Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

Subprime litigation may be all the rage, but the consolidated IPO Laddering case is back in the news, a seemingly distant reverberation from a long-gone era that may nonetheless still vex the same investment banks caught up in the current subprime crisis. The consolidated Initial Public Offering Securities Litigation is going forward in the district court after the Second Circuit reversed the district court’s grant of class certification (refer here regarding the Second Circuit’s reversal). On remand back to the district court, the plaintiffs have amended their Master Allegations and Complaints in the six focus cases, and the defendants moved to dismiss.

In a March 26, 2008 opinion (here), Judge Shira Scheindlin substantially denied the defendants’ motion to dimiss and also made is unmistakably clear that the litigation is going forward.

Judge Scheindlin’s rulings in the March 26 opinion are largely consistent with her prior rulings in the case, and, indeed, in significant parts of her opinion she simply repeats her prior ruling and states “I see no reason to reconsider this decision.” However, in two particular areas, intervening Supreme Court case law required Judge Scheindlin to reassess her prior analysis. Judge Scheindlin made it clear that the intervening case law did not change her view of the case.

First, Judge Scheindlin reexamined the plaintiffs’ scienter allegations in light of the Tellabs decision. The plaintiffs assert two separate claims under Section 10(b). One is asserted solely against the Underwriter defendants and is based on alleged market manipulation (based on the alleged tie-in arrangement that required IPO share buyers to purchase additional shares at higher prices). The other Section 10(b) claim is asserted against all defendants and alleges misrepresentations and omissions regarding the alleged manipulation scheme.

With respect to the market manipulation claim, Judge Scheindler reaffirmed her prior ruling, reiterating that the alleged conduct was so obviously manipulative that “it could not have been done inadvertently,” and therefore the inference of scienter was at least as compelling as the competing inference.

With respect to the misrepresentation allegations, Judge Scheindlin focused on the allegation that the issuer defendants’ officers and directors allegedly held shares that were inflated by the price manipulation. She viewed this consideration with the fact that each of the issuer defendants used “inflated shares as currency” to acquire target companies, as well as the fact that two of the issuer companies (from among the six focus companies) “raised additional capital through secondary offerings.” Judge Scheindlin said that “when these and other allegations against each issuer are viewed as a whole, they are sufficient to plead scienter in each case.”

Judge Scheindlin also reconsidered her prior ruling on the issue of loss causation, in light of the Supreme Court’s decision in the Dura case. Judge Scheindlin found that the intervening case law does “not support a reversal of my earlier decision.” Judge Scheindlin said

the misstatement and omissions concealed the alleged market manipulation that caused plaintiffs’ losses, and without such misstatements and omissions, plaintiffs’ losses could not have occurred. Further, plaintiffs’ losses are those that could be expected to result from the concealment of the market manipulation scheme. Plaintiffs have thus pled loss causation.

Judge Scheindlin did grant the defendants’ dismissal motion on two narrow grounds. First, consistent with her prior rulings in the case, she dismissed claims brought under Section 11 by those plaintiffs who sold their securities for a price in excess of the initial offering price. Second, she dismissed certain plaintiffs who purchased their shares outside the previously certified class period.

And so the Initial Public Offering Securities Litigation will grind on, a vestige of an earlier time and place, its significance seemingly eclipsed by more recent and more momentous events. Yet the collective litigation nonetheless remains significant. Its sheer bulk and scale makes the prospect of any definitive global resolution challenging, a prospect even further complicated by the Second Circuit’s class certification ruling. The current circumstances make future course of the litigation seem even more uncertain.

I welcome readers thoughts on the immediate procedural direction likely in the litigation, as well as any views about where the litigation ultimately is headed.

Special thanks to Edward Carleton of the Boundas Skarzynski Walsh & Black law firm for providing a copy of the March 26 opinion.

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The Supreme Court still has not yet issued its much-anticipated decision in the Tellabs case (about which refer here), but it did issue a 7-1 decision today (refer here) in the Credit Suisse Securities v. Billing case, holding that the securities laws preclude application of the antitrust laws in a case filed against ten investment banks and asserting IPO laddering allegations.

The plaintiffs alleged that between March 1997 and December 2000, the defendant investment banks "abused the practice of combining into underwriting syndicates" by allegedly agreeing among themselves to impose conditions on investors who wanted access to shares in sought-after IPOs. The alleged conditions included "laddering" (requiring investors to buy additional shares in the aftermarket); "tying arrangements" (requiring investors to purchase other, less-attractive securities), and excess commissions. The plaintiffs alleged that these supposed practices violated the Sherman Act, the Clayton Act, and state antitrust laws.

The case was before the Supreme Court on the question whether or not the securities laws "implicitly preclude the application of the antitrust laws to the conduct at issue in this case." The regulation of underwriting syndicates' behavior in connection with securities offerings is within the purview of the SEC, because it is "central to the proper functioning of well-regulated capital markets," and the law grants the SEC the legal authority to supervise the activities in dispute - a legal authority the SEC has "continuously exercised."

The court concluded that "to permit antitrust actions such as the present one threatens serious securities-related harm," particularly given the fine line that exists between permitted underwriting syndicate-building collaborative activity and prohibited collusive activity. The SEC, according to the Court, is responsible for drawing a "complex, sinuous line separating securities-permitted from securities-prohibited conduct." The Court asked "who but the SEC" could make these determinations with confidence? Without this sophisticated oversight, there is an "unusually high risk that different court will evaluate different factual circumstances differently," which would in turn "suggest that antitrust courts are likely to make unusually serious mistakes."

Under these circumstances, offering underwriters would not only steer clear of conduct the securities law forbids, "but also a wide range of joint conduct that the securities law permits and encourages (but which they fear could lead to an antitrust lawsuit and the risk of treble damages)."

The Court concluded that the need for antitrust-related enforcement is very small, since the SEC actively enforces its own existing rules prohibiting the contested conduct, and in any event, investors harmed by the disputed practices "may bring lawsuits and obtain damages under the securities laws."

This last point about the availability of remedies under the securities laws may be the most telling. Many of us who can remember the inundation of IPO laddering cases that flooded the courts in 2001 will remember the antitrust cases that also appeared as stray artifacts from a period of lawsuit-filing madness. The mad rush for a piece of the IPO laddering action led to the filing of securities cases against over 310 companies (subsequently consolidated into the IPO Laddering action, about which refer here). This antitrust case looked at the time like nothing more than an attempt to purchase by other means a piece of the litigation territory that prior plaintiffs had claimed in securities lawsuits. The Supreme Court may well have sensed this "end-run" attribute of the antitrust action, noting that "to permit an antitrust lawsuit risks circumventing [the statutory requirements of the PSLRA] by permitting plaintiffs to dress what is essentially a securities complaint in antitrust clothing."

There are several aspects of this decision that are interesting, beyond the holding itself. The first is that Justice Breyer, usually perceived as a member of the court's liberal wing, wrote the opinion for a 7-1 majority (Justice Kennedy not participating) that cut broadly across the court's usual political fault line. Justice Breyer has shown an interest in the past for business cases (he wrote the majority opinion in the punitive damages case earlier in the term). While this does not necessarily tell us anything one way or the other helpful to prognosticating the outcome of the Tellabs case, it does suggest that we can hope for an outcome that is at least clear-cut and that provides guidance on the pleading issues presented in the Tellabs case. (I wonder, without any basis whatsoever for so speculating, whether Justice Breyer will write the majority opinion in the Tellabs case?)

The second interesting aspect of this decision is that the Court seemed to have little trouble rejecting the compromise position advocated by the solicitor general, who advocated remanding the case to the lower court for further proceedings. This absence of deference to the government's official position suggests that the court might not be overly swayed by the SEC's amicus brief in the Tellabs case (refer here), which urged a narrow view of the PSLRA pleading standard. On the other hand, the majority opinion in the Credit Suisse case seems to reflect an awfully high opinion of the SEC's expertise on securities law issues.

Good brief descriptions of the Credit Suisse decision can be found on the SCOTUS blog (here) and on the Legal Pad blog (here).

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According to reports in a December 6, 2006 article in the New York Times entitled "Court Rejects Class Action Against Banks" (here, registration required) and a December 6, 2006 Wall Street Journal article entitled "Wall Street Wins Ruling Blocking IPO Class Action" (here, subscription required) on December 5, 2006, the United States Court of Appeals for the Second Circuit ruled in the IPO laddering cases that the district court had improvidently ruled that IPO investors' class action could proceed as a class action in against the 55 offering underwriter defendants. Specifically, the Second Circuit ruled that said the federal judge overseeing the lawsuit had erred in granting class-action status to six "focus cases" out of 310 consolidated class actions. This of course does not eliminate the possibility that investors could pursue individual actions against the underwriters. But even though individual actions can still go forward, the ruling has a certain disaggregating impact.

The Second Circuit's opinion may be found here. (Hat tip to the WSJ.com Law Blog, here, for the link to the opinion.)

The ruling also has an uncertain but curious potential impact on the pending settlement that the issuer defendants had entered into with investors. The issuers had agreed to pay the investors $1 billion dollars, with the issuers' obligation to be reduced to the extent of investors' recoveries from the underwriter defendants. (A brief summary of this settlement may be found here.) From the issuers' perspective, this settlement was looking very good when J.P. Morgan in April 2006 agreed to contribute $425 million to the settlement. But now that the Second Circuit has ruled that the investors' case cannot proceed against the underwriter defendants as a class action, it would appear that the issuers' settlement could unravel --the issuers' settlement with investors was merely proposed; it had not yet been approved by the court.

The question now on the table is whether the this unexpected but dramatic procedural undoes the issuers' $1 billion settlement and J.P. Morgan's $425 settlement. According to a December 6, 2006 Law.com article entitled "Huge IPO Case Hits Snag at 2nd Circuit" (here), "the issuers may try to get out of the settlement, say lawyers involved in the case" and the district court judge could "nix it based on Tuesday's ruling."

As the New York Times put it, in a statement that while strong is not an overstatement, "the ruling was a devastating blow to the embattled securities class-action powerhouse Milberg Weiss Bershad & Schulman, which is a co-leader for the plaintiffs."

A Bloomberg.com article discussing the Second Circuit's decision may be found here.

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