August 13, 2012
The past six months have seen securities class action filings increase slightly, and settlements decline dramatically, as the average settlement amount is reaching historic highs. The Supreme Court will decide two cases in the coming year that will be significant for securities litigation; at the same time, the lower courts are applying last year’s significant Supreme Court decisions in different contexts.
The first half of 2012 has not seen the series of landmark Supreme Court decisions that were handed down in 2011, but it has been a significant period as lower courts apply these decisions in different areas and in a number of different contexts. And the Supreme Court did decide one case–Credit Suisse Securities (USA) LLC v. Simmonds, 132 S. Ct. 1414 (2012)–relating to the statute of limitations under Section 16 of the Securities and Exchange Act of 1934, and granted review in two other cases–Amgen, Inc. v. Connecticut Retirement Plans & Trust Funds and Comcast Corp. v. Behrend–that are likely to result in watershed rulings on the issue of class certification in securities class actions.
Securities litigation filing trends remain generally steady in the face of these developments, with securities class action filings increasing only slightly in the first half of 2012, and the filings against particular sectors staying roughly similar to last year, with filings against financial industry companies at their lowest level since 2008. One particularly noteworthy development is that not a single securities class action filing thus far in 2012 has named an accounting firm as a defendant, possibly as a result of the Supreme Court’s rejection of aiding and abetting liability under the securities laws, emphatically reinforced last year in Janus Capital Group Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2012) (in which Gibson Dunn represented Janus).
Some of the most significant case law and legislative developments in the first half of 2012 are summarized by category below.
According to a study by NERA Economic Consulting issued in July 2012, the number of new class actions filed in federal court in 2011 under the Private Securities Litigation Reform Act of 1995 ("PSLRA") held close to the average number of filings over the last five years (i.e., approximately 221 per year from 2007 through 2011). See Dr. Renzo Comolli, Dr. Ron Miller, Dr. John Montgomery, & Svetlana Starykh, Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review: Settlements Bigger, But Fewer, NERA Economic Consulting (July 24, 2012). The number of filings this year is trending only slightly higher. A total of 116 new cases were filed through June. If securities suits continue to be filed at the same pace through the end of the year, then 2012 will mark a return to the exact number of new cases that were filed in 2010 (i.e., 232). See Figure 1 below (all charts courtesy of NERA Economic Consulting).
Companies in the finance, technology, and health technology sectors continue to be among those that are most frequently targeted in securities class actions. The proportion of suits filed against the finance sector as a percentage of total filings was lower the first half of this year than in any year since 2008. It was far lower than in 2008 and 2009, when nearly one out of two securities class actions targeted a financial-sector company. On the other hand, suits against companies in the fields of electronic technology and technology services, and health technology and services generally have been trending upward, and they are on the rise again this year as a percentage of overall suits.
Accounting firms may be faring best when it comes to new securities action filings. In each year from 2005 through 2009, accounting firms were named as codefendants in more than one out of ten new securities class actions. Claims against them dropped off significantly in 2010, and as of the first half of this year, no new securities class action has named an accounting firm as a codefendant. This trend may stem from the Supreme Court’s repeated rejection of plaintiffs’ efforts to evade the rule that there is no aiding and abetting liability for private securities claims. That rule was bolstered in the Court’s 2008 decision in Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148. The Court emphatically reinforced that rule last year in its landmark ruling in Janus Capital Group Inc. v. First Derivative Traders, 131 S. Ct. 2296, which held that private liability under Rule 10b-5 extends only to the "maker of a statement"–that is, "the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it." Id. at 2302.
Statistical data continues to suggest that a substantial proportion of class action securities complaints are infected with legal deficiencies. Data NERA collected from cases filed and resolved from the period from January 2000 through June 2012 show that defendants filed motions to dismiss in nearly 90% of cases. Of the cases that reached settlement, partial dismissal was granted in more than a third. Wholesale dismissal (with or without prejudice) was granted in nearly 10% of such cases. Thus, at least some claims were determined to be lacking in legal merit, even before discovery, in about 45% of the cases in which motions to dismiss were filed and settlements were ultimately reached. Significantly, these figures do not include cases that concluded without a settlement–such as cases that ended in outright dismissal. If such cases could be accounted for, one would expect to find that the overall proportion of securities suits that are marred by legal defects is yet higher.
NERA’s research reflects that only 30 securities class actions have proceeded to trial since Congress enacted the PSLRA in an effort to curb abusive securities lawsuits. See Dr. Renzo Comolli, et al., Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review, 36. There have been more than 3,909 suits filed. Id.
Settlement rates are slowing. There were 128 and 123 settlements of securities class actions in 2010 and 2011, respectively. This year is on pace for 98 settlements, with 49 cases having settled through June. See Figure 23 below. Of these, only 31 settlements yielded monetary compensation to investors. NERA observed that if this pace continues, this will be a record-setting year: in no year since the enactment of the PSLRA in 1995 have there been so few settlements resulting in monetary recovery for a securities class. See Dr. Renzo Comolli, et al., Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review, 23.
After a dip last year, settlement amounts have returned to the average levels they reached in 2009 and 2010. NERA data shows that the average value of securities class action settlements–excluding mega-settlements exceeding $1 billion, IPO laddering cases, and merger objection cases–was about $42 million in 2009, $41 million in 2010, and $31 million in 2011. The average value of settlements from the same selection of cases was $41 million for the first half of this year. See Figure 25 below. Notably, this figure is approaching the highest level of settlement values since the PSLRA was enacted.
Including the one settlement this year in excess of $1 billion, however, produces a significantly sharper rise in settlement value, bringing the average up to $71 million for the first half of the year.
Securities settlements have continued to provide a very low return to shareholders as a proportion of their alleged "investor losses" (which is a crude number based on the amount of a stock drop and affected shares, and which likely exceeds the amount of damages plaintiffs could recover even if they prevailed on all claims). Settlements in the first half of 2012 arose from cases that involved alleged investor losses that far exceeded the scope of those from any past year, and those settlements recovered a median of only 1.2% of those losses. This percentage is in line with last year’s and below those of prior years. The dip may be explained, however, by the vast scope of investor losses, which tend to correspond to smaller recovery percentages. See Figure 30 below.
Although plaintiffs’ attorneys’ median fees appear to be easing very slightly, their immensity remains astonishing. For the first half of this year, NERA reports that plaintiffs’ attorneys enjoyed a haul of 20% of settlements of $25 million or more.
The Supreme Court began its new term in October 2011 having decided, in the previous term, a number of significant securities cases bearing on primary liability for Section 10(b) violations, the pleading standards for materiality, and class certification. Perhaps unsurprisingly given these decisions, many of the most significant developments in securities litigation for the first half of this year did not occur at the Supreme Court itself, but instead in the lower courts, as they have worked to implement the Court’s decisions–and sometimes disagreed in doing so. These lower court decisions are discussed and analyzed in more detail below.
When the final cases of October Term 2011 were decided in late June 2012, the Supreme Court had decided only a single securities case–Credit Suisse Securities (USA) LLC v. Simmonds, No. 10-1261–and even there was unable to produce a majority opinion on one of the primary issues. But the Court’s limited securities docket this Term does not suggest that the Court has abandoned its previous focus on securities cases. To the contrary, just weeks before the Court left for its summer recess at the end of June, the Justices agreed to review an important case bearing on the standards for certifying securities class actions, as well as another case that, while arising in the antitrust context, appears likely to provide valuable guidance for securities litigation. In addition to summarizing Credit Suisse, therefore, we have also provided detailed summaries of these two cases that are scheduled to be considered after the Justices return to the bench in October 2012, and which we will continue to monitor.
The Supreme Court granted review in Credit Suisse Securities (USA) LLC v. Simmonds, No. 10-1261, to determine when the two-year statute of limitations for recovering "short-swing" profits from corporate insiders under Section 16(b) of the Securities Exchange Act of 1934 begins to run. With the Chief Justice recused, the remaining Justices unanimously agreed that the limitations period begins no later than when the plaintiff should have been aware of the facts underlying the Section 16(b) claim. They divided evenly, however, on whether the period begins even earlier–when the profit was realized–and thus left that issue for a future case.
Under Section 16(b) of the Exchange Act, a corporation or one of its shareholders may sue officers, directors, and certain beneficial owners of the corporation who realize profits from the purchase and sale, or sale and purchase, of the corporation’s securities within a six-month period–so-called "short-swing" profits. Section 16(b) provides that such suits must be brought within "two years after the date such profit was realized." 15 U.S.C. § 78p(b). Separately, Section 16(a) requires these corporate insiders to disclose any changes to their ownership interests in the corporation, see 15 U.S.C. § 78p(a)(2)(C), which is done pursuant to regulations promulgated by the Securities and Exchange Commission, see 17 C.F.R. § 240.16a-3(a).
The plaintiff in Simmonds filed 55 lawsuits in 2007 against financial institutions that had underwritten initial public offerings in the late 1990s and 2000. She alleged that they had inflated the aftermarket price of the stock above the IPO price, and thereby had profited from the aftermarket sale. Although the defendants disputed that they were subject to Section 16 and had not filed any disclosure statements under Section 16(a), the plaintiff maintained that their actions subjected them to both liability under Section 16(b) and the reporting requirements of Section 16(a).
The defendants moved to dismiss the lawsuits, arguing that they were filed more than two years after the alleged short-swing profits at issue. The Ninth Circuit, however, held that the limitations period was tolled because the defendants had not disclosed the relevant transactions under Section 16(a). According to the Ninth Circuit, Section 16(b)’s limitations period is "tolled until the insider discloses his transactions in a Section 16(a) filing, regardless of whether the plaintiff knew or should have known of the conduct at issue." Simmonds v. Credit Suisse Sec. (USA) LLC, 638 F.3d 1072, 1095 (9th Cir. 2011).
The eight participating Justices unanimously rejected the Ninth Circuit’s approach. They noted, as an initial matter, that while the defendants had argued that Section 16(b)’s "limitations period is a period of repose," and thus not subject to equitable tolling, it was unnecessary to "reach that contention" because, "even assuming that the 2-year period can be extended, the Ninth Circuit erred in determining that it is tolled until the filing of a § 16(a) statement." Credit Suisse Sec. (USA) LLC v. Simmonds, 132 S. Ct. 1414, 1419 (2012). "Section 16 itself," the Court emphasized, "quite clearly does not extend the period in that manner." Id. "Congress could have very easily provided that ‘no such suit shall be brought more than two years after the filing of a statement under subsection (a)(2)(C),’" but instead provided that "[t]he 2-year clock starts from ‘the date such profit was realized.’" Id. (quoting 15 U.S.C. § 78p(b)).
The Court explained that, "when a limitations period is tolled because of fraudulent concealment of facts, the tolling ceases when those facts are, or should have been, discovered by the plaintiff." 132 S. Ct. at 1420. "Allowing tolling to continue beyond the point at which a § 16(b) plaintiff is aware, or should have been aware, of the facts underlying the claim," in contrast, "would quite certainly be inequitable and inconsistent with the general purpose of statutes of limitations: ‘to protect defendants against stale or unduly delayed claims.’" Id. (quoting John R. Sand & Gravel Co. v. United States, 552 U.S. 130, 133 (2008)). Thus, "assuming some form of tolling does apply," Section 16(b)’s "limitations period is not tolled until the filing of a § 16(a) statement," but rather expires no later than "two years after a reasonably diligent plaintiff would have learned the facts underlying a § 16(b) action." Id. at 1420-21.
The Supreme Court’s decision not to address whether tolling of any form is permissible leaves the issue open for further litigation. And a statement in the Court’s concluding paragraph explains why: "We are divided 4 to 4 concerning" whether Section 16(b) "establishes a period of repose that is not subject to tolling." 132 S. Ct. at 1421. This 4-to-4 split was possible only because the Chief Justice had recused himself, and the issue will likely remain unsettled by the Court until it is presented in a case where all of the Justices are able to participate.
Given the equal division at the Supreme Court, defendants in Section 16(b) litigation are likely to mount a two-pronged defense based on the limitations period, arguing (where possible) both that the two-year period is not subject to tolling and that, to the extent tolling is permitted, the plaintiff should have known the relevant facts at least two years before bringing suit. Although it may be some time before the Supreme Court provides definitive guidance on this issue, it will be important in the interim to monitor how the lower courts resolve the issue.
Although the Supreme Court decided only one securities case in October Term 2011, it also granted review in two cases for October Term 2012 that could have significant implications for litigating securities class actions. The first of these is Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, No. 11-1085.
In Amgen, the Supreme Court will address two issues bearing on certification of securities class actions based on the fraud-on-the-market presumption endorsed in Basic, Inc. v. Levinson, 485 U.S. 224 (1988). In particular, the case presents the questions whether a district court must require proof of materiality before certifying a plaintiff class based on the fraud-on-the-market presumption, and whether the court must allow the defendant to present evidence rebutting the applicability of the presumption before certifying a class. The Court had noted, but declined to resolve, the latter issue in Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179, 2187 & n.* (2011).
As the Supreme Court has long recognized, "[r]equiring proof of individualized reliance from each member of the proposed plaintiff class effectively would . . . preven[t]" class certification because "individual issues then would have overwhelmed the common ones." Basic, 485 U.S. at 242. As a result, plaintiffs in securities cases are generally required to invoke a presumption of reliance–frequently, the fraud-on-the-market presumption announced in Basic, which presumes reliance on "public material misrepresentations" involving securities traded in an efficient market. Id. at 247.
The Supreme Court emphasized in Halliburton that "securities fraud plaintiffs must prove certain things in order to invoke Basic‘s rebuttable presumption of reliance," including "that the alleged misrepresentations were publicly known . . . , that the stock traded in an efficient market, and that the relevant transaction took place ‘between the time the misrepresentations were made and the time the truth was revealed.’" 131 S. Ct. at 2185 (quoting Basic, 485 U.S. at 248 n.27); see also Dukes, 131 S. Ct. at 2252 n.6 (similar). The lower courts have divided on whether the proponent of class certification must also prove that the alleged misrepresentation was material.
The Ninth Circuit held that securities plaintiffs "need not prove materiality to avail themselves of the fraud-on-the-market presumption of reliance at the class certification stage." Conn. Ret. Plans & Trust Funds v. Amgen Inc., 660 F.3d 1170, 1177 (9th Cir. 2011). Because "materiality is an element of the merits of [a] securities fraud claim," the Ninth Circuit maintained, this "merits issue" should be addressed only "at trial or by summary judgment motion." Id. at 1175, 1177. And because "a plaintiff need not prove materiality at the class certification stage to invoke the presumption," the Ninth Circuit concluded that the defendant is not entitled to introduce evidence rebutting materiality.
In contrast to the Ninth Circuit, the Second and Fifth Circuits have held that a plaintiff must prove materiality to obtain class certification, and that a defendant may present evidence at the certification stage to rebut materiality. See In re Solomon Analyst Metromedia Litig., 544 F.3d 474, 484 (2d Cir. 2008); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261, 265 (5th Cir. 2007), overruled on other grounds by Halliburton, 171 S. Ct. 2179; see also In re DVI Sec. Litig., 639 F.3d 623 (3d Cir. 2011) (holding that while plaintiffs need not prove materiality at the certification stage, defendants may nevertheless rebut the presumption of reliance by proving lack of materiality). The theory of these cases is that materiality is an essential element of the fraud-on-the-market presumption because, under Basic, "an effect on market price is presumed based on the materiality of the information and a well-developed market’s ability to readily incorporate that information into the price of securities." Solomon, 544 F.3d at 483 (emphasis added).
The Amgen case has the potential to be enormously significant for securities class actions. "A district court’s ruling on the certification issue is often the most significant decision rendered in . . . class-action proceedings." Deposit Guar. Nat’l Bank v. Roper, 445 U.S. 326, 339 (1980). It can be the "defining moment in class actions (for it may sound the death knell of the litigation on the part of plaintiffs, or create unwarranted pressure to settle non-meritorious claims on the part of the defendants)." In re Constar Int’l Inc. Sec. Litig., 585 F.3d 774, 780 (3d Cir. 2009); see also, e.g., In re Rhone-Poulenc Rorer, Inc., 51 F.3d 1293, 1298 (7th Cir. 1995) (noting "intense pressure to settle"). This is especially true in securities cases, where the asymmetric costs of discovery permit plaintiffs to impose disproportionate costs on defendants. For this and other reasons, "the vast majority of certified [securities fraud] class actions settle, most soon after certification." Robert G. Bone & David S. Evans, Class Certification and the Substantive Merits, 51 Duke L.J. 1251, 1291 (2002).
By declining to address materiality on the theory that it is a "merits" issue, the Ninth Circuit’s approach limits the ability of securities defendants to resist certification of putative class actions that are perhaps unlikely to succeed on the merits, but which could result in expensive settlements once a class has been certified. And this risk is particularly acute because of the difficulty that securities defendants face in seeking dismissal of putative class actions by challenging the materiality of the alleged false statements. See, e.g., Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1318-19 (2011). In contrast, if the Supreme Court concludes that plaintiffs must establish materiality at the class-certification stage, then securities defendants would have an additional avenue for resisting class certification, particularly in weak cases, and for avoiding the settlement pressures it entails.
Comcast Corp. v. Behrend, No. 11-864 also should provide helpful clarification regarding the scope of a district court’s inquiry at the class-certification stage. The Supreme Court granted review in Behrend to decide whether a district court may certify a class action without resolving whether the proponent of certification has introduced admissible evidence to show that the case is susceptible to a class-wide damages award. Although Behrend is an antitrust case, this same issue may arise in securities cases, and thus the Supreme Court’s decision is likely also to have significant implications for securities litigation.
In Behrend, a putative class of cable television subscribers sued Comcast, alleging that it had monopolized Philadelphia’s cable market and excluded competition in violation of federal antitrust laws. In an attempt to satisfy Rule 23(b)(3)’s requirement that issues susceptible to class-wide proof predominate over those that are not, the plaintiffs proffered an expert damages model that purported to prove each class member’s damages by evidence common to all. This model was premised on two assumptions: that the class members suffered injury by four different means, and that damages were distributed uniformly across the class. The district court rejected the first assumption, however, dismissing three of the plaintiffs’ four theories of injury. And Comcast challenged the second assumption, pointing to numerous differences in the amount of damages that, on the plaintiffs’ theory of injury, would have been suffered by class members.
The district court nonetheless certified the class, and the Third Circuit affirmed after expressly declining to consider Comcast’s challenges to the damages model. While the Third Circuit acknowledged that, "[t]o satisfy . . . the predominance requirement, Plaintiffs must establish that the alleged damages are capable of measurement on a class-wide basis using common proof," Behrend v. Comcast Corp., 655 F.3d 182, 200 (3d Cir. 2011), it nonetheless maintained that "[w]e have not reached the stage of determining on the merits whether the methodology [offered by the plaintiffs] is a just and reasonable inference or speculative," id. at 206. The court insisted that Comcast’s "attacks on the merits of the methodology" have "no place in the class certification inquiry." Id. at 206-07. Judge Jordan dissented in relevant part, concluding that the plaintiffs "failed to show that damages can be proven using evidence common to the class," and indeed "that damages can be proven using any evidence whatsoever–common or otherwise." Id. at 218.
The Supreme Court’s decision to grant review suggests that it will further clarify the appropriate degree of scrutiny into putative class actions at the certification stage, and in particular whether courts may (or must) examine the reliability of expert testimony offered in support of certification. This latter issue arises in securities cases and has deeply divided the lower courts, which have adopted multiple approaches to assessing expert testimony ranging from a full inquiry into reliability and admissibility under Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993), to a more lenient standard that defers meaningful scrutiny of the expert’s methodology until after certification. In addition, as in Amgen, the case presents the Court with the opportunity to clarify once again that courts must resolve even "merits" issues that bear on the class-certification inquiry.
The Supreme Court’s opinion in Behrend should provide useful guidance for lower courts and help to eliminate some of the confusion regarding the proper standards for class certification. For this reason, it is likely to be important not only for antitrust class actions, but also for securities class actions based on expert testimony.
Gibson Dunn represents Comcast before the Supreme Court.
Over the past year, federal circuit courts have addressed the standards for pleading and proving scienter in securities fraud claims on several occasions. The majority of the decisions reflect the exacting nature of the PSLRA’s requirement that plaintiffs "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind."
A little more than a year ago, in Janus Capital Group Inc. v. First Derivative Traders, the Supreme Court held that a person cannot be held primarily liable in a Section 10(b) and Rule 10b-5 private securities action for "making" a misleading statement or omission unless he or she had "ultimate authority" over "its content and whether and how to communicate it." 131 S. Ct. 2296 (2011). The Court concluded that Janus Capital Management, a registered investment adviser, could not be held primarily liable for drafting allegedly misleading prospectuses issued by its mutual-fund client, the Janus Investment Fund. Id. (Gibson Dunn successfully represented Janus in this matter.) Since the Supreme Court’s decision, lower courts have struggled to define the limits of the Janus holding.
One issue courts have struggled over is whether corporations can be held primarily liable for statements made by their subsidiaries. In City of Roseville Employees Retirement System v. EnergySolutions, Inc., for example, the Southern District of New York refused to apply Janus to dismiss Section 10(b) claims against a parent company relating to statements made in its wholly owned subsidiary’s initial public offering registration statement. No. 09 Civ. 8633 (JGK), 2011 WL 4527328, at *16-18 (S.D.N.Y. Sept. 30, 2011). In distinguishing the case from Janus, the court held that in light of the parent company’s sole "ownership" of its subsidiary’s stock, its "direct control over all corporate transactions, and its authority to determine when and whether to sell the shares being sold," a reasonable jury could find that the parent company’s role "went well beyond that of ‘a speechwriter drafting a speech.’" Id. at *18 (quoting Janus, 131 S. Ct. at 2302). To justify its holding, the court relied on language in Janus noting that attribution could be "implicit from surrounding circumstances.’" Id. (quoting Janus, 131 S. Ct. at 2302).
Just two weeks after the EnergySolutions ruling, however, in In re Optimal U.S. Litigation, the Southern District of New York relied on Janus to dismiss Section 10(b) claims against a parent company investment advisor relating to statements made by its wholly owned subsidiary investment fund in explanatory memoranda (fund prospectuses). No. 10 Civ. 4095(SAS), 2011 WL 4908745 (S.D.N.Y. Oct. 14, 2011). The court rejected plaintiffs’ "attempt to avoid Janus," and held that the complaint’s allegations regarding: (1) the parent company’s sole voting share ownership; (2) its power to select the board members of the subsidiary; and (3) the fact that its in-house counsel suggested changes to memoranda that the subsidiary fund adopted, were insufficient to constitute "ultimate authority" by the parent company with respect to the memoranda. Id. The court explained that under Janus, "a statement is ‘made’ not by the entity that drafted it . . . but rather by the entity that delivers it." Id. The court further noted that "Rule 10b-5 liability for a one-hundred percent shareholder of an entity ‘making’ a misleading statement is inappropriate; rather, [S]ection 20(a) is the appropriate source of liability." Id. at *6. The court distinguished its decision from the EnergySolutions decision by explaining that in EnergySolutions, "there were explicit statements in registration statements indicating that the defendant had ‘direct control over all corporate transactions, and . . . authority to determine when and whether to sell the shares being sold.’" Id.
In Fulton County Employees Retirement System v. MGIC Inv. Corp., the Seventh Circuit similarly relied on Janus to affirm the dismissal of Section 10(b) claims against mortgage insurer MGIC relating to statements made during one of its earnings calls by two executives of a company in which MGIC held a 46% stake. 675 F.3d 1047, 1051 (7th Cir. 2012). The court held that MGIC and its managers could not be held primarily liable for the executives’ alleged misstatements where the plaintiff failed to allege that MGIC directed the executives to say what they did, or conditioned the executives’ participation in the call on the executives’ promise to support the MGIC party line. Id. The Seventh Circuit determined that the company’s executives "appear[ed] to have been independent agents, speaking for themselves," and the entity over which they had control. Id. The court also found significant the fact that another mortgage insurer also owned a 46% stake in the company. Id.
District courts have also differed to some extent in determining whether primary liability applies to corporate insiders making statements on behalf of a company. In general, courts have found that corporate officers uttering or signing statements in their own name (such as Sarbanes Oxley certifications) can be held primarily liable under Janus. Where, however, corporate insiders more remotely contribute information to statements ultimately conveyed in the name of the corporation, courts have hesitated to allow primary liability.
In Hawaii Ironworkers Annuity Trust Fund v. Cole, for example, the Northern District of Ohio dismissed Section 10(b) claims against lower-level employees who provided allegedly inflated financial results that were incorporated into the company’s financial statements. No. 10-cv-371, 2011 WL 3862206, at *4-*5 (N.D. Ohio Sept. 1, 2011). The court held that plaintiff failed to state a claim for primary liability under Janus "because the defendants did not have ultimate authority over the content of the statement." Id. at *5. The court relied on allegations in plaintiff’s complaint reflecting that the employees only inflated the results due to management’s "mandatory directive." Id.
In In re Merck & Co. Securities, Derivative, & ERISA Litigation, by contrast, the District of New Jersey refused to dismiss Section 10(b) claims against a Merck executive relating to alleged misstatements made in SEC filings that the executive signed and articles where he was quoted. MDL No. 1658 (SRC), 2011 WL 3444199, at *25-*26 (D.N.J. Aug. 8, 2011). The court rejected the executive’s argument that the statements were made under the "ultimate authority" of the corporation, and held that the "ultimate authority" requirement does not apply to claims against corporate insiders, where "a plaintiff can plead, and ultimately prove, that those officers–as opposed to the corporation itself–had ‘ultimate authority’ over the statement." Id. at *25. The court distinguished the executive’s circumstances, where he had "responsibility and authority to act as an agent" for the company, from the circumstances in Janus, where the statements at issue were made by a separate, independent entity. Id. The court stated that "Janus does not alter the well-established rule that a corporation can act only through its employees and agents." Id. (citations omitted).
Similarly, in Local 703, I.B. of T. Grocery & Food Emp. Welfare Fund v. Regions Fin. Corp., the Northern District of Alabama refused to dismiss Section 10(b) claims against a company’s officers arising out of Sarbanes Oxley certifications they signed in the company’s public filings. No. 2:10-cv-02847, slip. op. (N.D. Ala. Aug. 23, 2011). The court held that "[n]othing in Janus stands for the proposition that CEOs and CFOs cannot be liable for false and misleading statements in their own company’s financial statements, for which they signed Sarbanes-Oxley certifications." Id. at 3. The district court explained that "unlike the separate legal entities in Janus, the defendants here are in ultimate authority over their statements" and can be held liable as the makers of those statements. Id. A number of other courts have also since held that corporate insiders may be found primarily liable for signing SOX certifications and other filings. See, e.g., SEC v. Mercury Interactive, LLC, No. 5:07-cv-02822, 2011 WL 5871020, at *2 (N.D. Cal. Nov. 22, 2011) ("Skaer is alleged to have both prepared and signed false and misleading proxy statements. Thus, at least arguably, she may be considered the "maker" of the statements contained therein."); SEC v. Das, No. 8:10-cv-102, 2011 WL 4375787, at *6 (D. Neb. Sept. 20, 2011) (two former CFOs were liable for statements in corporate documents that they had signed and certified).
Courts have also disagreed regarding whether, after Janus, corporate insiders can be found liable for the statements made by other corporate insiders. In Orlan v. Spongetech Delivery Systems, Inc., for example, the Eastern District of New York dismissed Section 10(b) claims against a director arising out of alleged false statements by other directors regarding the company’s revenue. No. 10-CV-4093 (DLI) (JMA), 2012 WL 1067975 (E.D.N.Y. Mar. 29, 2012). Relying on Janus, the court held that defendant director could not be primarily liable under Section 10(b) because plaintiffs did not allege that he made any of the challenged statements. Id. at *9. The court noted that while the "group pleading doctrine" (which allowed plaintiffs to rely on a presumption that group published statements were the collective work of individuals with direct involvement in a company’s everyday activities) was alive and well in the Second Circuit prior to Janus, it was "uncertain whether it survived." Id. at *10. Thus, the court dismissed plaintiffs’ claims with leave to amend, admonishing plaintiffs to include in their pleadings any statements directly attributable to the defendant director. Id.
Similarly, in In re Coinstar Inc. Securities Litigation, the Western District of Washington dismissed Section 10(b) claims against a company’s officers relating to statements made by other officers of the same company at various conferences. No. C11–133 MJP, 2011 WL 4712206, at *10 (W.D. Wash. Oct. 6, 2011). The court rejected plaintiffs’ attempt to invoke the group pleading doctrine and stated that "while the Supreme Court in Janus considered whether a business entity could be held liable for a prospectus issued by a separate entity, its analysis applies equally to whether [the defendants] may be held liable for the misstatements of their co-defendants." Id.
In City of Pontiac General Employees’ Retirement System v. Lockheed Martin Corp., however, the Southern District of New York disagreed, and refused to dismiss primary liability claims against a Lockheed Martin officer arising out of alleged misstatements made by other company officers about the performance of one of the company’s divisions. No. 11 Civ. 5026 JSR, 2012 WL 2866425, at * 14 (S.D.N.Y. July 13, 2012). The court adopted a narrow reading of Janus, holding that the Supreme Court’s decision "addressed only whether third parties can be held liable for statements made by their clients . . . and has no bearing on how corporate officers who work together in the same entity can be held jointly responsible on a theory of primary liability." Id. Accordingly, it held that the group pleading doctrine "is alive and well." Id.
Courts have also struggled to determine the extent to which Janus applies to primary liability outside of the Rule 10b-5 context. In SEC v. Kelly, for example, the Southern District of New York held that Janus applied to limit primary liability in SEC enforcement actions brought under Section 17(a) of the Securities Act of 1933. 817 F. Supp. 2d 340, 345 (S.D.N.Y. 2011) (stating that "[a]lthough the language of subsection (2) of Section 17(a) is not identical to that of subsection (b) of Rule 10b–5, both provisions have the same functional meaning with it comes to creating primary liability"). A number of other courts, by contrast, have refused to extend Janus to Section 17(a) actions, primarily based upon the provision’s absence of the "make" language in Rule 10b-5 that the Supreme Court focused on in Janus. See SEC v. Daifotis, No. C 11–00137, 2011 WL 3295139, at *5–6 (N.D. Cal. Aug. 1, 2011) (stating that "[i]importantly, the word ‘make,’ which was the very thing the Supreme Court was interpreting in Janus, is absent from the operative language of Section 17(a). Rather, Section 17(a) makes it unlawful (1) ‘to employ any device, scheme, or artifice to defraud,’ (2) ‘to obtain money or property by means of any untrue statement’ or omission of a material fact, or (3) ‘to engage in’ certain types of transactions."); SEC v. Mercury Interactive, LLC, No. 5:07-cv-02822, 2011 WL 5871020, at *3 (N.D. Cal. Nov. 22, 2011) ("[the defendant] also argues that Janus should be extended to § 14(a) of the Exchange Act and § 17(a) of the Securities Act, although the decision did not address either of those statutes. Janus discussed what it means to ‘make’ a statement for purposes of Rule 10b–5(b), which renders it unlawful to "make any untrue statement of a material fact . . . in connection with the purchase or sale of any security.’ The operative language of §§ 14(a) and 17(a) does not require that the defendant "make" a statement in order to be liable.") (citation omitted); see also S.E.C. v. Stoker, No. 11 Civ. 7388, 2012 WL 2017736, at *8 (S.D.N.Y. June 6, 2012) ("Janus implicitly suggests that Section 17(a)(2) should be read differently from, and more broadly than, Section 10(b)"). Similarly, courts have refused to extend Janus to Section 17(a) actions based upon the Supreme Court’s stated rationale for its decision that a broad definition of "make" would improperly expand the scope of private actions. See, e.g., S.E.C. v. Sentinel Management Group, Inc., No. 07-C-4684, 2012 WL 1079961, at *15 (N.D. Ill. Mar. 30, 2012) ("Section 17(a) does not create a private right of action. . . . Therefore, the Supreme Court’s policy concerns in Janus are not implicated by claims brought by the SEC under Section 17(a).") (citation omitted); SEC v. Daifotis, 2011 WL 3295139, at *5 ("Janus‘s stringent reading of the word ‘make’ followed from the Court’s prior decisions limiting the scope of implied private rights of action under Rule 10b–5 . . . . The same rationale does not apply in the context of Section 17(a) because there is already no implied private right of action for Section 17(a) claims").
In a potentially significant decision, the Second Circuit recently held that a plaintiff could state a claim under Section 11 and Section 12(a)(2) based on an issuer’s alleged failure to comply with the disclosure obligations of Item 303 of SEC Regulation S-K, which "requires registrants to ‘[d]escribe any known trends or uncertainties . . . that the registrant reasonably expects will have a material . . . unfavorable impact on . . . revenues or income from continuing operations.’" Panther Partners, Inc. v. Ikanos Commc’ns, Inc., 681 F.3d 114, 120 (2d Cir. 2012), quoting 17 C.F.R. § 229.303(a)(3)(ii).
In Panther Partners, the plaintiff alleged that the defendant was aware of defects in certain of its products, and was liable under Section 11 and Section 12(a)(2) for omitting to disclose "the magnitude of the defect issue" in its registration statement or prospectus for a secondary offering of its securities. Id. at 117. Significantly, the defendant had disclosed that "complex products" like those it sold "frequently contain defects and bugs"; that the defendant had "experienced, and may in the future experience, defects and bugs"; and that as a result of such problems, its "reputation may be damaged" and its customers "may be reluctant to buy [its] products." Id. After the district court granted dismissal, the plaintiff moved for leave to amend its claims to include additional allegations concerning complaints the defendant’s largest customers made about the product defects in the weeks before the offering. Id. at 119. The district court denied leave to amend, and the plaintiff appealed. The Second Circuit reversed, reasoning that the defendant’s "generic cautionary language" was "incomplete" and "did not fulfill [the defendant’s] duty," under Item 303, "to inform the investing public of the particular, factually-based uncertainties of which it was aware in the weeks leading up to" the offering. Id. at 122. The Second Circuit offered little guidance as to what issuers must disclose, observing only that "Item 303’s disclosure obligations, like materiality under the federal securities laws’ anti-fraud provisions, do not turn on restrictive mechanical or quantitative inquiries." Id. at 122.
The Second Circuit’s decision can be expected to generate additional litigation and sow confusion about the scope of the disclosures required, as plaintiffs scramble to characterize any downturn in issuers’ businesses as related to undisclosed "uncertainties" or "trends." Indeed, several district courts have recently opined on the applicability of Item 303 to securities class actions, often in ways that cannot be reconciled with Panther Partners.
For example, in Brasher v. Broadwind Energy, Inc., a judge in the Northern District of Illinois dismissed, in relevant part, claims grounded on alleged violations of Item 303. Case No. 11-CV-991, 2012 WL 1357699 (N.D. Ill. Apr. 19, 2012). The defendants had disclosed the company’s reliance on certain key customers, and that "’several of our customers . . . expressed their intent to scale back, delay or restructure existing customer agreements, which has led to reduced revenues from these customers.’" Id. at *14. Nevertheless, the plaintiffs alleged that these disclosures and other disclosures about layoffs at the company were not sufficiently detailed. The court concluded that, "[a]t times, the complaint reads as if Plaintiffs believe Defendants should be held liable not for failing to disclose risks, but for failing to surround truthful disclosures with flashing lights and arrows. Investors might prefer that, but the securities laws do not require it." Id. at *15. In addition, the plaintiffs alleged that the timing of disclosures about these customers’ declining demand forecasts was inaccurate and therefore violated Item 303’s requirement of disclosure of "known trends or uncertainties." Id. at *16. The court denied these claims, reasoning in relevant part that "[t]he period between October 2008 and March 2009 was one of the most economically uncertain times in American history. Plaintiffs cannot show what Defendants–or any other market participant–should have ‘reasonably expected.’" Id.
A court in the District of Massachusetts granted defendants’ motion to dismiss a complaint based, in part, on defendants’ supposed violation of Item 303 by failing to disclose negative information in the company’s internally-tracked advancing bookings. Washtenaw County Emps. Ret. Sys. v. The Princeton Review, Inc., Civ. No. 11-11359-RGS, 2012 WL 727125 (D. Mass. Mar. 6, 2012). The court rejected plaintiffs’ argument that Item 303 mandated disclosure because this was "tangible information" the company possessed at the time of the securities offering. Id. at *4. The court reasoned that: 1) the omitted information was remote, "whether measured in time or causation, from the ultimately disappointing third quarter results"; and 2) the "mere possession of material nonpublic information does not create a duty to disclose it." Id. at *5 (internal quotation marks and citations omitted). See also Mallen v. Alphatec Holdings, Inc., __ F. Supp. 2d __, 2012 WL 987314 at *11-12 (S.D. Cal. Mar. 22, 2012) (granting motion to dismiss claims based on Item 303, both because allegedly missing disclosures were in fact present in company SEC filings, and because other allegedly missing disclosures were not required because plaintiffs failed to allege that defendants believed trends were reasonably likely to have a material impact on the company’s results).
In another example, in McKenna v. Smart Technologies, Inc., a judge in the Southern District of New York granted in part and denied in part the defendants’ motion to dismiss claims based on alleged failures to make disclosures required under Item 303. Case No. 11 Civ. 7673 (KBF), 2012 WL 1131935 (S.D.N.Y. Apr. 3, 2012). Among other claims, the plaintiff alleged that the defendants failed to disclose: 1) a "known trend" of imminent decline in demand for the company’s key product, fueled by the end of certain government stimulus spending; and 2) potential technological limitations that would call into question the company’s ability to fulfill its claims about the development of a particular product. Id. at *2. As to the first alleged failure to disclose, the court granted the motion to dismiss with leave to amend, reasoning that while the alleged trend of decline in demand was required to be disclosed if known to defendants at the time, the plaintiff had not sufficiently alleged that the defendants in fact knew of the alleged trend at the time. Id. at *10-13. On the other hand, the court denied defendants’ motion to dismiss the claims based on alleged failure to disclose facts about technological limitations relevant to product sales. Id. at *13-15. The court held that, while the specific technological limitation in question was publicly known, the impact of that limitation on the company’s product development was a "known . . . uncertaint[y]" under Item 303, and thus should have been disclosed. Id. See also Underland v. Alter, Civ. No. 10-3621, 2012 WL 2912330 at *6 (E.D. Pa. July 16, 2012) (motion to dismiss denied where plaintiffs alleged failure to disclose material trends under Item 303, based on claim that company failed to disclose repricing of customer accounts for approximately 68% of its customers, and likelihood that such repricing would lead to account delinquencies).
In addition to the Supreme Court’s decision to grant review in Amgen, lower courts have grappled with several important issues related to class certification over the past year. Highlights are discussed below.
There is a noticeable trend–both in securities class actions and other types of class action litigation–of applying the Daubert standard for expert testimony at the class certification stage, as the Supreme Court strongly suggested was appropriate in Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2553-54 (2011) (questioning the lower court’s conclusion that "Daubert did not apply to expert testimony at the certification stage of class action proceedings"); see also Messner v. Northshore Univ. Healthsystem, 669 F.3d 802 (7th Cir. 2012) (in antitrust class action, relying on Dukes for the proposition that, "if a district court has doubts about whether an expert’s opinions may be critical for a class certification decision, the court should make an explicit Daubert ruling"); Dean v. China Agritech, 2012 WL 1835708, at *2-*3 (C.D. Cal. May 3, 2012) (finding that plaintiff’s proffered expert testimony as to market efficiency satisfied Daubert at the class certification stage).
A salient example is In re Federal Home Loan Mortgage Corp. (Freddie Mac) Securities Litigation. In Freddie Mac, the plaintiff moved to certify a class of purchasers of a certain class of preferred shares in Freddie Mac. 2012 WL 1028642, at *1 (S.D.N.Y. Mar. 27, 2012). The parties vigorously disputed the existence of an efficient market, a pre-requisite for the plaintiff to invoke the fraud-on-the-market presumption and obtain class certification. Id. at *5-*7. Conducting an in-depth analysis of the testimony of both parties’ market efficiency experts, the court ultimately found that the plaintiff had not established an efficient market in the preferred shares, reasoning that, at a minimum, the plaintiff’s expert could only show a minimal relationship between material news disclosures and stock price movement. Id. at *7 ("A plaintiff must show that the market responds to most new, material news."). The court further found such significant methodological flaws and inconsistencies in the plaintiff’s evidence that it excluded the testimony as unreliable under Daubert. Id. at *8. As a result of the court’s determinations, individualized issues of reliance predominate, and plaintiff’s motion for class certification was denied. Id. at *9.
The so-called Affiliated Ute presumption allows a plaintiff to presume the reliance element of a securities fraud claim has been satisfied when the defendant allegedly omitted to disclose a material fact. In In re Beacon Associates Litigation, the Southern District of New York addressed the applicability of the Affiliated Ute presumption at the class certification stage. A putative class of investors in a fund that had interests in the Bernie Madoff Ponzi scheme sought certification of their securities fraud and ERISA claims against the fund’s managers and certain of its advisors and consultants. 2012 WL 1123728, at *1 (S.D.N.Y. Apr. 4, 2012). The complaint alleged that the fund’s managers and advisors had failed to disclose their ongoing mismanagement of the fund. Id. at *2. The defendants challenged the putative class representatives’ claims under the "typicality" prong of Rule 23(a)(3), arguing that the Affiliated Ute presumption of reliance was not applicable, because the proposed class representatives failed to read the fund’s prospectus or to invest on the advice of the fund’s advisors, thereby subjecting each putative representative to "unique challenges to their reliance that undermine their typicality as representatives of the class." Id. at *10. The court disagreed and granted class certification, reasoning that presumption still applied because the plaintiffs’ inaction was irrelevant insofar as the representations made to the investors "when they were deciding whether to invest in the Beacon Fund are not the only sources of disclosure duties in this case." Id.
Specifically, the court determined that the fund’s investment advisor owed disclosure obligations to the plaintiffs’ agents, namely the Beacon Fund itself. Thus, the fact that the plaintiffs did not read the Beacon Fund prospectus or know about the existence of such an advisor "does not therefore affect these disclosure obligations, insofar as they run to the Plaintiffs’ agents rather than to Plaintiffs themselves." Id. at *11. Moreover, as to plaintiffs’ own investment advisors, those defendants "were entitled to reply upon their promise to supervise those investments" subsequent to their purchase of the interest in the Beacon Fund. Id. The fact that the plaintiffs had failed to read the fund’s prospectus "does not relieve [such defendants] of their duty to disclose to their clients when they were no longer able to perform that supervision." Id. Lastly, as to the manager-defendants, the court inferred a broker-client relationship because the managers "were empowered to make investment decisions with the Fund’s assets on behalf of the Beacon Fund investors." Id. As such, the managers had a broader disclosure obligation encompassing how they managed the fund–i.e., "that no due diligence was henceforth to be performed" on the fund’s outsized Madoff investment–not merely an obligation to update or correct the fund’s prospectus. Id. at *11.
At the class certification stage, courts continue to diverge on the question of whether class representatives have standing to represent investors who purchase securities that the class representatives themselves do not own. For example, in Facciola v. Greenberg Traurig, LLP, the District of Arizona held that putative class representatives had standing to assert claims for purchases of certain classes of mortgage-backed securities that they had not purchased. 2012 WL 1021071, at *2 (D. Ariz. Mar. 20, 2012). "Because lead plaintiffs, as well as their proposed class members, suffered the same injury from the same fraudulent scheme, and share a common statutory remedy," the court concluded that the lead plaintiff had standing "to assert claims on behalf of the proposed class regardless of the specific type of security offering they purchased." Id.; but see Pub. Emp. Ret. Sys. of Miss. v. Merrill Lynch Co., 227 F.R.D. 97, 107 (S.D.N.Y. 2011) ("This Court previously held that Plaintiffs have standing to pursue claims only with respect to those offerings in which they purchased Certificates.")
There have been a number of recent class certification decisions with respect to claims for alleged misstatements made in connection with offerings of mortgage-backed securities brought under Sections 11 and 12(a)(2) of the Securities Act of 1933. Importantly, in RALI/Harborview, the Second Circuit affirmed a district court’s denial of class certification in such an action. N.J. Carpenters Health Fund v. RALI Series 2006-Q01, 2012 U.S. App. LEXIS 8675 (2d Cir. Apr. 20, 2012). The district court had declined to certify a class because "to determine whether each purchaser had actual knowledge of the specific untruths or omissions at the time of its purchase would require many individualized inquiries" that would "outweigh the common issues in the case." Id. at *7. The Second Circuit held that the district court did not abuse its discretion in refusing to certify a class. Reviewing the limited record before it, the Second Circuit held that the court "permissibly determined that knowledge defenses would require extensive individual proceedings," notwithstanding the fact the evidence of plaintiffs’ knowledge "would not have sufficed to prove each knowledge defense on the merits." Id. The Second Circuit also affirmed the district court’s ruling that the plaintiff had failed to select a "cohesive" class definition. Id. at *9. The plaintiff had selected a class definition of all MBS purchasers of the original offering, notwithstanding their actual purchase date. Id. Because "purchasers of each security who purchased at different times would have had available different levels of public information[,] . . . individualized knowledge inquiries would be required." Id. The purchase date differences also "removed the possibility that the knowledge defense could be adjudicated on a class basis using publicly available evidence." Id. For these reasons, the Second Circuit concluded that the district court did not abuse its discretion in finding that Rule 23(b)’s predominance requirement had not been met.
Nevertheless, the Southern District of New York has recently certified several class actions brought under Sections 11 and 12(a)(2) of the Securities Act of 1933 alleging misstatements in the offerings of certain mortgage-backed securities. See Tsereteli v. Residential Asset Securitization Trust-A8, 2012 WL 2532172 (S.D.N.Y. June 29, 2012); Pub. Emp. Ret. Sys. of Miss. v. Goldman Sachs Group, Inc., 280 F.R.D. 130 (S.D.N.Y. 2012); Pub. Emp. Ret. Sys. of Miss. v. Merrill Lynch & Co., 277 F.R.D. 97 (S.D.N.Y. 2011); N.J. Carpenters Health Fund v. DLJ Mortgage Capital, Inc., 2011 WL 3874821 (S.D.N.Y. Aug. 16, 2011). In all four cases, defendants opposed certification on the ground that defenses to the causes of action resulted in individualized questions predominating over common ones under Rule 23(b)(3). And in each case, the court rejected those arguments. These cases highlight the difficulty of defeating class certification in Section 11 and 12(a)(2) cases involving widely traded securities. For example, Judge Rakoff in Merrill Lynch noted that "suits alleging violations of the securities laws, particularly those brought pursuant to Sections 11 and 12(a)(2), are especially amenable to class action resolution." 277 F.R.D. at 101.
In Merrill Lynch, for example, the court found that even though there were 18 different offering prospectuses at issue in the litigation, the defendants’ arguments about the lack of commonality with regard to misstatements were "grossly overstate[d]," because the overarching alleged misstatement concerned the underwriting standards generally and there was "substantially similar, boilerplate language across the Offerings." Id. at 113; see also Tesereteli, 2012 WL 2532172, at *10 (where "securities in a given offering are interrelated, then untrue statements and material omissions in the Offering Documents similarly affect the securities in each offering"). The court rejected the defendant’s argument that individualized reliance issues predominated, holding the securities’ distribution statement was not an "earning statement" under that defense to a Section 11 claim; as such, the defendant failed to shift the burden of proving reliance to the plaintiffs. Id. at 114-15; DLJ Mortgage, 2011 WL 3874821, at *7 (same); Tesereteli, 2012 WL 2532172, at *9-10 (same). The court also rejected the defendant’s argument that individualized issues of knowledge of the fraud, and therefore the application of the statute of limitations, would predominate, determining that while there was generalized negative market sentiment about mortgage-backed securities going back over years, the securities at issue were only formally downgraded within the limitations period. Id. at116; Goldman Sachs, 280 F.R.D. at 140 (similar); accord Tesereteli, 2012 WL 2532172, at *8 ("The Court assumes that some of the class members are sophisticated investors. But that does not establish knowledge, inquiry, or actual notice sufficient to defeat the predominance requirement.").
Gibson Dunn represents defendant Credit Suisse Securities (USA) LLC in the Tsereteli litigation.
In 2012, the lower courts have continued to define the contours of the rule set forth in the Supreme Court’s precedent-setting decision in Morrison v. National Australia Bank, 561 U.S. __, 130 S. Ct. 2869 (2010). In Morrison, foreign citizens sued a foreign issuer in the United States for alleged fraud under Section 10(b) in connection with securities transactions in a foreign country. Id. at 2875. The Court affirmed dismissal of the lawsuit on the ground that Section 10(b) does not apply extraterritorially. The Court held that the statute applies only to "the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States." Id. at 2884; see also id. at 2886 (describing the "transactional test" as "whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange"). Significant post-Morrison decisions have been issued on at least two issues relevant to securities litigation.
First, in Absolute Activist Value Master Fund Ltd. v. Ficeto, the Second Circuit addressed for the first time what constitutes a "domestic transaction" in securities not listed on a U.S. exchange. 677 F.3d 60 (2d Cir. 2012). As we noted in our 2011 mid-year review, the Eleventh Circuit held a "sale" was "consummated" in the United States when the transaction for the acquisition of the stock "closed" in the United States, thereby triggering the transfer of title–or "sale"–domestically. See Quail Cruises Ship Mgmt. Ltd. v. Agencia de Viagens CVC Tur Limitada, 645 F.3d 1307, 1310–11 (11th Cir. 2011). The Second Circuit held in Absolute Activist that "to sufficiently allege a domestic securities transaction in securities not listed on a domestic exchange," a plaintiff must "allege facts suggesting that irrevocable liability was incurred or title transferred within the United States." 677 F.3d at 68. The court noted that its test combines the "title transfer" test adopted by the Eleventh Circuit in Quail Cruises and the "irrevocable liability" test employed by district courts within the Second Circuit. Id.
The plaintiffs in Absolute Activist were "nine Cayman Island hedge funds" that "engaged [Defendant] Absolute Capital Management Holdings ("ACM") . . . to act as [their] investment manager." Id. at 62. "The complaint allege[d] that the defendants engaged in a variation on the classic ‘pump-and-dump’ scheme, causing [the plaintiffs] to suffer losses of at least $195 million through cycles of fraudulent trading of securities." Id. at 63. According to the plaintiffs, ACM "caused [them] to purchase billions of shares of thinly capitalized U.S.-based companies directly from those companies," after which the defendants "artificially inflated the prices of those stocks" and profited by (among other things) "sell[ing] previously locked-up shares and exercise[ing] warrants to obtain additional shares, which they then sold to the [plaintiffs] for a windfall, having obtained the shares or warrants for nothing or almost nothing." Id. at 63–64.
The defendants moved to dismiss the complaint on Morrison grounds, arguing principally that because some of the transactions at issue involved foreign buyers and foreign sellers, those transactions could not be considered domestic. Id. at 69. The Second Circuit rejected that argument. Instead, the court held that transactions are domestic if either (1) "irrevocable liability was incurred" in the United States or (2) "title [was] transferred within the United States." Id. at 68. Applying its test, the court "conclude[d] that the allegations d[id] not sufficiently allege that purchases or sales took place in the United States" (id. at 70) but that the plaintiffs "should be given leave to amend their complaint." Id. at 71.
Second, a "nascent consensus" has emerged in the United States District Court for the Southern District of New York that Morrison‘s transactional test applies equally to claims under various sections of the Securities Act of 1933. SEC v. ICP Asset Mgmt., LLC, No. 10 Civ. 4791, 2012 WL 2359830, at *2 (S.D.N.Y. June 21, 2012) (applying transactional test to Section 17(a) of the Securities Act); see also In re Vivendi Universal, S.A., Sec. Litig., — F. Supp. 2d —-, 2012 WL 280252, at *5 (S.D.N.Y. Jan. 27, 2012) (Sections 11 and 12(a)(2)); SEC v. Goldman Sachs & Co., 790 F. Supp. 2d 147, 164 (S.D.N.Y. 2011) (Section 17(a)); In re Royal Bank of Scot. Grp. PLC Sec. Litig., 765 F. Supp. 2d 327, 338 & n.11 (S.D.N.Y 2011) (Sections 11 and 12(a)(2)). Courts in the Southern District of New York have noted the Supreme Court’s statements in Morrison that the Securities Act "’was enacted by the same Congress as the Exchange Act’ and ‘form[s] part of the same comprehensive regulation of securities trading’" (In re Vivendi Universal, 2012 WL 280252, at *5 (quoting Morrison, 130 S. Ct. at 2885)) and that "the Securities Act shares the ‘same focus on domestic transactions’ as the Exchange Act." In re Royal Bank of Scot. Grp., 765 F. Supp. 2d at 338 (quoting Morrison, 130 S. Ct. at 2885). Accordingly, those courts have held that "Morrison permits Securities Act claims only ‘in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.’" In re Vivendi Universal, 2012 WL 280252, at *5 (quoting Morrison, 130 S. Ct. at 2884). The extension of Morrison‘s transactional test to claims under the Securities Act may suggest the emergence of a view that the test is not grounded exclusively on statutory language that is particular to Section 10(b) alone (i.e., "in connection with the purchase or sale of any security"). See Vivendi, 2012 WL 280252, at *5 (Sections 11 and 12(a)); Royal Bank of Scot., 765 F. Supp. at 338 & n.11 (same).
The past year has been significant for subprime and credit-crisis related securities litigation, as a large number of cases filed in the wake of the financial crisis of 2008 continue to work their way through the courts.
Filing and Settlement Trends. The number of new federal securities class actions relating to the credit crisis has continued to decline. There were 34 such cases filed in 2010, 12 last year, and only 4 so far in 2012. See Dr. Renzo Comolli, Dr. Ron Miller, Dr. John Montgomery, & Svetlana Starykh, Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review: Settlements Bigger, But Fewer, NERA Economic Consulting, at 5 (July 24, 2012). These figures suggest that new litigation over the credit crisis of 2008 is approaching an end.
Standing Issues. Even as the events of 2008 grow distant, courts remain split on the issue of tranche-based standing, specifically whether a named plaintiff has standing to sue for injuries sustained from purchases of tranches other than the one which the individual purchased. Compare In re Bear Stearns Mortg. Pass-Through Certificates Litig., 2012 U.S. Dist. LEXIS 45679, at *86-*87 (S.D.N.Y. May 15, 2012) (holding that plaintiffs do not lack standing over tranches they did not purchase) with Me. State Ret. Sys. v. Countrywide Fin. Corp., 722 F. Supp. 2d 1157, 1164 (C.D. Cal. 2010) (holding that there is no constitutional standing as to tranches for which a plaintiff did not purchase). District courts are also divided over whether commencement of a class action suit tolls the limitations period for putative class members when the named plaintiffs ultimately lack standing. Compare Me. State Ret. Sys., 722 F. Supp. 2d at 1166 (finding that "tolling applies only to securities where the named plaintiffs had actual standing to bring the lawsuit."), with Genesee Cnty. Emp. Ret. Sys. v. Thornburg Mortg. Sec. Trust., 825 F. Supp. 2d 1082, 1129 (D.N.M 2011) ("[W]hen a plaintiff has filed a class action, the filing of the class action tolls the statute of limitations period under section 13 for all the putative class members until class certification is denied.").
Class Certification Issues. As discussed above, the Second Circuit affirmed a denial of class certification based on issue predominance. N.J. Carpenters Health Fund v. Residential Capital, LLC, 272 F.R.D. 160, 169-70 (S.D.N.Y. 2011), aff’d sub nom. N.J. Carpenters Health Fund v. RALI Series 2006-Q01, 2012 U.S. App. LEXIS 8675 (2d Cir. Apr. 20, 2012). However, the majority of district court cases deciding the issue, including three out of the Southern District of New York, have granted class certification, holding that individual issues did not predominate over common issues. See supra Part F.4.
The first half of 2012 has seen a number of courts reject claims on loss causation grounds.
In Hubbard v. State-Boston Retirement System, the Eleventh Circuit upheld (though on different grounds) a district court’s decision to grant judgment as a matter of law following a jury trial due to a failure of plaintiffs to prove loss causation. No. 0:07-cv-61542, 2012 WL 2985112, at *7, *10 (11th Cir. July 23, 2012). The case arose from the deterioration of the share price of BankAtlantic, a Florida-based bank whose real estate loan losses were heavily affected by the 2007 Florida real estate downturn. Plaintiffs’ loss causation expert conducted an event study attempting to isolate a large one-day drop in BankAtlantic stock from market effects, by comparing the stock to both the S&P 500 index and the NASDAQ Bank index. The result of the study was a finding that the price drop was entirely attributable to the revelation of concealed credit risk, not to greater market factors. Rejecting this comparison to broader stock indices, the Eleventh Circuit reasoned that in order for a jury to conclude that an omission was the "’substantial’ or ‘significant contributing cause’" of investor losses, any event study would need to account for the unique circumstances facing a Florida-focused bank. Plaintiffs failed to "present evidence that would give a jury some indication, however rough, of how much of the decline in Bancorp’s stock price resulted . . . from the general downturn in the Florida real estate market – the risk of which Bancorp is not alleged to have concealed." Id. at *10.
Defendants also prevailed in several other recent cases on loss causation grounds. In Wozniak v. Align Tech. Inc., the court rejected plaintiff’s argument that statements lowering the company’s short-term outlook were sufficient to plead loss causation, where it was "far more plausible . . . that [the] company had failed to hit prior earnings estimates." No. C–09–3671, 2012 WL 368366, at *14 (N.D. Cal. Feb. 3, 2012). In In re Immersion Corp. Sec. Litig., the court found that several alleged partial disclosures were only indicative that the company was "not doing as well as investors had hoped," and that this was insufficient to adequately plead loss causation, which requires at least a showing that fraud was a "substantial cause" of an investment’s decline in value. No. C–09–4073, 2011 WL 6303389, at *10–11 (N.D. Cal. Dec. 16, 2011). And the court in In re Merck & Co. Inc. Sec., Derivative & ERISA Litig., held that a particular partial corrective disclosure that occurred "after it was clear that [a] product about which misrepresentations were made had lost all of its commercial viability," was insufficient to plead loss causation. No. MDL 1658, 2011 WL 34441999, at *33 (D.N.J. Aug. 8, 2011). The statement failed to "establish proximate cause between the fraud and the loss" because it did not "relate to the facts about which a defendant allegedly lied," and instead went only to the adequacy of management where "corporate management is not the subject matter of the misrepresentations or omissions." Id.
On the other hand, the Second Circuit recently reversed a district court’s dismissal of a securities complaint on loss causation grounds. Acticon AG v. China North East Petroleum Holdings Ltd., __ F.3d ___, Case No. 11-4544-cv, 2012 WL 3104589 (2d Cir. Aug. 1, 2012). The district court had dismissed the case because, "[o]n twelve days" during the two months following disclosure, the defendant’s "stock closed at a price higher than" the plaintiff’s average purchase price. In re China Ne. Petroleum Holdings Ltd. Secs. Litig., 819 F. Supp. 2d 351, 353 (S.D.N.Y. 2011). Thus, the plaintiff would have "turned a profit" if it had sold on those days, and "a purchaser suffers no economic loss if he holds stock whose post-disclosure price has risen above purchase price–even if that price had initially fallen after the corrective disclosure was made." Id. at 352 & 353. The Second Circuit disagreed, reasoning that at the pleading stage of the case, the district court should have inferred that the plaintiff had suffered economic loss at the time of the disclosure, satisfying the loss causation requirement for pleading purposes. Acticon, 2012 WL 3104589 at *7.
In reaching this conclusion, the Second Circuit discussed the Supreme Court’s rejection in Dura of a loss causation rule that "’would allow recovery where a misrepresentation leads to an inflated purchase price but nonetheless does not proximately cause any economic loss.’" Id. at *5 (quoting Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 346 (2005)). The Second Circuit read this holding very narrowly, however, and rejected the district court’s reading of Dura because it "is inconsistent with the traditional out-of-pocket measure of damages, which calculates economic loss based on the value of the security at the time that the fraud became known . . . ." Id. at *6. The Second Circuit also held that the district court’s ruling was inconsistent with the "bounce back" rule of the PSLRA, which limits damages to the difference between the purchase price and the "mean trading price" during the 90 days following disclosure of alleged fraud. Id. at *4, citing 15 U.S.C. § 78u-4(e)(1). Despite this law, the Second Circuit reasoned that "it is improper to offset gains that the plaintiff recovers after the fraud becomes known against losses caused by the revelation of the fraud if the stock recovers value for completely unrelated reasons." Id. While neither the Second Circuit nor the district court discussed whether the "mean trading price" during the bounce-back period was greater than the plaintiff’s average purchase price, this reasoning is still fundamentally inconsistent with Congress’s direction. The Second Circuit’s decision is, at a minimum, confusing. It remains to be seen how this perplexing holding is interpreted by other courts.
In another group of recent loss causation decisions, several for-profit colleges successfully moved to dismiss securities class actions based on plaintiffs’ failure to adequately plead loss causation. The cases arose based on the stock market’s negative reaction to a series of governmental inquiries and policy changes that affected these institutions. See Okla. Firefighters Pension and Ret. Sys. v. Capella Ed. Co., No. 10–4474, 2012 U.S. Dist. LEXIS 76011, at *38 – 44 (D. Minn. June 1, 2012) (finding that plaintiffs were unable to link a drop in stock prices to any revelation about a fraudulent omission, particularly where many disclosures "concerned the for-profit educational industry as a whole."); Boca Raton Firefighters and Police Pension Fund v. Devry Inc., No. 10-C–7031, 2012 U.S. Dist. LEXIS 41305, at *44–69 (E.D. Ill. Mar. 27, 2012) (similar; finding several governmental inquiries and news stories insufficient to prove loss causation); Karam v. Corinthian Colleges, Inc., CV–10–6523-GHK, 2012 U.S. Dist. LEXIS 44153, at *35–38 (C.D. Cal. Jan. 30, 2012) (similar, finding that disclosures were "primarily in response to announcements about potential changes in regulations," and were "not exclusive to [Defendant]."); Kinnett v. Strayer Edu. Inc., 8:10-cv–2317-T, 2012 U.S. Dist. LEXIS 37737, at *52 – *62 (M.D. Fla. Jan. 3, 2012) (same).
In GE Investors Retirement Plan v. General Electric Co., 447 F. App’x 229 (2nd Cir. 2011), the Second Circuit affirmed the Southern District of New York’s dismissal of claims in a putative class action arising out of GE’s announcement that it planned to offer $15 billion in new equity, including a $3 billion preferred stock offering to Berkshire Hathaway. The news was announced prior to the stock market open, and on that day the stock climbed from $23.63 per share to $24.50 per share. When GE’s $12 billion common stock offering priced at $22.25 the next day, GE’s stock fell to similar levels. The Second Circuit rejected plaintiffs’ reliance on this pricing as a corrective disclosure, as Plaintiffs had "not allege[d] that defendants concealed the pricing of the offering," and stated that "no loss occurred upon the revelation" of the offering news itself. Id. at 231.
In Findwhat Investor Group v. Findwhat.com, 658 F. 3d. 1282, 1315 (11th Cir. 2011), the Eleventh Circuit held that "confirmatory information that wrongfully prolongs a period of inflation–even without increasing the level of inflation–may be actionable under the securities laws." The court reasoned that a "falsehood that endures within the marketplace for a longer period of time . . . will cause greater harm than one that endures for a shorter period of time," and therefore there was "no reason to draw any legal distinction between fraudulent statements that wrongfully prolong the presence of inflation in a stock price and fraudulent statements that initially introduce that inflation." Id. at 1316. The court concluded "Defendants who commit fraud to prop up an already inflated stock price do not get an automatic free pass under the securities laws." Id. at 1317.
Finally, while it is unusual to see plaintiffs arguing about failure to plead loss causation, the PSLRA’s presumptions in favor of an investor with the largest financial interest has caused at least one class action plaintiff to do just that. Arguing that a pension fund that had sold all of its shares of a company prior to a full corrective disclosure (i.e., an "in-and-out trader") would "suffer from unique adequacy and typicality defenses that may become the focus of the litigation," one plaintiff convinced a court to select it, rather than an institutional investor, as lead plaintiff under the PSLRA. Bensley v. Falconstor Software, Inc., 277 F.R.D. 231, 237–39 (E.D.N.Y. 2011). But see In re Gentiva Sec. Litig., No. 10-cv–5064, 2012 WL 258679 (E.D.N.Y. Jan. 26, 2012) (rejecting an argument that a plaintiff that sold shares only after a partial disclosure should be rejected as a lead plaintiff).
The past 12 months have seen a steady flow of follow-on derivative and securities fraud litigation stemming from alleged violations of the FCPA. Continued attention to FCPA investigations and enforcement proceedings by the DOJ and SEC (as reported on in Gibson Dunn’s 2011 Year-End FCPA Update and 2012 Mid-Year FCPA Update) has been matched by a spate of follow-on cases alleging securities fraud and (more commonly) breaches of fiduciary duty arising out of the alleged conduct giving rise to the government proceedings. See Gibson Dunn’s 2012 Mid-Year FCPA Update.
Large corporations experiencing FCPA issues, particularly those that announce investigations by, or settlements with, the government, are targets for these lawsuits. In the past twelve months, several such companies have been targeted by follow-on suits, including:
The overwhelming majority of the cases identified above are derivative actions, and thus it is not surprising that the handful of reported court opinions addressing follow-on FCPA cases in the past 12 months have focused on derivative issues, and in particular, on demand futility. One very recent example is Strong v. Taylor, Civ. A. No. 11–392, 2012 WL 2564907 (E.D. La. July 2, 2012). There, following Tidewater, Inc.’s November 2010 settlements with the SEC and DOJ over alleged FCPA violations, a shareholder asserted claims under Delaware law for breach of fiduciary duty against Tidewater’s board and certain officers. Id. at *1-*2. The court granted defendants’ motion to dismiss on demand futility grounds. Id. at *16. After analyzing the complaint under both the Rales test for board action and the Aronson test for board inaction, the court held that "the Complaint is completely devoid of any allegations of an interested director"; that plaintiff’s allegations of directors’ "substantial likelihood of liability" were "completely conclusory," particularly inasmuch as plaintiff failed "to allege a single particularized fact detailing knowledge as to any particular director"; and that plaintiff’s "bald assertion" of director dependence was "completely insufficient to raise a reasonable doubt as to whether any one of the directors could have independently considered demand." Id. at *8–*11. The court did not grant plaintiff leave to amend the complaint, but also did not totally foreclose a possible further complaint, as it "allow[ed] the Plaintiff twenty days to file a Motion for Leave to Amend the Complaint." Id. at *17.
Other courts in the past 12 months likewise have granted defendants’ motions to dismiss derivative complaints on demand futility grounds in FCPA follow-on cases. See Saginaw Police & Fire Pension Fund v. Hewlett-Packard Co., No. 5:10-cv-4720-EJD, 2012 WL 967063, at *7 (N.D. Cal. Mar. 21, 2012) (dismissing complaint arising out of alleged FCPA violations in Europe on demand futility grounds because, inter alia, "Plaintiff has failed to allege particularized facts that any of the Director Defendants knew of violations and took no steps in good faith to prevent or remedy the situation," but granting leave to amend); Freuler v. Parker, No. 4:10-cv-03148, 2012 WL 896414, at *1-*3 (S.D. Tex. Mar. 14, 2012) (dismissing on demand futility grounds derivative claims arising out of alleged bribery in Kazakhstan and Nigeria; court previously had granted motion to dismiss on demand futility grounds, and court held that amended complaint again failed to plead demand futility).
An interesting development that bears consideration recently occurred in two other pending FCPA follow-on derivative cases. In cases involving Avon Products, Inc. and Bio-Rad Laboratories, Inc., plaintiffs this year voluntarily dismissed their complaints without prejudice, in one instance to make a demand on the board, and in another to allow the company to finish the governmental investigation process into alleged FCPA violations. See Plaintiffs’ Motion to Voluntarily Dismiss Action, In re Avon Prods., Inc. S’holder Derivative Litig., Master Case. No. 10-CN-5560-KBF (S.D.N.Y. Feb. 13, 2012), ECF No. 59 (voluntarily dismissing complaint because "[i]n light of continuing revelations, and the probability that the investigation is unlikely to end anytime soon, Plaintiffs believe that the most efficient way to proceed is to voluntarily dismiss the action in order to make a demand upon the Avon Board of Directors"); Stipulation and Order of Voluntary Dismissal Without Prejudice, City of Riviera Beach Gen. Emps.’ Ret. Sys. v. Schwartz, No. MSC11-00854 (Cal. Super. Ct. Contra Costa Cnty. May 24, 2012) (approving stipulation of voluntary dismissal where DOJ and SEC "investigations into Bio-Rad for possible violations of the FCPA are ongoing" and the parties entered into a tolling agreement "until 60 days after the FCPA investigations have been settled, terminated or otherwise resolved").
When combined with the two cases discussed above, where courts this year dismissed FCPA follow-on derivative complaints for failure to plead demand futility (compared to no reported cases where courts denied such motions), this development around voluntary dismissals suggests that plaintiffs are having trouble successfully pleading these kinds of claims. We will continue to watch for other instances of this potential trend and report back in our 2012 Year-End Update. In the meantime, a more detailed discussion of the issues and implications of follow-on FCPA litigation can be found in the article Strategies for Mitigating Civil Liability Consequences of FCPA Investigations & Enforcement Actions, by Palo Alto partner George Brown, Los Angeles partner Debra Wong Yang, and San Francisco associate Matthew Kahn, which was published in the April 2012 issue of Thomson Reuters’ Securities Litigation Report.
"Upon a proper showing, a [federal] court may stay discovery proceedings in any private action in a State Court, as necessary in aid of its jurisdiction, or to protect or effectuate its judgments, in an action subject to a stay of discovery pursuant to [PSLRA]." 15 U.S.C. § 78u-4(b)(3)(D). In determining whether to stay discovery in related state-court actions, courts consider three factors: (1) the risk of federal plaintiffs obtaining the state plaintiff’s discovery, the extent of factual and legal overlap between the state and federal actions, and the burden of state-court discovery on defendants." In re Dot Hill Sys. Sec. Litig., 594 F. Supp. 2d 1150, 1165-66 (S.D. Cal. 2008).
Recent cases have illustrated the difficulties courts face in interpreting this standard. For example, in Brown v. China Integrated Energy, Inc., 2012 WL 1129909, at *1 (C.D. Cal. Apr. 2, 2012), the court denied a motion to stay discovery in three related state-court derivative actions, even though there was overlap in the factual and legal bases for the action. Id. at *8. The court denied the motion, in part, because the defendant failed to show "a relationship or coordination between the plaintiffs in the state and federal actions" even though the plaintiffs in two of the state-court derivative actions were also members of the putative federal class. Id. at *7. The plaintiffs in the derivative actions were also "amenable to the entry of a confidentiality order," "expressed a willingness to file materials . . . under seal," and had different legal counsel than that of the federal class. Id. However, in Moomjy v. HQ Sustainable Maritime Industries, Inc., 2011 WL 4048792, at *3 (W.D. Wash. Sept. 12, 2011), under seemingly similar circumstances, the court reached a contrary result. There, the court found that there was a "substantial" risk that discovery would reach the federal plaintiffs because the "state court plaintiffs [were] putative members of [the] federal securities class action" and, even though plaintiffs would agree to a protective order, discovery in the state court action would likely be "filed and heard publicly." Id. at *2.
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Thank you for your trust and confidence over the past 12 months. We look forward to updating you again in the future on important developments in the law relating to securities litigation.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact the Gibson Dunn lawyer with whom you work, or any of the following members of the Securities Litigation Practice Group Steering Committee:
Securities Litigation Group:
Jonathan C. Dickey – Co-Chair, New York (212-351-2399, [email protected])
Robert F. Serio – Co-Chair, New York (212-351-3917, [email protected])
Meryl L. Young – Co-Chair, Orange County (949-451-4229, [email protected])
Thad A. Davis – Co-Chair, San Francisco (415-393-8251, [email protected])
Paul J. Collins – Palo Alto (650-849-5309, [email protected])
George B. Curtis – Denver (303-298-5743, [email protected])
Ethan Dettmer – San Francisco (415-393-8292, [email protected])
Gareth T. Evans - Orange County (949-451-4330, [email protected])
Joel A. Feuer – Los Angeles (310-551-8808, [email protected])
Daniel S. Floyd – Los Angeles (213-229-7148, [email protected])
Barry R. Goldsmith – New York (212-351-2440, [email protected])
Mark A. Kirsch – New York (212-351-2662, [email protected])
John C. Millian – Washington, D.C. (202-955-8213, [email protected])
John H. Sturc – Washington, D.C. (202-955-8243, [email protected])
M. Byron Wilder – Dallas (214-698-3231, [email protected])
Please also feel free to contact any of the Securities Litigation Partners for further information about the topics covered in this alert.
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