The 10b-5 Daily

Whether trading under a Rule 10b5-1 trading plan can help shield corporate executives from securities fraud liability is a topic that courts continue to explore.

Rule 10b5-1, put into place in 2000, establishes that a person’s purchase or sale of securities is not “on the basis of” material nonpublic information if, before becoming aware of the information, the person enters into a binding contract, instruction, or trading plan (as defined in the rule) covering the securities transaction at issue. To take advantage of this potential affirmative defense, many executives have implemented trading plans for their sales of company stock.

Insider trading, of course, is often used by plaintiffs in securities class actions to create an inference of scienter (i.e., fraudulent intent). The plaintiffs allege that the individual corporate defendants profited from the alleged fraud by selling their company stock at an artificially inflated price. In the latest decision to consider the impact of Rule 10b5-1 trading plans on insider trading scienter allegations, the court in In re Netflix, Inc. Sec. Litig., 2005 WL 1562858 (N.D. Cal. June 28, 2005) found that the fact that the trading in question took place pursuant to a trading plan mitigated against a finding of an inference of scienter.

The author of The 10b-5 Daily has written an article (with one of his colleagues) on this topic.

In an interesting opinion released yesterday in the Parmalat securities class action, Judge Kaplan (S.D.N.Y.) addresses some important topics.

(1) Parmalat’s primary auditors were the Italian affiliates of two multinational accounting firms – Grant Thornton and Deloitte & Touche. The court found that the plaintiffs sufficiently alleged an agency relationship between the global umbrella organizations, Grant Thornton International (“GTI”) and Deloitte Touche Tohmatsu (“DTT”), and their Italian member firms so as to allow the claims against the global entities to go forward.

(2) GTI and DTT argued that the plaintiffs had failed to adequately plead loss causation “because they do not allege that any misrepresentation by them was the proximate cause of the decline in the value of the price of Parmalat securities or that a corrective disclosure about their prior misrepresentations caused the company’s collapse.” The court disagreed, holding that under Second Circuit precedent the plaintiffs’ allegations that the risks concealed by Parmalat and its auditors caused the decline in investor value were sufficient.

(3) Section 20(a) of the ’34 Act creates a cause of action against defendants alleged to have been “control persons” of those who engaged in securities fraud. There is a split within the Second Circuit over whether a plaintiff must allege culpable participation to state a legally sufficient claim under this provision. The court found that allegations of culpable participation are not necessary.

(4) The defendants evidently also moved to dismiss the 368-page complaint as failing to comply with F.R.C.P. 8 (“short and plain statement” of the claim). The court noted that it was in “substantial sympathy” with this position: “The requirement of pleading fraud with particularity does not justify a complaint longer than some of the greatest works of literature.” Nevertheless, the court declined to dismiss the complaint on this basis.