Bill Lerach gave the best motion to dismiss oral argument I’ve ever seen. Using a stock-price chart with key events and allegations plotted along the alleged class period, he told the complaint’s story with a wooden pointer and his superb narrative skill. Far too often, plaintiffs’ and defense lawyers get bogged down in the nitty-gritty of the allegations and fail to analyze whether the case hangs together structurally. And they often fail to understand the interrelatedness of all of the elements – for example, weak causation tends to show the challenged statements aren’t false or misleading, and weak falsity makes scienter hard to show because it’s hard to infer that someone intended to mislead investors through a barely-false statement. The effectiveness of Lerach’s argument was its use of the class structure a to tie together falsity, scienter, and loss causation.
That argument improved the way I analyze and defend securities class actions in multiple ways, including:
I can size up case structure better and earlier.
I started looking at the structure of securities class actions rather than the level of detail in the complaint. That allows me to analyze the entire litigation based on the initial complaint – waiting for the lead plaintiff’s amended complaint is frequently unnecessary. For example:
- What was the subject matter of the corrective disclosure? Under Dura, that defines and limits the subject matter of the litigation. For example, the lead plaintiff can’t take a restatement announcement and allege false financial forecasts; that would fail for lack of loss causation. With that limitation, we can identify and evaluate the challenged statement candidates.
- Were there non-10b5-1 plan stock sales? If not, it will be very difficult for the lead plaintiff to plead scienter – rarely does a case without a concrete personal financial motive for fraud pan out, and those either exist or do not exist at the inception of the case.
- What types of statements are or could be at issue? If they are opinions, Omnicare will make it very difficult to plead a false or misleading statement – in the Supreme Court’s words, Omnicare’s standard is “no small task” for a plaintiff to meet. If the challenged statements are forward-looking opinions, in addition to arguing lack of falsity, they are protected by the Reform Act’s safe harbor if accompanied by meaningful cautionary statements. This too is typically discernable at the outset based on disclosures that also either exist or do not exist at the inception of the case.
- Whatever the types of statements, we can look at their subject matter and the facts that would undermine those statements and build a “full context” record under Omnicare, which, properly understood, applies to both fact and opinion statements. Does that full context make the challenged statements (and those that might be in an amended complaint) feel fair? The full context is structural because the amended complaint can’t erase the public record within which the court will evaluate the challenged statements.
I look for economic flaws.
Focusing on the structure of the case necessarily involves spotting potential economic flaws. While these are mostly post-motion to dismiss issues, if I see a potentially good economic argument, it makes sense to engage an economist early to explore it so that the motion to dismiss can help set it up or at least not be inconsistent with it. For example:
- Is there a mismatch between the challenged statements and one or more of the corrective disclosures? If so, there’s a good argument under Dura that the challenged statements did not cause loss, and a class certification defense under Halliburton II and Goldman Sachs
- Are the challenged statements vague (e.g. “Our internal controls are effective”) and one or more of the corrective disclosures specific? If so, there may be a “genericness” Halliburton II/Goldman Sachs class certification issue.
- Did the stock price increase with each challenged statement? If not, the plaintiffs may have trouble showing price impact under Halliburton II, depending on whether there are valid price maintenance allegations and how the price reacted following the corrective disclosure(s).
- Are there multiple corrective disclosures? If so, on class certification, there may be a problem proving class-wide damages under Comcast.
Again, only lack of loss causation is a motion to dismiss argument, but the class certification/summary judgment analyses often influence how I argue the motion to dismiss, and definitely influence how I think about defense of the case if it survives the motion to dismiss.
Sizing up the litigation straightaway is critical to improving securities litigation defense. As I’ve written, the defense bar needs to get back to routinely doing an initial internal fact review to improve our motions to dismiss and planning. The ability to size up the litigation based on the initial complaint allows defense counsel to focus early case assessment on the right documents and witnesses and avoid having to try to do a background review while being on the motion-to-dismiss clock, which often means an internal fact review is not done well or at all. If defense counsel can effectively size up the initial complaint, the background factual review can be done efficiently, and cost shouldn’t be an impediment. Effective and efficient initial background work, in turn, allows us to plan our overall case strategy better. Defense counsel is able to have a pre-motion to dismiss strategic summit with the defendants, broker, and insurers (and sometimes an economist) to discuss together how to defend the litigation. For example:
- Is the risk so high that we should consider mediation during the motion to dismiss process? Some cases should be settled early, and it’s best to know that before the motion to dismiss is denied.
- Is the case one that could be defended through summary judgment? Some cases should be defended past the motion to dismiss if it is incorrectly denied. Far too often, defendants are forced to throw in the towel because of a lack of information about the merits of the case, so the defendants and their insurers are unable to make a good cost-benefit decision about defending the case further. In those situations, settlement seems safer and the right default decision – which is a shame when the case is, in fact, defensible.
- Are there good economic defenses? Whether the case is defensible or not, it’s smart to size up the economic defenses early. Most cases are in the middle of these two extremes, and the right strategy will depend on the strength of economic defenses at class certification or summary judgment. The defense bar has an effective kit of economic tools, and it’s a shame not to use them more. I’d venture to guess that more effective and efficient use of these tools would reduce the net severity of securities cases by at least 10%, and quite possibly much, much more.
All of this starts with an early understanding of the structure of the litigation.