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

As the most dramatic evens from the financial crisis recede into the past, there is an urge to consign the downturn to the pages of history, But the banking crisis in Cyprus earlier this week, along with persistent unemployment in this country and elsewhere, show that, as much as we would all like to turn the page, the credit crisis still is not yet in the past. And just like the economic effects, the litigation that accumulated as a result of the crisis continues to grind through the courts as well.

The most recent example of the continuation of the credit crisis litigation involves a case pending in the Southern District of New York against Deutsche Bank and four of its directors and officers. The case was filed on behalf of investors who purchased Deutsche Bank common stock between January 3, 2007 and January 16, 2009. (Based on Morrison, the district court dismissed from the case any shareholders who purchased their shares outside the United States.) 

In a March 27, 2013 order (here), Southern District of New York Judge Katherine Forrest largely denied the defendants’ motions to dismiss the plaintiffs’ complaint. There are a number of interesting things about Judge Forrest’s ruling, in particular the significance she attached to the massive (and profitable) short bet a Deutsche Bank trader made against residential mortgage backed securities (RMBS) and collateralized debt obligations (CDOs) at the same time Deutsche Bank was profiting from packaging and selling these very kinds of securities to outside investors.

Background

As discussed here, the plaintiffs first filed their lawsuit in 2011, seeking damages under the federal securities laws based both on an alleged scheme to defraud and on alleged misrepresentations or omissions. The plaintiffs alleged that the bank had structured and sold RMBS that it knew to be poor quality; misrepresented its risk management practices; failed to write down impaired securities; and disregarded findings that the residential mortgage loans did not comply with underwriting standards.

The defendants moved to dismiss, arguing that the “scheme” theory was after the fact construct rather than a before the fact plan; that the alleged misstatements were merely subjective opinions that are not actionable and that in any event were not made with scienter, and that the specific defendants were not the makers of actionable misstatements.

In drafting their complaint, the plaintiffs were able to draw extensively on the April 2011 report about the financial crisis of the U.S. Senate Subcommittee on Investigations as well as complaints that the U.S. Department of Justice and the Federal Housing Finance Agency filed against Deutsche Bank. Among other things to which plaintiffs were able to cite and to which Judge Forrest referred in her opinion were internal emails referring to the RMBS that the bank was marketing as “crap” and referring to the CDOs that the bank was structuring as a “balance sheet dump” (As is now all too familiar with allegations of damaging internal emails, there are many similar statements in this same vein.)

In her opinion, Judge Forrest also cites at length allegations based on internal communications relating to a massive bet a Deutsche Bank trader, Greg Lippmann, had made against the very kind of RMBS that the bank was packaging and selling. His short position ultimately grew to be as large as $4 to $5 billion. The position was so large that it drew the attention of the top company management, who reviewed his position and allowed him to continue to pursue his strategy. Judge Forrest’s opinion quotes numerous internal emails in which Lippmann disparaged Deutsche Bank’s own RMBS deals. Lippmann’s short bet ultimately returned profits of $1.5 billion, allegedly “the largest profit Deutsche Bank ever obtained from a single short position.”

In denying Deutsche Bank’s motion to dismiss, Judge Forrest found the “defendants had specific knowledge of the poor quality of the mortgages” and that the defendants “demonstrated this knowledge by authorizing Lippmann to take and expand a multi-billion dollar short position. Despite their awareness of these problems, the defendants “nonetheless repeatedly assured investors that their credit and lending practices were conservative and being adhered to.”

Judge Forrest specifically rejected the defendants’ argument that the alleged misrepresentations and omissions on which the plaintiffs sought to rely were mere non-actionable statements of opinion. She noted that the plaintiffs allege that “at the very time the market was beginning to experience the early effects of the sub-prime implosion, Deutsche Bank made statements that it had acted conservatively with respect to risk and had adhered to conservative lending standards.” Noting that the plaintiffs also alleged that at the same time defendants made these statements, “the same individuals who had made the statements had been provided information indicating the opposite,” allegations that present facts “supportive of both objective and subjective falsity.”

In concluding that the scienter allegations were sufficient as to three of the four individuals defendants (the fourth was dismissed for lack of any allegations tying the individual to any specific statements), Judge Forrest noted that the defendants had made statements about the mortgage-backed securities operations “while at the same time knowing that these assets were far riskier than an investor might reasonably suppose.” She specifically reference allegations that Lippmann had made presentations to the Executive Committee, of which the three defendants were members, supporting his view that a multi-billion dollar bet against RMBSs and CDOs was appropriate. These allegations, she found, “support a strong inference of scienter.”

Discussion

A few days ago, when it was announced that Citigroup had settled the subprime-related bondholders’ action for $730 million, there was a sense that the subprime litigation stage might finally be winding up, with only a little bit of moping up left to go. At almost the same time, however, the U.S. Supreme Court denied a writ of certiorari in the Goldman Sachs bondholders’ action, ensuring that the Goldman case would go forward with a broad class definition as a result of the Second Circuit’s opinion in that case (about which refer here, fourth item).

And now Judge Forrest has denied the motion to dismiss in this case involving Deutsche Bank. The ongoing cases against Goldman Sachs and now this one against Deutsche Bank are reminders that the subprime-related litigation wave may still have a lot further to run yet.

The significance that Judge Forrest attached to Deutsche Bank’s internal emails is nothing new. By now we have now grown accustomed to the damaging use that can be made of incautions or ill-advised internal emails. What is perhaps more interesting is the significance that she attached to Lippmann’s short position and his internal communications about it (that is, his defense to company management of his investment position). It is true that Lippmann’s short position ultimately grew to several billion dollars. At the same time, though, Deutsche Bank’s mortgage group held a $102 long position, and another affiliate held a separate long position of almost $9 billion.

The defendants had tried to argue that the much larger long position showed the company’s true beliefs about the market for mortgage-backed securities. Judge Forrest said about the divergent bets that “it simply means that they are gamblers unwilling to place their entire bet on red, versus black.” The plaintiffs’ complaint, she found, “plausibly suggests that they assured investors that their bets were in one direction – and omitted that they had taken bets in both directions.” That is, everything they said was consistent with and supported their long position, without divulging the (admittedly much smaller) short position.  The key seems to be that the plaintiffs alleged both that the defendants were aware of Lippmann’s short position and his reasons for taking it; they were not only aware of the concerns on which the short bet was based but they allowed him to expose billions of dollars on the bet, while providing reassuring words to investors.

Seventh Circuit Affirms Boeing Securities Suit Dismissal: The outcome of the dismissal motions in the Deutsche Bank case shows how advantageous it can be for plaintiffs lawyers when they have extensive public resources (like a 646-page Senate report) on which to rely in crafting their allegations. The Seventh Circuit’s March 26, 2013 affirmance of the district court’s dismissal of the securities suit that had been filed against Boeing and based on production delays involving its Dreamliner aircraft shows the challenges plaintiffs’ lawyers can face when they don’t have those kinds of resources to rely upon. The Seventh Circuit’s opinion can be found here.

As detailed in the appellate court’s opinion, written by Judge Richard Posner for a three-judge panel, the plaintiffs alleged that the defendants had misled investors by failing to disclose that the company would not make its target date for the “First Flight” of the airliner, despite knowing of production issues that would require the flight to be delayed. The plaintiffs’ initial complaint was dismissed because it lacked sufficient allegations to support the allegation that the defendants knew that the production issues would require the first flight to be delayed.

In order to try to address these problems in their amended complaint, the plaintiffs sought to rely on a single confidential witness, an engineer later identified as Bishunjee Singh. The complaint relied on Singh’s statements to support amended allegations that company management knew that the airliner had failed certain tests and that the failure might result in a delay of the first flight.

There was only one problem – “No one had bothered to show the complaint to Singh” and “investigations by Boeing soon revealed that the complaint’s allegations concerning him could not be substantiated.” In his deposition, Singh “denied virtually everything that the investigator had reported.” The appellate court noted that the district court thought that the plaintiffs’ lawyers “failure to attempt to verify their allegations in the investigator’s notes amounted to a fraud on the court.”

The appellate court not only affirmed the dismissal of the plaintiffs’ complaint but remanded the case to the district court for further proceedings with respect to question of sanctions. As if that were not bad enough, the appellate court made a point of noting that the same plaintiffs’ firm had been criticized for making misleading allegations concerning confidential sources in order to stave off dismissal in other cases. The appellate court noted that “recidivism is relevant in assessing sanctions.’

Alison Frankel has a particularly interesting commentary on the Seventh Circuit’s opinion in the Boeing case in a March 26, 2013 post on her On the Case blog (here).

Readers will be interested to note that the lead plaintiffs’ firm in both the Deutsche Bank case discussed above and in the Boeing case is the same firm. Any number of conclusions might be drawn from the outcomes in the two cases, starting with the fact that one case was dismissed and may result in the award of sanctions, whereas the other case is going forward. Among the many differences between the cases, however, is that in the one case, the plaintiffs were able to rely on a detailed report for a U.S. Senate Committee in drafting their complaint. In the other case, well, the sources were not so good.

Readers mulling this over and reaching conclusions about ultimate considerations of justice may want to pause a moment and consider, from the perspective of Boeing investors, the ultimate history of the Dreamliner aircraft. As detailed in an article entitled “Requiem for a Dreamliner?” in the February 4, 2013 issue of the New Yorker (here), the latest problems with the Dreamliner’s batteries, which have grounded the entire fleet of Dreamliners, “is just the latest in a long series of Dreamliner problems, which delayed the plane’s debut for more than three years and cost Boeing billions of dollars in cost overruns. The Dreamliner was supposed to become famous for its revolutionary design. Instead, it’s become an object lesson in how not to build an aircraft.”

Given the airliner’s checkered development history, the plaintiffs’ lawyers may feel that the problem was not that they didn’t have a valid claim, but that they just couldn’t come up with the right sources. And if you were of a certain frame of mind and only focused on the portion of the Seventh Circuit’s opinion about the sanctions issue (which has certainly drawn all of the media attention), you might (or might not) take the plaintiffs’ point.

However, Judge Posner also had some very interesting things to say about scienter, that might suggest how difficult it would be for plaintiffs’ to state a securities claims based on developmental stage production delays. Judge Posner’s comments about scienter go on for several pages and are worth reading in full; it would be hard to do them full justice here. Among other things, Judge Posner noted how implausible it is that the company had any motivation to mislead either investors or prospective customers by postponing for a few days (until after the Paris Air Show) the announcement that the first flight would be delayed. Posner noted that:

A more plausible inference than that of fraud is that the defendants, unsure whether they could fix the problem by the end of June, were reluctant to tell the world “we have a problem and maybe it will cause us to delay the First Flight and maybe not, but we’re working on the problems and we hope we can fix it in time to prevent significant delay, but we can’t be sure, so stay tuned.”

Citing Kant on the difference between “a duty of truthfulness and a duty of candor,” Posner added that “there is no duty of total corporate transparency – no rule that every hitch or glitch, every pratfall, in a company’s operations must be disclosed in “real time,” forming a running commentary, a baring of corporate innards, day and night.” (Call it a hunch, but I suspect that Posner’s words are in for a long run in future dismissal motions).

At this point, the Dreamliner has accumulated a lifetime supply of hitches, glitches and pratfalls. However, Posner is saying that without more, even a snootful of glitches doesn’t amount to securities fraud. As for what might constitute “more,” well, it seems like the factual details from a voluminous report of a Senate subcommittee appears to be enough. An unreliable witness definitely is not enough -- except perhaps for sanctions

Special thanks to a loyal reader for supplying me with a copy of the Boeing decision.

• Print
• Comments
• Trackbacks
• Share Link

Securities class action plaintiffs often allege that the defendants’ statements about their company’s internal controls are misleading. Typically, these internal control-related allegations are made in connection with allegations of accounting misrepresentations, as the plaintiffs contend that the alleged internal control deficienciesp allowed the accounting errors behind alleged accounting misrepresentations.

In a November 7, 2012 ruling (here), Judge Lewis Kaplan held in the Weatherford International securities class action litigation that the plaintiff’s internal control misrepresentation allegations were sufficient to survive a motion to dismiss, even where the accounting misrepresentations alleged were not sufficient to survive the dismissal motion. While this ruling may not be unprecedented, it does represent an unusual holding where the internal control allegations were found to be sufficient on a standalone basis. Because Judge Kaplan’s holding depended in part on the relevant corporate officer’s internal control certification, the ruling may also have important implications with respect to the certifications required under Sarbanes Oxley.

Background

The plaintiff’s complaint relates to Weatherford’s alleged understatement of tax expenses in its financial statements for the tax years 2007 through 2009 and for the first three quarters of 2010. The plaintiff alleged that beginning in 2007, the company reported industry low effective tax rates, something that was of particular interest to securities analysts and investors. The defendants allegedly touted the company’s low effective tax rate.

On March 1, 2011, the company announced that it was restating its financials for the period described in the preceding paragraph due to “material weaknesses” in internal control over financial reporting of income taxes. In particular, the company said that “the Company’s processes procedures and controls related to financial reporting were not effective to ensure that amounts related to current taxes payable, certain deferred tax assets and liabilities, reserves for uncertain tax positions, the current and deferred income tax expense and related footnote disclosures were accurate.” The company ultimately concluded that it had understated its tax liabilities during the period of the restatement by about $500 million.

The company share price declined on the news of the restatement and the plaintiff filed a securities class action lawsuit alleging two categories of misrepresentations: (1) those arising directly from the understatement of the company’s tax expenses and (2) those pertaining to Weatherford’s maintenance of its internal controls over its financial reporting. The complaint named as defendants the company itself; four individual directors and officers; and the company’s outside auditor.

With respect to the internal controls, the complaint alleged that in its filings with the SEC during the period of the restatement, the company’s CEO and CFO (Becnel) had certified that they were “responsible for establishing and maintaining” financial reporting controls; for designing the controls; and for evaluating and for reporting to the board all significant deficiencies and material weaknesses in the design or operation of the controls.

However, in the company’s March 2011 restatement announcement, the company identified a number of “material weaknesses” in internal controls, including that the inadequacy of staffing and technical expertise with regard to taxes; ineffective review and approval with respect to taxes; ineffective processes to reconcile tax accounts; and inadequate controls over the preparation of quarterly tax provisions.

The defendants moved to dismiss the plaintiffs’ complaint..

The November 7, 2012 Ruling

In his November 7 Memorandum Opinion, Judge Kaplan denied the motions to dismiss of the CEO (Becnel) and of the company itself with respect to the plaintiffs’ allegations concerning the alleged misrepresentations of the company’s internal controls. In denying the motion, Judge Kaplan noted Becnel’s personal participation in the design of the company’s internal controls, as Becnel himself had affirmed in the certifications in the company’s SEC filings. Judge Kaplan found further, in light of

the stark realities about the inadequacies of the internal controls that were revealed in the March 2011 restatement, the audit delays and control deficiencies expressly raised to him during the class period, and the fact that the Tax Department uniquely was experiencing problems even while he knew that its functions were of specific importance to the Company, the [amended complaint] sufficiently alleges scienter with regard to his statements.

Judge Kaplan found that these allegations were also sufficient to establish scienter with respect to the company itself, but not with respect to the other three individual defendants.

While Judge Kaplan found that the plaintiff’s allegations of alleged misrepresentations concerning the internal controls were sufficient as to Becnel and the company, he found that the plaintiff’s allegations regarding the understatement of the company’s tax expense were not sufficient as to any of the defendants.

Among other things, Judge Kaplan concluded that the alleged internal control misrepresentations alone were not sufficient to establish that the alleged misstatements of the company’s tax expense were made with scienter. Judge Kaplan said that “while Weatherford’s poor internal controls may give rise to liability with respect to the defendants’ statements about internal controls, the weak internal controls provide little if any circumstantial support that the statements that the understated tax expense were made with scienter.”

Judge Kaplan also rejected that the size of the restatement of the company’s tax expense, together with the extent to which the company touted its low effective tax rate in public statements, was sufficient to establish that the understatements of the company’s tax liability were made with scienter. He noted that the size of the fraud alone does not create an inference an inference of scienter, adding that “what is noticeably missing from the [amended complaint] is any allegation that the Weatherford defendants had any contemporaneous basis to believe that the information they related was incorrect.”

Though Judge Kaplan had granted the motions of the three individual defendants other than Becnel with respect to the Section 10(b) allegations against them concerning the alleged internal control allegations, he denied those three defendants’ motions to dismiss the plaintiff’s control person liability claims under Section 20(a), meaning that at least some claims against all four of the individual defendants survived the motion to dismiss, as well as the internal control claims against the company itself.

Discussion

Judge Kaplan’s decision represents the rare case where allegations of internal control misrepresentations were found to support a finding of scienter, a determination that is particularly unusual where as here the accompanying alleged accounting misrepresentations were found not to be sufficient to state a claim. Judge Kaplan’s holding that the alleged internal control allegations were sufficient on a standalone basis to survive a motion to dismiss, without an accompanying finding that alleged financial misrepresentations were sufficient to state a claim, represents a novel development, even if not entirely unprecedented.

Judge Kaplan’s ruling is particularly interesting to the extent it relies on the certifications that the CFO, Becnel, provided in the company’s SEC filings. Since the enactment of the Sarbanes Oxley Act, CEOs and CFOs have been providing certifications with respect to their company’s internal controls. There have been cases in which the internal control certifications have supported securities fraud claims (refer, for example, to Judge Shira Scheindlin’s November 2, 2007 ruling in the Scottish Re Group case), but those are typically n the context of claims in which the claimant has also established the sufficiency of financial misrepresentation allegations.

Judge Kaplan’s ruling represents a recognition that the internal control statements can be sufficient to state a claim for liability, even if the claimant is unable to establish sufficient claims of financial misrepresentation. The possibility that corporate executives can be held liable on a standalone basis for misrepresentations concerning internal controls arguably adds some teeth the responsibilities corporate executives undertake when they provide the internal control certifications required by Sarbanes Oxley.

Very special thanks to a loyal reader for providing me with a copy of Judge Kaplan’s opinion.

Nobody Could Make This Up: The November 11, 2012 Chapel Hill (N.C.) News-Observer, in an article entitled "Man Says He Saw a U.F.O. Fly Over Carrboro" (here), reports that  "Roy Mars was peeing in his compost last weekend -- it adds nitrogen -- when he looked up and saw something streak across the sky." (Hat Tip: Jim Romenesko)

• Print
• Comments
• Trackbacks
• Share Link

One of the ways in which the current wave of bank failures is different from the failures during the S&L crisis is that this time around, by comparison to that prior period, a number of the bank closures have been accompanied by shareholder lawsuits brought  against the former directors and officers of the failed institutions. Some of these shareholder suits have survived dismissal motions, as was the case, for example, with the lawsuit involving Corus Bankshares, the recent settlement of which is discussed below.

But there have also been a number of these failed bank shareholder suits that have not survived the preliminary motions, as was the case with the shareholder suit involving UCBH Holdings, as also described below. To be sure, the court’s grant of the UCBH defendants’ motion to dismiss is without prejudice. But in view of the nature of the factual allegations involved, the dismissal motion ruling is noteworthy. In particular the court’s consideration of the FDIC’s regulatory actions regarding the bank are particularly interesting.

UCBH was the holding company of United Commercial Bank of San Francisco. The FDIC took control of United Commercial Bank on November 6, 2009 (refer here). Shareholders filed a securities class action lawsuit in the Northern District of California against eight officer defendants and six director defendants, as discussed at greater length here. Their complaint originally named UCBH  as well, but following UCBH’s November 25, 2009 bankruptcy filing, the claims against UCBH itself were stayed.

The plaintiffs allege that during the class period  the defendants issued false and misleading statements concerning UCBH’s allowances and provisions for loan loss and falsely represented that the company’s financial reporting controls were effective. The complaint further alleges that on May 8, 2009, the company’s auditor, KPMG, met with the FDIC and state banking authorities to discuss the deterioration in asset quality and overall deterioration of UCBH’s financial condition.

On May 13, 2009, KPMG alerted UCBH’s audit committee that illegal acts may have occurred relating to the overvaluation of impaired and real estate owned loans. The audit committee investigated. On September 8, 2009, the company announced that as a result of the investigation UCBH was required to restate its financial statements and that UCBH had reached a consent agreement with FDIC relating to a cease and desist order concerning alleged improprieties. UCBH’s  stock value fell and the bank ultimately was closed.

The defendants moved to dismiss the plaintiffs’ complaint. In a May 17, 2011 order (here), Northern District of California Judge Jeffrey S. White granted the defendants’ motion to dismiss without prejudice, on the grounds, inter alia, that the plaintiffs had not adequately alleged scienter.

In concluding that the plaintiffs allegations were insufficient to create a strong inference scienter, Judge While found that the plaintiffs allegations based on UCBH’s statements about the efforts of “senior management” to monitor and evaluate the bank’s loan portfolio did “not contain sufficiently particularized allegations to give rise to a strong inference of scienter.” Similarly, Judge Whit found that the plaintiffs’ allegations that the senior officers were motivated to conceal UCBH’s financial condition in order to obtain TARP funds also failed to allege that the these defendants had information about the bank’s financial condition that was withheld or falsely reported.

The more interesting part of Judge White’s scienter analysis concerned the plaintiffs’ efforts to rely on the FDIC’s actions and findings. In particular the plaintiffs sought to rely on the findings in the FDIC’s “material loss review” (MLR) that “senior executives” engaged in deliberate misconduct to conceal the Bank’s deteriorating financial condition by delaying risk downgrades and minimizing the bank’s loan loss allowance. Judge White observed that these allegations do not support a strong inference of fraud “as to any one Defendant,” since the MLR does not name “any particular individual as responsible for the alleged misconduct.”

The plaintiffs also sought to rely on the FDIC’s report of examination in April 2009 and KPMG’s May 2009 report to the company’s audit committee to establish scienter, but Judge White found that the allegations do not establish when the defendants became aware of the alleged misconduct and which defendants became aware.

Finally Judge White rejected plaintiffs attempt to rely on the “core operations inference” to satisfy the scienter pleading requirement, essentially arguing that the matters alleged to be misrepresented were so essential  to the bank’s core operations as to establish that the defendants had access to the disputed information. Judge White rejected this suggestion, concluding that the plaintiffs had not sufficiently alleged that the loan loss allowances and provisions were part of the bank’s “core operations.”

Judge White’s ruling in the defendants’ favor on the dismissal was without prejudice, and the plaintiffs were given leave to replead. It may be that the plaintiffs will overcome the pleading deficiencies in their amended complaint – indeed, in many respects Judge White’s opinion provides a roadmap for repeading.

Nevertheless it is striking that the dismissal motion was denied in a case where the company’s own auditor reported that illegal acts may have occurred and where company’s own audit committee investigation preceded a restatement and an entry into a cease and desist order, and where the FDIC itself concluded that the “senior executives” engaged in deliberate misconduct to conceal the bank’s deteriorating financial condition. Judge White’s analysis represents  a very demanding application of the PSLRA’s specificity requirement. In particular, his unwillingness to accept the FDIC’s conclusions of misconduct involving “senior executives” as sufficient allegations against any one individual defendant is a very exacting application of the standard -- although certainly justified, from the defendants’ perspective.

It of course remains to be seen whether the plaintiffs will be able to cure the deficiencies on repleading.. But it is noteworthy that the UCBH is only one of several shareholder suits filed against directors and officers of failed banks that have faced difficulties overcoming the initial pleading hurdles. Motions to dismiss have been granted in a number of these cases, including for example the cases relating to Downey Financial (refer here), Fremont General (here) and Bank United (here -- without prejudice).  But as noted below, a number of survived the dismissal motions as well.

I have in any event added the UCBH ruling to my running tally of credit crisis dismissal motion rulings, which can be accessed here.

Corus Bankshares: Among the failed bank securities class action lawsuit is the one filed against the former directors and officers of Corus Bankshares, the parent company of Corus Bank, which closed on September 11, 2009 (about which refer here). As discussed here, in April 2010, Northern District of Illinois Judge Elaine Bucklo denied the defendants’ motion to dismiss (The opinion that stands in interesting contrast to Judge White’s opinion in the UCBH case.)

On May 17, 2011, the parties to the Corus Bankshares case filed a stipulation of settlement (here) indicating that the case has been settled for $10 million, all which is to be paid for by company’s D&O insurance. I have added the Corus settlement to my list of credit crisis securities lawsuit settlements, which can be accessed here.

As a result of its relatively modest size, the Corus settlement may not seem particularly noteworthy, which may be a fair assessment. What strikes me about the Corus settlements is that it represents something that still seems to be surprisingly rare, which is a settlement of credit crisis-related securities class action lawsuit.

Even though there were well over 230 credit crisis-related securities class action lawsuits filed, there still have only been 20 settlements of the credit crisis securities suits. To be sure, a fair number of these cases were dismissed, but a substantial number (like the Corus case) were not dismissed. Even though many of these cases are now several years old only a very small number have settled so far – indeed the Corus settlement is only the third such settlement this year.

It seems to me that there is a substantial backlog of these as-yet unresolved cases, many of which are moving – apparently very slowly -- toward settlement. Eventually these cases will settle in substantial numbers. Though many of the settlements will, like the Corus settlement, be relatively modest, some will not be so modest and in the aggregate the total settlements will likely represent a very large figure. Even though a large chunk of these settlements may not be insured, a big chunk will be insured. The collective cost to D&O insurers could represent an impressive total. Reasonable minds may question whether or not insurers are now fully reserved for this eventuality.

• Print
• Comments
• Trackbacks
• Share Link

One of the most interesting aspects of the complicated sequence of events surrounding the Bank of America/Merrill Lynch merger is the suggestion that Treasury Secretary Henry Paulson instructed BofA’s CEO Ken Lewis not to disclose to BofA shareholders that the government, in order to keep BofA from backing out of the deal, was backstopping BofA to the tune of billions of dollars of additional TARP funds and asset guarantees.

As I recently pointed out in my discussion of the opinion, Southern District of New York Judge Kevin Castel, in his August 27, 2010 dismissal motion ruling in the BofA/Merrill securities suit, found that the plaintiffs had not sufficiently alleged scienter in connection with BofA’s alleged failure to disclose this federal backstop.

In support of this conclusion, Castel said the defendants were "acting at the instruction of the Treasury Secretary during a moment of acute economic and political uncertainty. There are no allegations of personal gain derived from the federal funds, or a violation of a statute or regulation in a ‘highly unreasonable’ manner."

Castel doesn’t say that BofA didn’t have a duty to disclose the existence of the federal backstop. But if BofA had a duty to disclose the information, what difference does it make under the federal securities laws that Paulson told Lewis not to disclose it? As CNN Money journalist Colin Barr noted on September 1, 2010 in his Street Sweep blog post entitled "Judge Embraces ‘Paulson Made Me’ Defense" (here), Castel’s ruling has "left some observers scratching their heads."

Is Castel suggesting that there is some kind of governmental instruction or national emergency exception to the disclosure requirements under the federal securities laws? On what basis? Whose instruction is sufficient? What level of exigency is sufficient and who decides?

I was glad to see Barr’s post focusing on this aspect of Judge Castel’s ruling. I think these issues are both interesting and important, but for whatever reason, this part of Castel’s opinion has largely gone without public comment.

I did explore these issues in my prior post about Judge Castel’s opinion. Because I think these issues are worthy of attention and further consideration, and at risk of appearing a little too self-referential, I am reproducing here my prior comments about this aspect of Judge Castel’s ruling, in order to try to highlight these issues and to try to encourage further discussion of these questions. Here are my thoughts on this issue:

The BofA/Merrill Lynch merger was one of highest profile events during the peak of the global financial crisis in late 2008 and early 2009. The disclosures in early 2009 about Merrill’s losses and about the bonus payments were highly controversial. As a result, Judge Castle’s opinion in the consolidated shareholder litigation undoubtedly will provoke extensive scrutiny and commentary. There are indeed a number of parts of the opinion that are worthy of discussion, but the part this is the most interesting to me is his conclusion regarding the inadequacy of the scienter allegations in connection with the alleged failure to disclose the federal bailout that Lewis negotiated with Paulson.

As alleged in the complaint, this massive federal package was negotiated after the shareholder vote but before the deal closed. Its existence was apparently critical to the BofA board’s vote to go forward with the deal rather than to invoke the MAC clause. Moreover, it was understood that Paulson’s verbal agreement would have to be disclosed if it were reduced to writing – and accordingly, it was not reduced to writing so it wouldn’t have to be disclosed.

In concluding that these actions, which seem to have been taken precisely so that something everyone recognized as important would not have to be disclosed prior to the merger closing, do not give rise to a strong inference of scienter, Judge Castel relied on two considerations: (1) Paulson "instructed" Lewis not to disclose the federal package; and (2) Lewis had nothing to gain personally from withholding disclosure.

Though these factors undoubtedly are relevant, it strikes me that these points do not necessarily answer the question whether or not Lewis consciously misled BofA shareholders of acted with reckless indifference to the truth.

It could be argued that the allegations strongly suggest that Lewis did not want the BofA shareholders to know that the only reason the BofA board was willing to go forward with the deal was the existence of massive federal support. A plausible inference is that he, like Paulson, feared the chaos that would have emerged if these facts were revealed before the deal closed. It is also plausible to infer that Lewis and others didn’t want to anger Paulson and risk losing the proffered federal support.

These might all have seemed like good and sufficient reasons to withhold the information, but whether or not the reasons might have seemed good and sufficient does not answer the question whether Lewis and others acted with awareness of or conscious disregard whether BofA shareholders would be misled.

The fact that Paulson "instructed" Lewis to withhold disclosure does not answer the question whether or not Lewis was aware BofA shareholders would be mislead; to the contrary, it might actually suggest a concern that BofA’s shareholders couldn’t be trusted with the truth. (Indeed, Paulson’s instruction arguably does nothing more than make him complicit in the alleged deception, which in Paulson’s case, encompassed not just BofA shareholders but also U.S. taxpayers.)

Why is Paulson’s "instruction" relevant at all to the question whether or not the securities laws were violated? Is Castel suggesting that there is some sort of immunity from securities liability if the actions were at the request of a government official? It seems to me that the supposed relevance of Paulson’s instruction is surprisingly unexamined in Castel’s opinion, and the entire discussion of the issue is disconnected from the question whether or not Lewis knew that the shareholders would be misled.

Judge Castel’s emphasis on Lewis’s lack of personal benefit, while not irrelevant, is also beside the point. Lewis’s lack of personal benefit certainly doesn’t answer the question whether Lewis and others were deliberately taking steps to avoid disclosing material information because they were afraid of what would happen if they did.

In the final analysis, I think Judge Castel’s ruling can perhaps only be understood by his observation that these events took place "during a moment of acute economic and political uncertainty." While this fact has nothing to do with whether or not Lewis was consciously withholding information from BofA shareholders, it does suggest Castel is simply unwilling to permit liability for actions taken at the direction of senior public officials at a time of national exigency. It is almost as if he is saying, with shrugging shoulders, "What else was BofA going to do?" I certainly understand this way of looking at these circumstances. The problem is that it doesn’t necessarily address the questions required by the securities laws.

Judge Castel does not actually say he is inferring either an official instruction or national emergency exception to the requirements of the securities laws. But by emphasizing those aspects of the situation, he seems to be suggesting that these exceptions exist and apply.

To be sure, Judge Castel did observe that the scienter allegations regarding the nondisclosure of the federal package, which he characterized as "thin," might have been sufficient if they were accompanied by adequate allegations of motive or recklessness. It could be argued that his ruling is simply a reflection of insufficient factual pleading, which may be the case. Nevertheless, his analysis raises many questions that in my view are insufficiently examined, whether or not the scienter allegations themselves were or were not sufficient.

Given the high profile nature of this case, I suspect there will be much discussion of Judge Castle’s opinion in the weeks and months ahead. Legal proceedings arising out of these circumstances do seem to attract controversy – as, with for example, Judge Rakoff’s high profile rejection of the SEC’s settlement of its enforcement action against BofA arising from these circumstances.

Back to School: Add one more company to the list of for-profit education companies that have recently been sued in securities class action lawsuits. As I discussed in a recent post, within the space of just a few days in August, plaintiffs’ lawyers filed a cluster of lawsuits against for-profit education companies. On August 31, 2010, plaintiffs’ lawyers added one more company to the list when they sued Corinthian Colleges and certain of its directors and offices, based on allegations similar to those raise against the other for-profit education companies. A copy of the plaintiffs’ lawyers’ press release can be found here.

Old School: I wonder if this for-profit education company’s schools cover their chairs with Soft Corinthian Leather. For those who miss the reference, and in respectful memory of Ricardo Montalban, here is the original Chrysler Cordoba advertisement to which I was referring :

• Print
• Comments (1)
• Trackbacks
• Share Link

In a November 26, 2008 opinion (here), the Ninth Circuit affirmed the lower court’s dismissal of a lawsuit asserting securities law violations against InVision and certain of its directors and officers based on FCPA-related disclosures. The case is noteworthy not only for its involvement of FCPA-related allegations, but also for the appellate court’s consideration of "collective scienter" issues, as well as of the significance of Sarbanes-Oxley certification issues.

Background

On March 15, 2004, InVision announced it would be acquired by GE in a cash-for-stock transaction. That same day, the company filed its annual filing on Form 10-K to which the merger agreement was attached. On July 30, 2004, InVision announced that an internal investigation had revealed possible violations of the Foreign Corrupt Practices Act (FCPA). The company voluntarily reported the activities to the SEC and the DOJ. The company later entered negotiated arrangements with the DOJ and the SEC (refer here). GE later consummated the pending merger.

Shortly after InVision announced the FCPA concerns, shareholders initiated a securities class action lawsuit against the company and certain of its directors and officers. (Refer here for further background regarding the case). The plaintiffs based their claims on three alleged misstatements in the merger agreements, which InVision had attached to its 10-K.

The plaintiffs alleged that the merger agreement misleadingly stated that the company was "in compliance … with all applicable law"; in compliance with the "books and records" provision of the FCPA; and that that neither the company nor any of its officers, directors or employees had knowledge that the company had violated the FCPA’s antibribery provisions.

The district court dismissed the complaint and the plaintiffs appealed.

The Ninth Circuit’s Decision

The appellate court essentially assumed that the plaintiff had satisfied the requirement to plead falsity with respect to the three alleged misrepresentations stating that "even if [the plaintiff, Glazer] properly pled falsity, the district court’s dismissal would still be appropriate if Glazer failed to plead scienter adequately with respect to the three statements."

In order to satisfy the scienter requirement, the plaintiff urged the Ninth Circuit to adopt the "collective scienter" theory, following the Second Circuit’s recent decision in the Dynex Capital case (refer here) and the Seventh Circuit’s recent decision in the Tellabs case (refer here). Under this theory, as articulated by the Seventh Circuit, "it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud."

After reviewing the case law concerning corporate securities liability, including its own prior decision in the Nordstrom v. Chubb case (a decision that will be familiar to many of this blog’s readers), the Ninth Circuit ultimately concluded that this case did not require the court to decide whether or not to adopt the theory of collective scienter.

The court concluded that because of "the limited nature and unique context of the alleged misstatements" involved in the case, the "collective scienter" issue was not before the court. In reaching this conclusion, the court noted that

Glazer rests its securities fraud claim on three statements, all of which appear in a sixty-page legal document. If the doctrine of collective scienter excuses Glazer from pleading individual scienter with respect to these legal warranties, then it is difficult to imagine what statements would not qualify for an exception to individualized scienter pleadings. In fact, because the merger agreement warranted that the company was in compliance "with all laws," then under the collective scienter theory urged by Glazer, so long as any employee at InVision had knowledge of the violation of any law, scienter could be imputed to the company as a whole. This result would be plainly inconsistent with the pleading requirements of the PSLRA.

 

Accordingly, the Ninth Circuit held that in order to succeed on his claim, the plaintiff had to establish that individual defendants acted with scienter in making the statements in the merger agreement. The court said that "we see no way that [the defendant] could show that the corporation, but not any individual [director or officer] had the requisite intent to defraud." Only the company’s CEO and CFO had signed the merger agreement, and the plaintiff alleged scienter only with respect to the CEO, Magistri.

The court found with respect to Magistri, however, that Glazer had not pled any facts to demonstrate that "Magistri was personally aware of the illegal payments or that he was actively involved in the details of the details of InVision’s Asian sales."

The Ninth Circuit also refused to infer scienter from the CEO’s and the CFO’s signature of the Sarbanes-Oxley certifications, holding that the mere signature, without more, is insufficient to raise a strong inference of scienter.The Ninth Circuit followed prior decisions of the Eleventh and Fifth Circuits, concluding that there was no evidence that the SOX certification requirements were intended to alter the PSLRA’s pleading requirements. The Court said that "the Sarbanes-Oxley certification is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.

Discussion

The Ninth Circuit’s decision is noteworthy for its discussion of the "collective scienter" issue, although in the end it is of limited significance on this point given the court’s conclusion that it did not need to reach that issue. The decision is also noteworthy for its discussion of the Sarbanes-Oxley certification issue, but in that respect it also merely followed existing precedent.

But perhaps the greatest significance about the Ninth Circuit’s opinion may be what it suggests about securities cases based on FCPA-related disclosures. The Ninth Circuit’s refusal to allow the claim to proceed in the absence of allegations that senior officials were aware of the improper conduct could present a significant hurdle for FCPA-related securities claims, at least in the circuits that have not adopted the "collective scienter" theory.

As the Ninth Circuit noted in the InVision case, "the surreptitious nature of the transactions creates an equally strong inference that the payments would have deliberately kept secret – even within the company." Obviously, payments of this kind invariably are of a surreptitious nature and of a kind that would be kept secret, even within the company. The implication is that in order for a securities claim alleging FCPA-related disclosures to survive the initial pleadings stage, the claimants may have to plead that the company officials who prepared the company’s public disclosures were aware of the improper activities.

In prior posts (most recently here), I have noted the increasing prevalence of follow-on civil litigation accompanying FCPA investigations, including the increasing frequency of follow-on securities litigation alleging misrepresentations in the FCPA-related disclosures. The Ninth Circuit’s decision in the InVision case suggests that, at least in jurisdictions that have not recognized the collective scienter theory, the ability of these follow-on securities lawsuits to get past the pleading stage may depend on the existence of allegations that senior company officials were aware of the improper payments. Given the invariably "surreptitious nature" of these payments, claimants may find this a challenging requirement to satisfy.

The SEC Actions blog has a thorough analysis of the Ninth Circuit’s discussion of the pleading issues in the InVision case, here. The FCPA Blog also has a good discussion of the case, here.

Special thanks to Neil McCarthy of Lawyerlinks.com for providing me with a copy of the Ninth Circuit’s opinion.

Another New Wave Securities Lawsuit: In a recent post (here), I noted that there have been several recent securities class action lawsuits in which the companies involved have been hit with significant losses due to wrong way bets on commodities or currencies.

The latest example of this type of securities litigation involves a case filed on November 26, 2008 in the Southern District of Florida against Brazilian forest products manufacturer Aracruz Cellulose S.A. and certain of its directors and officers on behalf of investors who purchased the company’s American Depositary Receipts on the NYSE., as well as purchasers of the company’s common stock, which trades on the Sao Paulo Bovespa.

According to the plaintiffs’ lawyer November 26 press release (here), the complaint alleges that

During the Class Period, Aracruz entered into undisclosed currency derivative contracts to purportedly hedge against the Company's U.S. dollar exposure. The Company characterized the use of these contracts as protection against foreign interest rate volatility and assured investors that this type of trading did not represent "a risk from an economic and financial standpoint." However, these contracts violated Company policy in that they were far larger than necessary to hedge normal business operations. As a result of Aracruz's clandestine and speculative currency wagers, credit rating agencies downgraded Aracruz, the Company's CFO resigned, and Aracruz's stock suffered a severe decline, plummeting to the lowest levels in 14 years.

As I noted in my prior post, many companies were also exposed to sudden and unexpected losses by dramatic changes in the commodities and currencies markets earlier this year. For example, the November 29, 2008 Wall Street Journal reported (here) on several airlines that have recently reported the negative impact from fuel cost hedges that generated huge losses. These kinds of developments and other unexpected fallout from the crisis roiling global financial markets are likely to affect a wide variety of companies, some of which may be subject to securities litigation.

It is interesting to note that the plaintiffs’ lawyers in the Aracruz case appear to have made a conscious decision to include within the class the Brazilian company’s common shareholders. Within this group are likely to be a number of shareholders domiciled outside the U.S. that bought their shares against the foreign company on a foreign exchange. The presence of these so-called "foreign-cubed" litigants could pose subject matter jurisdiction issues, at least as to those claimants.

My recent post discussing the Second Circuit’s recent "foreign-cubed" litigant ruling in the National Australia Bank case can be found here. The November 24, 2008 Southern District of New York decision granting the motion to dismiss the securities class action lawsuit that had been filed against Vodafone for lack of subject matter jurisdiction, in reliance upon the National Australia Bank decision, can be found here. (Note: Special thanks to the reader who pointed out that I had incorrectly referred to the Vodafone case as the Vivendi case. My apologies for any confusion.)

• Print
• Comments (1)
• Trackbacks
• Share Link

The heightened susceptibility of life sciences companies to securities class action lawsuits is a phenomenon that I and others have previously noted (refer here). But while life sciences companies may experience greater securities class action claim frequency, many of these lawsuits against life sciences companies are dismissed (as discussed here).

In a case the First Circuit itself called “paradigmatic” of securities cases involving life sciences companies, the appeals court recently affirmed the lower court’s dismissal of the securities lawsuit pending against Biogen Idec and certain of its directors and officers. The court’s analysis is noteworthy because of its emphasis of the issues that contribute to the vulnerability of these kinds of companies to securities lawsuits. But by way of contrast I also discuss below a recent Ninth Circuit opinion reversing the district court’s dismissal of a securities lawsuit involving Gilead Sciences.

The First Circuit’s Opinion in the Biogen Idec Case: On August 7, 2008, in an opinion written by Chief Judge Sandra L. Lynch, the First Circuit issued its opinion in New Jersey Carpenters Pension & Annuity Fund v. Biogen Idec (here). The case involves Biogen’s alleged misrepresentations and omissions pertaining to Tysabri, a new drug for multiple sclerosis and other autoimmune disorders.

In November 2004, the FDA granted accelerated approval of Tysabri. Less than three months later, on February 18, 2005, continuing clinical trials “revealed that two patients had contracted a type of infection perhaps associated with the drug.” One of the two patients died. On February 25, 2005, the company voluntarily withdrew the drug from the market. Its stock price dropped and several lawsuits were filed.

In their amended complaint, the plaintiffs alleged that, in order to facilitate their sale of shares of company stock at inflated prices, the defendants misrepresented the safety and efficacy of the drug. As the First Circuit summarized the case, the “key theme” of the lawsuit is that the defendants were “aware or at least recklessly unaware of greater safety risks with TYSABRI for opportunistic infections, particularly in combination with other MS therapies, than had been announced to the public,” and that defendants “intentionally failed to disclose this information in order to keep the share price high.”

The district court dismissed the complaint, finding that while the plaintiffs had alleged material misrepresentations and omissions with appropriate specificity, they had not alleged scienter with appropriate specificity. The plaintiffs appealed.

In evaluating the plaintiffs’ allegations, the allegations relating to the timing of defendants’ receipt of information were critical, because, as the First Circuit noted, “defendants cannot have committed fraud if they did not know at the time that the failure to provide additional information was misleading.” In that regard, the First Circuit found that “plaintiffs’ amended complaint fails to allege facts both (1) as to when defendant had information about non-PML opportunistic infection and (2) that the information available sufficiently suggested a causal connection between TYSABRI and non-PML opportunistic infections.”

The First Circuit expressed its willingness to consider factual allegations supported only by confidential sources, but the confidential sources’ allegations did not create a strong inference of scienter, because the allegations do not indicate when during the clinical trials information about infections became known.

The court also found plaintiffs’ allegations that defendants had fraudulently failed to disclose dangers of use of Tysabri in combination with other drug therapies were insufficient. Plaintiffs’ allegations that defendants had no reasonable basis to say that Tysabri was safe in combination with other drug therapies, the First Circuit found, were “not nearly so compelling as opposing inferences from the undisputed facts in the record.”

Because the First Circuit concluded that the plaintiffs had not “sufficiently alleged … that defendants had any reason to know their statements were misleading before February 18, 2005,” the Court disregarded all insider trading prior to that date. Only one insider sale was alleged on or after that date, a February 18 sale by the company’s General Counsel. But the General Counsel was not a defendant to the Section 10(b) claim, and the First Circuit held that based solely on the General Counsel’s trading “a strong inference of scienter on the part of Biogen and other individual defendants cannot be drawn.”

The First Circuit found that the plaintiffs’ allegations of scienter were not sufficient to support an alleged violation of Section 10(b), and affirmed the district court.

The court’s opinion was informed by its observations of the peculiar characteristics of securities lawsuits filed against companies involved in the drug and device development business:

The situation here is paradigmatic of securities fraud cases against drug companies where a promising drug or medical device is approved by the FDA and then later proves to have health risks which affect the market for the drug.

The court also noted that disclosures about regulatory developments provide an important context within which sudden stock price changes can occur:

The investing public is well aware drug trials are exactly that: trials to determine the safety and efficacy of experimental drugs. And so trading in the shares of companies whose financial fortunes may turn on the outcome of such experimental drug trials inherently carry more risk than some other investments.

With these comments, the First Circuit recognized the circumstances that make life sciences companies susceptible to securities lawsuits. These companies have volatile share prices that are vulnerable to sudden shocks due to the uncertainty of the regulatory process or to unexpected safety concerns. All too often these reverses result in securities lawsuits, supported only by allegations that the reverses occurred and therefore company management must have known about the problems from which the reverses arose.

The First Circuit’s opinion also evinced an appreciation of the fact that merely because a company has encountered these types of setbacks does not mean that the company has committed securities fraud. The First Circuit’s analysis helps explain why both life sciences may find themselves accused of securities fraud more frequently than other kinds of companies, and also why these cases are frequently dismissed.

Ninth Circuit Reverses Dismissal of Gilead Science Case: But while a number of the securities lawsuits filed against life sciences companies may be dismissed, that certainly does not mean that life sciences companies inevitably prevail. Indeed, there have been a number of significant settlements in securities cases involving life sciences companies (particularly large pharmaceutical companies).

Life sciences companies also face the same challenges involved in securities claims against any corporate defendant, including the possibility that a victory at the trial court level can be reversed at the appellate level. That is exactly what happened in the securities litigation involved Gilead Sciences. In an opinion dated August 11, 2008 (here), the Ninth Circuit reversed the lower court’s ruling dismissing the case for failure to adequately plead loss causation.

Gilead’s flagship produce, Viread, is an agent used with other drugs to treat HIV. The complaint alleges that the company actively marketed the drug for off-label uses, in violation of FDA rules. The company received a Warning Letter from the FDA on this topic, which the company disclosed on August 8, 2003. The company’s share price did not decline in response to this news; in fact, the share price was higher on the following trading days.

In order to address the absence of any share price decline, the plaintiffs alleged that it was not until October 28, 2003 that the public “finally realized the impact of the off-label marketing and the Warning Letter.” After market close that day, the company disclosed that Viread sales had fallen below expectations due to wholesaler overstocking during the quarter. Market analysts attributed the sales decline to “lower end-user demand.” The plaintiffs alleged that the reduced demand was “a direct result” of the Warning Letter, which exposed Gilead’s off-label marketing.

The district court found that the complaint failed to “connect the chain of events” between the failure to disclose the off-label marketing; that the decline in demand for Viread was due to the Warning Letter; and that the reduced sales caused a decrease in Gilead’s share price. The district court said there were “too many logical and factual gaps.” The district court said it could not make “the unreasonable inference that a public revelation caused a price drop three months later.” The district court dismissed the complaint for failure to adequately plead loss causation.

The Ninth Circuit, by contrast, found “the complaint sufficiently alleges a causal relationship between (1) the increase in sales resulting from the off-label marketing, (2) the Warning Letter’s effects on Viread orders, and (3) the Warning Letter’s effect on Gilead’s share price.”

The Ninth Circuit went on to observe that “perhaps what truly motivated the dismissal was the district court’s incredulity.” The Ninth Circuit said that a district court ruling on a motion to dismiss “is not sitting as a trier of fact,” and as long as plaintiffs allege a theory that “is not facially implausible, the court’s skepticism is best reserved for later stages … when the plaintiffs’ case can be rejected on evidentiary grounds.” The Ninth Circuit concluded that “a limited temporal gap between the time of the misrepresentation is publicly revealed and the subsequent decline…does not render a plaintiffs’ theory of loss causation per se implausible.”

The Ninth Circuit said the market “did react immediately to the corrective disclosure” which the plaintiffs claims to be the October 28 press release, the date on which it is alleged the market had complete information to process the revelations about off-label marketing.

It is hardly my place to comment on the merits of a judicial opinion. Suffice it to say that reasonable minds may differ whether the district court was guilty of “incredulity” or the Ninth Circuit of “credulity.” Reasonable minds may also differ whether the three months’ lapse between the disclosure of the Warning Letter and the stock price drop is a “limited temporal gap.” Reasonable minds may also differ whether plaintiffs’ Rube Goldberg explanation for the delayed market reaction “is not facially implausible.”

On the other hand, it seems apparent that the allegation of off-label marketing troubled the Ninth Circuit and it is certainly true that a company whose alleged reverses are not due to unexpected regulatory developments or unanticipated clinical outcomes but rather to marketing activities is in a less sympathetic postion. That is obviously why the plaintiffs strained so hard to try to make the stock price drop relate back to the off-label marketing Warning Letter, because that supposed connection put the defendants in a less favorable light. Regardless, I suppose, of whether or not the stock price drop was due to the wholesaler overstocking.

The one thing that is clear is that all litigants are susceptible to the vicissitudes of the litigation process, life sciences companies as well as any other kind of company. The plaintiffs in Gilead certainly established the value of continuing to fight, as you never know when an initially disfavored hand might still be just enough to take a trick. Of course, the plaintiffs must now go back to the district court and face a court whose skepticism even the Ninth Circuit acknowledged could justify rejecting plaintiffs’ case later.

The SEC Actions Blog has an excellent lawyerly analysis critical of the Ninth Circuit's opinion in Gilead, here.

More Drug News: Biogen Idec’s drug, Tysabri, which the FDA permitted the company to reintroduce to the market in July 2006, was back in the news recently. According to an August 1, 2008 Wall Street Journal article (here), two MS patients treated with the drug have recently contracted a potentially deadly brain infection. The article stated that the company “had no plans to recall the drug or restrict its use.”

The WSJ.com Health Blog also has a post (here) discussing this development. The comments following the post make for interesting reading. It is all too easy to consider these legal issues in a vacuum, but there are real patients whose only hope is the use of these kinds of drug therapies. The eloquent pleas of these patients for the drugs to remain available are moving and impressive.

But the adverse developments cannot be minimized, and in that regard it should also be noted that Biogen Idec also faces a lawsuit from the estate of one of the deceased patients. Recent procedural developments in the case were also discussed recently on the WSJ.com Health Blog (here).

All of that said,  this about business too, and it may come as no surprise that Carl Ichan viewed the stock price drop following Biogen’s recent advserse news as an opportunity to increase his holdings in the company’s shares, perhaps to advance his agenda of getting the company to sell itself, as discussed here.

There is a Balm in Gilead: Perhaps I am presuming too much, but for me the name Gilead Sciences evokes Jeremiah, Chapter 8, Verse 22: “Is there no balm in Gilead? Is there no physician there? Why then has the health of my poor people not been restored?” (New Revised Standard Version).

This line is memorably recalled in the African-American spiritual, There is a Balm in Gilead, whose refrain captures the soothing power of the song:

There is a balm in Gilead

To make the wounded whole;

There is a balm in Gilead

To heal the sin-sick soul.

• Print
• Comments
• Trackbacks
• Share Link

When the United States Supreme Court issued its June 21, 2007 opinion in the Tellabs case, media commentators generally viewed it as a defense victory. My own view (expressed here), was that the decision represented more of a draw, and that the practical impact would vary from Circuit to Circuit. The suggestion that Tellabs was not a comprehensive defense victory was arguably reinforced in the ongoing Tellabs case itself, when (as discussed here) the Seventh Circuit, reconsidering the case on remand from the Supreme Court, reaffirmed its prior reversal of the district court’s dismissal of the case.

An April 16, 2008 opinion (here) from the First Circuit in the Boston Scientific securities lawsuit provides even further support for the view that Tellabs by no means put the plaintiffs’ lawyers out of business, and indeed, that in some circuits – the First Circuit, for example – Tellabs may even put the plaintiffs in a better position than the were prior to Tellabs. I discuss the First Circuit’s opinion in the Boston Scientific case in detail below, but the critical point here is that the while the district court, applying the First Circuit’s pre-Tellabs standard, had dismissed the case, the First Circuit, applying the Tellabs standard, reversed the district court and remanded the case for further proceedings.

The background regarding the Boston Scientific case can be found here. In a nutshell, the complaint alleges that in late 2003, the company became aware of serious problems in Europe with its TAXUS stent, which at the time had not been introduced in the U.S. The company allegedly experienced serious problems, allegedly of the same kind as the prior problems in Europe, after the stent was introduced in the U.S. in March 2004. The plaintiffs allege that the company sought to soft-pedal the problems by representing that they were due to physician unfamiliarity with the stent, while the company allegedly knew that the problems were actually due to manufacturing defects. The defendants allegedly withheld the true information while TAXUS sales drove up the company’s share price, allegedly in order to permit the defendants to unload their shares of the company’s stock at the inflated prices. After the company announced a series of stent recalls, its share price fell and the securities litigation ensued.

In an opinion dated June 21, 2007 (here), issued ironically the same day as the U.S. Supreme Court issued its opinion in the Tellabs case, the district court granted the defendants’ motion to dismiss. Among other things, the district court held that the plaintiff failed, as required under the PSLRA, to plead facts supporting a “strong inference” that as of the time of the stent recall and manufacturing changes, the defendants had the requisite scienter. The plaintiffs appealed.

The First Circuit, in an opinion written by Judge Sandra Lynch, noted that “the district court did not have the benefit of the Tellabs opinion, which reversed a higher standard for scienter imposed by the prior law of the circuit. We apply Tellabs and that leads us to a different result.” The court went on to note that “while there is support for the defendants’ inferences, we think, at this stage, that plaintiff’s inferences are at least equally strong.”

The First Circuit also reversed the district court’s holding as to reliant on the view that the plaintiffs’ allegations were essentially just “fraud by hindsight.” In addition, the First Circuit said that while the plaintiffs’ insider trading allegations are “on the weaker end of the spectrum…a finder of fact could reasonable ask why [the defendants] would have sold so much stock at a time when the company appeared to be soaring on the strength of TAXUS.” On these and other bases, the First Circuit concluded that “plaintiff has pled enough to give rise to inferences that are at least as strong as any competing inference regarding scienter.”

In reversing the district court, the First Circuit expressly acknowledged that Tellabs has reversed “a higher standard” that the First Circuit itself had previously “imposed” as the “law of the circuit.” This specific statement is an explicit recognition that, in the First Circuit at least, the Tellabs standard not only did not advance the defendants’ interests, but it arguably aids’ plaintiffs’ interests by imposing a lower threshold pleading requirement.

At a minimum, the First Circuit opinion in the Boston Scientific case underscores that the Tellabs opinion represents something less than that the watershed defense victory it was initially portrayed to be. The decision also highlights that even after Tellabs, in certain circumstances, plaintiffs will be able to continue to meet the PSLRA’s pleading requirements – particularly in certain circuits.

Another Options Backdating Securities Lawsuit Dismissal: In the latest dismissal motion ruling in an options backdating-related securities lawsuit, Judge Susan Illston of the United States District Court for the Northern District of California, in an April 14, 2008 opinion (here) in the UTStarcom case (about which refer here), granted the defendants’ motion to dismiss, and directing the plaintiff to file an amended complaint by May 16, 2008.

Judge Illston found that while the plaintiff had adequately pled loss causation, he had not adequately pled scienter. In rejecting the plaintiff’s scienter allegations, Judge Illitson found that “none of these factual allegations is cogent and compelling…because each could equally support the inference that the stock option had been backdated through innocent bookkeeping error.”

The UTstarcom dismissal is the latest in a series of options backdating-related securities lawsuit dismissals, as discussed in my recent post (here) commenting on other recent dismissals. I have added the UTStarcom dismissal to my running tally of the options backdating lawsuit dismissals, denials, and settlements, which can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for copies of the Boston Scientific and UTstarcom opinions.

A Reflective Moment: The coincidence that both of the opinions cited above were both written by women made me wonder something – how many female members of the federal judiciary are there? The answer, determined after a little bit of Internet research, is that there are a lot of female federal judges, although women clearly are still underrepresented on the U.S. Supreme Court, the First Circuit, and several other federal courts. A slightly outdated list of women in the federal judiciary can be found here.  

The list includes, among others, Leonie M. Brinkema, now a district court judge on the United States District Court for the Eastern District of Virginia. I had the privilege of seeing Judge Brinkema, while she was still known to some as “Dee Dee”, appear in court when she was an AUSA (and I was a clerk for a federal judge). She was the most skilled and effective advocate I ever saw in action.  

I learned many things from watching her, including the lesson that you did not have to be loud or obnoxious to be an effective advocate, a very important lesson for a young attorney to learn. If others of my brethren (and sistren) at the bar could also have learned the same lesson, I might still be involved in the active practice of law. Judge Brinkema is perhaps best known for presiding over the trial of 9/11 conspirator Zacharias Moussaoui, whom she told at his sentencing to life imprisonment that he would "die with a whimper."

• Print
• Comments
• Trackbacks (1)
• Share Link