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

On March 7, 2011, in the latest development in a long-running securities suit that is among the few securities class action lawsuits to go to trial and that had previously resulted in a $277.5 verdict in plaintiffs’ favor, the U.S. Supreme Court denied Apollo Group’s petition for writ of certiorari. As a result, the ruling of the Ninth Circuit reinstating the jury’s verdict will now stand. In addition, as a result of the decision to decline taking up the case, the interesting and arguably important issues the cert petition raised will now not be reviewed by the Supreme Court.

 

As detailed in greater length here, plaintiffs filed the suit after the company’s share price declined following the disclosure of a U.S. Department of Education report alleging that the company had violated DOE rules. On September 7, 2004, the company agreed to pay $9.8 million to settle the allegations. News of the settlement first became public on September 14, 2004, but the company’s share price did not actually decline until September 21, 2004, when a securities analyst issued a report expressing concern about the company's possible exposure to future regulatory issues.

　

On January 16, 2008, a civil jury entered a verdict in favor of the plaintiff class on all counts, awarding damages of $277.5 million. Under the verdict, Apollo is responsible for 60 percent of the plaintiffs' losses, former Apollo CEO Tony Nelson is responsible for 30 percent, and former CFO Kenda Gonzales is responsible for 10 percent. The jury verdict is discussed at greater length here.

　

As discussed in greater length here, on August 4, 2008, Judge James Teilborg of the United States District Court for the District of Arizona entered an order (here) granting the defendants’ motion for judgment as a matter of law, based on his finding that the trial testimony did not support the jury’s finding of loss causation. Judge Teilborg’s order vacated the judgment and entered judgment in defendants’ favor.

 

In its post-trial motion, Apollo argued that the evidence at trial was insufficient to support a finding that the analyst reports represented "corrective disclosure," because they did not contain any new fraud-revealing information. Judge Teilborg found that "the evidence at trial undercut all bases on which [the plaintiff] claimed the (analyst) reports were corrective."　

 

Accordingly, the court concluded that although the plaintiff "demonstrated that Apollo misled the markets in various ways concerning the DoE program review," the plaintiff "failed to prove that Apollo’s actions caused investors to suffer harm." The court therefore concluded that "Apollo is entitled to judgment as a matter of law."

 

In a June 23, 2010 opinion (here), a three-judge panel of the Ninth Circuit held that the district court "erred in granting Apollo judgment as a matter of law." The opinion states that "the jury could have reasonably found that the (analyst) reports following various newspaper articles were ‘corrective disclosures’ providing additional or more authoritative fraud-related information that deflated the stock price."

　

The Ninth Circuit further held that Apollo is not entitled to a new trial and that there is no basis for remittitur (reduction of the verdict). The Ninth Circuit reversed and remanded the case with "instructions that the district court enter judgment in accordance with the jury’s verdict." The company filed a petition for writ of certiorari to the U.S. Supreme Court.

　

The basis for the company’s cert petition was basically that if the efficient market hypothesis means anything, then the information about the DoE investigation was fully incorporated into the company’s share price when the news first hit the market on September 14. Either the market did not efficiently incorporate this information, in which case the market for the company’s stock is not efficient and the plaintiffs ought not to be able to rely on the fraud on the market theory to establish reliance, or the market is efficient and the company’s share price simply did not decline at the time of the corrective disclosure.

　

In a June 28, 2010 guest post on this blog (here), noted securities litigation defense attorney Tower Snow of the Howard Rice law firm articulated the inherent tension between these two positions as follows:

　

The courts can't rely on the efficient market theory for purposes of creating a rebuttable presumption of reliance for purposes of class certification and then ignore its underpinnings for purposes of evaluating loss causation. Either one embraces the theory or one does not. If one embraces it, then once it is established that the prior disclosures revealed the truth about the allegedly misstated or omitted information, there is nothing left for the jury to decide. The later disclosure, by definition, cannot be corrective, as the market already had absorbed the information. Here, the "corrective" disclosure came out seven days after the information had been previously released. Seven days is an eternity in the financial markets.

　

As discussed in March 2011 memo from the Jones Day law firm discussing the U.S. Supreme Court’s cert denial in the Apollo Group case (here), the Circuits are split on the question of how soon after a corrective disclosure a stock price decline must occur in order for the loss causation requirement to be satisfied. At least two Circuits – the Second and the Third – have held that the claimant must show that the market immediately reacted. At least three Circuits – the Fifth, Sixth and Ninth – have head that the price decline may occur weeks or even months after the initial corrective disclosure.

　

In light of the Supreme Court’s refusal to take up the Apollo Group case, this split in the Circuits will remain unresolved. Moreover, the relatively plaintiff friendly standard articulated by the Ninth Circuit remains standing in that Circuit, where so many securities class action lawsuits are filed.

 

Finally, the Supreme Court’s cert denial means that the Ninth Circuit’s ruling in the Apollo Group case stands. The Ninth Circuit had remanded the case for "entry of judgment in accordance with the jury’s verdict." In other words, the Supreme Court’s cert denial means that the plaintiffs’ verdict in one of the very rare securities cases to go to trial will stand.

 

The Supreme Court’s cert denial was disclosed with little fanfare, as part of a long list of other rulings at the same time. Looking at the Apollo Group cert denial among the list of rulings might convey the impression that this is no big deal. But actually it is a little surprising. The U.S. Supreme Court has shown an active willingness to take up securities cases, having taken numerous cases up in each of the last few terms. And part of the willingness to take up these cases seemed to involve persistent hostility against securities suits in general. The opportunity to trim a plaintiffs’ victory and to resolve a circuit split certainly seemed to suggest the possibility that the Supreme Court might well grant the cert petition.

 

In any event, with the cert petition denial, the plaintiffs’ trial victory in this case appears as if it will stand. Even with the recent dramatic narrowing of the plaintiffs’ class in the Vivendi case, the plaintiffs overall are on a bit of a roll when it comes to securities lawsuit trials. The last three securities cases to go to trial (the Homestore case, refer here; the BankAtlantic case, refer here; and the Vivendi case, refer here) have all resulted in plaintiffs’ verdicts.

　

Trials in these cases are extremely rare, and these recent developments involve a very small percentage of all securities cases. Nevertheless, the plaintiffs’ bar undoubtedly will find this sequence of events, including the cert petition denial in the Apollo Group, to represent heartening developments.  Even with the cert denial in the Apollo Group case, however, there are still a couple of securities cases still pending before the court this term -- the Matrixx Initiative case (refer here) and the Janus Capital Group case (refer here) -- and it remains to be seen how plaintiffs will fare in those cases.　

　

　

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As I discussed in a recent post, on June 23, 2010, the Ninth Circuit issued an opinion reinstating the $277.5 million jury verdict in the Apollo Group securities class action lawsuit. In my post discussing the opinion, I included some observations about the Ninth Circuit’s ruling and the likely future course of the Apollo Group case, as well as about the current state of play on post-PSLRA jury trials in securities class action lawsuits in general.

 

Over the weekend, Tower Snow of the Howard Rice law firm sent me a note commenting on my observations. Because I think Tower makes a number of interesting points, I asked his permission to reproduce his observations on this blog. Tower very graciously gave me permission, and the text of his email is reproduced in indented text below.

　

Although I rarely disagree with what you post on the blog, I do disagree with the conclusions you draw re where the Apollo case is heading.

　

The Ninth Circuit reversed based on the concept that the market may have failed to appreciate the significance of earlier disclosures and that any earlier disclosures may not have been of sufficient intensity and credibility for the market to understand them. Thus, according to the Ninth Circuit, the jury could properly conclude that the disclosure at issue was "corrective."  These are alien concepts to economists and the efficient market theory.

　

There is a vast universe of economic studies and literature which incontrovertibly shows that the financial markets are incredibly efficient (and sophisticated) and absorb and properly evaluate new information entering the markets in a matter of minutes. There is no respected economic literature which supports the idea that markets sometimes "fail to appreciate the significance" of negative information or that markets may be misled by disclosures because they are not of sufficient "intensity or credibility" to be fully understood. To the contrary, all the studies conclude the opposite.

　

The courts can't rely on the efficient market theory for purposes of creating a rebuttable presumption of reliance for purposes of class certification and then ignore its underpinnings for purposes of evaluating loss causation. Either one embraces the theory or one does not. If one embraces it, then once it is established that the prior disclosures revealed the truth about the allegedly misstated or omitted information, there is nothing left for the jury to decide. The later disclosure, by definition, cannot be corrective, as the market already had absorbed the information. Here, the "corrective" disclosure came out seven days after the information had been previously released. Seven days is an eternity in the financial markets.

　

The district court denied the defendants' motion for summary judgment on this issue because it had not heard the evidence. When it did, the court properly concluded that the "corrective" disclosure was old news. It was, and it could not under well established economic doctrine have caused plaintiffs' losses. The district court got it right.　

　

This case has a good chance of eventually making its way to the Supreme Court. If it does so, the defendants will win. Loss causation is too important an issue, and the lower courts are all over the map in applying the efficient market doctrine in different contexts. Either the efficient market theory has to be embraced and applied consistently, as economists apply it, or it should be thrown out.

　

For what it is worth, I also come to a different conclusion re Post-PSLRA trial results. Although your win/loss numbers are correct, when one takes into account post plaintiff-verdict settlements and plaintiff verdicts in the context of the damages sought, plaintiffs have done very poorly. What the trials show is that juries view investing as a high risk game, they hold investors accountable for their actions and losses, and they are not inclined when seeing individual officers and directors-- absent very compelling evidence -- to easily conclude that  they engaged in fraud. Couple these dynamics with plaintiffs' fear of post-trial adverse rulings, the dangers of appeals, the time delays, and a host of other factors, and it becomes apparent that even a plaintiff "win" often turns into a loss. I personally doubt whether either the Apollo or Vivendi verdict will survive.　

 

I would like to express my thanks to Tower for taking the time to send a detailed commentary and for his willingness to allow me to reproduce it here. I welcome submissions from responsible persons who are interested in proposing guest posts for publication on this blog. I am in any event always interested in hearing what readers think.

　

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In a terse June 23, 2010 ruling (here), the Ninth Circuit reversed the district court’s post-trial ruling that set aside the $277.5 million jury verdict in the Apollo Group securities class action lawsuit, and remanded the case for "entry of judgment in accordance with the jury’s verdict."

 

Background

Apollo Group is the parent of the University of Phoenix (UOP), the largest for-profit provider of higher education in the United States. According to the plaintiff's amended complaint (here), in 2003, two former UOP employees filed a False Claims Act action against UOP alleging that UOP received U.S. Department of Education funding in violation of laws specifying the way company educational recruiters may be compensated.

 

The Department of Education initiated an investigation of the issues raised in the False Claims Act action, and on February 5, 2004, a Department of Education employee issued a "Program Review Report" that accused UOP of violating the Department of Education rules with respect to education employees' compensation. The plaintiff in the securities case alleges that the violations in the report could have resulted in the limitation or termination of Department of Education funding to UOP.

On September 7, 2004, Apollo agreed to pay the Department of Education $9.8 million to settle the program review. The settlement agreement (a copy of which can be found here) specified that Apollo's entry into the agreement did not constitute an admission of wrongdoing or liability. News of the allegations in the Department of Education report first became public on September 14, 2004. The price of Apollo's stock fell significantly on September 21, 2004, when a securities analyst issued a report expressing concern about the company's possible exposure to future regulatory issues. Plaintiff shareholders subsequently initiated a securities class action lawsuit in the District of Arizona.

 

On January 16, 2008, a civil jury entered a verdict in favor of the plaintiff class on all counts, awarding damages of $277.5 million. Under the verdict, Apollo is responsible for 60 percent of the plaintiffs' losses, former Apollo CEO Tony Nelson is responsible for 30 percent, and former CFO Kenda Gonzales is responsible for 10 percent. The jury verdict is discussed at greater length here.

 

As discussed in greater length here, on August 4, 2008, Judge James Teilborg of the United States District Court for the District of Arizona entered an order (here) granting the defendants’ motion for judgment as a matter of law, based on his finding that the trial testimony did not support the jury’s finding of loss causation. Judge Teilborg’s order vacated the judgment and entered judgment in defendants’ favor.

　

Judge Teilborg had held in connection with the parties’ pre-trial cross-motions for summary judgment that the issue whether the analyst reports constituted "corrective disclosure" sufficient to support a finding of loss causation was a question for the jury.

 

In its post-trial motion, Apollo argued that the evidence at trial was insufficient to support a finding that the analyst reports represented "corrective disclosure," because they did not contain any new fraud-revealing information. Judge Teilborg found that "the evidence at trial undercut all bases on which [the plaintiff] claimed the (analyst) reports were corrective."

 

Accordingly, the court concluded that although the plaintiff "demonstrated that Apollo misled the markets in various ways concerning the DoE program review," the plaintiff "failed to prove that Apollo’s actions caused investors to suffer harm." The court therefore concluded that "Apollo is entitled to judgment as a matter of law."

 

The Ninth Circuit’s Opinion

In its June 23, 2010 opinion, a three-judge panel of the Ninth Circuit held that the district court "erred in granting Apollo judgment as a matter of law." The opinion states that "the jury could have reasonably found that the (analyst) reports following various newspaper articles were ‘corrective disclosures’ providing additional or more authoritative fraud-related information that deflated the stock price."

 

The Ninth Circuit further held that Apollo is not entitled to a new trial and that there is no basis for remittitur (reduction of the verdict). The Ninth Circuit reversed and remanded the case with "instructions that the district court enter judgment in accordance with the jury’s verdict."

　

Discussion

Given the procedural development of this case so far, there may be no reason to assume that the June 23 ruling by the three-judge panel represents the case’s final stage. The defendants undoubtedly will seek rehearing and/or rehearing en banc, and given the stakes involved, the defendants may well seek Supreme Court review. However, the likelihood of the defendants obtaining rehearing or rehearing en banc, much less convincing the Supreme Court to take up the case, seems like a remote possibility. The defendants may continue to agitate, but they may be running out of options.

 

With the reinstatement of the plaintiffs’ verdict in this case, and the entry of the jury verdict in the plaintiffs’ favor in the Vivendi case, the securities class action jury trial scoreboard is looking more favorable to plaintiffs.

 

According to data included in the 2009 NERA year-end securities litigation study (about which refer here), and adjusted for the Ninth Circuit’s opinion in Apollo Group and for the verdict in Vivendi, the securities lawsuit jury verdict scoreboard shows as follow: since the enactment of the PSLRA, there have been 23 securities class action lawsuit that have gone to trial, of which 16 have gone all the way to verdict. Of those 16 cases, nine have resulted in a verdict for the plaintiffs in whole or in part, and six have gone in favor of the defendants.

 

Data from Adam Savett of the Claims Compensation Bureau (here) show that there have now been nine cases filed post-PSLRA involving conduct occurring after the enactment of the PSLRA that have resulted in jury verdicts or bench decisions at trial. Of these nine, five have gone for the plaintiffs and four have gone for defendants.

 

Plaintiffs have to be heartened by the Ninth Circuit’s decision in the Apollo Group case. But notwithstanding this development, and for many reasons, trials in securities lawsuits still are likely to remain extremely rare.

 

A June 23, 2010 Bloomberg article by Thom Weidlich and Emily Heller about the Ninth Circuit’s opinion can be found here.

 

Special thanks to a loyal reader for providing a copy of the Ninth Circuit’s opinion.

 

Self-Restraint:  I considered captoning this post "Apollo -- "Oh No!" but thought better of it.

　

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As reported in a prior post (here), on January 16, 2008, a civil jury returned a verdict in favor of the plaintiffs in the securities class action lawsuit pending against Apollo Group and its former CEO and CFO. In a January 24, 2008 statement (here), the company provided "clarification of certain matters in regard to the verdict."

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On January 16, 2008, a civil jury in the Apollo Group securities lawsuit in the United States District Court for the District of Arizona entered a verdict in favor of the plaintiff class on all counts, awarding damages of $5.55 per share, an amount that according to Bloomberg (here) could reach as much as $277.5 million. The Bloomberg report also states that Apollo is responsible for 60 percent of the plaintiffs' losses, former Apollo CEO Tony Nelson is responsible for 30 percent, and former CFO Kenda Gonzales is responsible for 10 percent. The company's statement about the verdict can be found here. The plaintiff's counsel's statement about the verdict can be found here.

Background

Apollo Group is the parent of the University of Phoenix (UOP), the largest for-profit provider of higher education in the United States. According to the plaintiff's amended complaint (here), in 2003, two former UOP employees filed a False Claims Act action against UOP alleging that UOP received U.S. Department of Education funding in violation of laws specifying the way company educational recruiters may be compensated. Background regarding the False Claims Act case can be found here.

The Department of Education initiated an investigation of the issues raised in the False Claims Act action, and on February 5, 2004, a Department of Education employee issued a "Program Review Report" that accused UOP of violating the Department of Education rules with respect to education employees' compensation. The plaintiff in the securities case alleges that the violations in the report could have resulted in the limitation or termination of Department of Education funding to UOP.

On September 7, 2004, Apollo agreed to pay the Department of Education $9.8 million to settle the program review. The settlement agreement (a copy of which can be found here) specified that Apollo's entry into the agreement did not constitute an admission of wrongdoing or liability. News of the allegations in the Department of Education report first became public on September 14, 2004. The price of Apollo's stock fell significantly on September 21, 2004, when a securities analyst issued a report expressing concern about the company's possible exposure to future regulatory issues.

The Lawsuit

The lead plaintiff in the case is the Policemen's Annuity and Benefit Fund of Chicago, on behalf of a class of persons who purchased Apollo stock between February 27, 2004 and September 14, 2004. The case was pending before Judge James A. Teilborg.

In a September 11. 2007 order (here), Judge Teilborg denied the parties cross-motions for summary judgment. The defendants had sought summary judgment arguing that they had no duty to disclose an interim regulatory report (which they believed to be both unauthorized and false). The court found that while the defendants "may not have an affirmative duty to disclose the interim regulatory findings they do have 'a duty to disclose material facts that are necessary to make disclosed statements...not misleading.'" Judge Teilborg found that there was a jury issue as to whether any of the defendants' statements between the February delivery of the report and the September disclosure were misleading. Judge Teilborg also found that there were jury issues on the question whether the interim report was material and whether the defendants' acted with scienter in withholding information about the report.

In a particularly interesting holding, Judge Teilborg also found that there was a jury issue on the question of loss causation. The defendants argued that that there was no jury issue because the company's stock price did not react to the September 14 disclosure of the settlement. But the plaintiffs argued that the corrective disclosure was actually a cumulative process that included the analyst's September 21 report. Judge Teilborg said he could not conclude as a matter of law that the analyst report was not part of the corrective disclosure. The judge said it was a jury question whether or not the corrective information was fully absorbed into the marketplace before the analyst's report issued. (This mattered because there was no significant stock price drop until the report came out.)

Trial commenced on November 14, 2007. During the trial the plaintiff called both Nelson and Gonzalez to the stand to testify as hostile witnesses for the plaintiff. (Calling adverse parties as hostile witnesses is an unusual move, but it has the advantage of allowing the examining attorney to use leading questions and other techniques of cross-examination, which would otherwise not be allowed on direct examination.) According to news reports (here), Gonzalez testified that the company withheld the report from investors to avoid news coverage about the allegations. The news reports quote Gonzalez as having said that "when we received the program review report, we felt very strongly we did not want it basically tried in the press." The news reports also state that Nelson testified that the company's lawyers advised the company against disclosing the report, and that he thought disclosing it would have caused the company's stock price to drop.

The jury began deliberation on January 10, 2008 and returned a verdict on January 16. The jury found for the plaintiff on all counts. In its statement on the verdict (here), the company said that the case was premised on the company's "supposed failure to disclose unsubstantiated allegations from a preliminary government report." The company's counsel is quoted in the statement as saying that the "law does not require the disclosure of preliminary or unproven damages." The statement also says that "the ultimate disclosure of the report's contents caused no statistically significant movement in Apollo's stock price."

Discussion

According to the Securities Litigation Watch blog (here), 19 securities lawsuits have gone to trial since 1996. Of these, six cases (including the Apollo Group case) involving post-PSLRA conduct have reached a jury verdict, with three verdicts going in favor of the plaintiffs and three going in favor of the defendants. The Ninth Circuit recently reversed one of the three defense verdicts, as noted further below. Among the six verdicts is also the November 27, 2007 defense verdict in the JDS Uniphase trial (about which refer here).

It is important to keep in mind that this case is not over - indeed, it may have a long way yet to go. The defendants undoubtedly will pursue an appeal to the Ninth Circuit if their post-trial motions are unsuccessful. On appeal, both parties will look with interest (and in the defendants' case, concern) on the Ninth Circuit's November 26, 2007 opinion in the Thane International case (here), in which the Ninth Circuit reversed and remanded a trial verdict that had been entered on behalf of the defendants in that case. (Refer here for my prior discussion of the Thane International case). While the ultimate outcome of any appeal in the Apollo Group case remains to be seen, there may well be significant issues on appeal, particularly with respect to the defendants' obligation to disclose the report; scienter; and loss causation. (Of course, the parties always have the opportunity of entering into a post-trial settlement, as well...)

It is worth asking why all of a sudden securities cases are going to trial. It is not clear why the Apollo Group case did not, like most of these cases, settle. The parties may simply have been unable to reach a mutually acceptable compromise. The Apollo Group case does seem like an odd case for the plaintiff to have pushed to trial since there were no insider trading allegations or other suggestions that the individual defendants personally benefited - although the jury verdict obviously validates the decision (to the extent there was an active decision) to try the case, and the absence of individual benefit clearly did not influence the ultimate outcome.

There is at least potentially an interesting insurance coverage question, which is whether the jury verdict represents an adjudication of fraud sufficient to trigger the fraud exclusion that typically is found in directors and officers liability insurance policies. I have not been able to obtain a copy of the questionnaire the jury used to see what specific factual findings the jury made, but to the extent the jury found knowing misrepresentations, the verdict could preclude coverage, although the possibility of an appeal could also affect this issue. (The possibility of a jury verdict triggering the fraud exclusion is one reason why so few securities cases go to trial.) It should also be noted that the amount of damages could exceed any amounts of insurance that are available. (I want to emphasize in making these insurance observations that I have no knowledge of any kind about the particulars of Apollo Group's insurance, and so I am merely speculating not expressing any insurance opinions.)

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