March 6, 2014
On Wednesday, the U.S. Supreme Court heard oral argument in the Halliburton v. Erica P. John Fund case, which brings into question the continued viability of the fraud-on-the-market presumption of reliance. The fraud-on-the-market presumption is crucial to pursuing a securities fraud case as a class action – without it, the proposed class of investors would have to provide actual proof of its common reliance on the alleged misrepresentation, a daunting task for classes that can include thousands of investors.
Much of the pre-argument commentary had focused on Chief Justice Roberts as the possible "swing vote" that could create a majority in favor of eliminating the fraud-on-the-market presumption (which was judicially created by a 1988 Supreme Court decision). Based on the questioning at the hearing, however, The 10b-5 Daily's prediction that Halliburton would be unable to find five justices who are willing to go that far seems more accurate. Indeed, to the extent that the Court is willing to change the current regime, it now appears that they are more likely to embrace the intermediate step of requiring evidence of price impact before a class can be certified (because price impact is a prerequisite of the fraud-on-the-market presumption).
Why read the tea leaves this way? A few highlights:
(1) Petitioner (Halliburton) started off arguing that the fraud-on-the-market presumption should be overruled because at least three things have changed since it was implemented: (a) the Court has consistently construed the private right of action for securities fraud narrowly, (b) the Court has issued decisions making it clear that class-wide issues should be addressed at the class certification stage, and (c) the economic premise that "investors rely in common on the integrity of the market price" is no longer accurate (assuming it ever was). In response, Justice Kagan noted that Petitioner apparently agreed "that market prices generally do respond to new material information," so in any particular case there will have to be a fact-specific inquiry into "whether there's an exception to this general rule." Petitioner responded that "if the Court were inclined to keep the presumption in some sense, it should at least place the burden on the plaintiff to establish that the misrepresentation actually distorted the market price, or to give defendants the full right of rebuttal at the class certification stage to establish the price was not impacted."
(2) Once the discussion turned to the use of price impact evidence, much of the rest of the hearing focused on that issue. Most notably, Justice Kennedy asked Petitioner to address whether a possible solution to the economic issues it had raised was to require plaintiffs to demonstrate - via an event study at class certification - that the alleged misrepresentation had impacted the market price. Petitioner readily agreed that it made "sense to focus like a laser on the only relevant question, whether the misrepresentation distorted the market price." In response to questions from Chief Justice Roberts and Justice Alito, Petitioner also argued that the cost of these event studies would not be significant because "plaintiffs are commonly using event studies right now as part of their [overall] market efficiency showing" at class certification and that event studies are "very effective" at determining a misrepresentation's price effect.
(3) Respondent (investors) and the government also were asked to address the use of price impact evidence at the class certification stage. In response to questioning from Justice Sotomayor and Justice Kennedy, Respondent argued that in a case alleging multiple misrepresentations, conducting event studies would be "very complicated" and "very expensive," and, moreover, "the idea that there are not significant merits filters that prevent cases from going to trial is simply wrong, both at the pleading stage and at the summary judgment stage." In contrast, however, the government readily conceded that if the Court were to require proof of price impact at the class certification stage, it "would be a net gain to plaintiffs, because plaintiffs already have to prove price impact at the end of the day."
Disclosure: The author of The 10b-5 Daily submitted an amicus brief on behalf of the Washington Legal Foundation in support of petitioner.
March 4, 2014
Chadbourne Decided (And Section 11 Is On Deck)
On the eve of the Halliburton oral argument, there have been two other developments in the U.S. Supreme Court related to securities litigation.
(1) Last week, in the Chadbourne & Parke LLP v. Troice case, the Court held that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) does not preclude state-law class actions unless the alleged misrepresentation "is material to a decision by one or more individuals (other than the fraudster) to buy or sell a 'covered security.'" The Court went on to find that the state-law class action against the defendants should be allowed to proceed because the alleged ponzi scheme, in which high-interest certificates of deposit (not covered securities) were sold to investors who were falsely told that the proceeds would be invested in liquid securities (at least some of which would be covered securities), did not satisfy this test.
The 7-2 decision authored by Justice Breyer provides an interpretation of the phrase "in connection with the purchase or sale" of a security that is contained both in SLUSA and Section 10(b) of the Securities Exchange Act (the primary statutory basis for federal securities fraud claims). The Court presents the following key arguments in support of its interpretation. First, SLUSA's language suggests that the requisite connection to the purchase or sale must "matter" and "[i]f the only party who decides to buy or sell a covered security as a result of a lie is the liar, that is not a connection that matters." Second, "every securities case in which this Court has found a fraud to be 'in connection with' a purchase or sale of a security has involved victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintained an ownership interest in financial instruments that fall within the relevant statutory definition." Finally, the Court's reading of SLUSA is consistent with the Securities Exchange Act and the Securities Act because "[n]othing in [those] statutes suggests their object is to protect persons whose connection with the statutorily defined securities is more remote than words such as 'buy,' 'sell,' and the like, indicate."
On its surface, of course, the decision is a victory for the plaintiffs' bar because it narrows the scope of SLUSA preemption. But the split within the Court - Justices Kennedy and Alito filed a vigorous dissent arguing that the new test is inconsistent with the Court's prior "broad construction" of the "in connection with" language - may be the result of two different forces at play. While the Court's test narrows the scope of SLUSA preemption, it also appears to narrow the overall scope of Section 10(b), limiting how far the plaintiffs' bar (and the SEC) can push the definition of a "securities fraud." This result sheds some light on why, for example, Justice Thomas joins the majority in a short, separate concurrence that applauds the application of "a limiting principle to the phrase 'in connection with'" - an outcome that no doubt appealed to a justice who has been in dissent in previous cases that arguably espoused a broader view of "in connection with" (e.g., O'Hagan).
(2) Apparently anxious to continue to delve into securities litigation issues, the Court also granted cert on Monday in the Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund case, which will be heard next term. At issue is the scope of Section 11 of the Securities Act, which provides a private remedy for a purchaser of securities issued under a registration statement filed with the SEC if the registration statement contains a material misstatement or omission.
The Court will consider the pleading standard for an allegedly false or misleading opinion (as opposed to statement of fact). While the Second, Third, and Ninth Circuits have held that under Section 11 a plaintiff must allege that the statement was both objectively and subjectively false - requiring allegations that the speaker's actual opinion was different from the one expressed - in Omnicare the Sixth Circuit held that if a defendant "discloses information that includes a material misstatement [even if it is an opinion], that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity." Stay tuned.
February 13, 2014
Applying the Safe Harbor
There are two prongs to the PSLRA's safe harbor for forward-looking statements. First, a defendant is not liable with respect to any forward-looking statement that is identified as forward-looking and is accompanied by "meaningful cautionary statements" alerting investors to the factors that could cause actual results to differ. Second, a defendant is not be liable with respect to any forward-looking statement, even in the absence of meaningful cautionary statements, if the plaintiff cannot establish that the statement was made with "actual knowledge" that it was false or misleading.
Although the circuit courts agree that the two prongs operate separately, they are split as to whether the defendant's state of mind should be considered in determining whether the cautionary statements are sufficiently "meaningful." The Sixth, Ninth, and Eleventh Circuits have held that the defendant's state of mind is irrelevant. The Seventh and Second Circuits, however, have suggested that it might be necessary to inquire into what the defendant knew about the risks facing the company before making that determination.
In In re Harman Int'l Indus., Inc. Sec. Litig., 2014 WL 197919 (D.D.C. Jan. 17, 2014), the district court agreed with the majority position and found that the defendant's state of mind is irrelevant. First, the plain text and the legislative history of the PSLRA make it clear that the first prong should be considered without reference to the defendant's state of mind. Second, considering the defendant's state of mind would improperly collapse the two prongs together, essentially making it impossible for a defendant to invoke the first prong at the pleadings stage of the case.
Holding: Motion to dismiss granted.
January 31, 2014
Compare and Contrast
NERA Economic Consulting and Cornerstone Research (in conjunction with the Stanford Securities Class Action Clearinghouse) have released their 2013 annual reports on securities class action filings. As usual, the different methodologies employed by the two organizations have led to different numbers, although they both identify the same general trends.
The findings for 2013 include:
(1) The reports agree that filings have increased by a slight amount. NERA finds that there were 234 filings (compared with 213 filings in 2012), while Cornerstone finds that there were 166 filings (compared with 152 filings in 2012). NERA normally has a higher filings number due to its counting methodology (see footnote 2 of the NERA report).
(2) The reports note that the number of companies listed on U.S. exchanges has declined nearly 50% from 1996 to 2013, but draw different (albeit not contradictory) conclusions from this statistic. NERA states that "the implication of this decline is that an average company listed in the US was 83% more likely to be the target of a securities class action in 2013 than in the first five years after the passage of the PSLRA." Cornerstone, in contrast, points to this decline as "one explanation for the recent relatively low levels of filing activity compared with historical averages."
(3) The Cornerstone report offers a new analysis of class certification trends. It notes that between 2002 and 2010, class certification was denied for reasons based on the merits of the motion (e.g., typicality, predominance, etc.) in less than two dozen cases.
(4) NERA found a sharp increase in the average settlement amount in 2013, reaching a new record of $55 million. The median settlement amount, however, decreased 26% to $9.1 million. NERA concludes that "a few large settlements drove the average up, while many small settlements drove the median down."
January 17, 2014
Following The Rules
If an SEC rule states that certain information does not have to be disclosed in a public filing, does that mean a company cannot act recklessly in failing to disclose that information? In In re Hi-Crush Partners L.P. Sec. Litig., 2013 WL 6233561 (S.D.N.Y. Dec. 2, 2013), the defendants noted that under the SEC's Form 8-K rules, they were not required to disclose that a major customer had terminated its contract with the company because the purported termination was invalid. In support of their argument that the plaintiffs had failed to adequately plead scienter, the defendants cited a different district court, addressing a similar set of facts, which held that "defendants' compliance with [SEC regulations] suggests that Lead Plaintiff has failed to show defendants acted recklessly in omitting such information."
The Hi-Crush court agreed that the Form 8-K rules did not require the disclosure, but disagreed that this meant the defendants had not acted recklessly. First, the court found that even in the absence of an affirmative disclosure obligation, the defendants could have a duty to disclose the information to avoid misleading investors. Second, given that the contract was supposed to generate 18.2% of Hi-Crush's revenue stream, it was "imperative" that investors be told about the threat of termination.
Holding: Motion to dismiss granted in part and denied in part.
January 10, 2014
Halliburton Briefing (Petitioners)
The Halliburton case in the U.S. Supreme Court is moving quickly, with oral argument scheduled for March 5, 2014. At issue, at least potentially, is the continued viability of the fraud-on-the-market presumption of reliance. The presumption was judicially created by the Court and is routinely invoked in securities class actions to justify the grant of class certification.
The merits brief for the petitioners (Halliburton and its CEO) and the supporting amicus briefs have been filed with the Court. A listing of the briefs can be found here. The author of The 10b-5 Daily - Lyle Roberts of Cooley LLP - assisted the Washington Legal Foundation (WLF) with the filing of an amicus brief that focuses on the second question presented: Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.
The WLF brief argues that price impact is not dispositive as to either materiality or loss causation for all class members and, as a result, allowing a price impact rebuttal at the class certification stage does not run afoul of the Court's Amgen decision. In addition, the brief points out that allowing a price impact rebuttal would harmonize the Court’s approach to affirmative misstatement and omissions cases and would better protect the rights of individual investors who can demonstrate actual reliance. The WLF brief is available on the Foundation's website.
December 27, 2013
Last Man Standing
The Gentiva securities class action is based on allegations that the company violated Medicare rules and artificially inflated the Medicare payments it received. In a previous post, The 10b-5 Daily discussed the motion to dismiss decision in the case, where the court found that the plaintiffs had adequately plead a strong inference of scienter against the company and two of its officers based solely on alleged suspicious insider trading. The defendants moved for reconsideration.
In In re Gentiva Sec. Litig., 2013 WL 6486326 (Dec. 10, 2013), the court reevaluated the trading and came to some different conclusions. As to the former CFO's trading, the court found "that trades under a Rule 10b5-1 plan do not raise a strong inference of scienter." If those type of trades were removed from the CFO's trading, all that would remain was a sale of 20,000 shares (or 12% of his holdings) that "occured more than six months before the announcement of the government investigation." Under these circumstances, the trading was not sufficiently suspicious and the court dismissed the securities fraud claim against the CFO.
But what did that mean for the two remaining defendants in the case - the former CEO and the company? As to the CEO, the court found that he sold 99% of his shares during the class period for approximately $2.14 millon and those sales were not made pursuant to a Rule 10b5-1 trading plan. The fact that no other officers were adequately alleged to have engaged in suspicious trading did not alter the court's conclusion that the CEO's trading created a strong inference of scienter as to him. When it came to the company, however, the court reversed field and found that the suspicious sale of stock by only one officer - as opposed to two officers - could not support a finding of corporate scienter and dismissed the securities fraud claim against the company.
So, after reconsideration, the case apparently will move forward against a single individual defendant - the former CEO.
Holding: Motion for partial reconsideration granted in part and denied in part.
December 13, 2013
That's Not Suspicious At All
The impact of a Rule 10b5-1 trading plan on a court's scienter analysis depends largely on the overall facts and circumstances surrounding the trading. In Koplyay v. Cirrus Logic, Inc., 2013 WL 6233908, (S.D.N.Y. Dec. 2, 2013), the court considered allegations that during the class period the individual defendants sold 14%, 11%, 46% and 10% of their stock holdings (for profits ranging from less than $1m to $4m). In surveying the case law, the court found that this trading was not "suspicious" for the following reasons:
(1) The timing of the sales, which allegedly took place at the "height" of the class period, "actually weighs against a finding of scienter, as the majority of the sales were neither at the beginning of the Class Period, soon after the misleading statements, nor clustered at its end, when insiders theoretically would have rushed to cash out before the fraud was revealed and stock prices plummeted."
(2) The court declined to adopt a rule that an insider's sale of more than 10% of his holdings is suspicious. Instead, the court noted that "courts have found scienter based on sales similar to these only where the volume of sales and total profit is overwhelming or where some other factor, such as the timing of the sales, further tips the balance."
(3) The court found that all but one of the sales were made pursuant to Rule 10b5-1 trading plans that "were entered into months before the class period." Although the plaintiffs argued that the defendants could have "timed the release of good and bad news to maximize insider trading profits based on triggers in the plan," the court found that "this argument effectively reduced to a claim that Defendants had scienter because they were motivated to raise the price of Cirrus stock."
Holding: Motion to dismiss granted.
December 6, 2013
The Fateful Work of Supernatural Forces
If the judge likens the events surrounding the collapse of your company to a "massive train wreck," is moving to dismiss the related securities class action worthwhile? That was the question facing the defendants in the MF Global Holdings case and the court did not like their answer.
In In re MF Global Holdings Ltd. Sec. Litig., 2013 WL 5996426 (S.D.N.Y. Nov. 12, 2013), the court started out by noting that its "train wreck" analogy "was meant as a hint giving a form of guidance." The case involved the alleged disappearance of $1.6 billion from customer accounts that was later found to have been "improperly commingled and used to cover questionable company transactions." Under these circumstances, the court believed that the parties would "turn to the search for relevant evidence," but instead was surprised to find that the defendants "seem convinced that no one named in this lawsuit could possibly have done anything wrong." Indeed, the defendants' contention that all twenty-three claims against them should be dismissed must mean that MF Global's collapse was "the fateful work of supernatural forces, or else that the explanation for a spectacular multi-billion dollar crash of a global corporate giant is simply that 'stuff happens.'"
The court went on to reject the motion to dismiss in its entirety. However, the court did make at least one legal ruling in favor of the defendants. A key issue in the case is whether MF Global's statements about its deferred tax assets were false or misleading. Deferred tax assets are losses, credits and other tax deductions that may be used to offset taxable income in the future, but they can only be recorded as assets on a company's balance sheet to the extent the company determines it is "more likely than not" they will be realized. The court found that under Second Circuit precedent, "statements about the realization of the DTA are statements of opinion, not of fact." Accordingly, the plaintiffs ultimately will need to prove that these statements were both false and not honestly believed at the time they were made.
Holding: Motion to dismiss denied.
Quote of note: "In evaluating the application of law that Defendants argue would allow the outcome that they seek at this stage of the litigation, the Court's assessment may be simply stated: It cannot be."
November 22, 2013
Stick To The Plan
Does the fact that an individual defendant's stock trading took place pursuant to a pre-determined Rule 10b5-1 trading plan undermine any inference that the trades were "suspicious"? Courts continue to be split on this question, with the answer often depending on the exact circumstances surrounding the plan's formation and execution.
In In re Questor Sec. Litig., 2013 WL 5486762 (C.D. Cal. Oct. 1, 2013), the court examined a plan that was created around the beginning of the class period and lead to periodic sales of 30,000 shares each until July 2012. When the plan terminated, however, the defendant "made two additional sales of 40,000, more than his usual 30,000 sales, in August and September 2012 [just prior to the end of the class period]." Based on this fact pattern, the court found that while the sales could have been innocent, it was "equally as plausible that, after observing the success of Questcor's aggressive and misleading marketing strategies, [the defendant] set up the plan to avoid the appearance of improper sales."
More generally, the decision contains an extensive analysis of the scienter implications of the defendants' stock trading. The court holds, inter alia, that (a) even where the percentage of stock sold is not suspicious, the sales can support an inference of scienter if the profits are "substantial," and (b) a company's implementation of a stock repurchase plan during the class period can be inconsistent with scienter, because it is illogical for a company to buy shares if it knows the price will fall.
Holding: Motion to dismiss denied.