The 10b-5 Daily

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. What is an efficient market? Courts have frequently interpreted the U.S. Supreme Court’s decision in Basic v. Levinson (which adopted the fraud-on-the-market theory) as incorporating the economic definition of an “efficient market.” That is to say, an efficient market is one in which the stock price rapidly reflects all publicly available information. See, e.g., Gariety v. Grant Thornton, LLP, 368 F.3d 356, 367 (4th Cir. 2004).

At least one court, however, has taken a hard look at the Basic decision and disagrees. In In re Polymedica Corp. Sec. Litig., 2004 WL 1977530 (D. Mass. Sept. 7, 2004), the court found 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.'” As a result, the court declined to consider the defendants’ argument (asserted as part of an opposition to class certification) that the fraud-on-the-market theory could not be applied because the market price of Polymedica stock did not fully and rapidly reflect public information.

Holding: Class certification granted (after excluding short sellers from the proposed class).

Quote of note: “When legal precedent is available, I follow it, not economic or academic literature. And though the First Circuit has not issued an opinion on the matter, Supreme Court precedent exists. Furthermore, it is plain in Basic that the Court did not want to adopt the ‘economic’ or ‘academic’ definition of efficient market.”

A growing number of plaintiffs’ firms have forensic accountants on their permanent staff. An article (via law.com – free regist. req’d) in The Recorder discusses this trend and the importance of forensic accounting in formulating securities class action complaints that can survive a motion to dismiss.

Quote of note: “[Andy] Rudolph said the wave of corporate scandals led by Enron Corp. has cast his work in a new light. ‘I used to go to seminars and give speeches and almost get booed’ by other accountants and company CFOs, Rudolph said. ‘The pendulum has swung. Now people want to hear about fraud.’ He also gets a different reaction at social events when he tells people he’s a forensic accountant. ‘Is it like CSI?’ people ask.”

The federal district court split over whether SLUSA bars the bringing of a securities class action alleging ’33 Act claims in state court continues. In Zia v. Medical Staffing Network, Inc., 2004 WL 2093505 (S.D. Fla. Sept. 16, 2004), the court held that SLUSA only permits the removal to federal court of securities class actions based on state law. Accordingly, the case was remanded. The decision notes, however, that the issue is currently before the U.S. Court of Appeals for the Eleventh Circuit in another case – ATC Enter., Inc. v. Williams – and oral argument was set to occur in September.

The Halliburton settlement just got even messier. Not only has the N.D. of Tex. rejected the proposed $6 million settlement, but the court now has appointed a trustee to protect the interests of the preliminary class members. The Houston Chronicle reports that Judge Lynn “made the decision to appoint the trustee, called a ‘guardian ad litem,’ Thursday, according to legal documents obtained Friday.”

Section 308 of Sarbanes-Oxley, the “Fair Funds” provision, allows the SEC to combine civil penalties with the disgorgement obtained from a securities law violator into a fund for the benefit of the victims of the violation. The Los Angeles Times has a feature article (free regist. req’d) today discussing the SEC’s use of its restitution powers. The article states that although accounts have been set up in 96 cases, amassing $2.6 billion in funds, the disbursement of those funds has proven to be a “logistical challenge” for the SEC and relatively little of the money has found its way to investors to date.

As for the impact on private litigation, the article notes that many of the supporters of the Fair Funds strategy “like the fact that the funds gave investors a means beyond class-action lawsuits to reclaim their losses.” In passing the legislation, however, Congress failed to specifically address whether these funds were supposed to supplement or offset funds obtained as the result of private litigation. The practical effect of large SEC civil penalties may be the reduction of private settlements, but it is not clear that they can be used as a direct offset.

The SEC, for its part, has not given defendants much comfort on this issue, suggesting that civil penalties should still be viewed as a punitive measure despite the Fair Funds provision. As the SEC’s Director of Enforcement stated earlier this year: “That harmed investors can benefit directly from these efforts is icing on the case, so to speak.” The courts may have to have the final say.

The Wall Street Journal reports (subscrip. req’d) today that Lehman Brothers is “close to reaching a deal to pay about $220 million to settle a class-action lawsuit alleging that it and other big brokerage firms participated in a scheme with Enron Corp. executives to mislead shareholders.”

Two articles on the mutual fund trading practices cases, which have been consolidated in the D. of Md., suggest that they may not be a “bonanza” for investors.

The Wall Street Journal reports (subscrip. req’d) that “the hefty penalties already levied by regulators in settlements with 11 fund firms make it less likely there will be a big payoff for investors in the private litigation.” Meanwhile, the Boston Globe finds that the existing “settlement talks remain at initial stages” and some of the “fund firms appear to be in no mood to settle with plaintiffs.”