Seven former independent directors of Satyam – the Indian company known as the “Indian Enron” due to the high-profile accounting scandal that swamped the firm in 2009 – have secured their dismissal from the U.S. securities litigation the company’s shareholder filed in the scandal’s wake. Southern District of New York Judge Barbara Jones’s January 2, 2013 opinion granting the directors’ dismissal motions can be found here. The opinion contains an interesting take on the U.S. Supreme Court’s 2010 Morrison decision and also, in its observation that the director defendants “were themselves victims of fraud,” provides an interesting perspective on the issues surrounding the liabilities of outside directors.
Background
Satyam was quickly dubbed the "Indian Enron" when it was revealed in January 2009 – in a stunning letter of confession from the company’s founder and Chairman — that more than $1 billion of revenue that the company had reported over several years was fictitious. Investors immediately filed multiple securities class action lawsuits in the Southern District of New York.
The plaintiffs’ consolidated amended complaint alleges that in addition to fabricating revenues senior company officials siphoned off vast sums from the company to entities owned or controlled by the Chairman and members of his family. The defendants include three inside directors, who were alleged to be primarily responsible for the accounting fraud; and seven independent directors, five of whom were alleged to be on the company’s audit committee; certain entities affiliated with the company’s chairman and individuals associated with those companies; and certain PwC-related entities.
As discussed here, in February 2011, Satyam agreed to settle the securities claims against the company itself for a payment of $125 million. The settlement did not resolve the claims against the other defendants, including the individual defendants, all of which remained pending. In May 2011, PwC agreed to settle the claims against the PwC-related entities for a payment of $25.5 million (about which refer here).
The director defendants moved to dismiss the securities suits on two grounds. First, they argued in reliance on the Morrison decision that certain claimants who had acquired their Satyam shares outside the U.S. could not assert claims under the U.S. securities laws. Second, they argued that the claimants’ claims did not satisfy the pleading requirements to establish a securities claim.
The January 2 Opinion
In her January 2 Opinion, Judge Jones granted the directors’ motions to dismiss on both grounds. First, Judge Jones held that the plaintiffs had not pled sufficient facts to establish a strong inference of scienter at least as compelling as the non-fraudulent inferences. Judge Jones observed that “the majority of the allegations” involve “an intricate and well-concealed fraud perpetrated by a very small group of insiders” that and “only reinforce the inference” that the directors defendants were themselves victims of fraud.”
Judge Jones also granted the director defendants’ motion to dismiss the claims of some of the claimants based on the Morrison decision. The director defendants had moved to dismiss the claims of shareholders who had acquired their Satyam shares on the Indian stock exchanges. The director defendants also moved to dismiss the claims of current and former Satyam employees who had acquired their Satyam shares through their participation in Satyam employee stock option plan. The director defendants argued in reliance on Morrison that because those claimants’ claims did not involve either shares listed on a U.S. exchange or a domestic securities transaction, the claims were not cognizable under the U.S. securities laws. (The director defendants did not seek to dismiss the claims of those who had acquired Satyam American Depositary Shares (ADS) on the NYSE.)
In opposing the motion to dismiss the claims of shareholders who purchased their Satyam shares on the Indian securities exchanges, the plaintiffs argued that Morrison did not apply because those shareholders had placed their buy orders in the U.S. and had suffered injuries in the U.S. Judge Jones said that this argument “is predicated on precisely the approach that the Supreme Court rejected in Morrison.” She added that “an investor’s location in the United States does not transform an otherwise foreign transaction into a domestic one.”
In opposing dismissal of the claims of Satyam employees who acquired Satyam ADSs through the company’s employee stock option plan, the plaintiffs argued that because the employees acquired ADSs through the stock option plan, and because ADSs traded on the NYSE, Morrison did not preclude the employees’ claims. Judge Jones found that the relevant question was not whether or not ADSs trade on a U.S. exchange; the question was whether or not the employees had acquired the ADSs in the U.S.. In reviewing the materials relating to the stock option plan, Judge Jones found that the “exercise of options to acquire Satyam ADSs occurred in India and therefore fall outside the scope of Section 10(b).” Judge Jones rejected the plaintiffs’ suggestion that the stock option exercise was nevertheless a domestic securities transaction merely because the ADSs acquired were the same as the ADSs that traded on the NYSE. Judge Jones said that fact that Satyam’s ADSs were also listed on the NYSE is “irrelevant” the employees acquired their ADSs in India.
Discussion
Many outside directors have significant concerns about their potential securities liability, particularly with the respect to the possibility that they might be held liable for management improprieties. However, the fact is that outside directors are rarely held liable under the U.S. securities laws. Judge Jones’s scienter determination arguably suggests one reason why that is so.
Notwithstanding the massive scale of the Satyam fraud and the fact that several of the director defendants sat on the audit committee, Judge Jones found that the plaintiffs had failed to satisfy the scienter pleading requirements. In reaching this conclusion, Judge Jones emphasized that the fraud, as massive as it was, had been perpetrated by a small group of insiders, and that the director defendants themselves were “victims of the fraud.” Judge Jones’s determination in this regard may provide some reassurance to outside directors concerned that they could be held liable for management misconduct of which the directors are unaware.
Judge Jones’s ruling that the claims of the Satyam shareholders who purchased their shares on the Indian exchanges were not cognizable under the U.S. securities laws is consistent with the developing body of case law under Morrison.
However, Judge Jones’s ruling with respect to the claims of the Satyam employees who acquired their shares through the stock option plans is interesting. It is n one respect consistent with prior decisions holding that the mere fact that a class of securities trades on a U.S. exchange does not mean that the U.S. securities laws apply to any transaction involving of that class of securities regardless of where it takes place. Judge Jones’s determination is nevertheless interesting because as far as I am aware it represents the first application of Morrison to securities purchased through a foreign-based employee stock option plan. Judge Jones’s opinion shows how Morrison should be applied to determine whether or not employees acquiring securities through a foreign-based plan can assert claims under the U.S. securities laws.
Jan Wolfe’s January 3, 2012 Am Law Litigation Daily story about Judge Jones’s opinion can be found here. Special thanks to a loyal reader for providing me with a copy of the opinion.