The history of securities and corporate governance litigation is full of wishes about the law that we later regret (or will), or are happy were not granted. Many of these are not obvious—and some will surprise people. From certain case-by-case tactical decisions such as establishment of special litigation committees, to the (failed) attempt to abolish
This year will be remembered as the year of the Super Bowl of securities litigation, Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), 134 S. Ct. 2398 (2014), the case that finally gave the Supreme Court the opportunity to overrule the fraud-on-the-market presumption of reliance, established in 1988 in Basic v.
In defending a securities class action, a motion to dismiss is almost automatic, and in virtually all cases, it makes good strategic sense. In most cases, there are only four main arguments:
- The complaint hasn’t pleaded a false or misleading statement
- The challenged statements are protected by the Safe Harbor for forward-looking statements
The recurring and pervasive problem of flawed confidential witness (“CW”) allegations tops my list of the key issues in securities class action litigation.* I don’t mean just notorious situations such as those recently at issue in the Lockheed, SunTrust, and Boeing securities class actions – which I discussed in an earlier post and…
Plaintiffs’ lawyers are facing intense judicial scrutiny of problems with their use of “confidential witnesses” (“CWs”) in the Lockheed Martin and SunTrust securities class actions. Courts have recently addressed similar CW problems in two other high-profile securities class actions, Sears Holdings (affirmed by the Second Circuit) and Boeing.
Courts need to scrutinize CWs more closely in deciding motions to dismiss – not just in post-denial motions for reconsideration or summary judgment following CW discovery. After discussing the two current cases, I propose two modest reforms.
In SunTrust, the court denied defendants’ motions to dismiss the First Amended Complaint (“FAC”), based primarily on purported claims from a CW, Mr. Trapani, that the individual defendants knew that certain financial reporting at the end of 2007 was false.* Mr. Trapani left SunTrust in August 2007, but the FAC alleged that Mr. Trapani worked at SunTrust from “2005 through 2007” and contained several references to information he provided concerning knowledge “throughout 2007.” During the motion to dismiss process, SunTrust asserted that Mr. Trapani left SunTrust in August 2007. The court acknowledged the assertion but expressly left the issue for later, stating it “must assume Trapani had personal knowledge” and if he does not, “the Court will consider later whether these allegations support a violation of the pleading standards under the Federal Rules of Civil Procedure.”
Defendants moved for reconsideration based on declarations from Mr. Trapani that he left SunTrust in August 2007, knew nothing about the challenged financial reporting thereafter, and never told plaintiffs’ investigator that he discussed the individual defendants’ knowledge of SunTrust’s financial reporting thereafter. Based on Mr. Trapani’s declarations, the court reconsidered its motion to dismiss order and dismissed the action. The court “reluctantly” decided against sanctions because it appeared that notes from plaintiffs’ investigator, Ms. Torres, supported the FAC’s allegations based on Mr. Trapani.
So it appeared that plaintiffs’ counsel was off the hook. But they might not be. Ms. Torres contacted the court to say she was concerned about the accuracy of plaintiffs’ counsel’s arguments against sanctions. In particular, she “stated that she had information she wished to share with the Court, including that Plaintiff’s counsel were involved in the interviews of Mr. Trapani and that, in those interviews, Mr. Trapani made clear that he did not have any knowledge after August 2007 ….”
The court has set a hearing for November 9, 2012 to hear more from Ms. Torres, her firm, and the parties. “The Court will, after the proceeding, evaluate whether further inquiry or action is required.”
City of Pontiac General Employees’ Retirement System v. Lockheed Martin
In Lockheed, Judge Rakoff denied defendants’ motion to dismiss. Discovery commenced. Discovery of the CWs revealed two categories of problems: (1) several CWs disputed telling plaintiffs’ investigator the facts the complaint attributed to them; and (2) certain of the CW allegations were not based on the CWs’ personal knowledge because the information they provided was outside of their employment dates and/or job responsibilities. Defendants moved for summary judgment, pointing out the flaws with the CW allegations on which Judge Rakoff relied in denying defendants’ motion to dismiss.
On October 1, 2012, Judge Rakoff held a day-long evidentiary hearing to determine “who the heck tried to pull a fraud on this court.” The 218-page hearing transcript allows a rare look into the securities-class-action-complaint-preparation kitchen. Plaintiffs and defendants submitted post-hearing briefs that slice and dice the complaint’s allegations and evidence revealed during discovery and during the October 1 hearing. At the hearing’s conclusion, Judge Rakoff offered some tentative thoughts about the witnesses’ credibility. He remarked that some CWs were credible and others were not, and that plaintiffs’ investigator was credible “on the whole.”
For more background, see here.