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.
November 15, 2013
Supreme Court Grants Cert In Halliburton Case
The U.S. Supreme Court has granted certiorari in Halliburton v. Erica P. John Fund, setting up what could be the most important securities litigation decision in the last twenty-five years. At issue is the continued validity of the fraud-on-the market-theory, whereby reliance by investors on a misstatement is presumed if the company's shares were traded on an efficient market that would have incorporated the information into the stock price. The presumption is routinely invoked in securities class actions to justify the grant of class certification.
In its petition, Halliburton presented the following two questions:
1. Whether this Court should overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory.
2. 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.
In granting review, the Court did not limit its consideration to either question. As a result, SCOTUSBlog notes that the Court presumably "at least will consider the broader plea to cast aside the prior ruling."
Quote of note (Bloomberg): "Four justices -- Antonin Scalia, Clarence Thomas, Anthony Kennedy and Samuel Alito -- suggested in a ruling in February that they might jettison the 'Basic presumption,' as it has become known. The outcome of the case may be in the hands of Chief Justice John Roberts, who usually joins that group in ideologically divisive cases."
October 25, 2013
Challenging The Fraud-On-The-Market Theory
Pursuant to the fraud-on-the-market theory, reliance by investors on a misstatement is presumed if the company's shares were traded on an efficient market that would have incorporated the information into the stock price. The presumption was judicially-created by the U.S. Supreme Court and is routinely invoked in securities class actions to justify the grant of class certification. In the Court's recent Amgen decision, however, four justices expressed concerns about the fraud-on-the-market theory's continuing validity. In particular, the Amgen dissent noted that the Court is not well-equipped to apply economic concepts and there is some disagreement about how market efficiency works. Given that invitation, it was only a matter of time before a securities class action defendant asked the Court to reconsider its current position.
Erica P. John Fund v. Halliburton, a securities class action that has been pending in the N.D. of Texas since 2002, has already been the subject of a Supreme Court decision relating to the fraud-on-the-market theory. In 2011, the Court held that loss causation is not a precondition for invoking the fraud-on-the-market presumption and, therefore, is not necessary to establish that reliance is capable of resolution on a common, classwide basis. On remand, the defendants pursued a related issue. Halliburton argued that it should be allowed to rebut the fraud-on-the-market presumption by establishing that the alleged misstatements did not have a stock price impact. The district court found that price impact evidence did not bear on the critical inquiry of whether common issues predominated under FRCP 23(b)(3) and certified the class. The Fifth Circuit subsequently affirmed, finding that although price impact evidence certainly could be used at trial to refute the presumption of reliance, it was not appropriate to consider this evidence at class certification.
Halliburton is once again seeking certiorari in the Supreme Court, but now it is going after an even bigger prize. In addition to arguing that the Fifth Circuit should have allowed the defendants to rebut the presumption by presenting price impact evidence, Halliburton asserts that the Court should overrule or substantially modify the fraud-on-the-market theory. It takes four justices to grant cert - will the Amgen group decide that the Halliburton case is the right vehicle through which to consider this question? A handful of amici have urged them to do so, including the U.S. Chamber of Commerce, and the issue has caught the attention of the legal press. Stay tuned.
October 11, 2013
On Monday, the U.S. Supreme Court heard oral argument in three related cases - Chadbourne & Parke v. Samuel Troice, No. 12-79; Willis of Colorado v. Troice, No. 12-86; and Proskauer Rose v. Troice, No. 12-88 - raising the issue of the scope of the Securities Litigation Uniform Standards Act of 1998 ("SLUSA"). SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities ("covered securities").
Observers who were hoping for a lot of discussion about the meaning and import of SLUSA, however, were sorely dissapointed. Instead, oral argument focused on an issue that the Court has considered before: exactly what fact patterns does "in connection with the purchase or sale" (which is taken from Section 10(b) of the Securities Exchange Act of 1934) cover? The three cases related to the Stanford 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).
The justices appeared to struggle with idea that a false statement concerning whether securities have been purchased can satisfy the "in connection with" requirement. Almost immediately, Chief Justice Roberts asked counsel for the petitioners "if I'm trying to get a home loan and they ask you what assets you have and I list a couple of stocks and, in fact, it's fraudulent, I don't own them, that's a covered transaction, that's a 10(b)(5) violation?" When counsel responded that the scenario would appear to be missing any representation about a purchase or sale, Justice Kagan argued that the problem is "In all of our cases, there's been something to say when somebody can ask the question: How has this affected a potential purchaser or seller in the market for the relevant securities? And here there's nothing to say." For his part, Justice Scalia appeared willing to go even further, noting that the "purpose of the securities laws was to protect the purchasers and sellers of the covered securities. There is no purchaser  or seller of a covered security involved here." Ultimately, counsel for the petitioners argued that the "in connection with" standard is satisfied "when there is a misrepresentation and a false promise to purchase covered securities for the benefit of the plaintiffs."
The government argued in favor of the petitioners' position, but also ran into stiff questioning, When the government suggested that Justice Kagan's "market effect" test was satisfied because the Stanford scheme would make investors less likely to trust the financial markets, Justice Kennedy responded that this argument was the equivalent of saying "if you went to church and heard a sermon that there are lots of people that are evil, maybe then you wouldn't invest."
Counsel for the respondents argued that the alleged scheme did not involve purchasing covered securities for the benefit of the plaintiffs. The seller of the C.D.'s "was only buying [covered securities] for itself. It did not pledge to sell the assets. It did not give the plaintiffs any interest in them." Moreover, what the Court's precedents "have said over and over and over and what has been the dividing line that has prevented 10(b)(5) from swallowing all fraud is these are misrepresentations that affect the regulated market negatively. This fraud did not do that."
September 27, 2013
That Word Does Not Mean What You Think It Means
In its Tellabs decision, the U.S. Supreme Court held that a court must assess a plaintiff's scienter (i.e., fraudulent intent) allegations "holistically" in determining whether the plaintiff has met the requisite "strong inference" pleading standard. The 10b-5 Daily noted at the time of the Tellabs decision that this holding "would appear to alter the evaluation of scienter in the Second Circuit and Third Circuit, both of which have held that a court can examine allegations of motive or knowledge/recklessness separately." The Second Circuit has failed to address this inconsistency, however, leading to decisions that are arguably at odds with binding precedent.
In In re Gentiva Sec. Litig., 2013 WL 5291297 (E.D.N.Y. Sept. 19, 2013), the court addressed allegations that the company violated Medicare rules and artificially inflated the Medicare payments it received. In its first motion to dismiss decision, the court found that the plaintiffs had failed to adequately plead either motive and opportunity to commit fraud or sufficient circumstantial evidence of conscious misbehavior.
As to the amended complaint, the court again concluded that there were insufficient allegations to establish that the "Individual Defendants knew or had access to information showing that Gentiva was pressuring its staff to provide as many therapy visits as possible to receive extra Medicare payments without consideration of patients' needs." On the issue of motive, however, the court found that two of the individual defendants had exercised stock options and sold a significant amount of shares during the class period. It also found that corporate scienter could be "inferred from the 'suspicious' insider stock sales." Accordingly, the court denied the motion to dismiss "to the extent the Plaintiff seeks to establish scienter of the Defendants Malone, Potapchuk, and Gentiva based on a theory of 'motive and opportunity.'"
What does it mean to "holistically" examine the complaint's scienter allegations if they are divided into two categories? The court offers no explanation, but the responsibility ultimately lies with the Second Circuit, which needs to address this question.
Holding: Motion to dismiss denied, with the court curiously stating the plaintiff would "not be permitted to present . . . at trial" a theory of scienter based on circumstantial evidence of misbehavior or recklessness.
September 13, 2013
Securities litigation is at the top of the Supreme Court's docket this fall. On October 7, the first day of the term, the Court will hear three cases - Chadbourne & Parke v. Troice, Proskauer Rose v. Troice, and Willis v. Troice - that have been consolidated for one hour of argument. The topic is the scope of the Securities Litigation Uniform Standards Act ("SLUSA").
SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities. In the three related cases, the Fifth Circuit held that the "best articulation of the 'coincide' requirement" is that the fraud allegations must be "more than tangentially related to (real or purported) transactions in covered securities." The Fifth Circuit then concluded that the relationship between the alleged fraud, which centered around the sale of certificates of deposit, and any transactions in covered securities was too attenuated to trigger SLUSA preclusion. The defendants successfully moved for certification on the grounds that the Fifth Circuit's "more than tangentially related" standard was in conflict with the standards articulated by other circuits.
The ABA Preview of Supreme Court Cases has all of the briefs, which include amicus briefs from the United States (petitioners), DRI - the Voice of the Defense Bar (petitioners), Occupy the SEC (respondents), and Sixteen Law Professors (respondents). A preview article in The National Law Journal (Sept. 4 issue - subscrip. req'd) focuses on the perceived threat to law firms and other third parties arising from the Fifth Circuit's decision to allow the state law claims to proceed.
Interestingly, both sides will be represented by prominent Supreme Court advocates: former solicitor general Paul Clement for the defendants (petitioners) and Tom Goldstein for the plaintiffs (respondents).
August 30, 2013
Two recent settlements of note:
(1) Diamond Foods, Inc. (NASDAQ: DMND), a packaged foods provider, has announced the preliminary settlement of the securities class action pending against the company in the N.D. of California. The case originally was filed in 2012 and relates to a scandal that involved the improper accounting of payments to walnut farmers. The 10b-5 Daily recently posted about the class certification decision in the case.
The settlement is valued at $96 million, including $11 million in cash (largely from the company's insurers) and 4.45 million shares of common stock. The company has the option "to privately place, or conduct a public offering of, the shares with the consent of the lead plaintiff and its counsel, prior to distribution of the Settlement Fund" and contribute the proceeds to the settlement in lieu of the shares.
(2) The Blackstone Group, L.P. (NYSE: BX), an investment banking company, has entered into a preliminary settlement of the securities class action pending against the company in the S.D. of New York. The case originally was filed in 2008 and relates to the company's alleged failure to properly disclose the value of certain investments as part of its initial public offering. In 2011, The 10b-5 Daily posted about the Second Circuit's reversal of the dismissal of the case.
The settlement is for $85 million. According to press reports, the case was scheduled to go to trial next month.
August 23, 2013
Staying On Track
Under the PSLRA's safe harbor for forward-looking statements, such statements cannot form the basis for securities fraud liability unless (a) the statements were not accompanied by "meaningful cautionary statements" and (b) the defendants had "actual knowledge" of their falsity. A company's forward-looking statements, however, often contain some reference to present facts. Does that make these statements ineligible for the safe harbor?
In IBEW Local 98 Pension Fund v. Best Buy Co., Inc., 2013 WL 3982629 (D. Minn. Aug. 5, 2013), the court considered this question in evaluating whether the company's statements that it was "on track to deliver and exceed our annual EPS guidance" and that its earnings were "essentially in line" with expectations were forward-looking. Although the defendants argued that these statements were simply affirmations of the projected guidance, and therefore forward-looking, the court concluded that they really were statements of present condition. Accordingly, the statements were not subject to the safe harbor.
Holding: Motion to dismiss granted in part and denied in part.
August 16, 2013
It's A Question Of Ethics
Are a company's ethical guidelines material (i.e., important to the investment decision of a reasonable investor)? In Cement & Concrete Workers District Council Pension Fund v. Hewlett Packard Co., 2013 WL 4082011 (N.D. Cal. Aug. 9, 2013), the plaintiffs alleged that the CEO's undisclosed relationship with an independent consultant (which lead to his firing and a significant stock price drop) caused the company's ethical guidelines to be misleading "because in light of [the CEO's] endorsement of these tenets, there was an implication that [he] was in fact in compliance with them." In addition, the company's public filings contained a disclosure about the risk to HP's operations associated with the need to retain key executives, which the plaintiffs claimed was rendered misleading by the omission of the CEO's "actual, fraudulent, and noncompliant business practices."
The court concluded that both sets of statements were immaterial. As to the ethical guidelines, the court found that they were "not specific, nor do they suggest that [the CEO] was in compliance with them at the time they were published." Indeed, no reasonable investor would "depend on [them] as a guarantee that [HP] would never take a step that might adversely affect its reputation." Similarly, the plaintiffs' argument that the risk factor about executive retention was material improperly conflated "the materiality of statements concerning whether [the CEO] would, in fact, remain at HP with the materiality of vague and routine statements concerning the retention of executives in general."
Holding: Motion to dismiss granted (without prejudice).