The 10b-5 Daily

Catching Up With Morrison

The Morrison decision limiting the extraterritorial application of the U.S. securities laws continues to be the subject of extensive judicial, practicioner, and academic commentary. Recent items include:

(1) Professor Hannah Buxbaum has published a paper entitled "Remedies for Foreign Investors Under U.S. Federal Securities Law," in which she discusses Morrison's transaction-based test and explores the possibility of foreign investors suing under U.S. law or participating in the SEC's Fair Funds program.

(2) The American Lawyer describes Morrison as "The Global Securities Case of the Decade (So Far)" (Jan. 20 - subscrip. req'd). The article summarizes the widespread impact of Morrison to date and notes that seven Morrison-related cases are currently on appeal in the Second Circuit alone.

(3) NERA has issued a report, in response to an SEC comment request, on "Cross-Border Shareholder Class Actions Before and After Morrison" (Dec. 2011). The authors conclude that by "reducing expected litigation costs, Morrison eases a deterrent to US listing by foreign issuers and thereby makes the US a more competitive venue for cross-listings, as well as for the volume in cross-listed stocks."

(4) The Harvard Law School Forum on Corporate Governance and Financial Regulation has a post entitled "A New Playbook for Global Securities Litigation and Regulation." The author discusses the rise of alternative forums to the U.S. for global securities litigation.

(5) A Reuters article (Feb. 1) discusses a recent decision in the Vivendi securities litigation confirming that Morrison applies to claims under both the Securities Exchange Act of 1934 (market activity) and the Securities Act of 1933 (offering and sale of securities).

The Little Birdy Sings A Different Tune

The use (and sometimes abuse) of confidential witnesses in securities cases is a contentious issue. Prior to full discovery, what remedy does the defendant have if a confidential witness was misquoted in the complaint? One possibility, recently approved by the Second Circuit, is to allow the witness to be deposed prior to the filing of a motion to dismiss. A recent decision from the D. of Minn. suggests another possible tactic, although the defendants were ultimately unsuccessful.

In Minneapolis Firefighters Relief Assoc. v. Medtronic, Inc., 2011 WL 6962826 (D. Minn. Dec. 12, 2011), the court considered the issue of class certification prior to the completion of discovery. In opposition to certification, the defendants argued that the plaintiffs could not adequately represent the class "because of alleged misrepresentations counsel made in the Amended Complaint regarding the testimony of the confidential witnesses." The defendants presented the court with declarations from thirteen of the fifteen confidential witnesses cited in the complaint. In their declarations, the witnesses took issue with how they were quoted, ranging from complaints about the plaintiffs' interpretation of their statements to an assertion by one witness that the statements attributed to him were "fabrications."

The court found that "the inquiry Defendants urge the Court to undertake - whether Plaintiffs misrepresented what the confidential witnesses said - is premature." In particular, the court noted that "[c]ounsel-drafted declarations are not a substitute for deposition testimony" and it declined to come to any conclusion about the conduct of plaintiffs' counsel until discovery was complete. The court therefore found that the plaintiffs were adequate class representatives and granted class certification.

Compare and Contrast

NERA Economic Consulting and Cornerstone Research (in conjunction with the Stanford Securities Class Action Clearinghouse) have released their 2011 annual reports on securities class action filings.

The findings for 2011 include:

(1) Cornerstone finds that there were 188 filings (compared with 176 filings in 2010), while NERA finds that there were 232 filings (compared with 241 filings in 2010). (For some insight on why NERA has a larger total, see footnote 2 of the NERA report, which discusses its counting methodology. Also, NERA's report came out in December, requiring it to use a projected number for December's total filings.) Both reports agree that cases against listed Chinese companies and M&A; cases have driven a significant portion of the filing activity. Meanwhile, credit crisis cases have dwindled (Cornerstone - 3 filings; NERA - 11 filings).

(2) Cornerstone has an interesting new analysis on the probability of a securities class action advancing through different stages of litigation. The analysis, using filings from 1996 to 2011, finds that prior to the filing of a motion to dismiss, 9% of cases were voluntarily dismissed and 16% were settled. Of the remaining 75% of cases, 32% were dismissed, 35% were settled, and 8% reached a ruling on summary judgment or beyond. The report also breaks down these numbers by circuit and year.

(3) NERA provides some settlement statistics and finds that, even excluding large settlement outliers, there was a substantial decline in average settlement values -- from $40 million in 2010 to $31 million in 2011. The median settlement value was $8.7 million, which was less than the 2010 all-time median settlement value of $11 million, but still the third highest on record.

The NERA report can be found here. The Cornerstone/Stanford report can be found here.

Ample Assistance

A few months ago, this blog noted an unusual lead plaintiff decision. A S.D.N.Y. court dismissed the lead plaintiff from a securities class action brought against Smith Barney Fund Management and Citigroup Global Markets because, after six years of litigation, it was revealed that the entity had not actually purchased the securities at issue. So what happened to the case?

All is revealed in the court's most recent order (In re Smith Barney Transfer Agent Litig., 2011 WL 6318988 (S.D.N.Y. Dec. 15, 2011)), along with some new twists and turns. The court decided to reopen the lead plaintiff selection process. The applicants included a new proposed lead plaintiff group associated with the former lead counsel for the case, as well as one of the unsucessful lead plaintiff applicants from back in 2005. As a group, the applicants associated with the former lead counsel had the largest financial interest in the relief sought. The court found, however, that "[p]laintiffs who moved for lead plaintiff appointment within sixty days of the original notice are entitled to priority over plaintiffs who only moved within sixty days of the order dismissing the prior lead plaintiff." Accordingly, the court selected the original applicant to handle the case.

Quote of note: "In appointing new lead counsel, this Court is mindful that [former lead counsel] served . . . for over six years. But it is investors - and not their lawyers - who are the focus under the PSLRA. And the Court would not have been confronted with this situation if [former lead counsel] had investigated their client's holdings in 2005. In any event, this Court has every confidence that [former lead counsel] will provide ample assistance to new lead counsel consistent with their professional responsibilities to their clients and their obligations as officers of the Court."

Improper Use

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 grapple with this issue in evaluating the existence of scienter (i.e., fraudulent intent) in securities fraud cases.

(1) In In re Novatel Wireless Sec. Litig,, 2011 WL 5873113 (S.D. Cal. Nov. 23, 2011), the court reviewed insider trading claims brought as a part of a securities class action. Defendants argued that several of the challenged trades were inactionable because they had been made pursuant to Rule 10b5-1 trading plans. The court noted, however, that "each defendant entered new or amended 10b5-1 plans . . . that contained accelerator clauses that called for immediate sales." Because the "improper use of 10b5-1 trading is evidence of scienter," the court found that a genuine issue of material fact precluded summary judgment on the insider trading claims.

(2) In The Mannkind Sec. Actions, 2011 WL 6327089 (C.D. Cal. Dec. 16, 2011), the court evaluated whether the plaintiffs had adequately pled motive based on a "suspicious" stock sale by one of the individual defendants. The defendant pointed out that the sale was only 10.5% of his holdings and "was made pursuant to a pre-determined 10b5-1 trading plan, and was identical to another 10b5-1 trading sale made 11 months earlier." The court concluded that the timing of the sale "appears suspicious." The plaintiffs' failure to rebut the contention that the sale had been made pursuant to a Rule 10b5-1 trading plan, however, meant that the sale could not "provide support for Plaintiffs' pleading of scienter."

Where's Waldo?

To what extent can a plaintiff protect the identity of his confidential witnesses once discovery in the case has commenced? Courts have tended to be skeptical of claims that the identity of these witnesses are attorney work product or should be kept secret to avoid possible employer retaliation (see here and here).

In Plumbers and Pipefitters Local Union No. 630 Pension-Annuity Trust Fund v. Arbitron, 2011 WL 5519840 (S.D.N.Y. Nov. 14, 2011), the court addressed these issues in a case where the complaint relied heavily on alleged statements from 11 former Arbitron employees. In discovery, the plaintiffs identified 83 people who were likely to possess discoverable information, but refused to specifically identify the 11 confidential witnesses from among that list. The court concluded that the names of the confidential witnesses were entitled to little, if any, work product protection, noting that "[i]t is difficult to see how syncing up the 11 [confidential witnesses] with these already disclosed names would reveal Plaintiff's counsel's mental impressions, opinions, or trial strategy." Moreover, the plaintiffs had "utilized the [confidential witnesses] offensively" and failing to identify them could require the defendants to take dozens of unnecessary depositions. As for possible retaliation, the court declined to accept any generic assertions that the confidential witnesses faced a risk of retaliation, but did give the plaintiffs' counsel a week to submit an affidavit setting forth any particularized facts it had on that subject.

Holding: Motion to compel disclosure of confidential witness names granted (subject to review of the requested affidavit).

Quote of note: "On the facts before it, the Court, balancing the relevant considerations, does not believe the work product doctrine compels Arbitron (or, derivatively, its shareholders) to bear these costs. The discovery rules 'should be construed and administered to secure the just, speedy, and inexpensive determination of every action and proceeding.' Fed. R. Civ. P. 1. These goals are disserved by forcing a party, in the name of an opponent's evanescent work product interest, to play a high-cost game of 'Where's Waldo?'."

Momentary Forgetfulness

The scope of the Securities Litigation Uniform Standards Act ("SLUSA"), which precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities, continues to be fertile ground for litigation more than 13 years after the legislation's adoption. A persistent issue is to what extent a plaintiff can disclaim that his case is based on an alleged misrepresentation, even if the nature of the case suggests otherwise, and thereby avoid SLUSA preclusion.

In Brown v. Calamos, 2011 WL 5505375 (7th Cir. Nov. 10, 2011), the U.S. Court of Appeals for the Seventh Circuit reviewed a SLUSA dismissal in a case about a fund's issuance of "auction market preferred stock." Although it was a "suit for breach of fiduciary obligation and not securities fraud," the complaint included allegations that the fund had falsely stated the term of the security "was perpetual" and omitted to disclose a material conflict of interest. Judge Posner found that SLUSA preclusion was appropriate under either (a) the Sixth Circuit's "literalist approach," because the complaint could be interpreted as alleging a misrepresentation; or (b) the Third Circuit's "looser approach," because the allegations of the complaint made "it likely that an issue of fraud will arise in the course of the litigation."

Holding: Dismissal affirmed.

Quote of note: "[I]t can be argued that a dismissal with prejudice is too severe a sanction for what might be an irrelevancy added to the complaint out of an anxious desire to leave no stone unturned - a desire that had induced momentary forgetfulness of SLUSA. But a lawyer who files a securities suit should know about SLUSA and ought to be able to control the impulse to embellish his securities suit with a charge of fraud."

Settlement Round-Up

As the 2011 fiscal year comes to a close, there have been a series of settlement announcements. Some of the more significant are:

(1) Arthrocare Corp. (NADAQ: ARTC), an Austin-based corporation that develops and manufactures surgical devices, instruments and implants, has announced the preliminary settlement of the securities class action pending against the company in the W.D. of Texas. The case, originally filed in 2008, stems from allegations that Arthrocare and certain of its officers and directors issued materially false financial statements. The settlement is for $74 million. Reuters has an article on the settlement.

(2) Wachovia Corporation, a financial services company now wholly owned by Wells Fargo & Co. (NYSE: WFC), has agreed to settle the securities class action pending against the company in the S.D. of New York. The case, originally filed in 2008, stems from allegations that Wachovia misled its equity investors about its underwriting practices and the quality of its mortgage portfolio. Interestingly, the district court had dismissed the settled claims, although the case was on appeal. The settlement is for $75 million. Reuters has an article on the settlement.

(3) Apollo Group, Inc. (NASDAQ: APOL), a Phoenix-based provider of private education, has agreed to settle the securities class action pending against the company in the D. of Arizona. The case, originally filed in 2004, stems from allegations that Apollo and certain of its officers failed to disclose that the company's financial results were materially inflated by the improper practice of tying recruiter's compensation directly to enrollments. The settlement is for $145 million. The case has a long history, including a jury verdict for the plaintiffs, a post-trial reversal, the reinstatement of the jury verdict on appeal, and the denial of defendants' cert petition.

(4) Over forty underwriters have agreed to settle the securities class action pending against them and against Lehman Brothers Holding, Inc., a now-defunct financial services firm, in the S.D. of New York. The case, originally filed in 2008, stems from allegations that, prior to Lehman’s June 9, 2008 disclosure of a $2.8 billion second quarter loss, the company misled investors about its financial health. The complaint alleged that the underwriters contributed to the fraud by failing to investigate the truth of statements made by Lehman in financial statements and securities offerings. The settlement with the underwriters is for $417 million. Lehman's former directors had previously settled for $90 million, bringing the total settlement amount to $507 million. Reuters has an article on the settlement.

We're All In This Together

What must a plaintiff do to invoke the fraud-on-the-market theory (pursuant to which reliance by investors on a misrepresentation is presumed if the company's shares were traded on an efficient market) in support of class certification? According to the U.S. Court of Appeals for the Ninth Circuit, nothing more than show (a) the security was traded on an efficient market, and (b) the alleged misrepresentations were public.

In Connecticut Retirement Plans and Trust Funds v. Amgen, Inc., 2011 WL 5341285 (9th Cir. Nov. 8, 2011), the court addressed whether a plaintiff also must prove that the alleged misrepresentations were material. Three circuit courts (First, Second, and Third) previously have held that this is a required part of the fraud-on-the-market analysis when evaluating whether a class should be certified. The Ninth Circuit joined recent decisions from the Third Circuit and Seventh Circuit, however, in rejecting that position. The court held that materiality is a merits question that does not affect whether class certification is appropriate.

Holding: Affirming grant of class certification.

Quote of note: "If the misrepresentations turn out to be material, then the fraud-on-the-market presumption makes the reliance issue common to the class, and class treatment is appropriate. If the misrepresentations turn out to be immaterial, then every plaintiff's claim fails on the merits (materiality being a standalone merits element), and there would be no need for a trial on each plaintiff's individual reliance. Either way, the plaintiffs' claims stand or fall together - the critical question in the Rule 23 inquiry."

Not So Suspicious

The Apollo Group, a large private education provider, has been a magnet for securities litigation. In the most recent securities class action brought against Apollo, investors allege that from May 2007 to October 2010 the company made false and misleading statements about its financial condition, business focus, ethics, compensation and recruitment practices, and compliance with federal student loan regulations. In a recent decision - In re Apollo Group, Inc. Sec. Litig., 2011 WL 5101787 (D. Ariz. Oct. 27, 2011) - the court dismissed the claims. The decision has a few interesting holdings:

(1) Internet Postings - The complaint cited certain anonymous internet postings. The court noted that "the only appreciable difference between anonymous internet postings and confidential witness statements is that anonymous internet postings are less reliable." As a result, "with regard to anonymous internet postings, it is Plaintiffs' burden to plead reliability and knowledge that are indicative of scienter to at least the same extent as it must when pleading scienter with regard to confidential witness statements."

(2) Suspicious Stock Trading - There were nine individual defendants in the case. The plaintiffs alleged that four of those defendants sold Apollo stock during the class period (21%, 15%, 34%, and 26% of their holdings respectively). The court found that these stock sales did not support a strong inference of scienter because (a) they were not "large sales amounts," and (b) there were no "corroborative sales" by the other individual defendants.

(3) SEC Investigation - There is a district court split regarding whether the announcement of an SEC investigation is sufficient to establish loss causation (presuming that the announcement does not otherwise disclose any information about the alleged fraud). In Apollo's case, the relevant press release stated that the SEC was conducting an informal investigation into the company's revenue recognition practices. The court found that this disclosure had a sufficient nexus to the alleged fraud, because it could have signaled to a "reasonable investor that there were improprieties in Apollo's revenue recognition policies."

Holding: Motion to dismiss granted based on failure to adequately plead scienter.