The 10b-5 Daily

When it comes to securities litigation, all of today’s action was in the U.S. Supreme Court.

First, the Court granted cert in the National Australia Bank case (over the objections of the DOJ and SEC) and will review the extraterritorial application of the U.S. securities laws. Bloomberg and Securities Docket have coverage of the decision. Interestingly, Justice Sotomayor recused herself from considering the cert petition.

Second, the Court heard arguments in the Merck case on when the running of the statute of limitations is triggered in securities fraud cases. According to press reports (which the oral argument transcript would appear to confirm), the justices seemed disinclined to overturn the Third Circuit’s ruling and find that the plaintiffs’ claims are barred by the statute of limitations. Exactly what the Court will hold is sufficient to begin the two-year “discovery” period, however, remains to be seen. The briefs filed in the case can be found here.

When the U.S. Supreme Court asked for the government’s view on the National Australia Bank cert petition, it seemed a safe bet that the government would encourage the Court to take the case. After all, the SEC had filed an unsuccessful amicus brief in the Second Circuit in favor of the plaintiffs. Here was an opportunity to get a second bite at the apple.

Earlier this week, however, the Solicitor General and SEC filed a joint amicus brief arguing that the Supreme Court should deny cert. The government now asserts that the Second Circuit’s decision was correct, even if its reasoning was wrong.

First, the government argues that the Second Circuit, along with all of the other circuits that have addressed the issue of the “transnational reach of Section 10(b),” have incorrectly described it as one of subject matter jurisdiction. In fact, the relevant jurisdictional provision has no geographical limitation. The need for a connection to the United States is better understood as being related to the elements of the claim. For a private plaintiff (but not the SEC), this includes the requirement that the plaintiff establish a connection between the defendant’s violation and the alleged injury.

Second, the government takes issue with the Second Circuit’s examination of where the “heart of the alleged fraud” took place. To the extent this analysis suggested that the conduct of National Australia Bank’s U.S. subsidiary did not violate Section 10(b) – because it was not the “heart” of the fraud – the holding was “erroneous.” Alternatively, the government proposes the following standard: “it is sufficient if the scheme involves significant conduct within the United States that is material to the fraud’s success.” The U.S. subsidiary’s creation of false information that was incorporated into National Australia Bank’s financial statements was sufficient to establish a violation of Section 10(b) and the SEC could have brought an action based on these facts.

For a foreign private plaintiff, however, an additional assessment must be made. According to the government, “the plaintiff should be required to prove that his loss resulted not simply from the fraudulent scheme as a whole, but directly from the component of the scheme that occurred in the United States.” As to this assessment, the Second Circuit apparently got it right, concluding that causation was too attenuated given all of the activity that took place in Australia prior to the issuance of the false financial statements.

Finally, the government concedes that there is a circuit split over the “conduct” test, with the D.C. Circuit having adopted the most restrictive version. The D.C. Circuit requires that a defendant’s “domestic conduct comprise all the elements . . . necessary to establish a violation of Section 10(b).” Nevertheless, the government argues that National Australia Bank “would not be a suitable vehicle for resolving that division” because the plaintiffs could not prevail under any of the existing conduct tests.

Whatever one makes of the government’s arguments, it’s overall position on granting cert is puzzling. Appellate court misunderstood fundamental legal question? Check. Appellate court applied wrong legal standard? Check. Appellate court decision caused or confirmed existence of circuit split? Check. The U.S. Supreme Court should resolve these important issues? Pass. Stay tuned for the Court’s decision.

Quote of note: “[O]ther nations might perceive affording a private remedy to foreign plaintiffs as circumventing the causes of action and remedies (and the limitations thereon) that those nations provide their own defrauded citizens, particularly if the plaintiff’s principal grievance appears directed at another foreign entity. Absent indications of a contrary congressional intent, the judicially-created private right of action under Section 10(b) should be tailored so as to minimize the likelihood of such international friction.”

The U.S. Court of Appeals for the Sixth Circuit issued an opinion this week in Indiana State District Council v. Omnicare, Inc., 2009 WL 3365189 (6th Cir. Oct. 21, 2009) that has a few interesting holdings.

(1) Loss causation – The court held that loss causation was inadequately plead as to certain alleged misstatements premised on non-compliance with GAAP. In the absence of any financial restatement and given the continued willingness of Omnicare’s auditors to certify the company’s GAAP compliance, the court concluded that “the complaint does not suggest that the alleged GAAP violations were ever recognized or revealed to the market.”

(2) Confidential Witnesses – The court reaffirmed its willingness to “steeply discount” the statements of confidential witnesses. In the instant case, the plaintiffs provided no information about a key confidential witness “except the title of his position” and there was a disconnect between what the witness knew and the alleged subject matter of the fraud.

(3) Pleading Standard for Section 11 Claims – The court joined the vast majority of other circuits (with the notable exception of the 8th Circuit) in holding that Section 11 claims that “sound in fraud” must be plead with particularity.

Holding: Dismissal of fraud claims affirmed; Section 11 claim remanded for evaluation of whether it met applicable pleading standard.

Quote of note: “Seizing on a few vague statements from management, the plaintiffs try to turn bad corporate news into a securities class action. Because the Private Securities Litigation Reform Act (“PSLRA”) forbids such alchemy, we generally affirm the district court’s dismissal, although we reverse its disposition regarding the claims brought under the Securities Act of 1933.”

There have been two recent appellate decisions discussing the scope of the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”), which pre-empts certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. The decisions address to what extent the statute requires the dismissal of “claims” as opposed to “actions.”

In Proctor v. Vishay Intertechnology Inc., 2009 WL 3260535 (9th Cir. Oct. 9, 2009) the court found that SLUSA only precluded one of the plaintiff’s three claims. As to the other two claims, the court (largely following a Third Circuit decision from earlier this year) held that they should not be dismissed but, instead, should be remanded to state court for further proceedings.

But what if the plaintiff does not carefully segregate the claims that may be precluded by SLUSA? In Segal v. Fifth Third Bank, 2009 WL 2958438 (6th Cir. Sept. 17, 2009), the complaint expressly disclaimed that any of its state-law claims were based upon alleged misrepresentations, but the court found that this was just “artful pleading” given the complaint’s overall contents. As to the plaintiff’s argument that his state-law claims did not “depend upon” any misrepresentations, the court held that even if the misrepresentations were “extraneous” there was no requirement that a misrepresentation be an element of a claim for the claim to be precluded by SLUSA. The court had “no license to draw a line between SLUSA-covered claims that must be dismissed and SLUSA-covered claims that must not be” and dismissed the entire action.