July 25, 2014
In its recent Chadbourne decision, the U.S. Supreme Court held that to be "in connection with" the purchase or sale of a security, an alleged securities fraud must involve "victims who took, who tried to take, who divested themselves of, who tried to divest themselves of, or who maintaned an ownership interest in financial instruments that fall within the relevant statutory definition." Whether that requirement is met, of course, depends heavily on the particular facts at issue.
In Hidalgo-Velez v. San Juan Asset Management, Inc., 2014 WL 3360698 (1st Cir. July 9, 2014) the court addressed whether SLUSA preemption, which applies only to cases involving the purchase or sale of securities traded on a national exchange ("covered securities"), could be invoked if the plaintiffs were investors in a fund that promised to invest at least 75% of its assets "in certain specialized notes offering exposure to North American and European bond indices." As a threshold matter, the fund shares were not covered securities. The court found, however, that "the analysis does not invariably end there." To the extent that "the primary intent or effect of purchasing an uncovered security is to take an ownership interest in a covered security," the "in connection with" requirement could still be met.
The court held that in analyzing this issue, the "relevant questions include (but are not limited to) what the fund represents its primary purpose to be in soliciting investors and whether covered securities predominate in the promised mix of investments." In the instant case, it was clear the fund was marketed "principally as a vehicle for exposure to uncovered securities" (i.e., the specialized notes). Accordingly, the "in connection with" requirement was not met and SLUSA preemption did not apply.
Holding: Judgment of dismissal vacated, reversal of order denying remand, and remittal of case with instructions to return it to state court.
Quote of note: "As pleaded, the plaintiffs' case depends on averments that, in substance, the defendants made misrepresentations about uncovered securities (namely, those investments that were supposed to satisfy the 75% promise); that the plaintiffs purchased uncovered securities (shares in the Fund) based on those misrepresentations; and that their primary purpose in doing so was to acquire an interest in uncovered securities. Seen in this light, the connection between the misrepresentations alleged and any covered securities in the Fund's portfolio is too tangential to justify bringing the SLUSA into play."
July 18, 2014
In Spitzberg v. Houston American Energy Corp., 2014 WL 3442515 (5th Cir. July 15, 2014), the Fifth Circuit reversed the dismissal of a securities class action based on alleged false statements concerning oil and gas reserves. The decision contains a few interesting holdings.
(1) Scienter - The district court found, among other things, that the company's decision to spend $5 million on more testing of one of its wells "would not make sense" if the defendants had believed that no oil or gas would be found. The Fifth Circuit noted, however, that this testing took place after the company had been "heavily criticized" for making optimistic statements regarding its reserves. Accordingly, it was just as plausible that the defendants "may have felt the need to substantiate the allegedly irresponsible statements they had made previously."
(2) Loss Causation - The district court held that the complaint "warranted dismissal because it did not allege specifically whether the alleged misstatements or omissions were the actual cause of [the plaintiffs'] economic loss as opposed to other explanations, e.g., changed economic circumstances or investor expectations or industry-specific facts." The Fifth Circuit disagreed with this pleading standard. Instead, the court concluded that "the PSLRA does not obligate a plaintiff to deny affirmatively that other facts affected the stock price in order to defeat a motion to dismiss."
(3) Forward-looking Statements - The Fifth Circuit joined "the First Circuit, Third Circuit, and Seventh Circuit in concluding that a mixed present/future statement is not entitled to the [PSLRA safe harbor for forward-looking statements] with respect to the part of the statement that refers to the present." In particular, while the company's statements concerning the commercial productability of its wells were forward-looking, to the extent that its statements about "reserves" communicated information on past testing of the wells, those statements were actionable.
Holding: Reversed and remanded for further proceedings.
July 11, 2014
Securities class actions brought against China-based companies often allege discrepancies between the company's Chinese regulatory filings and SEC filings. In that type of case, the plaintiff must allege at least some facts to support that (1) the SEC figures, and not the Chinese figures, are false, and (2) any variation is not attributable to variations in reporting rules or accounting standards.
In In re Silvercorp Metals, Inc. Sec. Lit., 2014 WL 2839440 (S.D.N.Y. June 23, 2014), the court addressed allegations that Silvercorp materially misrepresented three important metrics at its key Chinese mine. As alleged in the complaint, "the metrics reported in the SEC filings were dramatically different from those filed with Chinese authorities under the well-developed legal and regulatory regimes established by the Chiese central government and by Henan province, which are strictly implemented." The defendants argued that the plaintiffs were comparing "apples and oranges" because the Chinese filing covered only part of the mine's output.
The court disagreed, finding that whether the Chinese filing "is apple, orange, or lychee, plaintiffs have adequately pleaded that it uses the same denominator as the SEC filings, i.e., the whole of the [Chinese] mine." Indeed, "the Court may not prematurely determine the truth of plaintiffs' allegation that the comparison is proper, though it expects to be aided by affidavits from dueling experts in Chinese mining law if summary judgment is sought."
Holding: Motion to dismiss denied as to corporate defendant.
June 23, 2014
The U.S. Supreme Court has issued a decision in the Halliburton case holding that defendants can rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence of a lack of stock price impact. It is a 9-0 decision authored by Chief Justice Roberts, although Justice Thomas (joined by Justices Alito and Scalia) concurred only in the judgment. As discussed in a February 2010 post on this blog, Halliburton has a long history that now includes two Supreme Court decisions on class certification issues. A summary of the earlier Supreme Court decision can be found here.
Under the fraud-on-the-market presumption, reliance by investors on a misrepresentation is presumed if the misrepresentation is material and the company's shares were traded on an efficient market that would have incorporated the information into the stock price. 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.
The fraud-on-the-market presumption, however, is not part of the federal securities laws. It was judicially created by the Supreme Court in a 1988 decision (Basic v. Levinson). In Halliburton, the Court agreed to revisit that decision, but ultimately decided that there was an insufficient "special justification" for overturning its own precedent.
The Court rejected the following key arguments. First, Halliburton argued that the fraud-on-the-market presumption was no longer tenable because (a) there is substantial empirical evidence that capital markets are not fundamentally efficient, and (b) investors do not always invest in reliance on the integrity of a stock's price. The Court found, however, that the Basic decision was not undermined by either of these arguments because it was based "on the fairly modest premise that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices." Accordingly, "[d]ebates about the precise degree to which stock prices accurately reflect public information are . . . largely beside the point" and it is sufficient that most investors do rely, either directly or indirectly, on the accuracy of stock prices.
Second, Halliburton argued that the fraud-on-the-market presumption could not be reconciled with more recent Court decisions making it clear that plaintiffs must prove that their proposed class meets all of the certification requirements imposed by the Federal Rules of Civil Procedure. The Court disagreed, noting that plaintiffs who invoke the fraud-on-the-market presumption must still prove certain prerequisites for that presumption - publicity, market efficiency, and market timing - before class certification.
Finally, Halliburton argued that the fraud-on-the-market presumption, by facilitating securities class actions, "allow[s] plaintiffs to extort large settlements from defendants from meritless claims; punish innocent shareholders, who end up having to pay settlements and judgments; impose excessive costs on businesses; and consume a disproportionately large share of judicial resources." The Court found that these "concerns are more appropriately addressed to Congress, which has in fact responded, to some extent, to many of the issues raised by Halliburton and its amici." Moreover, the fact that Congress "may overturn or modify any aspect of our interpretations of the reliance requirement, including the Basic presumption itself" supports the notion that the principle of stare decisis should be applied to the Basic decision.
Although the Court was unwilling to overturn Basic, it did agree with Halliburton that defendants should be able to rebut the fraud-on-the-market presumption with evidence that the alleged misrepresentation did not actually affect the stock price. Notably, price impact evidence is already used at the class certification stage "for the purpose of countering a plaintiff's showing of market efficiency" by establishing that the stock price did not react to publicly reported events. If it can be used to rebut this prerequisite for the fraud-on-the-market presumption (which is nothing more than "an indirect showing of price impact"), the Court found that it also should be available to directly rebut the presumption as to the specific misrepresentation.
Holding: Vacated judgment and remanded for further proceedings consistent with opinion.
Notes on the Decision:
(1) There are two concurrences, which go in radically opposite directions. A concurrence authored by Justice Ginsburg (joined by Justices Breyer and Sotomayor) simply states that she joins the opinion because she understands that it "should impose no heavy toll on securities-fraud plaintiffs with tenable claims." In contrast, Justice Thomas (joined by Justices Scalia and Alito) concurs only in the judgment and forcefully argues that the Basic decision should be overturned, noting that "[t]ime and experience have pointed up the error of that decision, making it all too clear that the Court's attempt to revise securities law to fit the alleged new realities of financial markets should have been left to Congress."
(2) Missing from the fray is Justice Kennedy, who joined Justice Thomas' dissent in the recent Amgen decision. In that dissent, Justice Thomas expressed skepticism about the continued vitality of the fraud-on-the-market presumption. A number of commentators therefore assumed that Justice Kennedy was interested in overturning the Basic decision. Apparently not.
Disclosure: The author of The 10b-5 Daily submitted an amicus brief on behalf of the Washington Legal Foundation in support of petitioner. The amicus brief primarily argued that the Court should permit defendants to rebut the fraud-on-the-market presumption with price impact evidence.
June 11, 2014
What Happens in the Carpool Does Not Stay in the Carpool
A complaint that includes damaging statements from a confidential witness who used to carpool with the company's CEO and CFO seems like it should survive a motion to dismiss, but it may depend on how the plaintiffs frame the allegations. In In re Maxwell Technologies, Inc. Sec. Litig., 2014 WL 1796694 (S.D. Cal. May 5, 2014), the plaintiffs alleged that the company and its senior officers had engaged in a scheme to fraudulently recognize revenue. The court's decision addressed a couple of interesting pleading issues.
(1) Corporate scienter - The requirements for corporate scienter continue to be an open question in the Ninth Circuit. The court found while a corporation can be held responsible for the actions of its executives, corporate scienter cannot be "based only upon the scienter of a non-defendant who did not make or certify the statements at issue." Accordingly, the plaintiffs needed to demonstrate that one of the named defendants (the CEO and CFO) had acted with scienter.
(2) Confidential witnesses - The plaintiffs based their scienter allegations largely on statements from confidential witnesses. These witnesses included a senior director for global sales and marketing who (a) was fired for having a role in the revenue recognition issues, and (b) used to carpool with the CEO and CFO and reportedly heard them talking about taking certain actions necessary to "make the numbers." The court, however, took issue with how the confidential witness statements were plead, noting that it was often difficult to determine what the witnesses had actually said as opposed to the plaintiffs' characterizations of those statements. With respect to the carpooling senior director, the statements "certainly indicate that CW4 may have heard or seen something from which this Court could infer scienter . . . but many of the statements about the role of [the CEO and CFO] are conclusory and without foundation."
Holding: Dismissed without prejudice based on the failure to sufficiently allege scienter.
May 20, 2014
In 2003, America Online (AOL) investors brought a securities class action alleging that Credit Suisse First Boston (CSFB) fraudulently withheld relevant information from the market in its reporting on the AOL-Time Warner merger. After many years of litigation, the D. of Mass. granted summary judgment to CSFB, finding that the plaintiffs had failed to raise a triable issue of fact as to loss causation.
The key basis for the district court's decision was its rejection of the plaintiffs' expert study. In particular, the district court found that the study improperly (a) cherry-picked days with unusual stock price volatility, (b) overused dummy variables to make it appear that AOL's stock price was particularly volatile on the days CSFB issued its reports, (c) attributed "volatility in AOL's stock price to the reports of defendants analysts when, at the time of the inflation or deflation, an efficient market would have already priced in the reports," and (d) failed to conduct "an intra-day trading analysis for each event day with confounding information (which is, to say, nearly all of them) in order to provide the jury with some basis for discerning the cause of the stock price fluctuation."
On appeal, the First Circuit affirmed the exclusion of the expert testimony and the grant of summary judgment. See Bricklayers and Trowel Trades Int'l Pension Fund v. Credit Suisse Securities (USA) LLC, 2014 WL 1910961 (1st Cir. May 14, 2014). The appellate court disagreed that the expert's use of dummy variables was "inconsistent with the methodology or goals of a regression analysis" and concluded that it was a "dispute that should be resolved by the jury." However, the other three deficiencies identified by the district court were "more than sufficient" to find that the district court had not abused its discretion.
The plaintiffs argued that affirming the district court's decision was inappropriate because it was uncontested that 5 of the event days identified by the expert as having "statistically significant abnormal returns" (out of a total of 57 days) "did not suffer from any methodological infirmities." While the appellate court conceded that it could be an abuse of discretion to reject "mostly salvageable expert testimony for narrow flaws," in this case it "confront[ed] the reverse situation - pervasive problems with [the expert's] event study that, allegedly, still leave a few dates unaffected." Under these circumstances, the district court properly treated the entire event study as inadmissible.
Holding: Affirming exclusion of expert testimony and grant of summary judgment to defendants.
Quote of note: "Requiring judges to sort through all inadmissible testimony in order to save the remaining portions, however small, would effectively shift the burden of proof and reward experts who fill their testimony with as much borderline material as possible. We decline to overturn the district court's ruling on this specious logic."
May 9, 2014
Keeping It Domestic
In its Morrison decision, the U.S. Supreme Court held that Section 10(b) (the primary federal anti-securities fraud statute) only provides a private cause of action for claims based on " transactions in securities listed on domestic exchanges, and  domestic transactions in other securities." A number of subsequent lower court decisions have explored the scope of those two categories, with most of the decisions taking the view that they should be strictly construed to limit Section 10(b) claims to transactions that take place within the United States.
In the UBS securities litigation, for example, the court dismissed two sets of claims that Morrison arguably precluded. First, the court held that claims asserted by foreign plaintiffs who purchased UBS stock on a foreign exchange ("foreign-cubed claims") were barred even though UBS common stock is cross-listed on the New York Stock Exchange. Second, the court held that claims asserted by U.S. investors who purchased UBS stock on a foreign exchange ("foreign-squared claims") were barred even though the orders were placed from the United States.
On appeal, in a case of first impression at the appellate level, the Second Circuit has affirmed that decision. In City of Pontiac Policeman's and Firemen's Retirement System v. UBS AG, 2014 WL 1778041 (2d Cir. May 6, 2014), the court found that the plaintiffs' listing theory "is irreconciliable with Morrison read as a whole," in which the court "makes clear that the focus of both prongs was domestic transactions of any kind, with the domestic listing acting as a proxy for a domestic transaction." In addition, the Second Circuit test for whether a transaction is domestic is if "the parties incur irrevocable liability to carry our the transaction within the United States or when title is passed the United States." The fact that the purchaser is a U.S. entity or placed the order in the U.S. does not establish that it has met this test.
Holding: Dismissal of "foreign-cubed" and "foreign-squared" claims affirmed.
April 25, 2014
As the securities litigation bar awaits the fate of the fraud-on-the-market theory, an interesting federal district court decision highlights a fact pattern that did not allow for any possible presumption of classwide reliance. In Goodman v. Genworth Financial Wealth Mangement, 2014 WWL 1452048 (E.D.N.Y. April 15, 2014), a group of investors alleged that Genworth made misrepresentations related to the management of their securities portfolios. The court, as part of its class certification analysis, examined whether the investors could demonstrate a common method of proving reliance and concluded that they could not meet that burden.
First, the plaintiffs conceded the inapplicability of the fraud-on-the-market presumption of reliance because they could "identify no efficient market or market price for the particular securities in which the putative class invested."
Second, under Affiliated Ute, there is a presumption of reliance for securities fraud claims "involving primarily a failure to disclose" by one with a duty to disclose. If the withheld facts are material, then individual reliance need not be proven. Because the plaintiffs pointed to various written statements from Genworth about how the portfolios were managed, however, the court concluded that that any "omissions" were only "significant because they contradicted the affirmative misrepresentations." Under these circumstances, the claims could not be described as "primarily" concerning omissions.
Finally, the plaintiffs argued (based on a line of Second Circuit decisions in non-securities fraud cases) that they could prove classwide reliance based on circumstantial evidence. In particular, the plaintiffs cited the conclusion of their expert - a former SEC chairman - that the investors would have relied on the alleged misrepresentations. The court declined to decide whether circumstantial evidence is an acceptable method of common proof in securities fraud cases. Even if it were, however, the court found that the expert opinion merely established that the alleged misrepresentations were material, not that it was reasonable to conclude that every investor actually relied upon them.
Holding: Class certification denied.
April 23, 2014
All The CLE You Could Possibly Want
It is not too late to sign up for PLI's Handling a Securities Case 2014: From Investigation to Trial and Everything in Between. The program takes place on Thursday, April 24 in New York and via webcast (and, shortly thereafter, on demand). The details can be found here.
Lyle Roberts of Cooley LLP (the author of The 10b-5 Daily) is co-chairing the program. The outstanding faculty will cover a wide range of topics, all while following a hypothetical case from the initial investigation through trial. There even will be a panel on ethical issues, for those in need of ethics credits.
April 11, 2014
Cornerstone Releases Report On Settlements
(1) There were 67 settlements last year, a 17.5% increase from 2012. The report concludes that the increase is likely due to the settling of “credit crisis” cases.
(2) The average settlement value was $71.3 million (significantly higher than historical levels), but the median settlement value was $6.5 million (significantly lower than historical levels). The discrepancy can be explained by the presence of six settlements over $100 million, which increased the average settlement value even as the size of more typical settlements declined.
(3) Overall, 50% of cases since 1996 (post-PSLRA) have settled for between $3.6 million and $20.6 million.
(4) In 2013, the median time to settlement from filing was 3.2 years.
Quote of Note (press release): "This past year’s data also represent the fading echoes of the financial crisis, as some of the largest settlements resolve claims of fraud surrounding transactions in mortgage-backed securities. These lawsuits won’t be around in the coming years to drive aggregate settlement values.”