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."
Thursday, July 21, 2005
Wednesday, July 20, 2005
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."
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."
Tuesday, July 19, 2005
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."
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."
Monday, July 18, 2005
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."
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."
Friday, July 15, 2005
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."
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."
Thursday, July 14, 2005
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."
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."
Wednesday, July 13, 2005
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."
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."
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