The 10b-5 Daily

Will stock buyback programs provide the next basis for securities litigation? They are certainly the topic of the day. CFO Magazine has a feature article discussing whether insiders should be permitted to sell shares while a stock buyback program is in effect. Meanwhile, the New York Times has a column (subscrip. req’d) speculating that some stock buyback programs may be used to increase executive bonus payouts that are contingent on an increase in earnings per share. Thanks to Mike Gumport for the link to the CFO Magazine article.

Quote of note (CFO Magazine): “This June, Audit Integrity, a Los Angeles–based accounting and governance analysis firm, sent a note to clients identifying 16 companies with market capitalizations of at least $100 million that it considers at high risk for fraudulent behavior, including USANA, because the companies have high levels of both stock buybacks and insider selling. Meanwhile, [a prominent plaintiffs’ attorney] is putting the finishing touches on a lawsuit he plans to file against ‘one of the most high-profile companies in the United States,’ along with its CEO, over issues relating to its buyback programs.”

The plaintiffs’ bar must have been amazed when they opened the Wall Street Journal last week to find Senator Charles Schumer (D – N.Y.) suggesting that something needs to be done about frivolous securities class actions. In an op-ed (subscrip. req’d) written with Mayor Michael Bloomberg, Senator Schumer discusses ways to help New York’s financial services industry. Notably, the authors state that the litigation environment for corporations must be improved. Reuters has an article on all of this recent interest in securities litigation reform.

Quote of note (WSJ op-ed): “The total value of securities class-action lawsuits in the U.S. has skyrocketed in recent years, to $9.6 billion in 2005 from $150 million in 1997. The U.K. and other nations have laws that far more effectively discourage frivolous suits. It may be time to revisit the best way to reduce frivolous lawsuits without eliminating meritorious ones.”

There has been much more on the Committee on Capital Markets Regulation (a.k.a. the Paulson Committee) and its potential litigation recommendations in the Wall Street Journal this week.

(1) An op-ed (subscrip. req’d) in Monday’s edition, written by two Committee members, discussed the Committee’s concerns and goals.

Quote of note: “In addition to regulation and accounting standards, the liability system can also affect the competitiveness of U.S. markets. Firms are sometimes confronted with circumstances in litigation, including securities class-action suits, where even a small probability of loss, given the size of claims, could result in bankruptcy. Consequently, companies often must agree to large settlements that result in reduced value for shareholders rather than pursuing a successful outcome on the merits of its case.”

(2) An article (subscrip. req’d) in Wednesday’s edition discussed the desire of accounting firms to limit the potential liability for their audit work and the Committee’s possible recommendations on this issue.

Quote of note: “Recognizing, though, that auditor liability overhaul might be a tough sell on Capitol Hill, the committee may suggest that the U.S. Securities and Exchange Commission come up with a solution, Mr. Scott said. ‘The SEC could modify their own rules regarding liability,’ he added. One idea under study: Allowing accounting firms to negotiate liability caps with clients, a practice now barred to preserve auditors’ independence.”

Is it the end of private securities litigation? Not yet, but one could hardly tell given some of the fierce reactions to the possibility that The Committee on Capital Markets Regulation, a private group of business leaders and academic experts, may recommend that the SEC limit the ability of private plaintiffs to bring actions pursuant to Rule 10b-5.

The New York Times had a feature article on the “Paulson Committee” (as it is colloquially known because U.S. Treasury Secretary Henry Paulson provided a favorable quote for its initial press release) this past weekend. Although the main focus of the Paulson Committee appears to be examining the effects of the Sarbanes-Oxley Act, an initial recommendation to the Committee from Professor John Coffee that the SEC consider dis-implying a private right of action under Rule 10b-5 (in some or all cases) is garnering the most attention.

Reaction can be found in a New York Times column and posts in Point of Law, Ideoblog, and Securities Litigation Watch.

Two items from around the web:

(1) The Wall Street Journal has an article (subscrip. req’d) today on efforts by Bernstein Litowitz to remove Milberg Weiss as co-lead counsel and re-open the lead plaintiff/lead counsel selection process in the Merck securities litigation. Merck’s motion to dismiss the case is currently pending before the court.

(2) Following up on an earlier post in The 10b-5 Daily concerning the British Petroleum derivative suit filed in Alaska state court, the Financial Times has a column (via a reprint in South Africa’s Business Day) on the case, the spread of U.S.-style shareholder litigation, and the potential corporate governance effects on foreign companies.

The fraud-on-the-market theory states that reliance by investors on an alleged misrepresentation is presumed if the company’s shares were traded on an efficient market. But what is an efficient market? The PolyMedica securities litigation has offered a thorough examination of this issue.

In considering class certification, the district court originally held (contrary to most other courts) that an efficient market is simply one in which “market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.” On appeal, the U.S. Court of Appeals for the First Circuit rejected this definition in a decision – In re PolyMedica Corp. Sec. Litig., 432 F.3d 1 (1st Cir. 2005) – issued late last year. The appellate court held that an efficient market “is one is which the market price of the stock fully reflects all publicly available information.” In other words, the market price must respond “so quickly to new information that ordinary investors cannot make trading profits on the basis of such information.”

On remand – In re PolyMedica Corp. Sec. Litig., 2006 WL 2776669 (D. Mass. Sept. 28, 2006) – the district court focused on the expert evidence concerning whether there was a “cause-and-effect relationship, over time, between unexpected corporate events or financial releases and an immediate response in [PolyMedica’s] stock price.” The plaintiffs’ expert provided an analysis demonstrating that PolyMedica’s stock price moved in response to significant news events on certain days within the portion of the proposed class period in question, but the district court found that this analysis was insufficient to establish either causation or that the news was reflected “fully” and “quickly” in the stock price. Moreover, the district court found defendants’ expert evidence that (1) short selling in PolyMedica stock was difficult and (2) the price of PolyMedica stock exhibited positive serial correlation (the direction in which the stock moved on a given day was a statistically significant predictor of how it would move the next day) was sufficient to suggest that the First Circuit’s standard for market efficiency had not been met.

Holding: Class certification as to a portion of the proposed class period denied.

Quote of note: “Nothing in [plaintiffs’] analysis tends to show that all reactions to any news event were regularly complete within any given time frame, let alone ‘quickly.’ . . . It may be true, as [plaintiffs’ expert] suggests, that one ‘can observe a lot just by watchin,’ but Yogi Berra is hardly a competent expert in market efficiency.”