Central Bank Can’t Save Third Party Banker Defendants

Citigroup and CSFB had best break out the Stovetop, because they are definitely staying in the Parmalat securities class action, Central Bank or no Central Bank. You see, Judge Lewis A. Kaplan (S.D.N.Y.) has largely denied their motions to dismiss (as he did with Parmalat’s foreign auditors in another opinion reported by the Nugget last month, albeit on very different grounds). This time, Judge Kaplan tackles Plaintiffs’ 1934 Act claims against the banks for "(1) structuring and participating in transactions that were hidden or mischaracterized on Parmalat's financial statements" and (2) "making certain statements or omissions in connection with the foregoing, allegedly in violation of Rule 10b-5(b)."

The banks, hunkering down under Central Bank of Denver, N.A. v. First Interstate Bank of Denver, 511 U.S. 164 (1994) argued that "that they were at most aiders and abettors of a program pursuant to which Parmalat made misrepresentations on its financial statements." However, Judge Kaplan found that this argument "misses the mark," as "the transactions in which the defendants engaged were by nature deceptive" because "they depended on a fiction, namely that [certain worthless] invoices [that Citigroup purchased and securitized] had value."
Where most opinions simply analyze violation of Rule 10b-5, Judge Kaplan’s analysis went further. He analyzed the claims under 10b-5’s subsections, namely 10b-5(a) and (c). The banks argued that "subsections (a) and (c) apply only to the narrow category of acts understood as ‘manipulative’ in a technical sense." However, Judge Kaplan found that "this interpretation is refuted by the language of the rule as well as the case law, which make it clear that subsections (a) and (c) apply to at least some deceptive acts as much as to certain technical forms of market manipulation."

While being careful to note that his analysis of these subsections "is not a back door into liability for those who help others make a false statement or omission in violation of subsection (b) of Rule 10b-5," Judge Kaplan noted the "lack of precision" that many pre-Central Bank courts implemented when "dealing with primary violations as compared with aiding and abetting liability." For example, "for decades the distinction between the conduct covered by subsections (a) and (c) on the one hand, and subsection (b) on the other was largely insignificant. A corollary is that courts for the most part found it unnecessary to consider the extent to which the phrase ‘manipulative or deceptive device or contrivance’ in Section 10(b) applied to conduct other than misrepresentations, omissions, and market manipulation." He concluded that "it no longer is possible, however, to ignore these issues.

Thus, "the major question here is whether the banks directly or indirectly used or employed any device or contrivance with the capacity or tendency to deceive." He then parsed and separated each bank’s activities, finding that some of their activities satisfied this test, while others did not. He concluded by holding that "the complaint alleges that the banks' actions in connection with the relevant transactions actually and foreseeably caused losses in the securities markets. The banks made no relevant misrepresentations to those markets, but they knew that the very purpose of certain of their transactions was to allow Parmalat to make such misrepresentations. In these circumstances, both the banks and Parmalat are alleged causes of the losses in question. So long as both committed acts in violation of statute and rule, both may be liable."

Remains to be seen how many Plaintiffs will pick up this new twist against third party defendants.

You can read the decision, issued July 13, 2005, at 2005 U.S. Dist. LEXIS 14542.

Nugget: "It is impossible to separate the deceptive nature of the transactions from the deception actually practiced upon Parmalat's investors."

Nugget: "This analysis is not an end run around Central Bank. If a defendant has committed no act within the scope of Section 10(b) and Rule 10b-5 -- as in fact was the case in Central Bank -- then liability will not arise on the theory that that defendant assisted another in violating the statute and rule. But where, as alleged here, a financial institution enters into deceptive transactions as part of a scheme in violation of Rule 10b-5(a) and (c) that causes foreseeable losses in the securities markets, that institution is subject to private liability under Section 10(b) and Rule 10b-5."

Judge Steers Mutual Fund Investors to State Court

An investor bringing direct claims against "a number of defendants acting as mutual fund directors, advisors and affiliates of the Nuveen Family of Funds," for failing "to ensure that the funds participated in dozens of securities class action settlements for which they were eligible" has been handed a loss (at least on his federal claims) by Judge Milton I. Shadur (N.D. Ill.). You may recall the Nugget covered another case that reached a similar result last month, although James V. Selna (C.D. Cal.) took a slightly different approach in getting there.

In evaluating Plaintiff’s 1940 Act claims under § 36(a) (alleging "personal misconduct") Judge Shadur found that only the SEC could assert this claim, not private plaintiffs, because the Supreme Court’s recent decision in Exxon Mobil Corp. v. Allapattah Servs., Inc., 125 S.Ct. 2611 (2005) "forecloses any possibility of using Section 36(a)'s clear legislative history to create a private right of action where the unambiguous statutory language creates none." The court also held that "Congress plainly did not create Section 36(a) as a catchall for any fiduciary breach."

As for the Plaintiff’s 1940 Act claims under § 36(b) (for breach of fiduciary duty), Judge Shadur held that Plaintiff’s "’real complaint’ is that defendants made a poor management decision by failing to participate in dozens of settlement agreements for which some fund was eligible, and he has not alleged any inherent improprieties in the compensation agreement itself." In addition, "the textual and legislative history arguments previously addressed as to Jacobs' unsuccessful Section 36(a) claim have equal force as to Section 36(b)." Nailing the coffin, Judge Shadur ruled that "because the flaws identified here would not be resolved if Jacobs were to attempt to replead a derivative action, his Section 36(b) claim is dismissed without leave to replead."

As for Plaintiff’s "state law claims of negligence and breach of fiduciary duty," the court dismissed those "without prejudice" "so that those claims can be pursued in state court."

Bet we haven't seen the last of these Plaintiffs.

You can read the decision, issued July 20, 2005, at 2005 U.S. Dist. LEXIS 14762.

Nugget: "The prevailing caselaw has read ‘personal misconduct’ to require some showing of self-dealing. [Plaintiff] has advanced no such allegations, instead setting out a garden-variety fiduciary claim, which remains the domain of state law."

Court Wields SLUSA in Tossing Mutual Fund Action

In October 2003, an investor filed a putative class action in Madison County, Illinois against the Templeton Funds, alleging that the Fund “breached a duty of care owed to investors by using stale pricing information to value securities in their open end mutual funds” (to be more specific, during the interval that elapses between when the Fund sets its share Net Asset Value (or “NAV”) and releases it to the NASD for communication to the public, securities markets in countries such as Japan, Russia, Germany, and Australia have traded for an entire session, thus making the prices stale).

Anyway, a month after the case was filed, Templeton promptly removed the action to the Southern District of Illinois. However, Judge Michael J. Reagan sent the case back to the state court, finding that his federal forum had no subject matter jurisdiction. Over a year later, Defendants again removed the case, “claiming that the Seventh Circuit's April 5, 2005 opinion in an unrelated case, Kircher v. Putnam Funds Trust, 403 F.3d 478 (7th Cir. 2005), rendered” the action “freshly removable.” Judge Reagan noted that the Seventh Circuit’s opinion held that “SLUSA's removal and preemption provisions are triggered when four conditions are met: (1) the underlying suit is a "covered class action," (2) the action is based on state or local law, (3) the action concerns a "covered security," and (4) the defendant misrepresented or omitted a material fact for employed a manipulative or deceptive device or contrivance "in connection with the purchase or sale" of that security.” Since the judge found that the four conditions had been satisfied, he held removal proper, and further found that “Kircher mandates that this Court dismiss all of Plaintiffs' state law claims as barred by SLUSA,” as SLUSA “effectively blocks state court litigation of such claims.”

You can read the decision, issued July 12, 2005, at 2005 U.S. Dist. LEXIS 14500.

Nugget: “Plaintiffs -- whose briefs focused on removal under 28 U.S.C. § 1446(b) -- have not addressed the removability of the case under the above-cited SLUSA provision. Nor have Plaintiffs disputed Defendants’ argument that the allegations in this action are ‘identical’ to those examined by the Seventh Circuit in Kircher.”

KPMG Tagged as "Virtual Pushover" in Xerox Decision.

Judge Alvin W. Thompson (D. Conn.) has denied all of the motions to dismiss in the Xerox securities class action, which brings ’34 Act claims against the company, six of its executives, and KPMG. According to Plaintiffs, Xerox "was able to meet Wall Street's earning expectations only by engaging in massive accounting fraud." In doing so, Defendants "used a smorgasbord of methods to misstate Xerox's earnings, revenues and margins in virtually every reporting period throughout the Class Period." Xerox's "improper accounting methodologies throughout the Class Period included" what its auditor "KPMG referred to" as "half-baked revenue recognition," and rampant abuse of "Cookie Jar Reserves," just to name a couple. In fact, "without such accounting manipulations, Xerox would not have met earnings expectations in 11 of 12 quarters during 1997-1999 . . . Moreover, by 1998, almost $ 3 of every $ 10 of annual pre-tax reported earnings and up to 37 percent of Xerox's reported quarterly pre-tax earnings were generated through undisclosed accounting manipulations." Internally, Xerox "approved of and expressly directed the use of ‘accounting actions’" when referring to the accounting manipulations. In fact, a former Xerox Assistant Treasurer (who was fired when he attempted to expose the fraud), "stated that many executives at Xerox had developed the attitude ‘There is no accounting standard we can't beat.’" How's that for a marketing slogan?

Initially, Xerox tried to blame everything on its "Mexican subsidiary," (sounds a little like the runaway bride, doesn’t it), but eventually that ruse was exposed. By the time the dust of two restatements settled (along with what was at the time the largest SEC fine in history), Xerox shareholders were stuck with "a total reduction in profits of nearly $ 2.4 billion for the years 1997 to 1999." Ouch.

Given these facts, the court appears to have had little trouble denying each Defendant’s motion to dismiss. The court found that the factual allegations "make it clear that this is not a case of a client innocently relying on advice from its accountants," as the "Xerox Defendants knew the company was underperforming and used accounting manipulations to bridge the gap between actual versus desired financial results," the CFO "informed Xerox senior management, including both the chief executive officer and the chairman of the Board of Directors, that without the benefit of the accounting actions, Xerox had essentially no growth through the late 1990s, that the directives as to the accounting manipulations emanated from Xerox senior management," "that many of the Xerox Defendants' accounting manipulations involved violations of simple and unambiguous accounting principles, and in specified instances, the Xerox Defendants were told by their accountants that the accounting action violated GAAP but proceeded with the action anyway," "that the Xerox Defendants insisted that KPMG replace its senior audit engagement partner when he refused to sign off on one of their proposals," and "filed a minimal restatement and came out with a press release saying they had cleaned everything up, knowing full well that the staff of the SEC still had serious problems with Xerox's accounting."

As for the six executives’ knowledge, the court said "the plaintiffs do not allege scienter on the part of the Individual Defendants simply by virtue of the positions those individuals held at Xerox, but rather by virtue of the fact that Xerox's senior management orchestrated the scheme to disguise the company's true operating performance and the directives as to the accounting manipulations emanated from Xerox senior management at corporate headquarters."

Finally, the court denied KPMG’s request to dismiss the case, as "the factual allegations in the Complaint do, in fact, portray KPMG as a virtual pushover in its dealings with the Xerox Defendants, which at a minimum went along with accounting practices it knew to be clear violations of GAAP, and which, even after it was clear early in 2001 that there were very serious concerns about Xerox's accounting practices and it was apparent that it was questionable--at best--whether Xerox took seriously its obligation to comply with applicable accounting rules, was intimidated into signing off on a minimal restatement of Xerox's financial statements that accounted for only a small portion of Xerox's overstatements of revenues and pre-tax earnings."

C'mon guys, don't be so negative. Look at the bright side. At least there should be plenty of copiers available for all those documents those pesky owners (a/k/a shareholders) will soon be subpoenaing.

You can read the decision, issued July 13, 2005, at 2005 U.S. Dist. LEXIS 14427.

Nugget: "The PSLRA does not require a plaintiff to prove his case in his complaint. And, it is appropriate to recall that the heightened standard of pleading scienter was meant simply to prevent strike suits and other abuses that had arisen in securities fraud litigation. . . . Plaintiff generally must frame the facts respecting the defendant's mental state (i.e., the scienter element of the claim) without the benefit of discovery, and therefore, most often, allegations about a defendant's culpable state of mind must be drawn from limited state of mind evidence augmented by circumstantial facts and logical inferences."

Potential Minefield Awaits When Similar Securities Class Actions Settle

What’s a lead plaintiff to do when two potentially overlapping securities class actions are pending at the same time, and the other one settles? Who knows, but in the Citigroup/Global Crossing litigation we can see how one plaintiff’s choice turned out. In the action that settled, Plaintiffs alleged "that the Citigroup defendants participated in defrauding them by, among other things, issuing analytic reports on Global Crossing and Asia Global Crossing that misrepresented the defendants' true views of the prospects of those companies." In the other action, investors who had accounts with Salomon (n/k/a Citigroup) allege they received similar recommendations that were tainted by conflicts of interest that were undisclosed.

So when Citigroup settled with plaintiffs in the first action, the lead plaintiff in the other action objected, arguing that the release could be construed to apply to his claims against some of the same defendants. Well, that wasn’t good enough for Judge Gerard E. Lynch (S.D.N.Y.), who denied the objection, holding that if the objector "seeks, in the separate action, damages attributable to trading losses in Global Crossing securities, such damages result directly from the same alleged misconduct at issue in this case." "The losses were incurred as a result of the same investment decision, as a result of the same alleged misconduct, resulting in the same loss to the same plaintiff. If [the objectors] have a different legal theory of liability based on these facts, which they believe is stronger, and therefore more likely to yield a larger recovery or a better settlement, than the theories being advanced by Lead Plaintiffs, they were free to opt out of the present class and pursue recovery based on that theory." The objectors "are not free, however, to remain a part of the instant class, partake of an award of damages under the present settlement, and then pursue further damages in a separate action based on the same losses arising from the same investment decision as a result of the same misconduct. Any such result would be substantively unfair, as well as frustrating to class action settlements."

You can read the decision, issued July 12, 2005, at 2005 U.S. Dist. LEXIS 14245.

Nugget: "A defendant can hardly be expected to settle an action based on claims of a particular wrong, pay damages to plaintiffs under that settlement, and then have to continue to defend claims by some of the same plaintiffs for further compensation based on the same harm."

Nugget: "That is a question that can only be resolved as the facts and legal theories in his lawsuit are developed and litigated."

Split Continues with Securities Act Claims Remanded

Further widening the split of authority on whether SLUSA allows defendants to remove covered class actions from state to federal court when the complaint only asserts federal causes of action under the 1933 Act, Judge R. Gary Klausner (C.D. Cal.) has ruled in the Salem Communications Corporation action that he will not permit it. In finding that the "plain meaning" of SLUSA prohibits removal, the court declared that "the language of the 1933 Act clearly states that removal is allowed only for class actions" "based upon the statutory or common law of any State." "Thus, the plain language of the amended 1933 Act allows only for the removal of state claims or for federal claims brought along with state claims."

As for Defendants’ reliance on SLUSA’s legislative history, Judge Klausner recognized that "while some pieces of SLUSA's legislative history might, standing alone, show a desire by Congress to move many security class action claims to federal court, when taken as a whole the legislative history does not show a clearly contrary congressional intent," because "for instance, the Senate and the House stated that SLUSA was designed to limit the conduct of securities class actions under state law," and "these statements are consistent with Plaintiffs' proposed interpretation."

You can read the decision, issued June 28, 2005, at 2005 U.S. Dist. LEXIS 14202.

Nugget: "Two district courts in this Circuit have reached opposite conclusions."

LIFO Wins the Day in Lead Plaintiff Battle

Back in the free-wheeling carefree days of late 1995, the PSLRA’s new approach for selecting the lead plaintiff in securities class actions probably seemed enticingly simple. A court merely chooses the plaintiff (or group of plaintiffs) with "the largest financial interest" to serve at the helm. Despite these lofty hopes, one of the man problems is determining exactly what each plaintiff’s losses actually are. In calculating these losses, courts have long struggled with whether to use the "first-in, first out" ("FIFO") or the "last-in, first out" ("LIFO") technique. They’ve gone both ways, but LIFO wins this time around.

Judge Shira A. Scheindlin (S.D.N.Y.) recognized that "the FIFO method is often used by courts," however she noted that "more recently, courts have preferred LIFO and have generally rejected FIFO as an appropriate means of calculating losses in securities fraud cases. Moreover, in a number of instances where courts have used FIFO to calculate financial loss, they have done so reluctantly. LIFO, by contrast, has been used not only for lead plaintiff calculations, but also to determine compensation amounts for stockholders suffering losses due to securities fraud." Also, "the main advantage of LIFO is that, unlike FIFO, it takes into account gains that might have accrued to plaintiffs during the class period due to the inflation of the stock price. FIFO... ignores sales occurring during the class period and hence may exaggerate losses."

Judge Scheindlin also observed that the lead plaintiff applicant using FIFO "sold shares of eSpeed stock during the class period, when the price was inflated," and therefore its "losses due to eSpeed's alleged fraud were actually somewhat cushioned by the sales made when eSpeed's stock price was high." "By contrast, the other group’s utilization of LIFO reflects offsetting 'gains' that were attained through the sale of stock during the class period. This method matches the last purchases made during the class period with the first sales made during the class period." This further "demonstrates why FIFO... is inferior to LIFO."

Finally, in an unusual twist, the LIFO group (well, the group’s five individuals aren’t actually called that, they're styled as the Adib Group) isn’t quite the lead plaintiff just yet. The court wrote that "members of the class now have the opportunity to present evidence, if they wish, in an attempt to rebut the Adib Group's presumptive status. If no evidence is submitted or the evidence submitted is inadequate to rebut the presumption, the Adib Group will be named as the lead plaintiff."

You can read the decision, issued July 13, 2005, at 2005 U.S. Dist. LEXIS 14104.

Nugget: "The lead plaintiff determination does not depend on the court's judgment of which party would be best lead plaintiff for the class, but rather which candidate fulfils the requirements of the Act."

Nugget: "[A] group of unrelated investors should not be considered as lead plaintiff when that group would displace the institutional investor preferred by the PSLRA. But where aggregation would not displace an institutional investor as presumptive lead plaintiff based on the amount of losses sustained, a small group of unrelated investors may serve as lead plaintiff, assuming they meet the other necessary requirements."

First Circuit Reverses PSLRA Dismissal, Establishes New Clarity and Basis Test, and Restricts Safe Harbor Protections

File your appeal in the First Circuit, and a Second Circuit Judge authors the opinion? That’s what happened in Friday’s Stone & Webster decision, authored by Second Circuit veteran Judge Pierre Nelson Leval. Also serving on the Panel were District Judge Edward Francis Harrington (from the District of Massachusetts) and the First Circuit’s sole representative Judge Michael Boudin. Interestingly, Judges Boudin and Leval studied at Harvard together, and were both law clerks in the early 60’s for the Second Circuit’s legendary late pragmatic jurist Henry J. Friendly (also a Harvard alumnus). Of additional interest, of the seven First Circuit PSLRA decisions issued to date, this is the first one that was not written by First Circuit Judges Juan R. Torruella or Sandra Lea Lynch.

The Panel started its unanimous decision by noting that "the Complaint's strongest factual allegations fall into three main categories." "First, that S&W deliberately underbid on more than a billion dollars of contracts, which at the contract price could be performed only at a loss, and fraudulently reported anticipatory profits on these loss contracts, so as to overstate earnings; second, that S&W fraudulently concealed its loss on a huge contract in Indonesia with Trans Pacific Petrochemical Indotama ("TPPI") by concealing the cancellation of the contract and thus reported unreceived revenues, inflating the Company's profits or diminishing its losses; and finally, that S&W made public statements, which concealed and misrepresented its shortage of liquid reserves and its impending bankruptcy, as its finances slid into shambles."

From there, the Panel proceeded to evaluate Plaintiffs’ argument that Judge Reginald Lindsay (yes more Crimson here too) (D. Mass.) was wrong to dismiss their claims (on 12(b)(6) and later on summary judgment) that in committing these acts, Defendants (CEO & CFO Smith and Langford and PwC) violated § 10(b), § 18, and § 20(a) of the 1934 Exchange Act.

The Panel coined a new phrase they call the "clarity-and-basis" requirement. Basically, this is a simplified method for analyzing 15 U.S.C. § 78u-4(b)(1)’s specificity, reasons for falsity, and particularity prerequisites, and the Panel says that it is "closely related to the requirement of Federal Rule of Civil Procedure 9(b)" and that "the PSLRA's pleading standard is congruent and consistent with pre-existing Rule 9(b) pleading standards in this Circuit."

"The central allegations in the Complaint" "can be grouped into three general categories." "The first category of plaintiffs' claims principally relates to the allegation that S&W underbid various projects and fraudulently reported expected profits from these projects when, in fact, the projects were expected to produce losses." Noting the specificity of Plaintiff’s claims in this respect, the Panel said "in our view, this pleading is not the kind of vague prelude to a fishing expedition that Congress sought to bar by imposing the clarity-and-basis requirement of the PSLRA." In addition, "with respect to clarity, the Complaint sets forth a clear and precise statement of what the alleged fraud consisted of. With respect to basis, while the sources of information on which the Complaint relies for these allegations are not overwhelmingly impressive, they include sources within the Company who might well have access to the kind of information for which they are cited."

However, the Panel found "the Complaint deficient" with respect to these claims, because Plaintiffs provided "nothing supporting the inference that either Smith or Langford was directly involved in the detailed accounting for these ten particular contracts, or had knowledge of the alleged falsity." In sum, "irregular financial statements which overstate estimated results to only a small degree do not support a strong inference that the Chief Executive Office or the Chief Financial Officer of the company acted with intent to defraud, or with reckless disregard for the truth of the statements." Accordingly, the Panel affirmed the dismissal of these 10b-5 claims, but reached "a different result, however, where those claims are asserted under §§ 20(a) and 18," because those claims do not require proof of scienter, and the Panel "vacate[d] the judgment dismissing them."

"The second group of claims of fraud relates to the TPPI contract for construction in Indonesia, which was ultimately cancelled for lack of funding." The Panel held that "the allegations of exaggerated revenues and failure to report an expected loss are sufficiently detailed and supported to satisfy the PSLRA's clarity-and-basis requirement," because "the GAAP documents cited by the Complaint specify that the propriety of reporting unreceived payments as current revenue, matched with currently incurred costs, depends on a reasonable expectation that the buyer will satisfy the obligation to make the payments" and "the Complaint clearly states its theory that TPPI's expected failure to pay would result in very substantial losses to S&W, which it did not take as a charge against earnings."

However, the Panel found that the Complaint again failed the strong inference test as to the CEO and CFO because the complaint lacks "sufficiently compelling and clear factual allegations concerning the culpable involvement of Smith and Langford to support a strong inference of scienter on their part," and because "despite the Complaint's rhetorical flourish, accusing defendants of reporting 'phantom revenue,' the booking of revenues before their receipt does not necessarily involve any impropriety whatsoever."

"The Complaint's final major area of focus is on statements allegedly concealing S&W's financial deterioration. The Complaint contends that S&W issued false and misleading statements reassuring investors of S&W's financial viability and its access to sufficient cash to meet its needs, even as its finances fell into shambles, and eventually into bankruptcy." To this, the Panel found that "the allegations of financial deterioration are set forth in the Complaint at length and with specificity," and that "a jury could reasonably find that the cumulative sum of information provided to investors by that point was still materially misleading."
As for clarity and basis, the Panel said that "we have no doubt that these allegations pass the" test, because the "complaint paints a detailed account of the deteriorated financial conditions at S&W, replete with factual support and citations to sources likely to have knowledge of the matter."

Turning to the Defendants’ "safe harbor" defense, the Panel observed that the statute "seems to provide a surprising rule that the maker of knowingly false and willfully fraudulent forward-looking statements, designed to deceive investors, escapes liability for the fraud if the statement is identified as a forward-looking statement and [was] accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement." To that, the Panel said "we think that the meaning of this curious statute, which grants (within limits) a license to defraud, must be somewhat more complex and restricted." "By reason of the emphasis on "projections," "plans," and "statements of future economic performance," we understand the statute to intend to protect issuers and underwriters from liability for projections and predictions of future economic performance, which are later shown to have been inaccurate." "We believe that in order to determine whether a statement falls within the safe harbor, a court must examine which aspects of the statement are alleged to be false. The mere fact that a statement contains some reference to a projection of future events cannot sensibly bring the statement within the safe harbor if the allegation of falsehood relates to non-forward-looking aspects of the statement. The safe harbor, we believe, is intended to apply only to allegations of falsehood as to the forward-looking aspects of the statement," and "we do not think Congress intended to grant safe harbor protection for [statements] whose falsity consists of a lie about a present fact."

In applying this framework to the Company’s statements that it "has on hand and has access to sufficient sources of funds to meet its anticipated operating, dividend and capital expenditure needs," the Panel held that "we do not agree with the district court that this statement is necessarily protected by the PSLRA's safe harbor rule," and "we reject the district court's conclusion that the statements assuring that the Company had access to sufficient cash to cover anticipated needs were within the safe harbor."

In remanding the action back to the District Court, the Panel noted that "we do not purport to have ruled on each of the numerous fraudulent statements alleged in the Complaint. To the extent an allegation of fraud is not discussed in this opinion, the district court should rule again on defendants' motion to dismiss, in a manner consistent with the discussions herein."

You can read the decision at 2005 U.S. App. LEXIS 14325.

Nugget: "The falsity of a statement and the materiality of a false statement are questions for the jury," and "a court is thus free to find, as a matter of law, that a statement was not false, or not materially false, only if a jury could not reasonably find falsity or materiality on the evidence presented."

Nugget: "As we understand, it was not Congress's intention to bar all suits as to which the plaintiff could not yet prove a prima facie case at the time of the complaint, but rather to prevent suits based on a guess that fraud may be found, without reasonable basis or a clear understanding as to what the fraud consisted of, but in the hope of finding something in the course of discovery."

Nugget: "In our view, the safe harbor of the PSLRA does not confer a carte blanche to lie in such representations of current fact."

Nugget: "One difficulty we find with the district court's decision is that in several instances, in ruling on defendants' motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), the court failed to read the Complaint in the light most favorable to the plaintiff and failed to give the plaintiff the benefit of inferences that could reasonably be drawn."

Nugget: "A plaintiff has the right to plead in the alternative, and the plaintiff's doing so does not undermine the validity of the complaint. The stronger of the conflicting allegations must be accepted as if the conflicting alternative allegation had not been included. Nor is this changed by the PSLRA's strong-inference requirement. In assessing whether the pleading satisfies the strong-inference requirement, a court must draw all reasonable inferences in the plaintiff's favor, and then weigh whether they satisfy the statutorily mandated strong inference."

Nugget: "We recognize that a plaintiff must show under § 20(a) that the controlled entity committed a violation of the securities laws. If that violation was, for example, a violation of Rule 10b-5, which requires a proof of scienter, then the plaintiff under § 20(a) must prove that the controlled entity acted with "a particular state of mind." Nonetheless, if the statute is read literally, the strong-inference requirement of the PSLRA does not apply"

Nugget: "Where the state of mind in question is the defendant's knowledge of the fraudulent nature of the Company's financial reports, and the PSLRA requires that facts be stated with particularity giving rise to a strong inference that the defendant acted with that state of mind, the requirement is not satisfied by a pleading which simply asserts that the defendant knew of the falsity."

Nugget: "The Complaint alleges furthermore that throughout 1998 comprehensive internal financial reports of the Company's current condition were regularly distributed to the Company's top executives. Id. Although the contents of the reports are not described, we can fairly infer that they described what they purported to describe - the Company's current financial condition."

Judge Eyes Net Seller in Evaluating Lead Plaintiff Group

A group of investors in the Zix securities class action can claim victory over three other proposed groups in their bid for that highly coveted of all positions – Lead Plaintiff. In making their respective arguments, each competing group burst out of their bucking chutes so hard, even Little Yellow Jacket himself would be impressed. Fortunately, Judge Ed Kinkeade (N.D. Tex.) was there to score the rides.

In determining that a group of four stockholders (self titled as the Shinabarker Group) "has sufficiently shown they sustained a larger financial loss," Judge Kinkeade first recognized that "the evidence before the Court establishes the Shinabarker Group sustained the largest loss, with approximate losses of $563,185." However, another group (self-titled with the Siegel Group moniker), with approximate losses of $171,934, complained that the Shinabarker Group actually experienced a net gain, rather than loss." Specifically, they said that one of the Shinabarker Group’s members "was a net seller, thereby profiting from the alleged fraud." The judge rejected this though, finding that "the Siegel Group did not provide sufficient evidence supporting this claim" because "the Court cannot determine from the single document the Siegel Group cited… how they arrived at this conclusion." The court also found the point irrelevant, because if the alleged net seller was eliminated from the group, "the remaining Shinabarker Group members would still have sustained larger losses than any other group."

Moving to the limited Rule 23 inquiry, the court next found that Shinabarker Group met "the typicality and adequate representation requirements." Again however, "in its attempt to rebut the presumption that the Shinabarker Group is the most adequate to represent the class" another competing group (this one styled as the Brody Group) argued that the Shinabarker Group has failed "to establish its cohesiveness as a group." But the court again rejected the competing group’s position, holding that Shinabarker Group’s joint declaration (which said that the group decided to work together to prosecute this Action and, that in working together, they can fairly and adequately represent and protect the interests of the other class members) "sufficiently establish[es] for this Court the group's cohesiveness."

You can read the decision at 2005 U.S. Dist. LEXIS 13871.

Nugget: "Factual differences will not defeat typicality as there is no requirement the claims be identical."

Dura Rides Again

Judge Lewis A. Kaplan (S.D.N.Y.), who enters an impressive third Nugget appearance in two weeks, bravely takes on multiple motions to dismiss in the Net Asset Value ("NAV") actions involving several hedge funds. A hedge fund is no different than any other fund, at least with respect to the fact that one of the most important measures of its success or failure is its value. For many funds, value is an easy metric to evaluate. However, in the case of these hedge funds, the securities they owned were not traded on any exchange, so valuing them "was not a matter of looking up closing prices in the Wall Street Journal." Instead, it was a matter of "judgment." We’re headed for trouble now, aren’t we? Yep, you guessed it. There's a lawsuit involved here. Basically, Plaintiffs (who were shareholders and or limited partners of the funds) sued defendants for overstating their value (again, called NAV), neglecting to use independent valuations, and misrepresenting that the NAV’s were calculated in good faith.

There’s lots of details in this case you may want to check out, but the main item of interest here is the discussion of the loss causation issue under Dura (oh, and the court accepted the group pleading doctrine too in case yuo wanted to know). But let’s stick to loss causation. The court began by citing to Dura, and noting that "if a purchaser sold his investment in the Funds before the truth about NAVs became known, the alleged misstatements would not have caused his losses." The court then analyzed the various fraudulent schemes advanced by Plaintiffs, and held that "plaintiffs adequately allege that defendants materially overstated NAVs and concealed losses from April through September 2002, that plaintiffs purchased securities at inflated prices in reliance upon the misrepresentations, and that plaintiffs were injured when the overvaluation -- the subject of the alleged misrepresentations -- was revealed."

Judge Kaplan also weighed Defendants argument "that there can be no loss causation because plaintiffs' losses supposedly were caused by a drop in interest rates," and "investors… [who] held short positions in U.S. Treasury securities lost money during the summer of 2002 when interest rates fell." But he rejected this position, finding that "this assertion, even if true, would not necessarily explain all of the Funds' losses," and again because "plaintiffs' allegations suggest that defendants delayed in revealing the decline in the Funds' NAV." The judge observed that "even if a decline in interest rates prompted that decline, defendants' failure to disclose the decline on a timely basis caused injury to investors who purchased at inflated prices and were injured when the decline was revealed."

Finally, Judge Kaplan recognized that "plaintiffs adequately plead loss causation for the second and third categories of misstatements -- that the Beacon Hill Defendants promised to value the securities in good faith and/or using independent prices" because "they assert that the Beacon Hill Defendants misrepresented that the Funds' NAVs were calculated in good faith and/or using repo prices, that the NAVs instead were based on the defendants' own valuations, that defendants' valuations fraudulently concealed losses, that plaintiffs purchased at inflated prices in reliance upon the misrepresentations, and that plaintiffs were injured when the losses were disclosed, a disclosure that caused the Funds' collapse." Based on this, he found that "these allegations are sufficient to show that the subject matter of the alleged misrepresentations -- that prices would be valued in good faith and using independent prices -- caused plaintiffs' losses."

You can read the decision at 2005 U.S. Dist. LEXIS 13094.

Nugget: "Although Dura was a fraud-on-the-market case, its reasoning is equally applicable here. The Court based its ruling in part on the fact that ‘the logical link between the inflated share purchase price and any later economic loss is not invariably strong . . . . If, say, the purchaser sells the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss.’ The same is true here. If a purchaser sold his investment in the Funds before the truth about NAVs became known, the alleged misstatements would not have caused his losses."

Deloitte Ordered to Hand Over Foreign Documents

After reading this one, you might not take blowing off providing a detailed privilege log so lightly next time. You see, in connection with the Parmalat securities litigation, Deloitte Touche Tohmatsu ("DTT") (known since 2003 simply as the brand "Deloitte") will be required to "produce documents located in Switzerland that were provided to it by member firms of the Deloitte organization, allegedly for the purpose of obtaining legal advice in connection with an investigation into the Parmalat scandal by the S.D.N.Y. U. S. Attorney."

First, an understanding of how major international accounting firms are structured is helpful. Basically, "Deloitte and other such organizations consist of individual firms organized under the laws of each of the countries in which business is done, as well as an umbrella entity with which the individual, country-specific firms are affiliated. In Deloitte's case, DTT is the umbrella organization, and it is organized as a verein under Swiss law, a form of business organization that DTT asserts is analogous to an incorporated membership association. According to DTT, it ‘does not control its member firms’ and performs no accounting or auditing services."

Well, "when it became apparent that there would be litigation relating to Parmalat, DTT engaged a U.S. law firm to provide legal advice to DTT and on behalf of certain member firms that conducted the Parmalat Audits and which it coordinated. Some member firms provided DTT in Switzerland with documents concerning the Parmalat audits for review by that law firm. Others allowed the law firm to go to their offices in their respective home countries to review documents. To whatever extent DTT possesses or controls documents relating to the Parmalat audits, it asserts, it does so only by virtue of the foregoing. These documents would have been unobtainable by subpoena prior to their transfer to DTT, it contends, and they therefore should be unobtainable now by virtue of the attorney-client privilege."

Unfortunately for Deloitte, this wasn’t good enough to keep Judge Lewis A. Kaplan (S.D.N.Y.) from telling it to fork the documents over. He began by posing the "threshold question" of "whether these documents would have been obtainable by subpoena in the hands of the DTT member firms." To that he answered: "there simply is no way to tell on this record."

Why? Well, first he noticed that "there is no privilege log." Oops. Nor had DTT disclosed the "identities of the producing firms, the documents as to which DTT asserts privilege, nor the identities of the firms that also retained DTT's U.S. law firm." Double oops. Judge Kaplan held that "these are not irrelevant details," noting that the rules require that any party objecting to disclosure on grounds of privilege produce a privilege log, and that DTT's failure to provide one is by itself sufficient basis to overrule their objection.

Secondly, "and independent of the prior point, the vagueness and opacity of Deloitte's presentation prevents anything other than an ill-informed guess as to whether the documents sent to Switzerland by member firms could have been obtained by compulsory process directly from the member firms. It may well be that some or, indeed, all of the producing firms are subject to U.S. compulsory process and perhaps even more likely that the materials could be obtained pursuant to the Hague Convention on Taking Evidence in Civil or Commercial Matters."

Better fire up that Xerox. What’s the moral? You be the judge. But a good start would sure seem to be providing that privilege log, and perhaps easing up a bit on that perennial favorite two-step called the "overbroad and unduly burdensome" routine.

You can read the decision at 2005 U.S. Dist. LEXIS 12554.

Nugget: "Documents held by an attorney in the United States on behalf of a foreign client, absent privilege, are as susceptible to subpoena as those stored in a warehouse within the district court's jurisdiction."

Secondary Offering Class Certified in Celera

Judge Christopher F. Droney (D. Conn.) has certified a 1933 Act class of secondary offering investors suing Celera, the human genome mapping company that once sold for nearly $250 per share back in its heyday of early 2000. But don't worry, you're in luck, because you can have your very own share today for only 12 bucks. But let's get down to brass tacks.

Defendants didn’t contest numerosity or commonality, but fought the class representatives on just about everything else, starting with typicality. Defendants argued "that the claims of the proposed class representatives… are not typical because neither party can set forth successful claims under Section 11 or 12 due to the manner in which they purchased Celera common stock." But the court found this argument "unpersuasive," holding that "there was only one prospectus issued, and it applied equally to all purchases of stock during that secondary offering," and "although the defendants may be able to prove that [the class representatives] purchased some of their shares before the secondary offering, this goes to each party's damages; also, they purchased at least some of their shares after the secondary offering, and therefore their claims are typical of the class."

As for adequate representation, the court rejected Defendants position regarding the class representative’s knowledge, holding that "it is unrealistic to require a class action representative to have an in-depth grasp of the legal theories of recovery behind his or her claim."

Having established the 23(a) criteria, the court moved on to 23(b)(3). You get the picture though, this isn’t going to take long. Defendants raised "a truth [on] the market defense" but Judge Droney rejected this too, saying "this defense -- that this information was available to all purchasers prior to the secondary offering -- will be against the entire class, and not the individual purchasers." The court also held that "questions of whether the information was disseminated and available prior to the secondary offering, and what weight to give to that information, are factual questions that go to the merits of the plaintiffs' claims, and therefore are inappropriate to address at this stage of the proceedings."

The court finished things off by certifying the class, noting that "there is only one principal issue in this case -- whether the defendants made proper disclosures in conjunction with the secondary public offering, the Court finds that a class action is superior to other available methods for the fair and efficient adjudication of this controversy."

You can read the decision at 228 F.R.D. 102.

Nugget: "Given the complexities of a securities litigation case, the interest of individual stockholders in controlling the prosecution of separate actions is low."

Progress Energy Class Action Dropped Like It’s Hot

When Progress Energy and Florida Progress merged back in 1999, their “proxy indicated that each share of Florida Progress stock would be exchanged for $54.00 in cash or stock as well as one Contingent Value Obligation ("CVO").” Sure, a CVO. Don’t feel bad if you don’t know what a CVO is because they made it up. That’s right, they invented their own security. What is it? Well, you’ll be sorry you asked because a CVO “represents the right to receive contingent payments based upon the net after-tax cash flow to Progress Energy generated by certain synthetic fuel plants operated by Progress," to be "equal to 50% of the net after-tax cash flow generated by the synthetic fuel plants in excess of $ 80 million per year for each of the years 2001 through 2007, as well as any payments thereafter associated with carryforward credits, which were defined as any synthetic fuel credits earned during an Operation Year and carried forward as part of defendant's minimum tax credit (within the meaning of Section 53 of the Internal Revenue Code) and utilized in one or more tax years after 2007.”

My God. Talk about over-complicating things. Why not just make the price, oh say, $54.30 and call it a day? Anyway, a couple years later, after the merger was completed, Progress told investors that “because of the operation of the alternative minimum tax ("AMT"), synthetic fuel credits earned from the operation of its synthetic fuel plants could not completely eliminate its income tax burden, and, in fact, could not reduce that liability below twenty percent.” The CVOs, which had been trading at 54 cents each, immediately dropped to 42 cents. Plaintiffs filed a 10(b) class action soon thereafter.

In evaluating Plaintiffs' claims, Judge John E. Sprizzo (S.D.N.Y.) held that “it is indisputable that there can be no omission where the allegedly omitted facts are disclosed,” as “defendants disclosed in the proxy the limitations on the use of the synthetic fuel credits which were imposed by the Internal Revenue Code.” “Although the proxy did not mention the AMT by name, it directed investors to the relevant Internal Revenue Code provisions, and it indicated that synthetic fuel credits that could not be used in a given year would be carried over to future years as part of defendants' minimum tax credit.”

Second, the court found that “even if this disclosure was deemed inadequate, the information allegedly omitted here is not of the type which defendants had a duty to disclose,” as it is a “publicly known” “generally applicable tax provision that applies to all corporations.” Finally, the court held that “even if it is assumed that defendants should have disclosed the existence of the AMT, it is simply not the case that the omission of this information made statements that were disclosed materially misleading.”

The court capped things off by dismissing the case with prejudice (thereby denying plaintiffs any chance to amend their complaint), but finding all parties had met their Rule 11(b) obligations regarding bringing claims in good faith.

You can read the decision at 371 F. Supp. 2d 548.

Nugget: “The federal securities laws simply do not require the excruciatingly lengthy and complicated disclosure that would result if every indicia of the modern regulatory state needed to be compiled, catalogued, and explained to potential investors.”

District of Wyoming Issues First Reported PSLRA Decision Ever

When any of the judges in the District of Wyoming weighs in on the PSLRA, you had better lean in close and listen like it was E.F. Hutton himself. Why? Well, in the ten years since the PSLRA’s enactment, no reported decision from that District has ever mentioned the statute. That is until now. Who knows why that means you should listen more, but you have to at least be able to use this information to win some kind of bet. Or here is a better one to try on your friends. Since the District of Wyoming was first created on September 20, 1890, how many Article III judges have served on the Court? Nope, way to high. Six. Yes, 6. It’s true. And that even includes the current three sitting now. You still don’t believe it? O.K., verify it here at the Federal Judicial Center’s Judicial Database.

Anyway, seems a Wyoming company called Bishop Capital decided that it no longer wanted to be a public company, so they issued a proxy to their shareholders proposing a 1 for 110 reverse stock split. But before a vote could take place, a New York investment company filed a 10(b) action alleging Bishop made “false, misleading, and unlawful statements in their proxy statement in an effort to discourage shareholders from voting against the stock split.”

Judge Clarence Addison Brimmer, Jr. evaluated the claims under the PSLRA, first finding that “the Amended Complaint specifically sets forth the statements made by Bishop Capital which Plaintiffs believe were misleading and why such statements were misleading.” Statements like “the proxy statement among other things falsely stated that the value of the Company's gas interests was $ 351,605, when in fact the value was in excess of $ 2.33 million” hit the spot.

Second, the court found Plaintiffs had properly “established a strong inference of scienter” under Pirraglia v. Novell, Inc., 339 F.3d 1182, 1194 (10th Cir. 2003) because “Defendants could have made false statements in the proxy statement to encourage the reverse stock split which would allow the company to acquire outstanding shares at an unfairly low value.” The court also found “motive and opportunity,” as Plaintiffs alleged Defendants “intentionally made fraudulent statements regarding the various assets of the company in order to facilitate the reverse stock split.” In conclusion, the judge stated “these allegations of motive, opportunity, and fraudulent statements, when combined and read as a whole, meet the legal pleading requirements of the PSLRA in regards to the Defendants' state of mind.”

So there you have it, and you had better enjoy it. At this rate, we won’t get another until George Jung is released.

You can read the decision, issued June 29, 2005, at 2005 U.S. Dist. LEXIS 12932.

Nugget: “In reviewing the Amended Complaint as a whole, and accepting Plaintiffs' allegations as true, it is clear that Plaintiffs have established a strong inference of scienter.”

Seventh Circuit Shoots Down Professional Objector

The American Lawyer recently called him a "holdup artist," "the outlaw of class action litigation," and a "notorious class action objector." You see, for those of you not yet lucky enough to meet John Pentz, he is the lawyer who calls his firm the "Class Action Fairness Group" (guess the old title of the "Objector's Group" was a little too obvious, but it still seems a bit odd to refer to yourself as a "Group"). O.K., O.K., but you be the judge if he was being resourceful or just plain shameless for filing an objection on behalf of his late grandmother in an AT&T/Lucent settlement a couple years ago in Madison County, Illinois. "That's my Johnny, such a good boy."

Anyway, seems Mr. Pentz, who started his objecting organization back in 2000 after several years as an associate at Berman DeValerio, is still stirring things up today. This time around its about 300 clicks north at the headquarters of the Chicago School of Economics, the Seventh Circuit. Seems Mr. Pentz' client, Hannah Feldman, wasn't too keen on the $7.25 million settlement in the Aon securities class action. Never mind the fact that "an SEC investigation essentially cleared Aon of any perceived wrongdoing," or the fact that the District Court held that it "was not an easy case," or that "counsel was taking on a significant degree of risk of nonpayment with the case." No, the Class Action Fairness Group was here with Ms. Feldman (the only objector by the way) to save the day by trying to torpedo lead counsel's 30% fee. Can't we all just get along?

But alas, seems Circuit Judges Kanne, Bauer, and Ripple didn't see it Pentz' way. First they held that he failed to articulate an "argument regarding fee-setting methodology to the court below," and thus "waived the argument." Then, the court proceeded to the less stringent abuse of discretion standard, but again rejected the objector's arguments, pointing out "thirteen cases in the Northern District of Illinois where counsel was awarded fees amounting to 30-39% of the settlement fund," and that "attorneys' fees from analogous class action settlements are indicative of a rational relationship between the record in this similar case and the fees awarded by the district court." As for the "objector's quarrel" with the $111,000 expense award, the Seventh Circuit noted that it "barely warants comment."

So 30% it is.

You can read the decision, issued July 5, 2005, at 2005 U.S. App. LEXIS 13310.

Nugget: "District courts are far better suited than appellate courts to assess a reasonable fee in light of the case's history."

Second Time Not Quite a Charm in Whitehall Securities Class Action

Earlier this year, Judge Amy J. St. Eve (N.D. Ill.) blocked Plaintiffs in the Whitehall securities class action from challenging false statements made after the Lead Plaintiff's last purchase of the stock. Basically, the court ruled that because Greater Pennsylvania Carpenters Pension Fund’s last sale occurred 18 months before the end of the class period, they could not have been misled by any statements after that date. Despite this, Judge St. Eve allowed Plaintiffs to file an amended complaint to fix the standing issue.

Instead of attempting to add another Lead Plaintiff, Plaintiffs simply added an individual (one Mr. Milton Pfeiffer) as a "representative party" in their new complaint. Mr. Pfeiffer purchased his five shares after all of the false statements had been issued. But Defendants balked, arguing that Pfeiffer, who was one of the original named Plaintiffs, failed to submit a new sworn certification, and did not otherwise meet the requirements of Rule 23. The judge agreed with Defendants that Pfeiffer's certification was flawed in that it did not inform the court whether Pfeiffer has ever "sought to serve as a representative on behalf of a class." However, the court gave Plaintiffs 20 days to fix this problem by filing an amended certification. Here we go again.

Defendants also argued that since Pfeiffer has filed nine securities class actions in the past three years, and since he only purchased five shares of Whitehall stock for $53.80 (sounds like a very careful investor), that he is inadequate to serve as a class representative. But Judge St. Eve rejected that argument, noting that the PSLRA "does not provide a vehicle for the court to address his adequacy at this stage of the litigation."

Finally, our old friend Dura popped up again, and followed the emerging trend of, well, not changing anything very much. The judge quickly disposed of Defendants' argument that Dura should alter her January 2005 decision on their motions to dismiss, recognizing that "Plaintiff has alleged more than simply inflation of the purchase price."

You can read the decision, issued June 30, 2005, at 2005 U.S. Dist. LEXIS 12971.

Nugget: “Once a potential representative party complies with the PSLRA's certification requirements, the Court must wait to address class representative issues under Rule 23's standards. The PSLRA does not alter Rule 23.”

Class Reps Hold Up Under Heavy Fire

Judge William E. Smith (D.R.I.) has certified a 10(b) class of investors in the Textron securities class action, appointing three benefit funds for the International Brotherhood of Teamsters Local 710 and an individual as class representatives against the aircraft and weapons giant. The representatives allege that Textron engaged in fraudulent accounting practices by delaying required accounting adjustments with respect to its V-22 Osprey Tiltrotor helicopter program. They also allege accounting misdeeds related to Textron’s contract with the DOD to upgrade 280 H-1 "Super-Huey" attack helicopters, and an improper goodwill impairment charge relating to Textron's $477 million acquisition of an industrial equipment manufacturer called Omniquip.

Defendants opposed class certification on the typicality of Local 710 under 23(a)(3) and the adequacy of Swartchild under 23(a)(4). Five separate challenges were lodged against the union based on the fact that that all its investment decisions were made by investment manager Bear Stearns. The court noted that “analysis of Bear Stearns's actions in connection with those purchases (and testimony related thereto) is the key to the resolution of the motion before this Court as it pertains to Local 710.”

In addressing the defendants arguments related to Bear Stearns, Judge Smith found “the critical question is whether a broker's decision to purchase stock at or near its nadir precludes that broker's client from claiming it was the victim of securities fraud as to purchases made on its behalf when the price was at or near its apex. In this Court's view, the fact that Bear Stearns concluded, for example, that Textron stock was a good buy at $ 32.77, following full disclosure, is essentially irrelevant to the question whether it relied on misleading information in buying Textron stock at, for example, $ 50.51 during the Class Period.”

Second, the court found that the deposition testimony of Bear Stearns’ representative which revealed he did not rely on earnings statements in making his purchasing decisions “does not rebut the presumption of reliance granted Plaintiffs under their fraud-on-the-market theory.”

Third, the court rejected the logic of Zlotnick v. Tie Communications, 836 F.2d 818 (3d Cir. 1988), finding Local 710 is not subject to a unique defense because Bear Stearns believed Textron stock was undervalued when it bought shares during the Class Period.

Fourth, the court rejected Defendants’ argument that that Local 710 is subject to a unique defense because Bear Stearns testified that it was not misled ("Q: Do you believe that you were misled in connection with the purchase of Textron stock? A: No."). In doing so, the court noted that at the time of his statement the Bear Stearns representative was not aware of all the alleged improprieties of Textron and thus his testimony might change once he is made aware of all the relevant facts. The court also held that “even if [he] took the stand at trial after reviewing all the pertinent evidence and reiterated his belief that he was not misled, a reasonable jury might still find in favor of Plaintiffs, particularly given that Bear Stearns is not a plaintiff in this case and has nothing to gain (and perhaps something to lose) by publicly accusing a company like Textron of fraud.”

Fifth, Judge Smith found that “the fact that Local 710 sold some shares of Textron stock during the Class Period does not, in light of the significantly greater number of purchases, create a conflict going to the heart of this lawsuit.”

As for Mr. Swartchild (an individual who purchased 1,000 shares of Textron stock during the class period), the attack resembled an assault from Textron’s Huey’s 7.62mm machine guns (an impressive 750 to 850 rounds per minute, mind you). They blasted away at him, saying that Swartchild testified that he has no idea who would have decision-making authority on behalf of the class, has a demonstrated history of abdicating decision-making authority to his counsel, didn’t know the name of the co-lead plaintiff in his attorneys' earlier filings, has never had any communication with Local 710 in the two and one-half years that this lawsuit has been pending, has no attorney-client relationship with plaintiffs' proposed class counsel, and was solicited to participate in the lawsuit. Finished yet?

Plaintiffs countered that Defendants cited certain testimony out of context, and that Defendants are seeking to disqualify “Mr. Swartchild on the ground that he is confused about some of the intricacies of the litigation.” The court concluded that “in light of Plaintiffs' responses to Defendants' specific allegations concerning Swartchild, the applicable standard, and the fact that in the context of complex securities litigation, attacks on the adequacy of the class representative based on the representative's ignorance are rarely appropriate, Plaintiffs have carried their burden, however narrowly, as to Swartchild's adequacy as class representative."

You can read the decision, which was published over the weekend, at 369 F. Supp. 2d 204.

Nugget: “Securities actions are considered particularly appropriate for class action treatment.”

Nugget: “A failure to be ‘shocked’ by the September 26 announcement does not take one outside the parameters of the proposed class.”

Nugget: “The mere fact that a plaintiff sold stock during the class period does not in itself disqualify him from acting as class representative.”

Nugget: “Named plaintiffs are not required to 'have expert knowledge of all the details of the case.”

Psst… Hey Mack. Wanna Buy the Brooklyn Bridge?

Talk about some nice fellas. Well, at least it appears they started out that way. Back in 1987, a company called Immune Response Corporation ("IRC") invented a drug called REMUNE® to treat HIV. A noble cause no doubt. What wasn't so noble is what IRC did when "Study 806" showed that REMUNE® had "no effect on indicators of immune response and viral loads." Is that bad? We had better meet with these "science folk." At the meeting, IRC's representatives "feverishly reviewed" the data, but apparently could not put Humpty Dumpty back together again. So they did what we all do in dire straights -- they issued a press release. But somehow the release failed to mention "the negative results from Study 806." Oops. We just forgot to mention it, really. Oh, and what about the smaller, less "comprehensive" study that showed "significant improvements" in patients using REMUNE®. You know, the one our statistician told us not to "over-interpret." We mentioned that one.

Well, a series of other press releases went out, none of which disclosed Study 806, and eventually IRC conducted a Secondary Offering. $15 million later, still no real deep discussion of that pesky study. Then things got interesting. Seems the doctor in charge of Study 806 decided to publish a manuscript describing Study 806 in JAMA. The unmitigated gall. But before he could do so, IRC filed an arbitration to put a stop to that medical nonsense. Wow, an arbitration? Please no, not that! So, the next day, the manuscript appeared where? Very good, a gold star for you today -- in JAMA. Have these guys ever heard of a TRO?

The stock tanked 24% after the JAMA article was published. IRC trashed the article as "tabloid journalism," and said that "the truth in the long run will come out." Side Note: That was nearly five years ago, and well, you can take a quick peek here and see for yourself whether REMUNE® has been approved yet. Go ahead, it'll be fun, guaranteed.

Anyway, it was up to Judge Napoleon A. Jones (S.D. Cal.) to sort out the shareholder's complaint regarding all of this fun. He started out by denying Defendants' attempt to submit additional documents (the decision doesn't say what documents, but probably the usual suspects) at the motion to dismiss stage. Every document Plaintiffs challenged -- he ruled he would not consider. Just isn't proper he said. Moving to the merits, the court accepted Plaintiffs' position on falsity, recognizing that "Plaintiffs' criticism is not that what was said was inaccurate, but that it was incomplete, thus portraying the results of the clinical trial in an unduly optimistic light." If you're looking for an omisions case, this is it. In addressing scienter, Judge Jones distinguished Silicon Graphics, finding that the complaint properly "alleges that Defendants had knowledge of the circumstances concerning REMUNE's ineffectiveness." No inside trading here.

As for loss causation, the court started out by finding that Dura "did not create a heightened pleading standard for loss causation." The Judge then went on to find that "the conjunction of these two allegations makes clear that Plaintiffs claim the disclosures caused the drop in stock price": "(1) Defendants' wrongdoing caused stock prices to become artificially inflated; and (2) stock price dropped sharply when the truth became public." Sorry to you Dura fans camping out all night to get in, that's it. Really.

In two other notable rulings (both of which the Ninth Circuit has never decided), Judge Jones accepted the inquiry notice standard, but denied Defendants' statute of limitations arguments. Defendants did a lot better on their argument that the court should accept the group pleading doctrine though. The court accepted that one, holding that "Defendants liability, if any, is based solely on the statements directly attributed to them." But after those two rulings, Defendants didn't fare so well in their "truth-on-the-market" argument, as the court said it "cannot conclude as a matter of law that the market had sufficient credible information indicating that Defendants' optimism about REMUNE was unwarranted."

In a final interesting note, the court upheld Plaintiffs' 1933 Act claims, finding that they meet "the requirements of Rule 9(b) and sufficiently state[] a claim." Wait a minute. Did he say 9(b)? Never fear, the Nugget has looked into this. Turns out Judge Jones relied on Falkowski v. Imation Corp., 309 F.3d 1123 (9th Cir. Cal. 2002), which does in fact say "violations of the 1933 Act" are subject to Federal Rule of Civil Procedure 9(b)." However, four months later the Ninth Circuit amended that decision in Falkowski v. Imation Corp., 320 F.3d 905 (9th Cir. Cal. 2003). Another gold star if you guessed the amendment: "In the second sentence of part IVB, insert "to the extent the claims are grounded in fraud." Keep an eye out for a correction to the IRC decision soon too, and steer clear of a certain law clerk bound to be in a bad mood.

You can read the decision at 2005 U.S. Dist. LEXIS 12602.

Nugget: "Defendants would not be responsible if its investors' perceptions were based solely on Defendants' predictions about the prospects of REMUNE's efficacy or FDA approval. That is not the case, however. Rather, Plaintiffs allege that Defendants' misstatements of fact formed a false basis for its investors' perceptions."

Nugget: "Where negative clinical study results are fully available to the market, investors can better weigh positive predictions, and securities are more accurately valued."

Nugget: "In the present matter, Plaintiffs' Complaint contains the very allegations regarding share price decrease and public exposure to the truth the Supreme Court found lacking in the Dura complaint."

Note: The thoughts in italics above are manufactured for your entertainment by the Nugget, not the actual parties, but you knew that already.