The 10b-5 Daily

A trial verdict that results in $9.3 billion in potential damages is likely to engender a slew of post-trial motions. The court’s decision on those motions in the Vivendi securities class action was made public this week.

The media focus has been on the court’s application of the National Australia Bank (NAB) decision to dismiss the fraud claims by purchasers (including U.S. purchasers) of Vivendi shares on foreign exchanges. The dismissal was in line with other post-NAB cases, although the Vivendi court was quick to point out that the Supreme Court’s decision contains imprecise language. In particular, on the issue of whether the decision permits, based on the existence of a dual listing (U.S. and foreign exchange), a U.S. cause of action for investors who purchased their shares on the foreign exchange, the court suggested that “perhaps Justice Scalia simply made a mistake.” That is to say, “[Scalia] stated the test as being whether the alleged fraud concerned the purchase or sale of a security ‘listed on an American stock exchange,’ when he really meant to say a security ‘listed and traded’ on a domestic exchange.” In any event, there was no indication that the Supreme Court “read Section 10(b) as applying to securities that may be cross-listed on domestic and foreign exchanges, but where the purchase and sale does not arise from the domestic listing.”

The Vivendi court’s other rulings are at least as interesting and two of them stand out.

(1) Corporate scienter – The court addressed how the jury could have found that Vivendi acted with scienter in committing securities fraud, while dismissing the claims against Vivendi’s former CEO and CFO. The court agreed that to prove corporate scienter, the plaintiffs needed to establish that a Vivendi agent committed a culpable act with scienter. However, the court found, the “fact that the jury absolved [the former officers] of liability does not negate the fact that there was sufficient evidence in the record in the first instance to enable a reasonable jury to find against all three defendants on the issue of scienter, thereby foreclosing judgment as a matter of law in Vivendi’s favor.” As to whether the verdicts were inconsistent, which is a possible ground for a new trial, the court concluded that “significant evidence admitted against Vivendi, but not against [the former officers], could have led the jury to find that plaintiffs proved that Vivendi violated Section 10(b) based on the scienter of [the former officers], even if the jury was unable to conclude the plaintiffs had met their burden of proof against [the former officers].”

(2) Reliance – The court noted that “certain means of rebutting the presumption of reliance require an individualized inquiry into the buying and selling decisions of particular class members.” Vivendi should have the opportunity to make this rebuttal as to individual class members, perhaps even through separate jury trials if necessary, although the exact procedures for the “individual reliance phase” would have to be determined. As a result, the court declined to enter a final judgment in the case.

Holding: Dismissed claims brought by purchasers of ordinary shares (as opposed to American Depositary Shares). Denied Vivendi motion for judgment as a matter of law or, in the alternative a new trial, except as to one statement. Denied entry of final judgment.

Item 303(a) of Regulation S-K, which requires issuers to disclose known trends or events “reasonably likely” to have a material effect on operations, capital, and liquidity, has been referred to as the “sleeping tiger” of securities litigation. Item 303(a) certainly has two attributes that are attractive to plaintiffs: it requires the issuer to offer a prediction on the effects of a known trend, but the disclosure arguably is not subject to the PSLRA’s safe harbor for forward-looking statements (other than two subsections dealing with off-balance sheet arrangements and contractual obligations). The use of Item 303(a) in securities litigation has a mixed history, but the Second Circuit may have woken the tiger last week.

In Litwin v. The Blackstone Group, L.P., 2011 WL 447050 (2d Cir. Feb. 10, 2011), the court considered whether the plaintiffs had adequately alleged that Blackstone failed to make required disclosures under Item 303(a) related to two portfolio companies and its real estate investment funds. The claims were brought pursuant to Section 11 and 12 of the ’33 Act, based on omissions in Blackstone’s registrations statement and prospectus, so the applicable pleading standard was notice pleading (i.e., enough facts that the claim is plausible on its face). Moreover, there was no dispute that there was a downturn in the real estate market at the time of Blackstone’s IPO. Accordingly, the sole issue was the pleading of materiality.

The court made the following key holdings.

First, the court rejected Blackstone’s argument that it was not required to make an Item 303(a) disclosure because the downturn in the real estate market was already part of the “total mix” of information available to the market. While investors knew about the downturn, the “potential future impact [on Blackstone’s investments] was certainly not public knowledge.”
Second, the court declined to find that Blackstone was not required to disclose information about particular portfolio companies because the investments were relatively small and the gains or losses from the investments were aggregated at the fund level. To hold otherwise, the court found, would “effectively sanction misstatements in a registration statement or prospectus related to particular portfolio companies so long as the net effect on the revenues of a public private equity firm like Blackstone was immaterial.” Moreover, the portfolio company investments were in key sectors of Blackstone’s business.

Finally, the court held that the plaintiffs were not required to identify specific real estate investments that had been adversely effected by the downturn. Indeed, that was the exact information, along with potential effect of the downturn, that the plaintiffs claimed was omitted. In any event, the plaintiffs had alleged enough facts connecting the real estate downturn with potential adverse effects on Blackstone’s real estate investments to state a plausible claim.

So what impact will the Blackstone decision have? At a minimum, the decision seems likely to encourage the use of Item 303(a) as a vehicle for private securities litigation, although obviously not every case is amenable to an allegation that there was a known, undisclosed trend. Second, the decision can be read to create a low materiality threshold (although this case did not allege fraud and therefore was not subject to the heightened pleading standard of Rule 9(b)). While the district court relied heavily on the fact that the investment losses did not have a significant impact on Blackstone’s overall financial results, the Second Circuit applied a more holistic, “what would a reasonable investor want to know,” standard. Of course, the Supreme Court soon will be weighing in on the issue of materiality. Stay tuned.

Holding: Dismissal vacated and remanded for further proceedings.