The 10b-5 Daily

2003-08-27T17:39:00.000-04:00

Motion For Voluntary Transfer Granted - Like so many blogs before it, The 10b-5 Daily has moved to a home it can call its own. You have always been able to access this blog via www.the10b-5daily.com, but now it's the only option! Please update your bookmarks and visit the new location soon. In fact, you should be taken there automatically after a short delay . . .

2003-08-26T19:35:00.000-04:00

Computer Associates Settles - Computer Associates International Inc. (NYSE: CA) has announced that it will issue up to 5.7 million shares to obtain a global settlement of the securities class actions, ERISA class actions, and derivative litigation pending against the company. (There may be a cash component to the settlement, however, depending on the share price of the stock at the time of distribution.) The cases are based on how the company, which makes software from corporate mainframe computers, recognized revenue and awarded executive compensation. In anticipation of the settlement, the company plans to take a pre-tax charge of approximately $144 million in the current quarter.

Quote of note: According to an Associated Press article, lead counsel for the plaintiffs stated "that getting stock today, if the company has a good future, has a better upside for our clients than waiting three, four, or five years to resolve the case."

2003-08-25T19:25:00.000-04:00

How Much Particularity Is Enough? - Less than many other circuit courts have required, is the answer from the U.S. Court of Appeals for the Tenth Circuit in Adams v. Kinder-Morgan, Inc., 2003 WL 21906117 (10th Cir. August 11, 2003). Pursuant to the PSLRA, plaintiffs attempting to plead securities fraud based on information and belief (as opposed to personal knowledge) must "state with particularity all facts" supporting their belief that the specified statements were misleading. Courts have routinely grappled with the meaning of the words "all facts."

The Second Circuit, in Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000), concluded that interpreting the text literally would lead to absurd results, including requiring dismissal "where the complaint pled facts fully sufficient to support a convincing inference if any known facts were omitted." The Second Circuit tempered its holding, however, by finding that it is not enough for plaintiffs to baldly allege facts in support of their allegations, they must provide "documentary evidence and/or a sufficient general description of the personal sources of the plaintiffs' beliefs." (The Fifth Circuit has also adopted this approach, while the First and Ninth Circuits have required detailed source information.)

In Adams, the Tenth Circuit agreed with the Second Circuit that "all facts" should not be interpreted literally, but declined to impose a requirement that plaintiffs state the source of their facts. Noting that the PSLRA did not "purport to move up the trial to the pleadings stage" and does not mention the pleading of sources, the court held that it will "apply a common-sense, case-by-case approach in determining whether a plaintiff has alleged securities fraud with the particularity required by [the PSLRA] without adding a per se judicial requirement that the source of facts must always be alleged to support substantive allegations of fraud in an information and belief complaint." The court did note, however, that in the absence of source information, the facts in the complaint "will usually have to be particularly detailed, numerous, plausible, or objectively verifiable by the defendant before they will support a reasonable belief that the defendant's statements were false or misleading."

Holding: Reversed in part (dismissal based on a lack of particularity, and other grounds, as to all defendants), affirmed in part (dismissal based on insufficient scienter allegations and lack of control as to one defendant).

Quote of note: "While the PSLRA certainly heightened pleading standards for securities fraud lawsuits, we believe that if Congress had intended in securities fraud lawsuits to abolish the concept of notice pleading that underlies the Federal Rules of Civil Procedure, Congress would have done so explicitly."

2003-08-22T16:04:00.000-04:00

DaimlerChrysler Settles Merger Suit - The big news today is the announcement of a proposed $300 million settlement in the securities class action against DaimlerChrysler AG. The suit alleges that Daimler-Benz AG misrepresented the acquisition of Chrysler as a "merger of equals" to avoid paying Chrysler shareholders a takeover premium for their shares. (The 10b-5 Daily has posted a few times about the case - see here and here.)

A separate suit brought by billionaire financier Kirk Kerkorian, who was Chrysler's largest single shareholder at the time of the merger, is unaffected by the settlement because Kerkorian will opt out of the class. Kerkorian's case is set for a December trial in the D. of Del.

Bloomberg appears to have the most comprehensive article on the settlement (at least as of this posting). The State Board of Adminstration of Florida, a teacher's and workers' pension fund that acted as one of the lead plaintiffs in the case, has issued a press release.

Quote of note (Bloomberg): "The offer, before any opt-outs, is worth about 43 cents a share, minus attorneys' fees. With Kerkorian opting out, the remaining shareholders would each receive about 47 cents per share, minus attorneys' fees. If approved, the settlement would be one of the largest ever in a securities fraud case, according to Bloomberg data. The agreement is tied for ninth place among the largest recoveries in shareholder class-action suits in history, the data shows."

Quote of note II (Bloomberg): "Han Tjan, a spokesman for the Stuttgart, Germany-based automaker, said the company has insurance to cover $220 million of the settlement. DaimlerChrysler officials say the class-action claims by investors other than Kerkorian presented the 'major risk' in the case. 'Now we'll concentrate on the suit with Tracinda [Kerkorian's holding company],' company spokesman Hartmut Schick said."

2003-08-21T19:29:00.000-04:00

The Battle Over Greenfield's Estate - Harvey Greenfield was a plaintiffs' securities class action lawyer who passed away in 2002. A proud alumnus of Harvard Law School, Greenfield indicated to people that he planned to leave the bulk of his $35 million estate to the school. But a year after Greenfield's death, his will cannot be located and there is an ongoing battle between Harvard and his sole living heir over who will receive the money. The August 20, 2003 edition of the New York Law Journal contains an article (via law.com - free registration required) discussing Greenfield (including his famously abrasive dealings with other lawyers) and the legal contest over his estate.

2003-08-21T19:10:00.000-04:00

PricewaterhouseCoopers 2002 Securities Litigation Study - PricewaterhouseCoopers LLP has issued a study on private securities litigation trends in 2002 and the first part of 2003. Notable findings for the period from January 1, 2003 to July 31, 2003 include:

(1) 60 securities class actions were settled with a total settlement value of $1.5 billion ($25.1 million average).

(2) The total number of securities class action filings in 2003 is on track to be approximately 190 (down from 217 in 2002).

(3) The number of securities class actions involving health services and pharmaceutical companies is rising, while the number of cases against telecommunications and utlilities companies has dropped dramatically.

Quote of note (from the related press release): "In 2002, approximately one out of every five shareholder class actions involved either a Department of Justice investigation, or a federal indictment, conviction or guilty plea/conviction, a 200 percent increase over 2001, and a 290 percent increase over the average for the years 1996 through 2000."

2003-08-20T15:42:00.000-04:00

Analysis Of The Milberg Weiss Breakup - The August 18, 2003 edition of the Legal Times has an article (via law.com - free subscrip. required) on the previously announced breakup of Milberg Weiss Bershad Hynes & Lerach, widely recognized as the leading plaintiffs' securities class action firm. (The 10b-5 Daily posted extensively on this development back in June, starting with this post.) The front page story by Andrew Longstreth (of The American Lawyer) takes a comprehensive look at the issues that may have led to the split.

2003-08-20T15:21:00.000-04:00

New York Pursues Claims - The Associated Press reports today that the New York State Comptroller has released a report claiming that corporate scandals have cost New York nearly $13 billion over the last two years in reduced economic performance, tax revenues, and pension fund value. The article also notes that New York's pension fund is the lead plaintiff in several securities class actions.

2003-08-19T15:12:00.000-04:00

"Bounty On Directors and Officers" - According to the Recorder (via law.com), a prominent securities class action plaintiffs' attorney stated at a recent ABA seminar that "he has been offered 50 percent of any judgment that comes directly from the pocketbooks of individual directors and officers." Moreover, his institutional clients are committed to defending this type of fee arrangement in court.

Note, however, that this is not really a new revelation. An article in the January 2003 issue of the Corporate Legal Times (only available online via Westlaw or LexisNexis) discussed the use of premium fee arrangements to target the personal assets of alleged corporate wrongdoers under the sub-headline "Institutional Investors Place a Bounty on Directors and Officers." Just something else to keep corporate executives up at night.

2003-08-19T14:02:00.000-04:00

Medi-Hut Settles - Medi-Hut Co., Inc., a New Jersey pharmaceutical and medical device maker, has announced the settlement of the securities class action filed against it in the D. of N.J. The suit was based on alleged accounting fraud. If approved by the court, the settlement will pay investors $400,000 in cash and 861,990 shares of stock (currently trading at about 15 cents a share).

Addition: The August 20, 2003 edition of the Newark Star-Ledger has an article on Medi-Hut and the settlement.

2003-08-18T21:11:00.000-04:00

Qwest Cites Merrill Lynch Decision (And So It Begins) - There is little doubt that Judge Pollack's decision in the Merrill Lynch research class actions is destined to be widely cited by securities litigation defendants -- it certainly has caused attorneys to give more consideration to loss causation as a defense. Exhibit A: Qwest Communications International, Inc.

The Rocky Mountain News reported over the weekend that Qwest has filed a motion to dismiss the securities class action against the company citing the Merrill Lynch decision and arguing that plaintiffs have not adequately alleged that the supposed misconduct, rather than a general market decline, caused their losses. Predictably (especially if you regularly read The 10b-5 Daily), plaintiffs have responded that the Merrill Lynch case isn't relevant, in part, because none of the plaintiffs in that case bought their stock from Merrill Lynch. The Qwest suit is before the U.S. District Court for the District of Colorado.

Quote of note: "In its court brief, Qwest cited the Merrill Lynch decision this summer. The class-action claim was dismissed, Qwest said, because the plaintiffs didn't adequately prove that the conduct of the analysts, rather than a general market decline, caused their losses. Qwest attorneys argue that Qwest's stock price too 'generally rose and fell' in a pattern corresponding to the broader Nasdaq telecommunications index."

2003-08-15T16:30:00.000-04:00

Man's Attempt To Bite Dog Rejected - The McKesson HBOC securities fraud cases have generated a number of interesting legal developments over the years. The cases are based on the 1999 merger between McKesson and HBO & Co. After the merger was closed, McKesson announced that HBOC had improperly recorded certain software sales as revenues and that HBOC's financial results would have to be restated. Several securities class actions were filed and the New York State Common Retirement Fund was eventually selected as the lead plaintiff.

In January 2001, McKesson filed a complaint and compulsory counterclaim against the Fund and former HBOC shareholders who exchanged more than 20,000 shares of HBOC stock for McKesson stock. The theory was that the investors were unjustly enriched by trading inflated HBOC shares for properly-valued McKesson shares. The district court dismissed the claim.

On Wednesday, the U.S. Court of Appeals for the Ninth Circuit weighed in on the case, holding that McKesson cannot sue its own investors on an unjust enrichment theory. First, the court held that an equitable remedy for McKesson was unnecessary given that there are legal remedies available to the company for the same alleged wrong. "McKesson has potential legal claims against any number of parties who, unlike the former shareholders, actually played a substantial role in the decision to enter the Merger Agreement; the former HBOC shareholders are not the only targets for recovery." Second, the court declined to pierce the corporate veil to create liability for HBOC's shareholders, noting that "there is no allegation that the HBOC shareholders exercised - or even had the ability to exercise - domination or control over HBOC." Finally, the court concluded that the expansion of liability to the shareholders, who were unaware of the risk that they could be personally liable for corporate acts, would be unjust.

The Recorder has a story on the case (via law.com) and the decision can be found here. The case certainly highlights the difficulties in determining the winners and losers in securities fraud.

2003-08-15T11:34:00.000-04:00

Q2 2003 Review of Securities Class Actions - Veritas, an Atlanta corporation that provides securities litigation data and services, has released some of the results from its review of class action activity from April 1, 2003 to June 30, 2003. Notable findings include:

(1) 59 securities class actions were filed during the second quarter of 2003, a slight decline from the 65 securities class actions filed during the first quarter of 2003.

(2) Milberg Weiss was bumped out of its historically commanding position for lead counsel appointments by Schiffrin & Barroway, who garnered 27% of lead counsel appointments in the second quarter (Milberg came in second with 23% of the appointments).

(3) Milberg Weiss continued to dominate the settlement arena, with 30% of the settlements that were approved in the second quarter for a total of 68% of the total funds recovered.

2003-08-14T23:53:00.000-04:00

Alliant Energy Case Dismissed - The Milwaukee Business Journal reports that the securities class action against Alliant Energy, filed in the U.S. District Court for the Western District of Wisconsin, has been dismissed without prejudice. The case was based on Alliant's alleged misrepresentations concerning its expected financial performance.

2003-08-14T23:34:00.000-04:00

Homestore Settles - Homestore Inc. has agreed to pay $63.6 million in cash ($13 million) and stock (20 millon shares) to settle the pending securities class action against the company. The Associated Press reports that the settlement terms include corportate governance reforms.

Quote of note: "As part of the settlement, Homestore agreed to adopt corporate governance reforms within 30 days of the final approval. The company agreed to two-year board terms, the appointment of a new shareholder-appointed director and minimum stock ownership requirements for directors. The company also agreed to not use future stock options for director compensation."

2003-08-13T07:50:00.000-04:00

Tenth Circuit Partially Reverses Novell Dismissal - The Salt Lake Tribune reports today that the U.S. Court of Appeals for the Tenth Circuit has partially reversed the earlier dismissal of a securities class action against Novell. The appellate court held that claims alleging that Novell and certain of its officers "created a fictional 'in transit' category and improperly recorded shipments to OEMs (or original equipment manufacturers, companies that incorporated Novell products into retail computers, or acted as resellers) as sales revenue" could proceed. The suit is based on conduct that allegedly occurred in 1996 and 1997. The decision can be found here.

2003-08-12T19:15:00.000-04:00

First Union Settles Just Inside Courthouse - First Union National Bank has agreed to settle the securities class action suit against the company, based on its alleged participation in a securities fraud commited by Cyprus Funds, for $5 million. According to an article in the Sun-Sentinel, the settlement was reached after two days of testimony in a federal jury trial in Fort Lauderdale.

Quote of note: "Legal experts say the case against First Union was unusual because it resulted in a jury trial. While 'third parties' such as banks or law firms sometimes are sued in connection with securities fraud cases, usually such matters are settled out of court or dropped."

2003-08-12T19:00:00.000-04:00

Intel Order - The recent unpublished order granting Intel Corp.'s motion to dismiss the securities class action against the company has been posted by The Securities Law Beacon. (The 10b-5 Daily has previously noted the decision.)

2003-08-12T18:08:00.000-04:00

Judge Pollack Declines To Rehear Merrill Lynch Cases - Reuters reports that Judge Pollack of the S.D.N.Y. has declined to reconsider his ruling, or allow the plaintiffs to file an amended complaint, in the Merrill Lynch research class actions he recently dismissed. (The 10b-5 Daily has posted extensively about the original decision, starting here.)

Quote of note: "Pollack said on Tuesday that the plaintiffs had done 'nothing to change the unalterable, judicially-noticeable facts relating to the widespread public dissemination, years prior to the filing of the cases at bar, of information regarding analyst conflicts of interest and the service of investment banking business.'"

2003-08-11T18:11:00.000-04:00

Ohio Sues Freddie Mac - The state of Ohio, on behalf of its pension funds, continues to supplement pending securities class actions with its own individual suits. Over the weekend, the Washington Post reported that Ohio has both individually sued Freddie Mac and certain fomer officers for securities fraud and filed a motion asking that it be named lead plaintiff in the securities class action. The state currently has individual suits pending against AOL Time Warner (discussed in The 10b-5 Daily here), Enron, and WorldCom and is the lead plaintiff in a securities class action against Global Crossing.

Quote of note: "'I don't mean be excessively litigious, but I think in terms of what we've seen, we need to see more corporate accountability,' [Ohio Attorney General Jim Petro] said."

2003-08-11T18:07:00.000-04:00

SuperGen Obtains Voluntary Dismissal - SuperGen, Inc. (NASDAQ: SUPG) has announced the voluntary dismissal of the securities class action against the pharmaceutical company. The suit, originally filed in April in the U.S. District Court for the Northern District of California, alleged that the company sold shares while failing to disclose material information about one of its drugs.

2003-08-08T18:56:00.000-04:00

Appellate Monitor (Loss Causation) - It has been a big summer for loss causation cases. A clear split in authority has developed between courts that believe plaintiffs must demonstrate a causal connection between the misrepresentations and a subsequent decline in the stock price (Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir. 2000); Robbins v. Koger Props, Inc., 116 F.3d 1441 (11th Cir. 1997)) and courts that believe plaintiffs merely need to allege that the misrepresentations artificially inflated the stock price (Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824 (8th Cir. 2003)). (The 10b-5 Daily discussed the ConAgra decision here.)

In Broudo v. Dura Pharmaceuticals, 2003 WL 21789028 (9th Cir. Aug. 5, 2003), the Ninth Circuit clarified that it will not require plaintiffs to establish a causal connection between the misrepresentations and a decline in the stock price: loss causation "merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause." The facts of the case, however, underline the problems with this reasoning. Broudo is a securities class action on behalf of investors who purchased Dura stock between April 15, 1997 and February 24, 1998. The defendants allegedly made misleading statements during that time period about, among other things, the clinical trials necessary to obtain new drug approval from the FDA for Dura's Albuterol Spiros delivery device for asthma medication. On February 24, 1998, Dura revealed that it expected lower-than-forecast 1998 revenues and 1998 earnings per share, but did not make any disclosures about its Albuterol Spiros delivery system. The February 24 announcement caused Dura's stock price to decline by 47%. It was not until November 1998, nearly nine months after the end of the class period, that Dura announced the FDA had "found the Albuterol Spiros device not approvable due to electro-mechanical reliability issues and chemistry, manufacturing, and control concerns." The district court found that the plaintiffs had failed to properly plead loss causation for his claims based on misleading statements concerning the Albuterol Spiros device because the complaint did "not contain any allegations that the FDA's non-approval [of the Albuterol Spiros device] had any relationship to the February price drop."

The 9th Circuit reversed. The court did not address the logical inconsistency of the plaintiffs' argument that statements revealed to be misleading in November caused them to suffer losses the previous February. Instead, the court found that it was unnecessary for the plaintiffs to plead "that a disclosure and subsequent drop in the market price of the stock have actually occurred, because the injury occurs at the time of the transaction."

The decision improperly conflates transaction causation and loss causation. Plaintiffs may have purchased on the basis of the alleged misrepresentations, but any loss requires the stock they purchased to decline in value. The practical problems created by the Broudo opinion are significant. As noted by Judge Pollack in the Merrill Lynch cases, "allowing plaintiffs in a fraud on the market case to satisfy loss causation simply by alleging that a misrepresentation caused the price to be artificially inflated without having to allege any link between the conduct and the decline in price would undoubtedly lead to speculative claims and procedural intractibility." Moreover, the PSLRA expressly states that plaintiffs have the burden of establishing that their losses were caused by the defendants' acts or omissions. How can plaintiffs' claims be plead with particularity if they do not connect the alleged fraudulent conduct to any loss?

Holding: Reversed and remanded with leave to amend.

2003-08-07T21:22:00.000-04:00

Halliburton Settlement On Hold - The Financial Times has a story on the dispute between the lead plaintiffs in the Halliburton securities class action. As previously noted in The 10b-5 Daily, Halliburton Company announced at the end of May that it had agreed to a $6 million settlement.

In a remarkable development, however, Scott + Scott (which represents one of the four lead plaintiffs) has refused to sign onto the settlement and is attempting to have Schiffrin & Barroway removed as lead counsel in the case. Scott + Scott claims that Schiffrin "did not convene a single meeting of the lead plaintiffs, refused to give other firms evidence it had investigated the charges, and then settled the case for $6m, even though some have estimated the damages as high as $6.8bn." There is also some controversy over why Vice President Dick Cheney, the CEO of Halliburton during some of the class period, was not named as a defendant.

The court has scheduled a hearing for August 25.

2003-08-06T14:26:00.000-04:00

The Rent-Way Story - The Eire Times News is running an interesting series of articles on the financial fraud at Rent-Way, Inc. (NYSE: RWY), one of the nation's largest rent-to-own retailers. The articles detail both the fraud, which was first revealed in Oct. 2000, and the legal consequences for the company and its officers. The first article in the series can be found here (links to subsequent installments are at the bottom of the page).

2003-08-06T13:56:00.000-04:00

ABA Considers Ethics Proposals On The Reporting Of Financial Misconduct - As part of its upcoming annual meeting, the American Bar Association is considering new ethics proposals on the reporting of financial misconduct by lawyers, including when lawyers can reveal information to public authorities about their clients. Opponents of the proposals, according to a Reuters article, fear that the new ethics rules will make lawyers an inviting target for securities litigation.

Quote of note: "The vote will be closely watched by the Securities and Exchange Commission, which has been charged by the U.S. Congress to set standards of professional conduct for in-house and outside attorneys who advise public companies. Some SEC rules for lawyers went into effect earlier this week and the agency could adopt more stringent requirements if it is dissatisfied with the ABA's actions."

Quote of note II: "Philadelphia attorney Lawrence Fox, who previously chaired the ABA's ethics committee, said the amendments would 'drive a wedge' between lawyers and their clients. He also said it was 'not much of a leap' to envision lawsuits charging that attorneys should have known about financial fraud, even though the defendant lawyers may not be accountants. 'We're setting lawyers up,' Fox said."

2003-08-05T19:15:00.000-04:00

Journal Roundup - Looking for some fun beach reading this summer? Stay away from these articles! But if you want some interesting examinations of securities class action law, here are a few of the latest offerings.

1) The Santa Clara Law Review has an empirical study entitled "Securities Class Action Settlements" by Mukesh Bajaj, Sumon Mazumdar, and Atulya Sarin (43 Santa Clara L. Rev. 1001 (2003)). The authors studied 1203 federal case filings and 92 state court filings, spanning from 1988 to 1999, to draw conclusions about dismissal and settlement trends.

Quote of note: Among other conclusions, the authors found: (a) "The settlement process, as well as the rate of dismissals, has declined since the passage of the PSLRA;" (b) "Quick settlements generally involve relatively small settlement amounts;" (c) "Mean and median settlements have increased in the post-PSLRA period;" and (d) "Cases naming accounting firms as co-defendants, while relatively rare, involve average and median settlements that are greater than the sample as a whole." Many of these results are similar to those in the recent NERA study (discussed in The 10b-5 Daily here).

2) The ALI-ABA has published an article entitled "Central Bank is Alive and Well: Defense Strategies for Defeating 'Scheme To Defraud' Allegations in Private Securities Litigation" by Brian Pastuszenski, Christopher Robertson, and Jason Frank (SHO83 ALI-ABA 439 (May 8-9, 2003)). The authors focus on plaintiffs' recent attempts to use the holding in SEC v. Zandford, 535 U.S. 813 (2002), where the Supreme Court found a broker liable for engaging in a "scheme to defraud" under Rule 10b-5 when he misappropriated funds from a customer's account, to avoid the prohibition on "aiding and abetting" liability found in the Court's earlier holding in Central Bank. Recent district court decisions (notably in the Enron case) "have allowed claims to proceed against secondary actors who were not alleged to have made any actual misstatements relied on by plaintiffs, but instead were alleged only to have participated in certain transactions underlying the alleged misstatements."

Quote of note: "Successfully arguing a motion to dismiss based on Central Bank, however, requires articulating clearly the difference between (a) a 'misstatement' case in which plaintiffs complain about the purchase of stock at inflated prices as a result of allegedly false and misleading statements and (b) a case that alleges other forms of 'deception' that caused plaintiffs harm . . . In the typical class action case, only the defendant who actually made the offending statements themselves has any potential liability after Central Bank." (A discussion of another recent article on this general topic, with a different viewpoint, can be found in The 10b-5 Daily here.)

3) The same ALI-ABA "course of study" has an article on "Anonymous Informants: How Identifiable Must They Be Under The PSLRA" by Peter Saparoff and Justin Kudler (SH083 ALI-ABA 479 (May 8-9 2003)). The authors survey the recent case law on this contentious issue.

Quote of note: "The trend in the case law now has solidified around providing a description of the informant, but not necessarily his or her name, in a complaint alleging violations of the federal securities laws that was pleaded under the PSLRA."

2003-08-05T12:00:00.000-04:00

FTD Settles - FTD, Inc. (Nasdaq: FTDI) has sent itself a bunch of flowers with the announcement that it is settling the securities class action against the company for $10.7 million in stock. The case was related to the company's 2002 FTD.com merger.

2003-08-01T18:04:00.000-04:00

Appellate Watch (Stay of Discovery) - The PSLRA provides that "all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party." With the passage of SLUSA, Congress attempted to strengthen the discovery stay by granting the power to federal court judges to quash discovery in state court actions if discovery in the state case conflicted with an order of the federal court.

In Newby v. Enron Corp., 2003 WL 21658666 (5th Cir. July 30, 2003), the underlying lawsuit was a state court action in Texas (Bullock), filed on behalf of thirteen individuals, against many of the same defendants as in the Enron federal securities class action litigation (Newby). The plaintiffs received permission from the state court to commence discovery, even though there was no dispute "that the discovery sought in Bullock would have fallen squarely within the discovery that may eventually take place in Newby if the plaintiffs survive a motion to dismiss." The defendants requested emergency injunctive relief from the U.S. District Judge presiding over the Newby case to stay discovery in the Bullock case. Pursuant to SLUSA, the discovery was enjoined until a ruling on the motion to dismiss in the Newby case. The Bullock plaintiffs appealed.

In Newby, the Fifth Circuit addressed whether the power granted to federal court judges to quash state court actions is only limited to state court actions brought on behalf of a class of investors. The plain language in SLUSA would appear to suggest otherwise, "a court may stay discovery in any private action in a State court . . . ." Appellants argued, however, that (1) the PSLRA and SLUSA were enacted to combat abuses in class action securities cases; and (2) other provisions of SLUSA refer specifically to state court class actions and control over the more general terminology in the operative provision.

Not surprisingly, the Fifth Circuit decided to stick with the plain language of the statute. "The title of [the SLUSA provision] reflects its purpose: to prevent the 'circumvention of stay of discovery' provided for in [the PSLRA]. The provision in [SLUSA] allows the federal court presiding over an action subject to the automatic stay of discovery to order a similar stay in a state court action. On its face [the SLUSA provision] applies to 'any private action in a State court.' The action stayed by the district court is plainly within the scope of this clause."

Holding: Stay of discovery affirmed (the panel also upheld additional injunctive relief granted by the district court).

2003-08-01T15:30:00.000-04:00

Winona, Martha & The Securities Fairy - Fortune magazine has a short, often funny, and very effective interview with former SEC commissioner Joseph Grundfest. Among other things, Grundfest has a two-word explanation for the recent spate of corporate scandals: Winona Ryder. (Thanks to the Securities Law Beacon for the link.)

Quote of note:

Interviewer: "You've argued historically the class-action system has compensated investors - but hasn't deterred future misbehavior. Why?"

Grundfest: "I'm not suggesting that it has no deterrent effect. It's just weak compared with the criminal and the SEC enforcement mechanisms. The reason is that only 0.5% of the settlements in the 15 largest settlements came out of the pockets of the wrongdoer."

2003-07-31T21:31:00.000-04:00

Dismissal Of Suit Against Two WorldCom Executives Upheld - The Jackson Clarion Ledger reports that the U.S. Court of Appeals for the Fifth Circuit has upheld the dismissal of a securities class action against WorldCom former executives Bernie Ebbers and Scott Sullivan. The decision can be found here.

It is important to note, however, that this suit was not based on the accounting irregularties that led to WorldCom's recent bankruptcy. Instead, it was based on the failure of WorldCom to write-off certain receivables in 2000.

Quote of note: "In the original complaint, shareholders claimed Ebbers and Sullivan withheld information about $685 million in write-offs of uncollectible receivables. The ruling said, 'the plaintiffs simply ignore evidence that WorldCom frequently took large write-offs and that, indeed, a $768 million write-off had been taken in 1999.'"

2003-07-31T21:05:00.000-04:00

Rising Cost Of D&O Insurance - Today's Wall Street Journal (subscrip. req.) has a feature article on the rising cost of directors and officers liability insurance (for more on this topic see these posts on The 10b-5 Daily). Insurers are both raising premiums and "holding firm on many of their efforts to rein in the generous terms and conditions they adopted during a price war in the late 1990s." A side graph identifies AIG (34% of premiums; 19% of policies) and Chubb (16% of premiums; 21% of policies) as the D&O insurance leaders.

Quote of note: "And while the reforms of the Sarbanes-Oxley corporate-governance act may reduce corporate scandals, in the near future they could prove expensive. For example, the law increases the responsibility of audit-committee members for overseeing the company's audits, potentially raising the stakes for individual committee members if problems are later found. 'There's a general confusion about what Sarbanes-Oxley really means,' says Bill Cotter, chief underwriting officer for National Union Fire Insurance Co., of Pittsburgh, a unit of American International Group Inc., the leading underwriter of D &O insurance. 'The fear is that it will be defined through litigation.'"

Quote of note II: "Companies have a variety of options to mitigate higher costs. These include buying less coverage and retaining more of their risk with higher deductibles or co-insurance, in which the policyholder pays a fixed portion of eventual claims, much as health-insurance often requires patients to pay part of their costs, brokers say. Deductibles, recently $1 million or even lower on even large policies, have risen to as high as $100 million. Co-insurance of 10% to 30% or more has become more commonplace as well."

2003-07-30T21:02:00.000-04:00

"Biggest Hog At The Trough" - The Bristol Herald Courier has an article today on the lead plaintiff contest in the King Pharmaceuticals securities class action in the E.D. of Tenn. (Thanks to the SW Virginia Law Blog for the link.) The case is based on allegedly misleading financial statements made by the company.

At least two groups of pensions funds, as well as some individual investors who were shareholders in a company King Pharmaceuticals acquired, have moved for lead plaintiff status. U.S. Magistrate Judge Dennis Inman presided over the hearing.

Quote of note: "Inman said federal law favors the appointment of the stockholder who lost the most money. 'I'd like to know who is the biggest hog at the trough,' Inman said. That question prompted a lively debate among the dozen-plus lawyers, all of whom had a reason that their client should get the nod."

2003-07-30T19:26:00.000-04:00

The Fine Line Between Being An "Aider and Abettor" Or A "Primary Violator" - There is an interesting article on the ABA's Business Law eSource (July 2003) entitled "Securities Litigation Against Third Parties: Pre-Central Bank Aiders And Abettors Become Targeted Primary Defendants." The authors, Jay Eisenhofer and Cynthia Calder, offer a comprehensive summary of the post-Central Bank case law on who is a "primary violator" for purposes of Rule 10b-5, including separate sections on cases involving accountants, lawyers, underwriters/investment banks, and ratings agencies.

As noted previously in The 10b-5 Daily, the line between a "primary violator" (liable) and an "aider and abettor" (not liable) is becoming blurred. Eisenhofer and Calder conclude that "accountants, lawyers, and investment bankers ought to be taking a hard look at their relationships with their clients, and their own potential for primary liability under Rule 10b-5 in cases of corporate fraud."

Quote of note: "Although neither has achieved majority acceptance, two different approaches - the 'bright line' and 'substantial participations standards - have emerged from the lower courts. According to those courts that have adopted the 'bright line' standard, only if a defendant actually makes a statement to the plaintiff (or the investing public) which contains a misrepresentation or omission can that defendants be liable. By contrast, under the 'substantial participation' rubric, a defendant that plays a significant role in creating the statement can be held liable."

2003-07-29T20:14:00.000-04:00

Banks' Enron Settlement - J.P. Morgan Chase & Co. and Citigroup, Inc have agreed to pay $305 million in fines to the SEC and the Manhatten district attorney's office to settle charges that they helped Enron hide billions of dollars worth of loans. The Washington Post ran this story on the settlement in yesterday's edition.

Quote of note: "'The shareholders' claim is that the various banks, including these two, were doing exactly what the SEC says they were doing in this action,'" [Professor Henry T.C. Hu, a law professor at the University of Texas] said. "'The banks are not paying this amount of money for charity purposes; it is not chump change. It tends to give credence to the shareholder allegations. . . . This settlement, complete with the SEC's harsh language, will be materially helpful to the massive shareholder lawsuit.'"

Quote of note II: "Under today's settlement with the SEC and the district attorney, $236 million will eventually be distributed to 'victims' of Enron's fraud. Exactly who will be eligible for restitution has not been determined."

2003-07-29T19:07:00.000-04:00

Baxter Suit Dismissed - Apparently, it's a good day to be a defendant. Baxter International, Inc. , a medical products maker, has announced the dismissal of the securities class action filed against it in Illinois federal court. The suit was based on earnings forecasts Baxter had made for FY2002.

2003-07-29T18:41:00.000-04:00

Intel Suit Dismissed With Prejudice - The Associated Press reports that the securities class action against Intel Corp., the semiconducter company, has been dismissed with prejudice.

Quote of note: "U.S. District Judge Jeremy Fogel granted Intel's motion to dismiss Monday, saying plaintiffs failed to show company officials knowingly misled investors about Intel products or revenues in the third quarter of 2000."

2003-07-28T14:53:00.000-04:00

Pollack Keeps Getting Press (Even Overseas) - TheLawyer.Com, a UK website, has an article on Judge Pollack's decision in the Merrill Lynch analyst research cases. Notably, the article contains the words "loss causation."

Quote of note: "Coffee [Columbia University law professor John Coffee] reckons that Judge Pollack's most important line of reasoning is that the plaintiff has to prove 'loss causation'. 'They can't simply prove that the plaintiff was fraudulently induced to buy the stock by the false inflated and insincere recommendation, but rather he has to prove first, and then later, that the recommendation was causally related to the stock's ultimate fall.' That is a very difficult burden for litigators to have to meet, he adds."

2003-07-26T00:51:00.000-04:00

Baker's Bill Postponed- Reuters reports that Rep. Baker has agreed to postpone a vote on the Securities Fraud Deterrence and Investor Restitution Act of 2003 (discussed in The 10b-5 Daily here).

Quote of note: "The bill is largely aimed at boosting the SEC's powers. But one section of it targets state officials, such as New York Attorney General Eliot Spitzer, by proposing barring them from writing securities law exceeding or adding to federal statute. State securities regulators have attacked the bill as a shield meant to protect Wall Street's largest brokerages from state-level investigations like the one Spitzer mounted recently into stock analyst conduct at Merrill Lynch."

2003-07-26T00:26:00.000-04:00

Plaintiffs' Perspective - The Associated Press has a lengthy interview with Mel Weiss of Milberg Weiss, the leading plaintiffs' securities class action firm.

Quote of note:

Interviewer - "How big was the $1 billion settlement for ordinary investors in the IPO fraud case in your view? How much do you hope to get from the brokerages?"

Weiss - "The billion dollars is an expression of concern that these allegations are real and could give rise to staggering liability. It simplifies the litigation in that we can focus our attention on the conduct of the investment banks. The interesting part here is how much broader our inquiries will be than the government's has been because we're covering 55 banks, not 10. It's going to be far more fascinating to demonstrate that the conduct we allege to be serious violations of the law was widespread throughout the entire industry. ... I would be very disappointed if we don't achieve multiple billions (in recovery)."

2003-07-23T15:24:00.000-04:00

South Korea Proceeds With Plan To Permit Securities Class Actions - As previously posted in The 10b-5 Daily, the South Korean legislature is considering a proposal to permit investors to bring securities class actions. The JooAng Daily reports that the Legislation and Judiciary Committee’s review subcommittee approved the measure yesterday.

Quote of note: "[T]he proposed legislation only allows filing of such suit for financial fraud complaints: book-rigging, stock price manipulation or false disclosures and audits. At least 50 shareholders who collectively owns either 0.01 percent of a firm’s shares or own shares valued at 100 million won would be required for a suit to be filed. The court would have the right to investigate the qualifications of shareholders as plaintiffs. The court could also ask for basic information from financial authorities. If a court rejected the filing of a lawsuit, aggrieved shareholders would have the right to appeal the decision. "

2003-07-23T14:49:00.000-04:00

Green Tree Settles - The Associated Press reports that Green Tree Financial Corp. has settled the securities class action against the company that has been ongoing since 1998. The suit alleged that the company and its officers engaged in fradulent accounting practices to artificially inflate its stock price and increase the CEO's compensation. The preliminary settlement is for $12.5 million, which will be paid by the company's D&O insurer.

Note that this suit led to the 8th Circuit's seminal decision interpreting the scienter pleading requirements of the Reform Act: Florida State Board of Admin. v. Green Tree Financial Corp. (8th Cir. 2001).

2003-07-23T12:49:00.000-04:00

President of ATLA Criticizes Class Action Reform - In case there was any doubt about the Association of Trial Lawyers of America's position on the Class Action Fairness Act.

Quote of note: "Alexander stated that the convention would work 'to strengthen the fight against the Administration's and Congress' anti-consumer actions, especially concerning medical malpractice rights, and class action lawsuits against major malfeasant corporations like Enron and Global Crossing, who are almost unaccountable on issues from pensions to pollution.'"

2003-07-23T12:11:00.000-04:00

Where Is Judge Pollack Taking Us? - An interesting column by Michael Carroll in yesterday's Wall Street Journal (subscrip. required) about the potential ramifications of Judge Pollack's decision in the Merrill Lynch cases. The author questions whether private securities class actions, as opposed to regulatory actions by the S.E.C., are the right method for remedying the societal costs of misleading market information.

Quote of note: "The judge's ruling draws on ideas which, if they are followed by other courts, could change the world of securities class actions as we know it. As Judge Pollack put it, when plaintiffs are a class of disappointed investors who lost money in trades on the secondary market, there is another class of lucky investors who were on the other side of those trades. In the language of economics, the losses that class plaintiffs were seeking to recover in the Merrill Lynch case were transfer payments that had been made to other investors in the market. Judge Pollack decided that Merrill Lynch did not have to underwrite those transfer payments."

Quote of note II: "Transfer payments among investors based on false or misleading market information impose a cost on society, but it is not a cost that is best measured by the total of all transfer payments or that is best remedied by private lawsuits. The societal cost imposed by bad market information is a lessening of market confidence and the decrease in investment activity that can follow. These are macro results that can be addressed by regulatory agencies such as the Securities and Exchange Commission, whose job it is to protect market confidence by policing information in the market."

2003-07-22T11:40:00.000-04:00

AOL Sued Separately By Ohio And California Pension Funds In State Court - Over the weekend, the Associated Press reported that state public employee pension funds in Ohio and California have declined to join the federal securities class action against AOL (postings about the AOL case can be found here and here). Instead, they have sued AOL separately in state court based on the same conduct. Note that this is part of a trend for the Ohio funds, which have also sued Enron and WorldCom in state court.

Quote of note: "'The class-action lawsuit, you get peanuts at the end of it,' Ohio Attorney General Jim Petro said."

2003-07-22T11:16:00.000-04:00

The Plaintiffs' Hot List - The National Law Journal (July 21, 2003 edition) has a breakout of "The Plaintiffs' Hot List" of law firms. A number of plaintiffs firms that focus on securities class actions have made the list.

2003-07-18T18:59:00.000-04:00

Read Judge Pollack's Opinion For Yourself - The conventional wisdom on Judge Pollack's decision in the Merrill Lynch analyst research cases is that he dismissed the cases because the plaintiffs were not Merrill Lynch clients, and therefore could not demonstrate that they reasonably relied on the brokerage's research. Columnists for Forbes and Bloomberg continue to provide a forum for this incorrect reading of the case, which is being promoted vociferously by (surprise) attorneys representing individual Merrill Lynch clients in arbitration claims against the brokerage.

In fact, as discussed in The 10b-5 Daily here and here, Judge Pollack dismissed the cases because plaintiffs failed to establish any connection between the analyst research and the companies' financial troubles or the collapse of the overall market. In Judge Pollack's view, that is what actually caused plaintiffs' losses. But as Chico Marx once said, "who are you going to believe, me or your own two eyes?" Here's the opinion again -- whether you agree with Judge Pollack or not, it's fascinating reading.

2003-07-17T16:19:00.000-04:00

Panel Discussion On Lead Plaintiff/Lead Counsel Selection - The May 2003 edition of the Fordham Law Review contains a transcript of an interesting, if slightly dated, panel discussion on the selection of lead plaintiff/lead counsel in securities class actions. See 71 Fordham L. Rev. 2363 (panel discussion took place on Feb. 5, 2002). The panel participants included Judge Edward Becker (3rd Cir.), Judge Milton Shadur (N.D. Ill.), Jill Fisch (Professor - Fordham), Gregory Joseph (private attorney), and Mel Weiss (private attorney).

Quote of note (Judge Becker): "Congress originally thought that institutions in this new client-driven, as opposed to lawyer-driven, regime that it was creating would be the lead plaintiffs, but it really has not turned out that way. The only institutions that have agreed to be lead plaintiffs are public pension funds and a few union-related institutions. By and large, the mutual funds was the group that I think Congress had in mind--because they've got more stock than anybody in any of these corporations that go sour--but the mutual funds won't touch it. Doing a cost/benefit analysis, they think that it just ain't worth it for them to get involved. So the mutual funds have not come forth as lead plaintiffs. The private pension funds have not."

2003-07-17T15:32:00.000-04:00

The Enron Watch V - Mark your calendars. The judge in the Enron securities class action has laid out the case schedule. According to an article in the Houston Chronicle, the trial will commence on Oct. 17, 2005, provided, of course, that the case ever gets to that stage.

2003-07-16T19:46:00.000-04:00

The PSLRA: Much Ado About Nothing?- NERA, an economics consulting firm, has released its latest study on securities class actions entitled "Recent Trends in Securities Class Action Litigation: Will Enron and Sarbanes-Oxley Change The Tides?" The study reached the following conclusions about the trends in securities litigation since the passage of Sarbanes-Oxley in June 2002:

1) Securities class action filings have not increased dramatically (annual rate of 214 filings, compared to average annual rate of 208 filings from 1996-2001).

2) Dismissals have fallen sharply (half as many dismissals as in the previous 11 month period).

3) Average settlement values have fallen modestly ($22.7 million per settled case, compared to $25.5 million from 1996-2002).

These short-term trends are not nearly as interesting, however, as NERA's findings suggesting that the PSLRA (enacted in 1995) has not achieved Congress' goal of reducing meritless securities litigation. Indeed, the chances of a publicly-traded company being sued in a securities class action has increased (by 40.5%), while the percentage of cases dismissed (12-13%) or settled for nuisance value (24%) have remained roughly the same. These results lead to one question: has all of the controversy over the PLSRA (presidential veto, periodic calls for its repeal, etc.) been much ado about nothing?

Congress may want to take a hard look at the lessons of the PSLRA as it considers the Class Action Fairness Act and other tort reforms.

2003-07-15T19:16:00.000-04:00

Motion To Dismiss Filed In The AOL Time Warner Case - The New York Times is keeping on top of the AOL Time Warner securities class action. In a followup to its July 7 overview of the case (posted on The 10b-5 Daily), the paper has an article on the recently filed motion to dismiss. Among other things, AOL Time Warner argues that its restatement of $190 million is just 1% of its revenue over the period in question and that it disclosed all of its two-way deals with customers.

Quote of note: "The company's motion to dismiss the suit is an expected part of the proceedings, and legal scholars consider it unlikely to succeed. But the relative strength of AOL Time Warner's legal defense will help determine how costly it is for the company to resolve the suit, most likely through a settlement payment."

2003-07-15T12:25:00.000-04:00

Using Sarbanes-Oxley In Securities Litigation - The July 11, 2003 edition of the New York Law Journal contains an article (via law.com - regist. required) on the potential impact of the Sarbanes-Oxley Act of 2002 on securities litigation. The authors, Robert Jossen and Neil Steiner, discuss three issues: (1) the statute of limitations; (2) the advancement of legal fees for individual defendants; and (3) possible attempts to bootstrap violations of the act into Rule 10b-5 claims.

Quote of note: "One area that can be anticipated to be a field for imaginative claims concerns the new certification requirements of the act. Indeed, class action plaintiffs in at least two recent cases have included allegations that the company and its top executives filed the certifications required by Sarbanes-Oxley, but the underlying financial data nevertheless was incorrect. While those complaints do not take the next step and allege that the incorrect certification itself constituted a violation of the securities laws, it may be only a matter of time before defendants see class action complaints make such allegations."

2003-07-14T22:00:00.000-04:00

Double Down On Winnick - Gary Winnick, the former Global Crossing executive, was not amused to find that his likeness appears on the "Shareholders' Most Wanted" playing cards and sent a cease-and-desist letter directly to the distributers. The distributers, however, claim in this Reuters article that the letter was inappropriate because they are plaintiffs in the Global Crossing securities class action.

2003-07-14T19:16:00.000-04:00

IPO Settlement Examined - The San Jose Mercury News ran a story yesterday on the proposed settlement by the issuer defendants in the IPO allocation cases. The author states that investors should not expect a quick or large recovery. The 10b-5 Daily has an earlier post on the settlement terms.

Quote of note: "Like many average IPO investors, Gallagher is hazy on exactly what iBeam or its investment bank was alleged to have done wrong. But he feels he deserves a cut of the settlement anyway. 'I feel I deserve it because, well, I'm not certain why,' Gallagher said sheepishly. 'Nobody talked me into it, that's for sure. The opportunity was there, and I decided to go for it.'"

2003-07-14T18:54:00.000-04:00

Employees vs. Executives - The Atlanta Business Chronicle (via MSNBC News) has an article on the proliferation of ERISA class actions by employees being filed in the wake of similar securities class actions by shareholders. BellSouth and Scientific-Atlanta are two companies facing this situation. The 10b-5 Daily has commented on the issues raised by these parallel ERISA suits.

Quote of note: "The lawsuits are among the first in what could be many by members of company retirement plans, who, under federal law, can sue their employers more easily than average shareholders. Such lawsuits have already prompted some companies to extricate themselves from the process of overseeing their retirement plans."

2003-07-10T23:07:00.000-04:00

The Enron Watch IV - According to a Reuters article, the trial in the securities class action against Enron is now scheduled to begin in October 2005 (nearly four years after the company's bankruptcy).

Quote of note: "Kathy Patrick, a lawyer who represents Enron's outside directors, told the judge that discovery could produce more than 100 million pages of documents. She likened the case to 'the Bataan death march.'"

2003-07-10T00:41:00.000-04:00

Sarbanes-Oxley And The Statute Of Limitations - The June 27, 2003 edition of the National Law Journal contains a column (via law.com - subscrip. required) analyzing the case law on the statute of limitations for securities fraud cases. Sarbanes-Oxley has extended the statute of limitations "to the earlier of two years after the discovery of the facts constituting the violation or five years after such violation."

Quote of note: Sarbanes-Oxley "clearly provides that this amendment 'shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of this Act [July 30, 2002].' Left unresolved is whether the amendment salvages expired claims or extends the limitations period for pending claims. Compare Roberts v. Dean Witter Reynolds Inc., 2003 WL 1936116 (M.D. Fla. March 31, 2003) (holding that the amendment revives expired claims) with De La Fuente v. DCI Telecommunications Inc., 2003 WL 832009 (S.D.N.Y. March 4, 2003) (holding that the amendment does not apply to claims pending at time of enactment)."

2003-07-09T23:56:00.000-04:00

Who Sold The Hard Cheese? - The securities class action (along with another securities fraud case) against the former executives of Suprema Specialties, a bankrupt cheese manufacturer, have been dismissed by Judge William Walls of the D. of N.J. The Newark Star-Ledger reports that testimony and evidence in the related bankruptcy case raised questions about the validity of the company's "hard cheese" sales, but Judge Walls held that the allegations of fictitious sales in the securities fraud cases lacked details and failed to meet the applicable pleading standards.

Quote of note: "'The complaints certainly paint a picture of a company which was troubled and ultimately failed, a picture where, perhaps, something smelled a little funny,' Walls wrote in his June 25 decision. 'But the complaints lack the factual specificity demanded by (securities fraud law) and may not be so maintained.'"

2003-07-08T00:19:00.000-04:00

WorldCom Settlement Update II - WorldCom's proposed $750 million settlement (a combination of cash and stock) with the SEC has been approved by Judge Rakoff of the S.D.N.Y. The Associated Press report can be found here.

Quote of note: "Rakoff said killing the company 'would unfairly penalize its 50,000 employees, remove a major competitor from a market that involves significant barriers to entry, and set at naught the company's extraordinary efforts to become a model corporate citizen.'"

CorpLawBlog has posted a persuasive critique of the settlement. No word on how the settlement will effect the pending securities class actions.

2003-07-07T01:00:00.000-04:00

Status Of The AOL Time Warner Case - The The New York Times has a lengthy article in today's edition on the securities class action against AOL Time Warner. The author concludes that a dismissal of the case appears unlikely.

Quote of note: "In what one legal scholar called 'the judicial equivalent of a Freudian slip,' Judge Shirley Wohl Kram of United States District Court in Manhattan responded to a preliminary letter from shareholders' lawyers by ordering AOL Time Warner to turn over millions of pages of documents before the lawyers filed a formal motion or the company had a chance to respond. When AOL Time Warner's lawyers complained, she quickly rescinded the order."

Quote of note II: "[L]egal experts say that the settlement in this case may well exceed previous benchmarks and formulas because of the political impetus among judges and regulators these days to crack down on corporate fraud. 'There has been a regime change,' said Joseph A. Grundfest, a law professor at Stanford and a former member of the S.E.C., adding that 'settlements are more difficult for companies to negotiate in the post- Enron environment.'"

2003-07-06T23:37:00.000-04:00

NYT On The Merrill Lynch Case - On Friday, the New York Times ran a news analysis on Judge Pollack's decision in the Merrill Lynch case. Unfortunately, the author misstates the central holding in the case, leading to a number of erroneous conclusions. In support of the proposition that the decision has little precedential value, the article conflates two elements of a Rule 10b-5 claim that Judge Pollack took great pains to separate: reasonable reliance and loss causation. The article states: "The judge's point, instead, was that even if the research was fraudulent, the plaintiffs could not prove that their losses were tied to the research because they were not Merrill Lynch clients."

Wrong. Instead, as discussed in The 10b-5 Daily here, Judge Pollack held that the plaintiffs must "allege facts which, if accepted as true, would establish that the decline in the prices of 24/7 and Interliant stock (their claimed losses) was caused by any or all of the alleged omissions from the analyst reports." Finding that there was no alleged connection between the analyst reports and the companies' financial troubles or the collapse of the overall market, the court held that the plaintiffs failed to meet their pleading burden.

In other words, Judge Pollack's ruling is much broader than the New York Times suggests. The key was not whether the plaintiffs were Merrill Lynch clients and therefore could establish that they reasonably relied on Merrill Lynch's research. Judge Pollack notes in his decision that in a fraud-on-the-market class action, price inflation is typically used as a surrogate for reliance. Instead, the court focused on loss causation and whether the plaintiffs, presumably regardless of their status as Merrill Lynch clients, had adequately alleged that their investment losses were caused by the analyst reports. And that, as they say, is a bird of a different feather.

Addition: The 10b-5 Daily should note that the article's overall theme, that Judge Pollack's decision does not necessarily prevent Merrill Lynch clients from successfully bringing individual arbitration claims against the brokerage, is correct. It's simply correct for a different reason. Judge Pollack's decision addresses a fraud-on-the-market class action based on Rule 10b-5, it does not address every type of individual claim that might be brought against Merrill Lynch by a client (including breach of fiduciary duty, breach of contract, etc.).

2003-07-03T19:13:00.000-04:00

WorldCom Settlement Update - The Washington Post reports that WorldCom has sweetened its settlement with the SEC, offering $500 million in cash and $250 million in company stock. The 10b-5 Daily has commented on the proposed settlement here.

2003-07-03T18:56:00.000-04:00

Merrill Lynch Optimistic That Remaining Suits Will Be Dismissed - Having gone three-for-three in front of Judge Pollack of the S.D.N.Y. this week, Merrill Lynch is apparently optimistic that the remaining 24 securities class actions against the company based on allegedly biased research reports will be dismissed. According to a Reuters article, the general counsel of Merrill Lynch sent an e-mail to employees stating: "Although the dismissals apply only to these three class actions, we believe the reasoning of the decisions is equally applicable to other research-related class actions as well."

2003-07-03T18:37:00.000-04:00

Ninth Circuit Affirms Read-Rite Dismissal - The Securities Law Beacon reports that the Ninth Circuit has affirmed the dismissal of the securities class action against Read-Rite Corp. The court agreed with the lower court's determination that the plaintiffs failed to adequately plead scienter. The opinion can be found here.

2003-07-03T18:20:00.000-04:00

WSJ Profiles Judge Pollack - In the wake of his recent opinions, Judge Pollack of the S.D.N.Y. is profiled in today's Wall Street Journal (suscrip. required).

Quote of note: "Judge Pollack was just as brassy in his days as a plaintiffs' lawyer, said Michael Mukasey, chief judge of the Southern District where Judge Pollack sits. As Judge Mukasey tells the story, one day when taking a deposition from Spyros Skouras, then head of the 20th Century Fox movie studio, in Mr. Skouras's wood- paneled office, Mr. Pollack calmly selected a cigar from a humidor, bit off the end and lit up. Visibly reddening, Mr. Skouras said: 'Mr. Pollack, I don't remember offering you a cigar.' Mr. Pollack replied, 'Those aren't your cigars, those are the stockholders' cigars.'"

2003-07-02T19:18:00.000-04:00

Judge Pollack Strikes Again - For the second time in as many days, Judge Pollack of the S.D.N.Y. has dismissed a securities class action against Merrill Lynch. According to Reuters, the plaintiffs, investors in Merrill Lynch's Global Technology Fund, had alleged "they were duped in part because the fund invested in the stock of companies that Merrill Lynch investment bankers were doing business with."

Quote of note: "'She (the lead plaintiff) was suing on the same general theme of having bought some shares in a fund and that Merrill Lynch was responsible for the decline in the value of the funds,' Pollack told Reuters. 'I tossed her out.'"

Addition: The opinion in the Global Technology Fund case can be found here. (Thanks to the Securities Law Beacon for the link.)

2003-07-02T11:29:00.000-04:00

Investor Suits Based On Research Reports Dismissed - The Washington Post has a comprehensive article on the decisions by Judges Pollack and Baer of the S.D.N.Y. dismissing securities class actions against Merrill Lynch and other brokerages that were based on the dissemination of allegedly biased research reports about 24/7 Real Media Inc., Interliant Inc., and Covad Communications Group. The cases are part of 27 similar consolidated actions involving different stocks.

Judge Pollack's decision in the Merrill Lynch case is sweeping in its scope, with the court finding that "plaintiffs were among the high-risk speculators who, knowing full well or being properly chargeable with appreciation of the unjustifiable risks they were undertaking in the extremely volatile and highly untested stocks at issue, now hope to twist the federal securities laws into a scheme of cost-free speculators' insurance." (CorpLawBlog has a post discussing the rhetoric in the decision.) The court held that the plaintiffs had failed to adequately plead their Section 10(b) claims and that the claims were, in any event, barred by the statute of limitations.

Note that when it rains loss causation cases, it pours loss causation cases. In direct contrast to the Eighth Circuit's holding in ConAgra (discussed below), Judge Pollack found that merely alleging that the stock price was artificially inflated is not sufficient to satisfy loss causation. (Indeed, he states that to allow this "would undoubtedly lead to speculative claims and procedural intractability.") The plaintiffs needed "to allege facts which, if accepted as true, would establish that the decline in the prices of 24/7 and Interliant stock (their claimed losses) was caused by any or all of the alleged omissions from the analyst reports." Finding that there was no alleged connection between the analyst reports and the companies' financial troubles or the collapse of the overall market, the court held that the plaintiffs failed to meet their pleading burden.

Quote of note (Washington Post): "'This was something of a test case for [lawsuits] involving similar facts,' Pollack said. 'The question is, are the facts similar?" Pollack said he did not believe the case was a close one. "Anybody who goes out to Las Vegas and loses can't sue the croupier,' he said."

Quote of note II (Washington Post): "Columbia University law professor John C. Coffee Jr. called Pollack's decision 'a huge victory for Merrill Lynch' because the judge ruled that the losses were caused by the bursting of a bubble rather than the allegedly false research. 'That's the part of his decision that has the greatest application to other cases. It's [also] the most debatable. He doesn't have much factual evidence.'"

2003-07-01T23:11:00.000-04:00

Appellate Monitor (Materiality) - The Eighth Circuit's decision in the ConAgra case (Gebhardt v. ConAgra Foods, Inc., (8th Cir. June 30, 2003)) highlights how difficult it can be to establish the immateriality of alleged fraudulent statements at the motion to dismiss stage of a securities class action.

In ConAgra, plaintiffs alleged that the company had engaged in fraud by permitting its United Agri Products subsidiary to prematurely recognize revenue from sales where the delivery of the goods had not yet taken place. The Eighth Circuit found that "the problem was mostly one of having the money attributed to the wrong year, as opposed to not having ever made the money at all." As a result, "ConAgra's income, before taxes, was reduced by $111 million for the years 1998 through 2000, while its income for 2001 was increased by $127 million." When the restatement was announced in May 2001, the stock price dropped from $20.61 to $20.07. It quickly recovered, however, and began to trend higher.

The district court dismissed the case on two bases. First, the lower court noted that the amount of earnings misrepresented was merely .4% of ConAgra's total revenues during the years in question. The lower court concluded that "[a] reasonable investor with complete knowledge of the UAP accounting issues would have realized that ConAgra's overall earnings were basically unaffected by any of those issues." Second, the lower court held that the plaintiffs' pleadings failed to allege loss causation. The alleged misrepresentations were immaterial and the company's stock price was barely affected by the announcement of the restatement.

The Eighth Circuit disagreed with both conclusions. On the issue of materiality, the appellate court found that focusing on the percentage of total revenues misstated was insufficient. As a result of its revenue recognition problems, ConAgra overstated its net income for 1999 and 2000 by 8%. A discrepancy of that magnitude is not immaterial as a matter of law. The appellate court also found that it was inappropriate for the lower court to rely on the fact that ConAgra was eventually able to receive the revenues it prematurely recognized. The company "could not know for certain it would receive the profits it had booked." Accordingly, a reasonable investor, at the time of the misrepresentation, may have found information about the premature revenue recognition to be material.

As for loss causation, the Eighth Circuit found that because the alleged misrepresentations were material, the plaintiffs can "invoke the fraud-on-the-market theory and assume that the misrepresentations inflated the stock's price." Even though the stock price did not decline when the restatement was announced, the appellate court declined "to attach dispositive significance to the stock's price movements absent sufficient facts and expert testimony, which cannot be considered at this procedural juncture, to put this information in its proper context."

The Eighth Circuit's opinion leaves little room for a materiality argument to succeed on a motion to dismiss. Here, the amount of the restatement was relatively small (even for net income), the company's overall finances were unaffected, and the stock market had virtually no reaction upon being told of the problem. Nevertheless, the appellate court goes out of its way to justify a finding that materiality and loss causation were adequately plead, including dismissing the lack of a negative stock market reaction by holding that "stockholders can be damaged in ways other than seeing their stocks decline. If a stock does not appreciate as it would have absent the fraudulent conduct, investors have suffered harm." The allegations in the case, however, were that the company's stock price was artificially inflated, not lowered, as a result of the misrepresentations.

Holding: Judgment of the district court reversed.

Quote of note: "A reasonable investor might be concerned about one of ConAgra's subsidiaries reporting earnings not yet received, especially if this was done under orders from ConAgra's senior management. The fraud-on-the-market theory then would allow the fact finder to presume that the stock's price reflected the inflated earnings, and it makes sense to conclude that the plaintiffs were harmed when they paid more for the stock than it was worth."

Addition: Note that the Eighth Circuit comes to virtually the opposite conclusion on materiality as the S.D.N.Y in the Allied Capital case. A discussion of Allied Capital can be found here.

Addition: Note also that other courts have expressly rejected the idea that the fraud on the market theory supports a presumption of loss causation. See, e.g., Robbins v. Koger Props, Inc., 116 F.3d 1441, 1448 (11th Cir. 1997).

2003-07-01T13:06:00.000-04:00

Ahold Update - The Baltimore Business Journal has an article on the litigation pending against Ahold NV based on alleged accounting fraud at U.S. Foodservice, its Columbia, MD subsidiary. The Judicial Panel on Multidistrict Litigation has consolidated the shareholder and employee suits in the D. of Md. before Judge Catherine C. Blake. The 10b-5 Daily has previously posted about the large number of suits that have been filed in this case.

2003-07-01T10:48:00.000-04:00

Eighth Circuit Overturns ConAgra Dismissal - The Associated Press reports that the 8th Circuit has overturned the district court's dismissal of the securities class action against ConAgra Foods, Inc. Plaintiffs allege that ConAgra overstated the earnings of its subsidiary, UAP, by recognizing sales when the delivery of the goods had not yet taken place. As a result, ConAgra prematurely recognized revenue in the years 1998 through 2000. The case was originally filed in the D. of Neb.

The court's opinion can be found here and contains an interesting discussion of materiality. More to follow.

2003-06-30T23:37:00.000-04:00

Motion To Dismiss Monitor (Safe Harbor) - The PSLRA creates a safe harbor for forward-looking statements to encourage companies to provide investors with information about future plans and prospects. There are two prongs to the safe harbor. First, a defendant shall not be liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by "meaningful cautionary statements" that alert investors to the factors that could cause actual results to differ. Second, a defendant shall not be liable with respect to any forward-looking statement, even in the absence of meaningful cautionary statements, if the plaintiff cannot establish that the statement was made with "actual knowledge" that it was false or misleading.

As noted by numerous commentators, the statutory scheme arguably gives companies a license to lie. If a company uses appropriate cautionary language, it can make a forward-looking statement that it knows to be false without fear of liability. Accordingly, courts have struggled with how to apply the first prong of the safe harbor where the plaintiffs allege that the defendants knew their forward-looking statements were false and merely offered cautionary language to create a smoke screen for their fraud.

In In re Seebeyond Technologies Corp. Sec. Litig., 2003 WL 21262498 (C.D. Cal. May 28, 2003), the court disagreed that the safe harbor permits knowing falsities. The key is the requirement that the cautionary language be "meaningful." The court found that "[i]f the forward-looking statement is made with actual knowledge that it is false or misleading, the accompanying cautionary language can only be meaningful if it either states the belief that it is false or misleading or, at the very least, clearly articulates the reasons why it is false or misleading."

This reading of the statute is subject to a number of objections, some of which the court itself raises. First, it appears to require a court to determine whether the statement was made with actual knowledge of falsity as a prerequisite for determining whether the cautionary language was meaningful. Congress did not impose a state of mind requirement in the first prong of the safe harbor; leaving that examination for forward-looking statements that are not accompanied by cautionary language. Second, other courts have held that to take advantage of the safe harbor, a defendant is not required to have identified the exact factor that ultimately rendered the statement untrue. It is enough to have cautionary language that reasonably alerted investors to the risks. The court's holding would appear to severely weaken this principle - as long as the plaintiff adequately alleges actual knowledge, the defendant's disclosure is never sufficient unless the exact factor that ultimately rendered the statement untrue is revealed. The bottom line: Congress is going need to solve this one.

Holding: Motion to dismiss granted in part and denied in part (plaintiffs were allowed to proceed with their claims based on forward-looking statements).

Quote of note: "Subsection (A) may still provide safe harbor where cautionary language is used, even if the defendant has actual knowledge that the statement is false or misleading. The idea that sufficient cautionary language may be used when the defendant has actual knowledge that a statement is somehow misleading (for instance, where the company is engaging in 'puffery' of some sort) is not so far-fetched."

2003-06-27T00:28:00.000-04:00

Daimler-Chrysler Update - As discussed previously in The 10b-5 Daily, Chrysler Corp.'s former shareholders have brought a class action in the D. of Del. alleging that Daimler-Benz misrepresented the acquisition of Chrysler as a "merger of equals" to avoid paying them a takeover premium for their shares. The court recently certified the class and things are continuing to go well for the plaintiffs. The Associated Press reports that Judge Farnan has denied the portion of Diamler-Benz's summary judgment motion based on the statute of limitations.

Quote of note: "In his ruling on DaimlerChrysler's statute of limitations argument, Farnan wrote: 'I agree with the plaintiffs' assertion that they could not have known that the merger-of-equals representations were false until Schrempp revealed his true intent in the Financial Times article.' Farnan has not yet ruled on other parts of DaimlerChrysler's motion for summary judgment."

2003-06-27T00:10:00.000-04:00

Enron's Employees Get Three Bites At The Apple - There is already a securities class action and an ERISA class action seeking damages on behalf of Enron's employees who invested in Enron stock through the company's pension plan. Now the Department of Labor is joining the bandwagon. The Houston Chronicle reports that the DOL has brought its own ERISA claim on behalf of the employees for violations of the pension laws. The suit "accuses former Chairman Ken Lay, former CEO Jeff Skilling, the former board of directors and officers on a committee overseeing Enron's retirement plans with failing to fulfill their responsibilities." Reuters also has an article.

Just as in the securities and ERISA suits, however, the DOL's suit appears to focus on alleged false statements that induced employees to invest in the stock at artificially high prices. But isn't this circumventing the PSLRA? (See this post for a discussion of the conflict.) And aren't the public and private ERISA suits going after the exact same sources of recovery? (See this post about a similar overlap problem between the SEC and securities class actions.)

Quote of note (Houston Chronicle): "'Mr. Lay went so far as to tout Enron stock as a good investment for employees even after he had information on the accounting scandals,' said Elaine Chao, U.S. Secretary of Labor."

Quote of note (Reuters): "Radzely [Labor Solicitor] later told Reuters that the department would seek to recover money where it could, including from each individual defendant and from an $85 million fiduciary liability insurance policy that covers some of them. But the court will determine the extent of each defendant's liability, he said. 'We're going to go wherever the money is,' he added."

Benefitsblog has collected links to related articles.

2003-06-26T22:37:00.000-04:00

Restoring Aiding and Abetting Liability - There is an interesting Reuters article on the nascent, but perhaps growing, movement to override the U.S. Supreme Court's decision in the Central Bank case and restore aiding and abetting liability in private Rule 10b-5 cases. While the absence of aiding and abetting liability does not completely shield a company's lawyers, accountants, and bankers from litigation risk, it does make it more difficult for investors to bring claims against them.

Legislation to restore aiding and abetting liability has been proposed in the House of Representatives (see this earlier post). Meanwhile, courts (notably in the Enron case) have begun to chip away at Central Bank's holding by creating a broad definition of "primary violator."

Quote of note: "Rolling back Central Bank of Denver to expose corporate advisers to more liability is favored by plaintiffs' lawyers who bring suits on behalf of shareholders. 'This rule is important ... Many, if not, most frauds involve participation of a whole network of assistors,' said Jon Cuneo, spokesman for the National Association of Shareholder and Consumer Attorneys."

2003-06-26T15:35:00.000-04:00

Issuers To Settle IPO Allocation Cases - The big news today is the proposed settlement for $1 billion of the more than 300 cases against companies who made initial public offerings of their shares in the high-tech boom years. The cases, known as the "IPO Allocation" cases, were previously consolidated in the S.D.N.Y. Plaintiffs have alleged, as summarized by Reuters, that the issuers and/or their underwriters "manipulated the market with optimistic research; ramped up trading commissions in exchange for access to IPO shares; and that investors allocated IPO shares were required to buy shares in the after-market to help push up the share price."

The key to the settlement, however, is that the companies and their insurers may never have to pay a dime. Indeed, they may even get to recoup their costs for defending against the litigation to date. A Bloomberg article on the proposed settlement explains that the companies are only liable for the difference between $1 billion and what the plaintiffs are able to collect from the underwriter defendants. In other words, if the plaintiffs recover more than $1 billion from the underwriter defendants, the companies will not have to make any payment. If the plaintiffs recover more than $5 billion from the underwriter defendants, the companies will actually be able to recover various expenses associated with the litigation. In return, the companies appear to have assigned any related claims they may have against the underwriters to the plaintiffs.

2003-06-25T21:46:00.000-04:00

Looking For Trouble In Promising Places - An article in the Financial Times examines the recent "Mass Torts Made Perfect" seminar held in Chicago. The trial lawyers in attendance appear to agree that Wall Street is a ripe target, with the $1.4 billion settlement by the investment banks for analyst fraud merely the beginning.

Quote of note: "Mike Papantonio, the head of the mass tort department at Florida law firm Levin, Papantonio who has a record of securing million-dollar awards, said: 'The money from Spitzer is a drop in the bucket. [Investment bank] reserves need to be in line with the major pharmaceutical companies.'"

2003-06-25T21:20:00.000-04:00

Class Action Against Arthur Anderson May Proceed - Reuters reports that the S.D.N.Y. has denied Arthur Anderson's motion to dismiss a WorldCom-related securities class action pending against the defunct accounting firm. The suit "accuses Andersen of failing to properly review and investigate WorldCom's adjustments and journal entries in its books and argues the firm should have discovered the $11 billion accounting fraud at the telephone company."

2003-06-24T23:40:00.000-04:00

Deloitte Touche Bermuda To Stand Trial - Deloitte Touche Bermuda is accused of aiding and abetting the Manhattan Investment Fund's alleged $400 million fraud through audits it conducted for the 1996 and 1997 fiscal years. On Monday, the New York Law Journal reports, the S.D.N.Y. rejected a summary judgment motion by the accounting firm. Among other things, Deloitte had argued that the court lacked subject matter jurisdiction because the plaintiffs are not U.S. citizens.

Quote of note: "'All of the causes of action and defendants are tied together through their connection to the single scheme which was the fraud committed by Berger [who controlled the hedge fund] in New York,' [Judge] Cote said. 'It matters not, therefore, whether any beneficial owner of shares in the Fund or the two named plaintiffs are United States citizens.'"

2003-06-24T23:20:00.000-04:00

El Paso Update - A few weeks ago The 10b-5 Daily speculated that Oscar Wyatt, Jr., who was both helping to finance the attempt to oust the current board of El Paso Corp. and acting as the lead plaintiff in a shareholder class action against the company, would be in an interesting position if the dissident slate of directors won. Would his interests be sufficiently aligned with the the interests of the rest of the class if El Paso was controlled by individuals he had helped elect? We'll never know. The Houston Chronicle reported last week that the incumbent board of directors was reelected in a close vote.

Quote of note: "Wyatt, who founded a company, Coastal Corp., that was later sold to El Paso, is the lead plaintiff in a shareholder lawsuit accusing El Paso of federal securities violations. Kuehn [El Paso's CEO] recognized Wyatt to speak [at the shareholders' meeting]. 'Mr. Kuehn, you don't really need to recognize me. I'm recognized by a lot of people, which is something you are not.'"

Quote of note: "Several dozen shareholders cast their ballots at the meeting, including those who were undecided heading in. Among them was Jacqueline Goettsche of Katy who said she bought shares of El Paso four months ago just so she could attend the meeting. 'It's more exciting than going to the opera,' Goettsche said."

2003-06-20T19:18:00.000-04:00

ERISA Claims Against WorldCom Can Proceed - In case anyone thought that the issues noted by The 10b-5 Daily here were merely theoretical, along comes the motion to dismiss decision in In re WorldCom Inc. ERISA Litigation (S.D.N.Y.). As reported yesterday in the New York Law Journal (via law.com), the court made two rulings of note: 1) it dismissed the ERISA claims against directors and employees who it found were not fiduciaries under ERISA; and 2) it held that ERISA claims could be brought against WorldCom's former CEO both for failing to disclose material facts about the company's financial condition and for making affirmative missrepresentations concerning the prudence of investing in the company's stock in SEC filings. The second ruling was made despite the former CEO's argument that his duty to disclose arose under the securities laws and not ERISA. Benefitsblog has a full summary of the opinion.

Quote of note (from the opinion): "When a corporate insider puts on his ERISA hat, he is not assumed to have forgotten adverse information he may have acquired while acting in his corporate capacity."

Quote of note (from the opinion): "Ebbers' potential liability to employees who invested in WorldCom stock through the Plan for violations of the federal securities laws cannot shield him from suit over his alleged failure to perform his quite separate and independent ERISA obligations."

2003-06-19T15:15:00.000-04:00

Motion to Dismiss Monitor (Scienter) - The opinion in the Interpublic Group case (In re Interpublic Securities Litigation, 2003 WL 21250682, (S.D.N.Y. May 29, 2003)) is a must-read because it brings three strands of questionable law together to eviscerate the PSLRA's scienter (i.e., fraudulent intent) pleading requirement. It has taken The 10b-5 Daily a while to get around to addressing the opinion, but only because there is so much to say!

A little background is in order. Interpublic (“IPG”) is a New York holding company that ranks as the second-largest owner of advertising agencies in the world. The case is the result of a restatement IPG announced last August for the five years from 1997 to 2001, which corrected inter-company charges that had been wrongly declared as income for the European offices of one of IPG's agencies.

The three strands of questionable law are:

1) Section 20(a) liability has no scienter element- Section 20(a) of the '34 Act creates a cause of action against defendants alleged to have been "control persons" of those who engaged in securities fraud. Good faith may be asserted as an affirmative defense. Six circuit courts have held that plaintiffs do not have to show that the control persons acted with scienter (the 5th, 7th, 8th, 9th, 10th, and 11th Circuits); two have held that such a showing is required (the 3rd and 4th Circuits). The Second Circuit has not definitively answered the question, but has stated that to prove a Section 20(a) claim a plaintiff must show, inter alia, "that the controlling person was in some meaningful sense a culpable participant." Although some district courts in the Second Circuit have found that this creates a scienter pleading requirement, others have disagreed. The effect of no scienter requirement, however, is that the heightened pleading standards of the PSLRA do not apply. All plaintiffs need to show at the pleading stage is: (a) there was a primary violation by a controlled person; and (b) control of the primary violator by the defendant.

2) Corporate acquisitions for stock can be a motive for securities fraud - There is a line of cases, especially in the Second Circuit, which hold that a desire to acquire other companies through the use of stock as consideration may be a sufficient allegation that defendants had a motive to make misstatements for the purpose of artificially inflating the stock price. (Note that the question of whether the motive and opportunity to commit fraud is sufficient, on its own, to establish scienter for a Rule 10b-5 claim is a whole separate debate. The Second Circuit has held that it is, but other circuit courts have disagreed.) The relatively unexplored question is: motive for whom? The company may benefit from obtaining another entity at a cheap price, but the “concrete benefit” for the individual defendants (i.e., officers or directors) is in the value of their stock. So in the absence of stock sales by the individual defendants at an inflated price (with the acquisition presumably included), are corporate acquisitions really a motive for individual defendants to commit fraud?

3) Personifying the company - It is generally understood that a company acts through its officers and directors. As a result, courts uniformly hold that allegations of scienter as to the individual defendants in a securities fraud case can be used to plead a claim against the company. In other words, the scienter of the individual defendants is imputed to the company. But is the reverse true? Can a securities fraud case continue against a company if there are insufficient allegations of scienter as to the individual defendants? For some courts, the corporate acquisitions motive appears to be the answer to this question. In In re IPO Securities Litigation, 241 F.Supp.2d 281 (S.D.N.Y. 2003), for example, the court separately examined the motive allegations against the companies and the individual defendants that had been sued. For the companies, the court considered whether there had been stock-based acquisitions or add-on offerings during the class period. For the individual defendants, the court looked at stock sales during the class period. In other words, the motive of a company to commit fraud was evaluated without reference to the motive of the company's officers or directors.

All of which leads to the holdings in IPG opinion, the perfect storm that happens when these three strands of questionable law come together. As to the Rule 10b-5 claims in the case, the court made the following rulings: (a) the series of stock-for-stock acquisitions made by IPG during the class period created a strong inference that IPG had acted with scienter; and (b) there were insufficient allegations concerning the individual defendants' stock sales and knowledge of the accounting problems to create a strong inference that the individual defendants had acted with scienter. As a result, the Rule 10b-5 claims were allowed to continue against IPG, but were dismissed against the individual defendants.

The individual defendants were not, however, free to go. Since they controlled IPG and the court had found that a Rule 10b-5 claim was adequately pled against IPG, the Section 20(a) claims for controlling person liability against the individual defendants still remain.

This is a troubling result on two levels. By analyzing the scienter of IPG separately, the court, in essence, ends up holding that IPG acted with fraudulent intent, but its officers and directors did not. How can a company do anything if not through its officers and directors? Moreover, the PSLRA was designed to protect individuals from unsubstantiated securities fraud claims. By applying Section 20(a) in this manner, the court allowed the plaintiffs to bypass the heightened pleading requirements for scienter in the PSLRA. Based on the IPG holding, plaintiffs merely have to establish that the company had a motive for fraud (or, one supposes, that some unnamed person at the company knew of the misstatements or was reckless with respect to them), and can then continue to bring their securities fraud claims against both the company and its officers and directors (in the form of Section 20(a) claims) without having to make any specific scienter allegations concerning the individual defendants. That does not comport with the PSLRA’s requirement that scienter be sufficiently alleged as to each defendant.

This post covers a lot of ground. Readers comments, as always, are welcome.

2003-06-18T22:07:00.000-04:00

Scandals Are Expensive - The Associated Press has an article discussing the financial costs associated with the problems at Rite-Aid Corp. The 10b-5 Daily has previously posted about the related securities class action here. Interestingly, both plaintiffs' counsel and an independent expert appear to agree that it is very difficult to determine the actual damages suffered by Rite-Aid's shareholders as a result of the alleged fraud.

2003-06-17T12:52:00.000-04:00

More Accounting Problems At Tyco - The Wall Street Journal (subscription required) reports today that Tyco International Ltd. will "restate its financial results back to 1998 to correct $696.1 million that it mistakenly classified as pretax charges in recent quarters." It is the fifth time in seven months that Tyco has announced accounting problems. The restatement will not change the overall financial results for the Company during the period in question.

As discussed here in The 10b-5 Daily, Tyco is a defendant in a securities class action in the D. of N.H.

Quote of note: "The restatements also complicate Tyco's legal situation in shareholder lawsuits it is facing over scandals that have battered its share price. Once companies restate, plaintiffs no longer have to prove past financial statements were wrong."

2003-06-17T11:38:00.000-04:00

Using ERISA To Avoid The PSLRA - It is axiomatic that bad facts make for bad law. One area of the law that is changing rapidly in response to the recent corporate scandals is Employee Retirement Income Security Act of 1974 ("ERISA") litigation. ERISA creates a right of action against company executives overseeing employee stock ownership plans who violate their fiduciary duties to the plan participants.

The recent trend, however, is for employees who lost retirement savings as a result of their investment in company stock to file an ERISA class action against the company that parallels the pending securities class action on behalf of all investors. In other words, the employees allege the company and its officers violated their fiduciary duties under ERISA by making false statements that induced employees to invest in the stock at artificially inflated prices. These parallel ERISA class actions have been filed, for example, against Enron, Qwest, WorldCom, and Global Crossing.

ERISA class actions based on false statements to the market are problematic for two reasons. First, the suits attempt to significantly expand the scope of ERISA liability to include officers not responsible for the management of plan assets and statements that are not related to plan benefits. David Gische and Jo Ann Abramson of Ross, Dixon & Bell have an excellent overview of these issues in an article entitled "Corporate Fiduciary Liability Claims in the Post-Enron Era" that was written last year. (Thanks to the Securities Law Beacon for the link.) Second, the suits allow plaintiffs to make an end run around the procedural safeguards of the PSLRA. Because they are brought under ERISA, rather than the federal securities laws, plaintiffs can obtain early discovery and seek to force a quick settlement. An article in Monday's edition of The Recorder discusses the growth of these suits and their overlap with securities class actions.

Quote of note (The Recorder): "One of the reasons companies don't always mount the most aggressive defense to ERISA suits is that any settlement comes from a fiduciary liability insurance fund -- separate from insurance for securities litigation -- that's often untapped. Consequently, the mainstream securities fraud bar usually has no problem with the ERISA suits."

Quote of note II (The Recorder): "Courts are still working out the limits of fiduciary duties in these cases . . . For example, what if an executive has inside information that the company's financial picture isn't as good as touted? As fiduciaries, shouldn't they divest employee stock? Sure. But wouldn't that be insider trading?"

2003-06-17T00:25:00.000-04:00

4th Circuit Upholds Dismissal of Duratek Case - The U.S. Court of Appeals for the Fourth Circuit has upheld the dismissal of a securities class action against Duratek, Inc., a Columbia, Md.-based company that disposes of radioactive waste materials for nuclear facililties. The opinion can be found here.

Any securities litigation opinion from the Fourth Circuit has the potential to be big news, because the court has never decided whether recklessness suffices to meet the scienter requirement for 10b-5 actions and, correspondingly, what a plaintiff must plead to satisfy the PSLRA's heightened pleading standards for scienter. But no luck today. Duratek is a per curiam opinion and simply holds that "even under the lenient Second Circuit standard" the complaint failed to adequately plead scienter.

2003-06-17T00:04:00.000-04:00

The Enron Watch III - According to an article in the Houston Chronicle, the federal judges overseeing Enron's bankruptcy and securities class action suits have appointed a new mediator for the settlement negotiations. As noted here in The 10b-5 Daily, the judges previously gave the job to U.S. District Judge Kevin Duffy of the S.D.N.Y. Judge Duffy's name was withdrawn, at his request, a week later. They did not go far to find Judge Duffy's replacement -- the new mediator will be Senior U.S. District Judge William Conner, also of the S.D.N.Y.

2003-06-16T18:45:00.000-04:00

The Big Breakup Keeps Getting Press - The Los Angeles Daily Journal has an article on the Milberg Weiss split, including further speculation on the causes. (Thanks to Corp Law Blog for the link.)

2003-06-16T12:30:00.000-04:00

Monday Morning Settling - Nanonphase Technologies Corp. (Nasdaq: NANX) and Cutter & Buck Inc. (Nasdaq: CBUK) have agreed to settle the securities class actions pending against them.

Nanophase will pay $2.5 million to settle claims arising from the Company's public disclosures in 2001 regarding its dealings with Celox, a British customer.

Cutter & Buck will pay $4 million in cash, plus an additional $3 million based on a formula applied to any recovery of funds from its ongoing suit against its D&O insurer (who has evidently sought to rescind its policy). The settlement also covers a separate derivative suit and includes the implementation of certain corporate governance policies.

2003-06-16T11:51:00.000-04:00

The Martha Stewart Watch III - Well, it's not exactly about Martha Stewart, but it's related. Judge Owen of the S.D.N.Y. apparently has denied the motions to dismiss in the two securities class actions against ImClone Systems, Inc. (Nasdaq: IMCLE).

2003-06-16T11:40:00.000-04:00

WP Supports Class Action Reform - Over the weekend, the Washington Post editorial page came out in favor of the Class Action Fairness Act.

2003-06-13T16:28:00.000-04:00

Rising Insurance Costs II - There was a comprehensive article on the topic of D&O insurance a few weeks ago in The Journal News (which covers Westchester, Rockland, and Putnam counties in N.Y.). The author finds that both insurers and companies are struggling in the current environment. While insurers have been forced to pay out huge claims over the past few years due to corporate fraud and understandably want to limit their risk, the rise in premiums hits companies just as they are trying to weather the weak economy. Annual premiums of $1 million or more have become commonplace, with large cap companies often paying much more.

Quote of note (1): "Companies in industries that have gained dubious publicity for corporate fraud, such as securities, health care, technology and telecommunications, are getting hit the hardest, says Pam Sedmak, a partner in Sedmak & Co., and executive search firm in Cleveland. Sedmak says executives that her firm recruits for clients now routinely ask for details on the coverage the company's insurance will offer them if they're named as defendants in a lawsuit or investigation by the U.S. Securities and Exchange Commission or other agency. 'They're putting their personal wealth at stake, not to mention their freedom,' she says of those who dare serve as a top executive or director of a public company."

Quote of note (2): "Besides the lawsuits that have already been filed, the uncertainty about how much liability directors and officers will have in future claims is also driving premiums up, says attorney Lance Kimmel, an author of the Foley & Lardner study. That's because it remains to be seen how courts rule on claims brought against officers and directors who are alleged to have violated the Sarbanes-Oxley law, which Congress passed last year to police corporate conduct."

Quote of note (3): A insurance broker states that "she has seen companies go from policies that provided $10 million in coverage with a $100,000 deductible to policies that provide $5 million in coverage and carry a $200,000 deductible. Even with the inferior coverage, the new policy costs more, she says."

2003-06-13T13:15:00.000-04:00

Rising Insurance Costs - An important piece of the securities class action puzzle is directors and officers liability insurance ("D&O insurance"). Due in large part to the surge in shareholder claims severity over the past few years, the premiums paid by companies have skyrocketed. According to a 2002 survey by Tillinghast-Towers Perrin:

1) Companies paid nearly 30% more for D&O insurance in 2002 (a similar increase occurred in 2001);

2) Although claim frequency and severity for most type of claims has stabilized, the average indemnity paid for shareholder claims has increased to $23.35 million, compared with $17.8 million in 2001, and $9.62 million in 2000; and

3) There was a decrease in the D&O average policy limits for the first time in 8 years (which may be a result of the dramatic rise in costs).

2003-06-12T17:37:00.000-04:00

House Passes Class Action Reform - Reuters reports that the Class Action Fairness Act of 2003 has been approved by the U.S. House of Representatives by a vote of 253-170.

Quote of note: "Rep. James Sensenbrenner, a Wisconsin Republican and chairman of the House Judiciary Committee, said forcing cases into federal court would stop lawyers forum-shopping for sympathetic state courts such as in Madison County, Illinois, where a judge recently granted a $10.1 billion verdict in a suit against cigarette maker Philip Morris. 'The class action judicial system itself has become a joke, and no one is laughing except the trial lawyers, all the way to the bank,' Sensenbrenner said."

2003-06-12T00:42:00.000-04:00

Certification Granted In DaimlerChrysler Suit - Of course, there are always exceptions to the rule. The class certification appeal provision in the Class Action Fairness Act of 2003 (see below) might have played a role in the case by Chrysler Corp.'s former shareholders against DaimlerChrysler AG. The investors allege that Daimler-Benz AG misrepresented the acquisition of Chrysler as a "merger of equals" to avoid paying Chrysler shareholders a takeover premium for their shares. Bloomberg reports that District Judge Farnan of the D. of Del. has certified a class, over the defendants' objections, that includes both U.S. shareholders who exchanged their shares in the transaction and U.S. shareholders who purchased or acquired DaimlerChyrsler shares after the merger through November 2000 (when the fraud was allegedly revealed).

2003-06-12T00:16:00.000-04:00

House To Vote On Class Action Reform - The U.S. House of Representatives will hold a vote today on the Class Action Fairness Act of 2003. As noted previously in The 10b-5 Daily, the legislation applies some of the reform concepts in the PSLRA and SLUSA to all class actions. Notably, the House bill (a) requires most class action suits with more that $2 million at issue to be heard in federal court (unless the substantial majority of the plaintiffs are from the same state as the principal defendants), (b) allows parties to appeal class certification rulings, and (c) attempts to limit "coupon" settlements. The House is expected to pass the bill.

The New York Times, in a lengthy article on the bill, states that the class certification appeal provision "could cause delays in pending federal-court cases that seek to recover money lost through the corporate scandals at Enron and other large companies." The newspaper evidently is not familiar with how securities class actions are usually resolved (i.e., before the class certification stage of the case). The Washington Post is also covering the story.

Quote of note (NY Times): "'Just about every industry group is on the bandwagon on this because every industry is affected,' said Lawrence Fineran, the vice president for regulatory and competition policy at the National Association of Manufacturers. For the business community, the bill is the most significant lawsuit-related legislation since Congress overrode President Bill Clinton's 1995 veto of a bill to limit private lawsuits for securities fraud. 'It's the biggest thing in years,' Mr. Fineran said."

Addition: The House bill specifically excludes securities class actions from its jurisdiction provisions, presumably to avoid any conflict with SLUSA.

Addition: The final House bill changed its jurisdiction provision to match the jurisdiction provision in the Senate bill. As a result, it now provides for class action suits to be heard in federal court when fewer than one-third of the plaintiffs are from the same state and when the plaintiffs' claims total at least $5 million.

2003-06-11T20:05:00.000-04:00

Still More On The Big Breakup - A Reuters article provides additional information on the post-split structure.

Quote of note: "Weiss cautioned that details of the breakup plan were still being discussed and that timing was unknown. But if the plan plays out, he said, 'the present Milberg Weiss will continue as an entity. Another firm will be formed by Mr. Lerach.'"

Addition: A story in The Recorder confirms that Milberg Weiss is likely to split into East Coast and West Coast operations, with the firm's San Diego and San Francisco offices forming a separate entity. The article also speculates on the reasons behind the split.

2003-06-11T11:41:00.000-04:00

More On The Big Breakup - The New York Times has an article in today's edition on the fate of Milberg Weiss (the San Diego Union Tribune has also run a story). Citing inside sources, the Times article states that the firm is likely to split in two, with East Coast and West Coast operations.

Quote of note (1) - "'In reality, once the dust settles, the 800-pound gorilla simply becomes two 400-pound gorillas,' said Paul J. Geller, a partner at Cauley Geller Bowman Coates & Rudman, a plaintiff firm with about 25 lawyers. He said the possible breakup was not that surprising because running a large firm financed by fees from unpredictable litigation and settlements was a significant challenge."

Quote of note (2) - "Dividing up lawyers might be a much thornier task. And at some point, lawyers at rival firms pointed out, the San Diego descendant firm would almost certainly want to open a New York office and the New York office would want to build a presence in California."

Quote of note (3) - "A Milberg Weiss lawyer, who spoke on the condition that he not be named, said a reason for both the partner departures and the split of the firm was the obvious one: money. 'It's easier to make money with fewer lawyers,' he said, 'and plaintiffs' lawyers at the end of the day want to make money.'"

2003-06-10T21:09:00.000-04:00

Breaking Up Is Hard To Do - Milberg Weiss Bershad Hynes & Lerach, widely recognized as the leading plaintiffs' securities class action firm, is breaking up. The Houston Chronicle reports today that the 200-lawyer firm will dissolve over the next few months, with the lawyers regrouping into smaller firms. Milberg Weiss has seven offices located throughout the country. The split, however, will not be "simply geographical."

Quote of note: "Lerach said he hopes that the resulting smaller firms will be 'friendly' competitors."

2003-06-09T17:15:00.000-04:00

Amended Complaint In Dynegy Case - The Houston Chronicle reports (in last Friday's edition) that an amended complaint has been filed in the securities class action against Dynegy, Inc. (NYSE: DYN). The amended complaint alleges that Dynegy hid an $850 million loan from Citicorp, known as the "Black Thunder" transaction, in an off-balance-sheet company in 2000 to avoid a downgrade of Dynegy's debt. The Black Thunder loan is one of two transactions cited in the suit.

Quote of note: "The deadline for filing the amended complaint against Dynegy had been extended numerous times to enable the company and plaintiffs time to negotiate a settlement. A spokesman for the University of California [the lead plaintiff in the case] would not confirm whether those talks were still under way but said the school remains open to settlement talks."

2003-06-09T13:00:00.000-04:00

Interpublic Decision - The 10b-5 Daily previously noted that there has been a decision in the Interpublic Group case. The opinion (In re Interpublic Securities Litigation, 2003 WL 21250682, (S.D.N.Y. May 29, 2003)) turns out to be a must-read for a number of reasons. More on this later in the week.

2003-06-08T00:15:00.000-04:00

What Happens If Your Lead Plaintiff Gets Involved In Running The Company? - There was an interesting Associated Press story on Friday about the ongoing proxy battle and securities class action involving El Paso Corp., a Houston-based provider of natural gas services. Oscar Wyatt, Jr. is the founder of Coastal Energy, which was sold to El Paso in 2001. As a result of the sale, Wyatt owns 5 million shares of El Paso. Currently, Wyatt is both helping to finance the attempt to oust the current board and acting as the lead plaintiff in a shareholder class action accusing "the company of hiding debt, reporting revenue from so-called 'wash' energy trades and defrauding investors." If the dissident slate of directors wins, however, can Wyatt continue as the lead plaintiff in the class action (even if he will not be a board member)? A court might find that Wyatt's interests are no longer sufficiently aligned with the interests of the rest of the class.

Addition: The Associated Press has a follow-up story about a full-page ad criticizing El Paso's management that Wyatt ran in the Sunday edition of the Houston Chronicle.

Addition: The June 9 edition of Fortune has a lengthy profile of Wyatt and El Paso. The story states: "People familiar with the matter say that even if Wyatt wins [the proxy battle], he'll continue to push forward with the lawsuit."