Fund v. Arbitron, 2011 WL 5519840 (S.D.N.Y. Nov. 14, 2011), the court addressed these issues in a case where the complaint relied heavily on alleged statements from 11 former Arbitron employees. In discovery, the plaintiffs identified 83 people who were likely to possess discoverable information, but refused to specifically identify the 11 confidential witnesses from among that list. The court concluded that the names of the confidential witnesses were entitled to little, if any, work product protection, noting that “[i]t is difficult to see how syncing up the 11 [confidential witnesses] with these already disclosed names would reveal Plaintiff’s counsel’s mental impressions, opinions, or trial strategy.” Moreover, the plaintiffs had “utilized the [confidential witnesses] offensively” and failing to identify them could require the defendants to take dozens of unnecessary depositions. As for possible retaliation, the court declined to accept any generic assertions that the confidential witnesses faced a risk of retaliation, but did give the plaintiffs’ counsel a week to submit an affidavit setting forth any particularized facts it had on that subject.

Holding: Motion to compel disclosure of confidential witness names granted (subject to review of the requested affidavit).

Quote of note: “On the facts before it, the Court, balancing the relevant considerations, does not believe the work product doctrine compels Arbitron (or, derivatively, its shareholders) to bear these costs. The discovery rules ‘should be construed and administered to secure the just, speedy, and inexpensive determination of every action and proceeding.’ Fed. R. Civ. P. 1. These goals are disserved by forcing a party, in the name of an opponent’s evanescent work product interest, to play a high-cost game of ‘Where’s Waldo?’.”

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December 15, 2011 · 4:55 pm

Momentary Forgetfulness

The scope of the Securities Litigation Uniform Standards Act (“SLUSA”), which precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities, continues to be fertile ground for litigation more than 13 years after the legislation’s adoption. A persistent issue is to what extent a plaintiff can disclaim that his case is based on an alleged misrepresentation, even if the nature of the case suggests otherwise, and thereby avoid SLUSA preclusion.

In Brown v. Calamos, 2011 WL 5505375 (7th Cir. Nov. 10, 2011), the U.S. Court of Appeals for the Seventh Circuit reviewed a SLUSA dismissal in a case about a fund’s issuance of “auction market preferred stock.” Although it was a “suit for breach of fiduciary obligation and not securities fraud,” the complaint included allegations that the fund had falsely stated the term of the security “was perpetual” and omitted to disclose a material conflict of interest. Judge Posner found that SLUSA preclusion was appropriate under either (a) the Sixth Circuit’s “literalist approach,” because the complaint could be interpreted as alleging a misrepresentation; or (b) the Third Circuit’s “looser approach,” because the allegations of the complaint made “it likely that an issue of fraud will arise in the course of the litigation.”

Holding: Dismissal affirmed.

Quote of note: “[I]t can be argued that a dismissal with prejudice is too severe a sanction for what might be an irrelevancy added to the complaint out of an anxious desire to leave no stone unturned – a desire that had induced momentary forgetfulness of SLUSA. But a lawyer who files a securities suit should know about SLUSA and ought to be able to control the impulse to embellish his securities suit with a charge of fraud.”

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December 9, 2011 · 3:01 pm

Settlement Round-Up

As the 2011 fiscal year comes to a close, there have been a series of settlement announcements. Some of the more significant are:

(1) Arthrocare Corp. (NADAQ: ARTC), an Austin-based corporation that develops and manufactures surgical devices, instruments and implants, has announced the preliminary settlement of the securities class action pending against the company in the W.D. of Texas. The case, originally filed in 2008, stems from allegations that Arthrocare and certain of its officers and directors issued materially false financial statements. The settlement is for $74 million. Reuters has an article on the settlement.

(2) Wachovia Corporation, a financial services company now wholly owned by Wells Fargo & Co. (NYSE: WFC), has agreed to settle the securities class action pending against the company in the S.D. of New York. The case, originally filed in 2008, stems from allegations that Wachovia misled its equity investors about its underwriting practices and the quality of its mortgage portfolio. Interestingly, the district court had dismissed the settled claims, although the case was on appeal. The settlement is for $75 million. Reuters has an article on the settlement.

(3) Apollo Group, Inc. (NASDAQ: APOL), a Phoenix-based provider of private education, has agreed to settle the securities class action pending against the company in the D. of Arizona. The case, originally filed in 2004, stems from allegations that Apollo and certain of its officers failed to disclose that the company’s financial results were materially inflated by the improper practice of tying recruiter’s compensation directly to enrollments. The settlement is for $145 million. The case has a long history, including a jury verdict for the plaintiffs, a post-trial reversal, the reinstatement of the jury verdict on appeal, and the denial of defendants’ cert petition.

(4) Over forty underwriters have agreed to settle the securities class action pending against them and against Lehman Brothers Holding, Inc., a now-defunct financial services firm, in the S.D. of New York. The case, originally filed in 2008, stems from allegations that, prior to Lehman’s June 9, 2008 disclosure of a $2.8 billion second quarter loss, the company misled investors about its financial health. The complaint alleged that the underwriters contributed to the fraud by failing to investigate the truth of statements made by Lehman in financial statements and securities offerings. The settlement with the underwriters is for $417 million. Lehman’s former directors had previously settled for $90 million, bringing the total settlement amount to $507 million. Reuters has an article on the settlement.

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November 28, 2011 · 3:59 pm

We’re All In This Together

What must a plaintiff do to invoke the fraud-on-the-market theory (pursuant to which reliance by investors on a misrepresentation is presumed if the company’s shares were traded on an efficient market) in support of class certification? According to the U.S. Court of Appeals for the Ninth Circuit, nothing more than show (a) the security was traded on an efficient market, and (b) the alleged misrepresentations were public.

In Connecticut Retirement Plans and Trust Funds v. Amgen, Inc., 2011 WL 5341285 (9th Cir. Nov. 8, 2011), the court addressed whether a plaintiff also must prove that the alleged misrepresentations were material. Three circuit courts (Second, Fifth, and, to a lesser extent, 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 recent 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.

Holding: Affirming grant of class certification.

Quote of note: “If the misrepresentations turn out to be material, then the fraud-on-the-market presumption makes the reliance issue common to the class, and class treatment is appropriate. If the misrepresentations turn out to be immaterial, then every plaintiff’s claim fails on the merits (materiality being a standalone merits element), and there would be no need for a trial on each plaintiff’s individual reliance. Either way, the plaintiffs’ claims stand or fall together – the critical question in the Rule 23 inquiry.”

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November 9, 2011 · 5:22 pm

Not So Suspicious

The Apollo Group, a large private education provider, has been a magnet for securities litigation. In the most recent securities class action brought against Apollo, investors allege that from May 2007 to October 2010 the company made false and misleading statements about its financial condition, business focus, ethics, compensation and recruitment practices, and compliance with federal student loan regulations. In a recent decision – In re Apollo Group, Inc. Sec. Litig., 2011 WL 5101787 (D. Ariz. Oct. 27, 2011) – the court dismissed the claims. The decision has a few interesting holdings:

(1) Internet Postings – The complaint cited certain anonymous internet postings. The court noted that “the only appreciable difference between anonymous internet postings and confidential witness statements is that anonymous internet postings are less reliable.” As a result, “with regard to anonymous internet postings, it is Plaintiffs’ burden to plead reliability and knowledge that are indicative of scienter to at least the same extent as it must when pleading scienter with regard to confidential witness statements.”

(2) Suspicious Stock Trading – There were nine individual defendants in the case. The plaintiffs alleged that four of those defendants sold Apollo stock during the class period (21%, 15%, 34%, and 26% of their holdings respectively). The court found that these stock sales did not support a strong inference of scienter because (a) they were not “large sales amounts,” and (b) there were no “corroborative sales” by the other individual defendants.

(3) SEC Investigation – There is a district court split regarding whether the announcement of an SEC investigation is sufficient to establish loss causation (presuming that the announcement does not otherwise disclose any information about the alleged fraud). In Apollo’s case, the relevant press release stated that the SEC was conducting an informal investigation into the company’s revenue recognition practices. The court found that this disclosure had a sufficient nexus to the alleged fraud, because it could have signaled to a “reasonable investor that there were improprieties in Apollo’s revenue recognition policies.”

Holding: Motion to dismiss granted based on failure to adequately plead scienter.

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October 28, 2011 · 6:20 pm

Win Big Or Go Home

A variation on the normal securities fraud case occurs when a short seller alleges that a company’s misstatements caused it to cover its short positions at artificially high prices. Although few cases have directly addressed loss causation in the context of short selling, they generally are not favorable for the plaintiffs. That trend continues in the recent decision in Wilamowsky v. Take-Two Interactive Software, Inc., 2011 WL 4542754 (S.D.N.Y. Sept. 30, 2011).

Take-Two previously had settled a securities class action related to options backdating, but the settlement’s plan of allocation excluded short sellers from recovery. Wilamowsky opted out of the settlement and brought his own individual action. On the issue of loss causation, however, the court noted that Wilamowsky’s transactions in Take-Two stock (both short sales and covering purchases) ended “prior to the relevant curative disclosure.” As a result, Wilamowsky could not “plausibly articulate why [his alleged] losses are attributable to Defendants’ misstatements and omissions” as opposed to “legitimate market circumstances and intervening events.” The court found that was “particularly so here, where the in-and-out stock transactions began after the stock price was already inflated, spanned an extended time period punctuated by constant legitimate market stimuli and repeated misstatements, and terminated more than a year prior to the corrective disclosure.”

Holding: Dismissed with prejudice.

Quote of note: “With hindsight, Plaintiff may wish that he either covered immediately at the end of his short-selling period in January 2005, when the stock fell below his average sale price, or waited until after the corrective disclosure, by which point the price declined enough to put him in a position to earn millions of dollars. But allowing him to state a claim under these circumstances would permit a short seller in any standard misrepresentation case to either win big in the marketplace by covering after a corrective disclosure, or win in court by ‘transforming a private securities action into a partial downside insurance policy.'”

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October 21, 2011 · 6:01 pm

Around the Web

A few items from around the web.

(1) The first dismissal in the current wave of China-related securities class actions has occured, but it is difficult to read too much into the decision. In In Re China North East Petroleum Holdings Ltd. Sec. Litig., 2011 WL 4801515 (S.D.N.Y. Oct. 6, 2011), the court concluded that the lead plaintiff had not suffered any economic loss. 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 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.” The New York Law Journal has an article (subscrip. req’d) on the decision.

(2) The National Law Journal has an interesting interview (free regist. req’d) with the lead defense counsel in a recent civil securities fraud trial. The case was brought by investors against the former CEO of Homestore.com, who had previously plead guilty to related criminal charges. Although the jury found that the former CEO was liable for certain misstatements that caused $46 million in losses, he was not required to pay any damages because other defendants had already paid more than that amount to settle the claims against them.

(3) The D&O Diary has an informative roundup of the U.S. securities class action filing activity through the third quarter of 2011. At the present pace, there will be 205 filings this year, which is just slightly above the post-PSLRA average.

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October 7, 2011 · 10:10 pm

Repeating Falsehoods

Is it necessary for the alleged false statements to have artificially inflated the company’s stock price to establish loss causation? The Eleventh Circuit recently considered this question in a case where the plaintiffs’ expert found that the company’s stock price was artificially inflated both before and during the class period by the same amount. The district court granted summary judgment for the defendants, concluding that because the stock price inflation predated the class period, the alleged false statements made during the class period could not have caused the inflation or any subsequent losses.

On appeal – FindWhat Investor Group v. FindWhat.com, 2011 WL 4506180 (11th Cir. Sept. 30, 2011) – the Eleventh Circuit disagreed. The court concluded that false statements “that prevent a stock price from falling can cause harm by prolonging the period during which the stock is traded at inflated prices.” Accordingly, “defendants can be liable for knowingly and intentionally causing a stock price to remain inflated by preventing preexisting inflation from dissipating from the stock price.”

Holding: Vacating dismissal of claims based on failure to establish loss causation (but affirming the dismissal of certain other claims)

Quote of note: “Defendants whose fraud prevents preexisting inflation in a stock price from dissipating are just as liable as defendants whose fraud introduces inflation into the stock price in the first instance. We decline to erect a per se rule that, once a market is already misinformed about a particular truth, corporations are free to knowingly and intentionally reinforce material misconceptions by repeating falsehoods with impunity.”

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September 30, 2011 · 4:56 pm

Who’s The Dummy?

Section 20(b) of the Exchange Act makes it unlawful for a person to effect a securities fraud through another person. Sometimes referred to as the “ventriloquist dummy” statute, it has rarely been invoked in securities cases. In the Supreme Court’s recent Janus decision, however, the Court limited Section 10(b) securities fraud liability to persons who had “ultmate authority” over the alleged false statement. Not surprisingly, Janus has revived interest in Section 20(b) as a potential vehicle for claims against secondary actors.

The New York Law Journal has an interesting column (Sept. 29 – subscrip. req’d) on the potential application of Section 20(b). As a threshold matter, the authors note that “[t]here is so little authority on Section 20(b) that is is not even definitive that it affords a private right of action.” Even assuming that a private right of action exists, plaintiffs will have to demonstrate both the existence of any underlying violation and that “the controlling person ‘knowingly used’ the controlled entity to violate the securities laws.”

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