June 14, 2013
Fire The Torpedoes
The class certification decision in In Diamond Foods, Inc. Sec. Litig., 2013 WL 1891382 (N.D. Cal. May 6, 2013) contains a number of interesting holdings.
(1) Market efficiency is an issue for the finder of fact - A rebuttable presumption of reliance based on the fraud-on-the-market theory is only available to plaintiffs if the company's stock traded on an efficient market. Market efficiency means that the company's stock price reflected all publicly available information, which is typically tested by examining a number of empirical factors. In Diamond Foods, the court noted that the Supreme Court and the Ninth Circuit have never addressed "whether market efficiency is an issue for the jury to determine in trial (or, where appropriate, summary judgment), or is a matter reserved for the judge." The court concluded, however, that the majority of courts correctly "treat efficiency as an issue for the finder of fact."
(2) Comcast decision inapplicable to securities class actions - In the Supreme Court's recent Comcast decision, it held that class certification should be denied if damages are incapable of measurement on a classwide basis. The Diamond Foods court found that the Comcast holding was inapplicable to securities class actions, where it is widely accepted that an event study can be "used to identify the economic loss caused by alleged fraud." Indeed, the defendant failed "to identify any specific complications that would make such a calculation impossible or ill-advised in this case."
(3) Pay-to-play allegations insufficient to find proposed class representative inadequate - The lead counsel had made political contributions to Mississippi Attorney General Jim Hood, who controlled the lead plaintiff's selection of counsel. The court found that none of the contributions, however, were made "after counsel were approved by the Court in June 2012." While lead counsel also had made contributions to the Democratic Attorneys General Assocation in 2012, there did not appear be any "communication between the law firms and Attorney General Hood, or his office, regarding any expectation that the law firms contribute to DAGA or that such contributions would eventually make their way to Attorney General Hood." Accordingly, the court held that "[d]efendant has not advanced a record adequate to torpedo this action based on a pay-to-play theory."
Holding: Motion for class certification granted.
May 31, 2013
In Massachusetts Retirement Systems v. CVS Caremark Corp., 2013 WL 2278599 (1st Cir. May 24, 2013), the plaintiffs asserted that the company had failed to disclose integration problems following a merger. The district court dismissed on loss causation grounds, holding that the complaint did not plausibly allege that the company's statements prior to the stock price decline, which related to lost contracts, revealed the supposed fraud. On appeal, the First Circuit provided guidance on how to evaluate loss causation.
(1) "Mirror-image" disclosure not required - The court found that "a corrective disclosure need not be a 'mirror-image' disclosure - a direct admission that a previous statement is untrue." Although the company did not attribute its lost contracts to integration issues, the company's statements "plausibly revealed to the market that CVS Caremark had problems with service and the integration of its systems." In particular, the court noted that the strongly negative analyst and stock price reaction "likely reflected an understanding that something systemic had gone wrong."
(2) Lost contracts v. reason for lost contracts - The defendants argued that CVS Caremark's loss of certain clients "was public knowledge" well before the disclosures that led to the stock price decline. The court agreed that the market knew about the lost contracts, but concluded that the core allegation in the complaint was that the disclosures revealed "for the first time the real reason for the loss: the failed integration of CVS and Caremark" and "this new information could plausibly have caused [the plaintiffs] losses."
(3) Use of analyst reports - To support their assertions about the "meaning" of the company's disclosures, the plaintiffs relied heavily on analyst reports. The court held that "[w]hen a plaintiff alleges corrective disclosures that are not straightforward admissions of a defendant's previous misrepresentations, it is appropriate to look for indications of the market's contemporaneous response to those statements." In this case, the analyst reports plausibly reflected an understanding that "the merger had failed to produce any value for CVS Caremark" and the reports "should have been considered in deciding the motion to dismiss."
Holding: Dismissal vacated and case remanded for further proceedings.
May 24, 2013
Reading the Tea Leaves
Section 11 of the '33 Act creates liability for material misrepresentations in a registration statement. According to the Second Circuit (Fait) and Ninth Circuit (Rubke), however, if the alleged misrepresentation is an opinion, the plaintiff must establish that the opinion was both objectively false and disbelieved by the defendant at the time it was made. In effect, these rulings convert a Section 11 claim based on an opinion from a strict liability (the company) or negligence (the individual defendants) standard to a knowing falsity standard.
The Omnicare securities litigation has generated a number of decisions discussing the pleading standards for Section 11 claims. After the district court dismissed the case, the Sixth Circuit reversed as to the Section 11 claim, finding that the district court had erred by requiring the plaintiffs to plead loss causation. The plaintiffs initially pursued a writ of certiorari on the issue of whether Section 11 claims can be subject to the heightened pleading standard of FRCP 9(b), but then, after the U.S. Supreme Court asked for the government's view of the cert request, withdrew their petition and went back to the district court. The district court then dismissed the Section 11 claim again, finding that the alleged misrepresentations were opinions and the plaintiffs had failed to sufficiently plead the defendants' knowledge of falsity.
In Indiana State District Council of Laborers v. Omincare, Inc., 2013 WL 2248970 (6th Cir. May 23, 2013), the court examined the "knowing falsity" rule for opinions. The court found that while it "makes sense that a defendant cannot be liable for a fraudulent misstatement or omission under Section 10(b) and Rule 10b-5 if he did not know the statement was false at the time it was made" that logic does not extend to strict liability claims. Under Section 11, if a defendant "discloses information that includes a material misstatement, that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity." Nor was the court persuaded by the reasoning of the Second and Ninth Circuits, which had relied on the Supreme Court's decision in the Virginia Bankshares case interpreting a non-strict-liability securities statute. According to the court, "it would be unwise for this Court to add an element to Section 11 claims based on little more than a tea-leaf reading in a Section 14(a) case."
Holding: Dismissal reversed in part and affirmed in part.
May 17, 2013
Shrug, Concur, and Move On
In a famous market manipulation that lead to multiple criminal convictions, the A.R. Baron brokerage engaged in a pump-and-dump scheme to induce customers to purchase the securities of small companies at artificially inflated prices. Among many others, investors sued an individual whose acts allegedly facilitated Baron's frauds in violation of Section 10(b). The district court dismissed the Section 10(b) claim.
On appeal, the Second Circuit addressed this dismissal (Fezzani v. Bear Stearns & Co., Inc., 2013 WL 1876534 (2d Cir. May 7, 2013) (Lohier, J. dissenting). The court found that manipulation violates Section 10(b) "when an artificial or phony price of a security is communicated to persons who, in reliance upon a misrepresentation that the price was set by market forces, purchase the securities." The Supreme Court, in its decisions in Stoneridge and Janus, has held that in a Section 10(b) claim involving a misrepresentation there can only be primary liability for entities or individuals who actually communicated the misrepresentation to the injured investors. Applying that principle in the instant case, the court found that because there was no allegation that the individual defendant actually communicated the artificial price information to the investors (as opposed to assisting Baron in its fraud), there could be no Section 10(b) primary liability.
In a vigorous dissent, however, one of the panel members challenged whether Stoneridge and Janus are applicable in a case alleging market manipulation. The dissent noted that a "market manipulation claim permits the plaintiff to plead that it relied on an assumption of an efficient market free of manipulation, whereas a misrepresentation claim requires the plaintiff to allege reliance upon a misrepresentation or omission." As a result, a plaintiff alleging market manipulation is entitled to use a fraud-on-the-market theory to establish reliance (i.e., the defendant engaged in a transaction that sent a fale pricing signal to the market, which was then communicated by the market to the investor). Accordingly, the dissent concluded, the fact that the individual defendant was a key participant in the transactions that sent a false pricing signal was sufficient to establish Section 10(b) primary liability.
Holding: Dismissal affirmed.
Quote of note (dissent): "I fear that every market manipulator . . . will be cheered by the extra shelter for stock manipulation under the federal securities laws that the majority opinion unnecessarily provides them. If I thought that Stoneridge or Janus required that result, I would shrug, concur, and move on. Because I conclude that neither case forecloses the federal claim of market manipulation against Dweck, I respectfully dissent."
May 10, 2013
Based on the Supreme Court's recent decisions, a plaintiff is not required to prove the existence of loss causation (Halliburton) or materiality (Amgen) to certify an investor class. In the Halliburton case, however, the defendants pursued a related issue on remand. Halliburton argued that it should be allowed to rebut the fraud-on-the-market presumption of reliance by establishing that the alleged misrepresentations did not have a stock price impact. The district court found that price impact evidence did not bear on the critical inquiry of whether common issues predominated under FRCP 23(b)(3) and certified the class. Halliburton appealed.
In Erica P. John Fund, Inc. v. Halliburton Company, 2013 WL 1809760 (5th Cir. April 30, 2013), the Fifth Circuit found that "Halliburton's price impact evidence potentially demonstrates that despite the presence of the necessary conditions for market price incorporation of fraudulent information (fraud-on-the-market reliance), no such incorporation occurred in fact." Although this evidence certainly could be used at trial to refute the presumption of reliance, the court questioned whether it was appropriate to consider it at class certification.
Under Amgen, the court held, price impact evidence should not be considered if it is "common to the class" and if there is no risk "that a later failure of proof on the common question of price impact will result in individual questions predominating." The court found that both criteria were met and the district court did not err in declining to consider Halliburton's price impact evidence. First, "price impact is ordinarily established by expert evaluation of a stock's market price following a specific event and it inherently applies to everyone in the class." Second, although defeating the presumption of reliance would presumably still leave open the possibility of individual claims, "[i]f Halliburton were to successfully show that the price did not drop when the truth was revealed, then no plaintiff could establish loss causation." Accordingly, the claims of all individual plaintiffs would fail.
Holding: Affirming grant of class certification.
Addition: As detailed in a February 2010 post, the Halliburton case has a remarkable procedural history that now includes a Supreme Court decision and two Fifth Circuit decisions on class certification. What next?
April 26, 2013
Cornerstone Report On Accounting Cases
(1) The number of accounting filings fell from 78 in 2011 to 45 in 2012. Two factors that contributed to this decline were the overall decrease in filings and the specific decrease in Chinese reverse merger cases (which frequently include accounting allegations).
(2) The proportion of accounting filings involving restatements (36%) and internal control weaknesses (67%) remained relatively constant.
(3) Accounting cases are less likely to be dismissed and more likely to settle than non-accounting cases. In 2012, accounting cases were less than 70% of the settled cases, but represented more than 90% of the total value of settlements.
April 19, 2013
All The CLE You Could Possibly Want
It is not too late to sign up for PLI's Handling a Securities Case 2013: From Investigation to Trial and Everything in Between. The program takes place on Thursday, April 25 in New York and via webcast. The details can be found here.
Lyle Roberts of Cooley LLP (the author of The 10b-5 Daily) is co-chairing the program. The outstanding faculty will cover a wide range of topics, all while following a hypothetical case from the initial investigation through trial. There even will be a panel on ethical issues, for those in need of ethics credits.
Hope to see you there.
April 12, 2013
Draining the Safe Harbor
Securities class actions alleging that a company issued false or misleading earnings guidance are frequently dismissed. Among other things, to overcome the PLSRA's safe harbor for forward-looking statements a plaintiff must adequately plead (a) the guidance was not accompanied by "meaningful cautionary statements" and (b) the company had "actual knowledge" of its falsity. Given the vagaries of business performance, courts generally find that one or the other pleading burden has not been met.
With that background, the decision in City of Providence v. Aeropostale, Inc., 2013 WL 1197755 (S.D.N.Y. March 25, 2013) is interesting because the court found that the plaintiffs successfully plead an "earnings guidance" claim, albeit with the help of a unique fact pattern and (arguably) a misreading of the law. Aeropostale is a clothing retailer. In the second half of 2010, the company decided to change the design of its women's fashion line and placed orders for the new styles that would provide inventory through the fall of 2011. The new styles sold poorly and, in December 2010, the company fired the officer who led the change.
In response to the poor sales, Aeropostale provided 2011 earnings guidance that was below its 2010 results. According to the complaint, however, this guidance still understated the sales and inventory problems and failed to disclose that the unpopular new styles had been pre-ordered and would continue to be stocked for the next several quarters. The defendants argued that its earnings guidance (and other statements about the company's future performance) were protected by the PSLRA's safe harbor, but the court disagreed.
First, the court found that Aeropostale had failed to provide "meaningful cautionary statements." While the company disclosed risks concerning "consumer spending patterns," "fashion preferences," and "inventory management," its failure to disclose that the new styles would continue to be sold throughout most of 2011 meant that these risks were not hypothetical. Accordingly, the cautionary statements were inadequate because they did not "disclose hard facts critical to appreciating the magnitude of the risks described."
Second, the court found that the "safe harbor does not apply to material omissions" and, as a result, the failure to dislose the pre-ordering of the unpopular new styles was "unprotected by the safe harbor, regardless of whether the statements thereby rendered misleading were forward-looking." Because the court "declined to find that the misleading nature of the statements rests on the forward-looking aspects of the statements," it also declined to find that the safe harbor's "actual knowledge" requirement was applicable.
The court's interpretation of the scope of the safe harbor is questionable (and perhaps unnecessary, given the court's general view of the strength of the complaint's allegations). The PSLRA expressly states that the safe harbor applies "in any private action that is based on an . . . omission of a material fact necessary to make the statement not misleading." While the safe harbor does not apply to statements of current fact (whether they are alleged to be misstatements or rendered misleading by a material omission), that is different than concluding that the safe harbor does not apply to forward-looking statements that are alleged to be misleading because of the omission of a current fact. Indeed, reading the statute in this manner would severely limit its application. Plaintiffs routinely allege that a company's projections were misleading based on its failure to disclose certain current facts.
Holding: Motion to dismiss denied.
Addition: The complaint also contained "opinion evidence from an expert in the retail and wholesale industry," who concluded that the "Defendants had no reasonable basis to believe that Aeropostale could meet the guidance they issued." Although the court summarized this opinion evidence in its decision, it also stated that it "did not consider any of the 'expert testimony' that was included - inappropriately in the Court's view - in the pleading."
April 5, 2013
The Sun May Not Rise Tomorrow
The Boeing securities class action related to its development of its 787-8 Dreamliner plane continues to provide some drama. In 2011, as noted on this blog, the district court granted the company's motion to dismiss (on a motion for reconsideration) after it was determined that a key confidential witness denied being the source of the allegations attributed to him in the complaint, denied having worked for Boeing, and claimed to have never met plaintiffs' counsel until his deposition. The plaintiffs appealed this decision to the U.S. Court of Appeals for the Seventh Circuit.
In City of Livonia Employees' Retirement System and Local 295/Local 851, IBT v. Boeing Company, 2013 WL 1197791 (7th Cir. March 26, 2013), the court affirmed the dismissal based on the complaint's failure to establish a strong inference of scienter. The opinion, authored by Judge Posner, contains some interesting commentary.
(1) Motive - The plaintiffs alleged Boeing had failed to disclose in a timely manner that the Dreamliner's first test flight would be cancelled. The court noted that the law does not require the disclosure of the mere risk of failure. Indeed, "[n]o prediction - even a prediction that the sun will rise tomorrow - has a 100 percent probability of being correct . . . If a mistaken prediction is deemed a fraud, there will be few predictions, including ones that are well-grounded, as no one wants to be held hostage to an unknown future." Moreover, it was unclear what motive Boeing would have had to put off the announcement, with the court wryly concluding that the main effect would be to "undermine Boeing's credibility with its customers and expose the company to a multi-hundred million dollar lawsuit for securities fraud."
(2) Confidential Witness - The court found that the recantation of the key confidential witness was fatal to the plaintiffs' claims, because his supposed evidence provided the only basis for concluding that the company knew (at an earlier date) that the first flight test would be cancelled. Moreover, the confidential witness would no longer be useful because "[e]ither he had told the investigator the same thing he said in his deposition, which would be of no help to the plaintiffs and would expose the investigator as a liar, or he had had made the opposite assertions on the two occasions, in which event he was the liar, which wouldn't help the plaintiffs either."
(3) Sanctions - The defendants had cross-appealed for sanctions. The court strongly suggested that sanctions were appropriate in the case, noting that the plaintiffs' lawyers "failure to inquire further [about the supposed evidence from the confidential witness] puts one in mind of ostrich tactics - of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing." Nevertheless, the court remanded the case to the lower court to determine whether sanctions should be imposed.
Holding: Dismissal affirmed, but case remanded for consideration of whether to impose Rule 11 sanctions.
March 21, 2013
Cornerstone Releases Report on Settlements
(1) There were 53 settlements in 2012, involving $2.9 billion in total settlement funds. While the overall number of settlements represents a 14-year low, the total settlement funds increased by more than 100% from 2011. The increase in total settlement funds was due in large part to an increase in $100m+ settlements (accounting for nearly 75 percent of all settlement funds in 2012).
(2) The average reported settlement amount increased from $21.6 million (2011) to $54.7 million (2012). There also was a sharp increase in the median settlement amount from $5.9 million (2011) to $10.2 million (2012). The key factor identified by Cornerstone as responsible for the increase in settlement values was a spike in the median "estimated damages" associated with the settled cases (a significant portion of which were related to the credit crisis).
(3) More than 50% of the settled cases were accompanied by a derivative action filing, compared with a post-Reform Act average of 30%. The presence of a derivative action historically coincides with a higher settlement value for the related securities class action.
Quote of Note (press release): "Class action securities fraud litigation is, like many other lines of business, ‘hit driven,’ in that a small number of settlements often account for a large percentage of the dollar flow. That fact of life can make annual settlement data quite lumpy. Settlement trends are often best viewed over time periods longer than a year, and by carefully analyzing settlement data to reflect the underlying characteristics of the cases being settled. So, just as a lull in last year’s data suggested a pickup for this year in the aggregate statistics, it is always possible that this year’s bump could cause total settlement dollars to tick downward next year."