Securities Class Action

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In our post in the immediate wake of the Supreme Court’s decision in Amgen Inc. v. Connecticut Retirement Plans, we concluded that rather than being a new threat to the defense of securities class actions, Amgen basically endorsed the status quo: In holding that plaintiffs do not need to establish that allegedly false statements…

The Supreme Court released its anxiously awaited decision in Amgen Inc. v. Connecticut Retirement Plans yesterday. On the face of the decision, it was a loss for defendants in that case, and for companies everywhere that are forced to defend themselves against securities class action lawsuits – as the Court found that plaintiffs do not…

This promises to be an eventful  year in securities and corporate governance litigation.  A number of looming developments have the potential to change the landscape for many years to come. This is the first of two posts – or three, if I get carried away – discussing some of these developments.

The Delaware Supreme Court’s …

For most readers of this blog, it is now old news that securities class action filings were down in 2012, especially in the second half of the year – this was extensively discussed and examined over the last several weeks by Kevin LaCroix in his blog, The D&O Diary, by Cornerstone Research, and by…

The Reform Act’s heightened pleading standards were designed to increase the number of securities class actions dismissed at the pleading stage.  An unintended consequence, however, has been a liberal application of the already liberal standards for amendment under Rule 15.  In Eminence Capital v. Aspeon, Inc., the Ninth Circuit explained the rationale for this approach:…

I am frequently asked about the safety of director service.  Below is the text of a short article I wrote for a forthcoming issue of a business publication.

Although the article is short and non-technical, I decided it was a good opportunity to start a discussion here on director service.  I would enjoy a dialogue…

I attended the Supreme Court argument in Amgen yesterday.  Law360 and the 10b-5 Daily, written by my former Wilson Sonsini partner Lyle Roberts (now at Cooley), have posted good summaries of the argument.

Here are links to (1) my October 15 blog post about Amgen and its significance and (2) the Amgen argument transcript.

After a reminder about the legal issue, I offer some thoughts about the argument, including Justice Scalia’s statement, “So maybe we should overrule Basic ….”

The Legal Issue

Reliance is an essential element of a Section 10(b) claim. Absent some way to harmonize individual issues of reliance, however, class treatment of a securities class action is not possible; individual issues would overwhelm common ones, precluding certification under Federal Rule of Civil Procedure 23(b)(3).

In Basic v. Levinson, the Supreme Court provided a solution: a rebuttable presumption of reliance based on the “fraud-on-the-market” theory, which provides that a security traded in an efficient market reflects all public material information. Purchasers (or sellers) rely on the integrity of the market price, and thus on a material misrepresentation.  Decisions following Basic have established three conditions to its application: market efficiency, a public misrepresentation, and a purchase (or sale) between the misrepresentation and the disclosure of the “truth.”

At issue in Amgen is whether the materiality of an alleged misrepresentation is also a condition to the presumption’s application for purposes of Rule 23(b)(3).

The Core of the Dispute

Most of the Amgen argument centered on the following debate:  Materiality is a substantive element of a Section 10(b) claim.  Amgen and the plaintiffs agree that materiality, as a substantive element, is a legal question common to the class.  The United States (and I suspect the plaintiffs too, if they had been asked) agreed that materiality is a condition to the application of the fraud-on-the-market doctrine for purposes of the merits, but not for purposes of Rule 23.

So the dispute boils down to this: if courts were to determine materiality at class certification, they would be deciding a “common question” (i.e. materiality as a substantive element), albeit for purposes of determining whether reliance is a common question; but if courts do not determine materiality at class certification, they are either prematurely or improperly certifying a class, because materiality is necessary to make reliance a common question.  Justice Scalia amplified the latter point as follows:

Materiality is a common issue.  Reliance is only a common issue if you accept the fraud-on-the-market theory.  That’s the problem.  And you are using the one, which is a common issue, to leapfrog into the second, to make the efficiency of the market reasoning something that it isn’t.

There was a lot of fairly technical discussion about the considerations bearing on these issues, including (a) the legal and practical effect of an immateriality ruling at class certification on a class member’s individual claim, (b) the difference between adjudication of materiality at class certification and summary judgment, and (c) the fact that market efficiency and a public statement – both undisputed conditions to the presumption’s application – also are common to all class members.

I’m not a Supreme Court observer and thus will leave the oral argument tea-leaf reading to others.    But it seems to me that, in resolving the technical legal question, the Court will be influenced by precedent proscribing the limits of securities class actions because of the “danger of vexatiousness” they present and the extraordinary pressure a certified class places on defendants to settle.  Justice Scalia emphasized the settlement-pressure point.  In response to a question from Justice Breyer, Seth Waxman of Wilmer Hale, on Amgen’s behalf, synthesized the technical legal point and policy point nicely:

the point of Rule 23 is to say, you get to use this very useful and powerful device if you have the key to the gate, and the key to the gate is showing that the answer to the question, will reliance be proven commonly – not lost commonly, but proven commonly – is in fact yes.


Continue Reading Supreme Court Argument in Amgen

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.

Belmont Holdings v. SunTrust Banks

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.

Continue Reading Confidential Witness Hearings in SunTrust and Lockheed Martin Demonstrate Need for Reforms

The Supreme Court’s decision in the Amgen securities case will have a profound impact on the future of securities class action litigation.  If the Court affirms the Ninth Circuit’s decision, it will eliminate an important event: a determination of whether the alleged false or misleading statements materially impacted the price of the company’s stock sufficient to invoke the “fraud-on-the-market” presumption of reliance.  That would mean, absent settlement, that the vast majority of all securities class actions that survive a motion to dismiss will remain alive until at least summary judgment, even those that are doomed to fail because the challenged statements were not, in fact, material.  If the Court reverses the Ninth Circuit, many future securities class actions will involve a meaningful class certification process.  That would yield several important strategic and economic consequences.   Argument is scheduled for November 5, 2012.

Before getting to my prediction and a discussion of the consequences of the Court’s ruling, following is a brief overview of the law and practice surrounding the issue the Court will decide.

Reliance is an essential element of a Section 10(b) claim.  Absent some way to harmonize individual issues of reliance, however, class treatment of a securities class action is not possible; individual issues would overwhelm common ones, precluding certification under Federal Rule of Civil Procedure 23(b)(3).  In Basic v. Levinson, the Supreme Court provided a solution: a rebuttable presumption of reliance based on the “fraud-on-the-market” theory, which provides that a security traded on an efficient market reflects all public material information.  Purchasers (or sellers) rely on the integrity of the market price, and thus on a material misrepresentation.  Decisions following Basic have established three conditions to its application: market efficiency, a public misrepresentation, and a purchase (or sale) between the misrepresentation and the disclosure of the “truth.”  At issue in Amgen is whether the materiality of an alleged misrepresentation is also a condition to the presumption’s application.

Over the years, defendants have argued that, absent a showing by plaintiffs that the challenged statements were material, or upon a showing by defendants that they were not, the presumption is not applicable or has been rebutted.  And, in a twist on such arguments, defendants sometimes argued that the absence of loss causation rebutted the presumption.  This argument was accepted by the Fifth Circuit in Oscar Private Equity Investments v. Allegiance Telecom, Inc.  But  Oscar rested on shaky analytic grounds, and indeed the Supreme Court in Halliburton unanimously rejected loss causation as a condition of the presumption of reliance.Continue Reading “Materiality” of Class Certification Procedure in Securities Class Actions at Issue in Amgen

The appeal of Judge Rakoff’s rejection of the settlement between the SEC and Citigroup is spectacular theater.  Behind the scenes, however, is a highly serious issue: does a federal district judge have the power, as a condition to approving a consent judgment, to require an admission of liability or to otherwise impose collateral estoppel effects.

The briefing is complete.  I commend it to you (if you have a couple of hours to spare); it is excellent and entertaining.  Oral argument has been requested but not scheduled.

Here’s some background.  The SEC investigated Citigroup’s marketing of collateralized debt obligations.  The SEC then filed a complaint alleging non-scienter violations of the Securities Act.  The same day, the SEC also filed a proposed consent judgment, enjoining violations of the law, ordering business reforms, and requiring the company to pay $285 million.  As part of the consent judgment, Citigroup did not admit or deny the complaint’s allegations.  Judge Rakoff held a hearing to determine “whether the proposed judgment is fair, reasonable, adequate, and in the public interest.”  In advance, the court posed nine questions, which the parties answered in detail.  Judge Rakoff rejected the consent judgment.

The rejection order rested, in part, on the court’s determination that any consent judgment that is not supported by “proven or acknowledged facts” would not serve the public interest because:

  • the public would not know the “truth in a matter of obvious public importance”, and
  • private litigants would not be able to use the consent judgment to pursue claims because it would have “no evidentiary value and no collateral estoppel effect”.

The SEC and Citigroup appealed, and sought an order staying the rejection order pending appeal.  A panel of the Second Circuit granted the motion, finding that the SEC and Citigroup have a strong likelihood of success on appeal, and rejecting the district court’s holding that a consent judgment may be approved only if “liability has been conceded or proved and is embodied in the judgment.”

The parties then filed appeal briefs.  One of the briefs is from pro bono counsel appointed to represent Judge Rakoff.Continue Reading Judge Rakoff’s Rejection of SEC-Citigroup Settlement: Second Circuit to Decide Power of Court to Condition Consent Judgment on Admission of Liability