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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Securities lawsuits rarely go to trial, but on February 24, 2011, just three months after the last securities suit trial concluded, a Central District of California rendered a verdict on behalf of plaintiffs against the sole trial defendant, the former CEO of the defunct Homestore company. The jury found that the defendant, Stuart H. Wolff, had violated the federal securities laws in connection with a series of statements the company made in 2001.

A copy of the jury verdict form can be found here. The court’s trial minutes for jury verdict can be found here. The February 25, 2011 press release about the verdict from the lead plaintiff, the California State Teachers’ Retirement System (CalSTRS), can be found here.

As detailed further here, investors first filed a securities class action lawsuit against the company and certain of its directors and officers in December 2001. CalSTRS was named as lead plaintiff in March 2002. Subsequent amended complaints named additional defendants, including the company’s auditor and certain other outside companies and entities.

Essentially, the plaintiffs alleged that the company had engaged in a scheme to create a circular flow of money through a series of roundtrip financial transactions whereby money flowed from Homestore to outside firms and then back to Homestore. Through these transactions, the company allegedly was able to represent itself as a successful and growing company. The company was later forced to restate more than $120 million in revenue.

During the course of the long and complicated procedural history of this case, a number of the defendants were dismissed out of the case, while other defendants, including the company itself, certain individual defendants, and the company’s outside auditor, entered into a series of settlements with the plaintiffs. On January 25, 2011, a civil jury trial commenced against the sole remaining defendant in the case – Stuart H. Wolff, the company’s former Chairman and CEO.

The jury returned its verdict on February 24, 2011. The Special Jury Verdict Form is very detailed and somewhat challenging to interpret. Basically, it appears that of the 22 allegedly misleading company statements on which the plaintiffs relied, the jury concluded ten were materially misleading. Of these, the jury found that Wolff was involved in the preparation of five of the statements, and that his involvement in those statements was knowing or reckless.

The jury also found with respect to four additional knowing or reckless misrepresentations that Wolff was responsible for the person making the statement, and therefore with respect to those four statements Wolff was subject to control person liability.

With respect to the question of damages, the jury found that a number of other company officials as well as Wolff were responsible, but in each case Wolff’s responsibility was 50% or greater. The jury also calculated the per share price inflation that resulted from each misrepresentation for which Wolff was responsible, in several cases calculating the inflation four places to the right of the decimal.

In its press release, CalSTRS said only that "the exact amount of damages is being calculated."

In some respects, the outcome of this jury trial may come as no surprise. In April 2010, Wolff was sentenced to four and a half years in prison after pleading guilty to conspiracy to commit securities fraud in connection with the company’s allegedly deceptive financial reporting. Wolff is incarcerated in the federal penitentiary in Lompoc, California, although he was transferred to facilities in Los Angles for the recent civil trial.

In addition, in December 2010, Wolff reached an $11.9 million agreement with the SEC, settling allegations that he had inflated the company’s reported revenues. As part of that settlement, Wolff did not admit to the SEC’s securities fraud allegations.

In light of these prior developments, the recent jury verdict may not be that surprising. But what is surprising is that the case went all the way to a jury trial at all. Trials in securities class action lawsuits are exceedingly rare, although there have been a rash of jury verdicts in recent months.

According to data compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, prior to the recent verdict against Wolff in the Homestore case, there had been a total of ten securities class action lawsuits filed after the 1996 enactment of the Private Securities Litigation Reform Act and involving post-PSLRA conduct that have gone to all the way through to jury verdict. In other words, the verdict against Wolff is just the eleventh verdict in a post-PSLRA securities class action lawsuit.

With the plaintiffs’ verdict against Wolff in the Homestore case, the securities class action jury verdict scoreboard (taking into account post-verdict proceedings and reflecting only the current status of post-verdict proceedings) is as follows: Plaintiffs 7, Defendants 4. (The scoreboard is subject to revision pending the outcome of additional proceedings in several of the cases.)

These numbers convey how rare securities lawsuit trials are. It is worth noting that the verdict in the Homestore case is the third in just thirteen months, coming as it does just three months after the verdict in the BankAtlantic case (about which refer here) and thirteen months after the verdict in the Vivendi case (refer here). My friends in the plaintiffs’ bar will undoubtedly be quick to point out that all three of these cases resulted in verdicts for the plaintiffs as well.

The histories of prior securities cases that have gone to trial show that verdicts in these cases are subject to extensive post-trial procedures. Indeed, just last week the Court in the Vivendi case entered an order substantially narrowing the scope (and value) of the plaintiffs’ verdict in that case. In all likelihood, there will be further developments in the Homestore case, particularly given the case’s long procedural history.

In addition to the prospect for post-trial procedural developments, the parties to the Homestore case also face a rather daunting challenge of trying to interpret and calculate the effect of the jury’s findings on damages. The combination the jury’s findings about Wolff’s proportionate level of responsibility and of its findings about the respective levels of per-share price inflation will require, in order to arrive at a precise dollar figure for damages, mathematical calculations approaching in terms of complexity the formulae used for calculating planetary motions.

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In the first securities class action jury verdict to arise out the credit crisis, on Thursday November 18, 2010, the jury in the BankAtlantic securities lawsuit in federal court in Miami returned a verdict in the plaintiffs’ favor, finding seven of the statements at issue to have been false, and awarding damages of $2.41 per share. According to sources, this damage measure translates to total damages of as much as $42 million.

The case went to the jury last week after more than four weeks of trial, testimony from 13 fact witnesses and one expert witness. The verdict form the jury was required to complete ran to some 53 pages. At the outset of the trial, the lead defense counsel had characterized the claim as a "completely made-up, frivolous claim."

In their completed verdict form, the jury found the company and two of the five individual defendants to be liable for seven of the 19 statements at issue. The two defendants held liable are the company’s CEO, James Lavan, and its CFO, Valerie Toalson. All of the statements for which the defendants were found liable had been made in 2007. The completed jury verdict form can be found here.

As reflected here, the plaintiffs’ complaint had alleged that the defendants had made misleading statements about the bank’s loan portfolio from October 2006 through October 2007 and had "materially understated reserves for real estate loan losses on its financial statements, and thus materially overstated net income." The plaintiffs alleged that the defendants (the bank holding company and five of its individual directors and officers) had made misleading statements about the quality of the bank’s loan portfolio, the bank’s exposure to loan losses and the bank’s loan loss reserves.

As noted here, the plaintiff’s initial complaint had failed to survive the defendants’ motion to dismiss, but the amended complaint survived the defendants’ renewed dismissal motion.

According to information compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, since the enactment of the PSLRA, there had previously been only nine securities class action lawsuits based on post-PSLRA conduct that have actually been tried to a jury verdict. (Another seven cases alleging post-PSLRA conduct went to trial but were compromised or otherwise resolved prior to verdict. An additional eleven securities cases have gone to trial post-PSLRA but involved pre-PSLRA conduct.)

In other words, the verdict in the BankAtlantic case represents only the tenth securities class action lawsuit verdict since the enactment of the PLSRA based on post-PSLRA conduct.

The current tally (taking into account post-verdict proceedings and reflecting only the current status of post-verdict proceedings) is as follows: Plaintiffs 6, Defendants 4. (The scoreboard is subject to revision pending the outcome of additional proceedings in several of the cases.)

With the plaintiffs’ verdict in the BankAtlantic case, the securities class action jury verdict scoreboard (taking into account post-verdict proceedings and reflecting only the current status of post-verdict proceedings) is as follows: Plaintiffs 6, Defendants 4. (The scoreboard is subject to revision pending the outcome of additional proceedings in several of the cases.)

The BankAtlantic case will now undoubtedly head into post trial motions, and perhaps even later appeals. As has been shown in the Apollo Group securities class action case (about which refer here), in which there the plaintiffs’ jury’s verdict has been set aside in post trial motions only to have the verdict reinstated on appeal, the verdict itself can effectively wind up as only one stop in a very long procedural grind. Stay tuned for further proceedings.

In a statement to The D&O Diary, Matthew Mustokoff, a partner in the Barroway Topaz law firm said "The jury’s verdict vindicates our position from the outset that this was a case with merits and it delivers a message that a financial institution can’t mislead their shareholders about the riskiness of its loans." The Barroway Topaz firm was co-lead counsel for the plaintiff on the case. The other lead attorneys were Andrew Zivitz of the Barroway Topaz firm and Mark Arisohn of the Labaton Sucharow firm.

A November 18, 2010 South Florida Business Journal article describing the verdict can be found here.

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