One of the most noteworthy stories over the past several months has been the flurry of accounting fraud allegations involving Chinese companies that obtained listings on U.S. securities exchanges through a reverse merger with a publicly traded domestic shell company. The emergence of these  allegations has certainly been one of the securities class action litigation stories so far this year (as discussed most recently here). One of the recurring questions I have been asked about these developments  is whether the SEC is going to step in and take action at some point. Signs are that the SEC is now getting into the action.

 

As discussed in a May 9, 2011 CFO.com article entitled “SEC Cracking Down on Foreign Shell Cos.” (here), the SEC has “become increasingly proactive” with respect to reverse merger companies—and not just with respect to the Chines companies that obtained their U.S. listings through reverse mergers.

 

The SEC heightened interest in this topic was specifically detailed in an April 27, 2011 letter that SEC Chairman Mary Schapiro sent to the House Committee on Oversight and Government Reform. In her letter, Schapiro stated that “the SEC has moved aggressively to protect investors from the risks that may be posed by certain foreign-based companies listed on U.S. exchanges.” She added that “while the majority of foreign-based issuers are engaged in legitimate business operations, others may take advantage of the remoteness of their operations to engage in fraud.”

 

Schapiro’s letter notes that last summer the SEC launched a “proactive risk based inquiry” into U.S. auditing firms that have a significant client base of companies whose principal operations are located outside the U.S. She notes that since the SEC launched this inquiry, 24 China-based companies have filed reports on Form 8-K disclosing auditor resignations, accounting problems or both. Many of these disclosures have noted the accountants’ concerns with cash and accounts receivable and the accountants’ inability to confirm these amounts.

 

Schapiro’s letter also notes that in the last several weeks the SEC has suspended trading in the securities of three China-based companies, HELI Electronics Corp., China Changjiang Mining & New Energy Co.; and RINO International Corp. The SEC has also revoked the securities registration of eight Chinese companies that obtained U.S. listings through reverse mergers. Schapiro’s letter also details enforcement actions the agency has pursued against auditors and individuals associated with the management of Chinese-based companies.

 

In addition to these actions by the SEC, the trading exchanges have also halted trading in more than a dozen Chinese reverse merger companies, which apparently has been a source of some frustration to investors, according to a May 10, 2011 Wall Street Journal article (here).

 

According to Schapiro’s letter (citing data from the PCAOB), there were a total of 159 Chinese-based companies that engaged in reverse merger transactions between January 1, 2007 and March 31, 2011. If Schapiro’s remarks in her April 27 letter are any indication, these companies’ disclosures are likely to be the source of heightened scrutiny. Indeed, SEC officials cited in the CFO.com article make it clear that all reverse merger companies, not just those linked to China, may face this same level of scrutiny.

 

The number of accounting-related concerns disclosed alone suggests the need for this heightened scrutiny. Schapiro’s letter and the SEC’s recent actions suggest that the SEC is gearing up for even greater enforcement and regulatory action.

 

In the meantime, private litigants are pressing ahead. In the last several days, investors have filed securities class action lawsuits against two more Chinese companies in U.S. courts. The first was filed on May 6, 2011 in the Central District of California against Sino Clean Energy Inc. and certain of its directors and officers. A copy of the plaintiffs’ counsel’s May 6 press release can be found here. The second was filed on May 8, 2011 in the Southern District of New York against Fushi Copperweld and certain of its directors and officers. A copy of the complaint can be found here. Both allege accounting and financial reporting misrepresentations.

 

With the filings of these latest two lawsuits, there have now been a total of 21 securities class action lawsuits filed against Chinese and China-linked companies so far this year. That is out of a total of about 85 new securities class action lawsuits YTD in 2011. That is, the Chinese-related suits represent almost one quarter of all new securities class action lawsuits this year.

 

The SEC may be becoming increasingly proactive with respect to non-U.S. reverse merger companies, and it may even have taken some very specific concrete actions in recent weeks. But at least so far it seems that the SEC is lagging not leading the effort. That said it does appear that the SEC is focused on the issue and further action seems likelier in the future.

 

Long-Running Alstom Securities Class Action Suit Settles: On May 9, 2011, the parties to the long-running Alstom securities class action lawsuit pending in the Southern District of New York filed their agreement to settle the case. As noted at greater length here, the plaintiffs first filed their action in 2003. Readers of this blog may recall that in September 2010, Judge Victor Marrero entered a significant ruling in the case, in which he granted the defendants’ motion, in reliance on the Morrison v. National Australia Bank case, to dismiss from the action the claims of the Alstom shareholders who had bought their shares in the France-based company outside the United States.

 

According to the parties’ settlement agreement (which can be found here), the parties have agreed to settle the case for $6.95 million dollars. The agreement itself does not specify whether or not this amount is to be funded by Alstom’s insurers; however, the agreement does specify that the funds are to be paid into escrow by the company or its insurers, and the released parties include the company’s insurers.

 

It seems fair to say that the size of the settlement reflects the drastic reduction in the size of the class as a result of Judge Marrero’s Morrison-related ruling. The settlement seems to indicate the extent to which Morrison may operate to reduce the magnitude of securities class action lawsuits filed against non-U.S. companies, even those whose shares or ADRs trade on U.S. exchanges. At least where only a small portion of the company’s shares trade in the U.S., the size of the lawsuit class will be substantially narrowed and the potential damages and settlement exposure may be substantially reduced.

 

Twelve Steps to Good Corporate Governance: In light of the changes wrought by the Dodd-Frank Act and other developments, the corporate governance landscape has been transformed. Many companies are struggling to come to grips with the requirements of the new environment. In recognition of the changing governance environment, the Latham & Watkins law firm has published an interesting memo entitled “12 Steps to Truly Good Corporate Governance” (here). This memo is readable and worth reading. It contains a number of valuable insights and useful suggestions for companies to come to grips with the demands and requirements of the new era of shareholder empowerment.

 

A number of different organizations  generate annual publicity for themselves by designating a word (or words) of the year. We are not yet half way through 2011 but I am already prepared to propose my own candidate for this year’s word of the year – the word is “whistleblower.” From the provisions of the Dodd-Frank Act and the predecessor provisions of the Sarbanes Oxley Act to the litigation activities of activist investors, whistleblowers’ actions and protections are a growing source of attention and concern – and litigation.

 

Since the Dodd Frank Act’s  passage last summer, the whistleblower provisions of the Dodd-Frank Act have received a great deal of scrutiny. The SEC proposed rules to implement the provisions last November (refer here).  The proposed rules have not yet been enacted by the SEC. However, according to a May 5, 2011 Reuters article (here), the vote on the final rules implementing the whistleblower provisions could come as early as May 25, 2011.

 

Among the issues surrounding the final rules is the question of whether or not they mandate  that would-be whistleblowers must first report wrongdoing internally before reporting violations to the SEC, in order to be eligible for the so-called whistleblower bounty.  According to the Reuters article, the SEC has “no plan to make internal reporting a mandatory first step for whistleblowers.” However other alternatives are under consideration, including the possibility of allowing company employees to reap full benefits of the bounty provisions if a combination of the employee’s tip and information from a company’s internal probe lead to the imposition of fines or penalties for securities law violations.

 

While the final rules on the whistleblower bounty provisions are pending, there have also been developments related to the other significant components of the Dodd-Frank whistleblower provisions — the provisions’ anti-retaliation protections. A May 4, 2011 order in a case pending in the Southern District of New York took a detailed look at who may invoke the anti-retaliation provisions and what is required to invoke the protection. The order can be found here. UPDATE: Please note that  in a subsequent September 1, 2011order, here, Judge Sands dismissed the plaitiffs’ claims with prejudice, having concluded that the plaintiff has insufficiently pled his claims of retaliation and of securities fraud.

 

This case was brought by an employee of Trading Screen. The employee believed the company’s CEO was diverting opportunities and assets from Trading Screen to a company solely controlled by the CEO. The employee reported the CEO’s actions to the company’s President, who in turn reported the information to the company’s Board. The Board hired outside counsel (the Latham & Watkins firm) which investigated and concluded that the activity was taking place as the employee reported. However, when the Board sought the CEO’s voluntary resignation from the company, the CEO  was able to wrest control of the Board. The CEO later fired the employee who had reported the violation.

 

The employee filed suit against TradingScreen, the CEO and a variety of related entities asserting a number of claims, including a separate cause of action for retaliatory discharge under the Dodd Frank whistleblower provisions (about which generally refer here). Among other things the relief available under the provisions includes reinstatement, double back pay, and costs and fees.

 

In moving to dismiss with respect to these allegations the defendants contended that the plaintiff is not covered by the Dodd Frank anti-retaliation provisions because he did not personally report the alleged violation to the SEC and because he does not otherwise come within the four other categories of activity that would bring his conduct within the provision.

 

The four other categories of disclosures protected under the Dodd Frank anti-retaliation provisions are disclosures: under the Sarbanes Oxley Act; under the Securities Act of 1934; under federal statutory provisions relating to investigative officers; or disclosures under any other law, rule or regulation of the Commission. In his May 4, 2011 order, Southern District of New York Judge Leonard Sand found that because TradingScreen is a private company, the employee’s disclosures did not come within the Sarbanes Oxley Act or the Securities Act, and that plaintiffs’ allegations were otherwise insufficient to bring his actions within the other two categories of disclosures.

 

The employee himself had not disclosed the alleged violation to the SEC. But the employee contended that he nevertheless came within the statute because he had made the disclosure to the SEC “jointly” with the outside law firm that investigated his allegations of misconduct. Judge Sand allowed that if the disclosures had been made to the SEC by the law firm, they were made “jointly” by the employee with the law firm, because law firm’s investigation of his report had led to the disclosure. However, Judge Sand also found that the plaintiff had not sufficiently alleged that the law firm had in fact disclosed the information to the SEC, but he granted the plaintiff leave to amend his complaint in order to try to establish that the law firm had in fact disclosed the information to the SEC. However, it should also be noted that in his September 1, 2011 order, Judge Sands dismissed the plaintiffs’ claims with prejudice, concluding in particular that "Plainitff’s Second Amended Complaint fails to allege a claim under the Securities Whistleblower Incentives and Protection provisions of teh Dodd-Frank Act." 

 

Much of the focus of discussion about the Dodd Frank whistleblower provisions has been on the whistleblower bounty. However, given the breadth of the anti-retaliation provisions, those provisions could also prove to be critically important. 

 

On May 3, 2011, the Ninth Circuit issued an opinion (here) in a separate alleged whistleblower retaliation case, this one under the whistleblower protections in the Sarbanes Oxley Act.  The case involved two individuals who had been part of the IT Sarbanes Oxley audit group at Boeing. The two had become concerned that Boeing was putting pressure on the audit team to rate Boeing’s internal controls “effective.” After raising concerns internally, the two had communicated with a reporter at the Seattle Post-Intelligencer, who wrote articles about the company’s audit process. After an investigation, the company concluded that the two had violated the company’s policy against releasing internal information to the press without authorization, and the company terminated the employment of the two individuals.

 

The two individuals filed an action against the company alleging retaliation for actions protected by Sarbanes Oxley. The district court had granted the company’s motion for summary judgment and the two individuals appealed.

 

In its May 3 order, the Ninth Circuit concluded that the individuals were not protected under Sarbanes Oxley because it provides protections only for disclosures to a federal regulatory agency; a member or committee of Congress; or a supervisor or other individual authorized to investigation such misconduct. “Members of the media,” the court found, “are not included,” noting that Congress had limited the activity protected under the provisions to “employees who raise certain concerns of fraud or securities violations with those authorized or  required to act on the information.”

 

The court concluded that the provision “does not protect employees of public companies who disclose information regarding fraud or certain securities violations to members of the media.” The court concluded that Boeing was within its rights to terminate the employees for violating company policy. The Ninth Circuit affirmed the district court.

 

The Ninth Circuit’s opinion and to a lesser extent Judge Sand’s opinion in the case discussed above serve as a reminder that those who comply with the statutory requirements will be able to bring themselves within the statutory protection.  The statutory provisions do not protect whistleblowing in and of itself, but only certain kinds of whistleblowing under certain kinds of circumstances and conditions. Along with cases exploring the protections available under these statutory provisions, we can expect further cases examining the question of when supposed whistleblowers are entitled to the protection of the statutory provisions.

 

One final note during on the general whistleblowing theme is the lawsuit that was unsealed this past week in which taxpayers allege that certain loans extended by the Federal Reserve Bank of New York in the fall of 2008 as part of the bailout of AIG had defrauded taxpayers. The lawsuit, which first filed in the Southern District of California in 2010, and which was ordered unsealed last month, asserts claims under the False Claims Act. The taxpayers’ amended complaint can be found here.

 

The taxpayers’ complaint relates to two emergency loans the government extended to AIG that totaled over $40 billion and that were used to settle trades involving blocks of mortgage-backed securities that AIG had guaranteed. The lawsuit, which names as defendants not only AIG but also the transaction counterparties (which included Goldman Sachs, Deutsche Bank, Bank of America and Societe Generale), alleges that the Fed’s loans were improper because they were made without first obtaining a pledge of appropriate collateral as required by applicable law. The plaintiffs seek to recover for the U.S. government the losses sustained by the government as a result of the fraud and false claims alleged in the complaint.

 

Though the taxpayers’ action may be different in kind and character than the other cases discussed above, the cases collectively serve to underscore the prevalence of whistleblowing activity. Courts undoubtedly will continue to sort out the prerequisites necessary to invoke the statutory whistleblower protections. But even while there may be many issues yet to be sorted out, whistleblowing itself already is a significant phenomenon, as witness by a host of current devopments, including the Wikileaks disclosures. With the protections and bounties under Dodd-Frank, its importance seem likely to increase. The likelihood for increased litigation involving whistleblower-related activity seems high.

 

Speakers’ Corner: On May 11, 2011, I will be moderating a session in Menlo Park, California entitled "Dodd-Frank and the Rise of Shareholder Empowerment." The session is sponsored by the Orrick law firm, The Directors Network and Deloitte, and will take at place at the Orrick law firm’s Menlo Park offices. The program, which is free and which will run from 8:45 am to 11:45 am, will provide insights and practical advice regarding fundamental changes in the corporate governance environment and the emerging role of shareholders in the U.S. corporation.

 

The session includes an all-star cast of panelists, including; Consuelo Hitchcock, Principal, Regulatory and Public Policy at Deloitte; Marc Gross, of the Pomerantz, Haudek, Grossman & Gross law firm; Anne Sheehan, Director of Corporate Governance at CalSTRS; George Paulin, the President of George Cook & Co.; and Jonathan Ocker and Bob Varian of the Orrick law firm.

 

Further information about the program, including registration information, can be found here.

 

Since late last year, reports have been circulating that the U.S. government is investigating whether drug companies paid bribes overseas to increase sales and to obtain regulatory approvals. Some firms have now announced that they have reached settlements with enforcement authorities. And now the first civil lawsuit relating to these investigations has been filed, as discussed below.

 

According to press reports and company filings, a number of companies have disclosed last year that they were being investigated for possible FCPA investigations involving a broad range of possible violations including bribing government-employed doctors; paying sales agent commissions that are passed along to doctors, paying hospital committees to approve drug purchases and paying regulators to win drug approvals. Additional press coverage regarding the breadth of this industry probe can be found here.

 

The first enforcement action and  settlement related to this investigation emerged last month, when governmental regulators announced that Johnson & Johnson had agreed to pay more than $70 million dollars to settle FCPA-related allegations. The SEC’s April 8, 2011 litigation release can be found here, the U.S. Department of Justice’s April 8, 2011 press release can be found here and the U.K. Serious Fraud Office’s press release can be found here.

 

As reflected in the enforcement authorities’ various press releases, Johnson & Johnson’s subsidiaries, employees and agents were alleged to have paid bribes to public doctors and administrators in Greece, Poland and Romania and kickbacks to Iraq to win business there. Johnson & Johnson’s payments to settle the various probes included $48.6 million to the SEC in disgorgement and prejudgment interest, a $21.4 million criminal penalty to the Justice Department and a £4.8 million ($7.8 million) to the U.K. Serious Frauds Office. A detailed overview of the allegations and the settlements can be found on the FCPA Professor’s Blog (here). According to the FCPA Blog (here), the Johnson & Johnson settlement is the tenth largest FCPA settlement ever.

 

Moreover, it appears that other settlements arising out of the probe may soon follow. Last week, Eli Lilly. disclosed that it is in “advanced discussions” to settle bribery related allegations. According to news reports, the activities under investigation involve alleged improper payments in Poland and possibly include activities in other countries as well.

 

The ongoing investigation is affecting ordinary business operations in companies caught up in the probe. For example, SciClone Pharmaceuticals announced earlier this week that its compensation committee would defer decisions on executive compensation until its board receives a report of a foreign bribery probe. The internal investigation is said to be parallel to that of the U.S. enforcement authorities.

 

And now it appears that the ongoing drug company bribery probe has also produced its first civil lawsuit. On May 2, 2011 investors filed a shareholders’ derivative suit in the District of New Jersey against Johnson & Johnson, as nominal defendant, and eleven board members, relating to the company’s settlement of the bribery charges. The complaint, which can be found here, alleges that the individual defendants breached their duty of loyalty by “failing to cause J&J to implement an internal controls system for detecting and preventing bribes to public doctors and administrators in Greece, Poland, and Romania, and kickbacks to Iraq to win business there.”

 

The complaint asserts claims for breach of fiduciary duty, mismanagement, abuse of control, corporate waste, unjust enrichment and violations of the federal securities laws.” The complaint seeks to hold the individuals liable to the company for damages, which the complaint alleges, referring to the fines, disgorgement and interest that the company has agreed to pay, exceed $70 million.

 

The FCPA itself does not provide for a private right of action. But as I have observed in previous posts (refer for example here) , one of the frequent accompaniments of an FCPA enforcement action is a follow on civil action, of the type filed against the Johnson & Johnson officials. And while the fines, disgorgements and penalties paid in connection with the FCPA settlement would not typically be covered un der a D&O policy, the defense costs incurred in connection with the follow on civil action would be covered, and settlements and judgments entered in the civil action would at least potentially be covered, subject to all of the applicable policies terms and conditions.

 

With the signs suggesting that there may be further enforcement actions and settlements in connection with the ongoing pharmaceutical industry bribery probe, there is an accompanying concern that as the overall investigation moves forward, there may also be a parallel wave of follow on civil litigation. This possibility is not only an added concern for the affected companies themselves and their senior executives, but is also a concern for the D&O insurance carriers.

 

There are a number of interesting features of the Johnson & Johnson settlement that may be significant in connection with the continuing investigations against the other drug companies. The first is that in connection with the Johnson & Johnson enforcement action, the governmental authorities took the position that the FCPA was relevant with respect to payments made to doctors in the counties specified. The position of the SEC and the other enforcement authorities is that because the health system in the counties involved is a government operation, the doctors involved are “foreign officials” within the meaning o f the FCPA, which , as discussed on the FCPA Professor blog here and here, is noteworthy issue of considerable interest and concern.

 

The other interesting about the Johnson & Johnson settlement relates to the comments in the DoJ’s press release with respect to Johnson & Johnson’s cooperation. The DoJ noted not only the company’s “timely voluntary disclosure” but also noted the company’s “significant assistance in the industry-wide investigation.” The press release also states that the company received a reduction in its criminal fine” as a result of its cooperation in the ongoing investigation of other companies and individuals.” The clear implication is not just that the probe is ongoing but that other companies and individuals are under investigation. The upshot may well be, as suggested above, that there will be further enforcement actions and possibly further settlements ahead.

 

The DoJ’s press release also underscored the extent to which the investigation of corrupt activities is a global, cross-border undertaking. In its press release, the DoJ noted not only the investigative collaboration with other U.S enforcement agencies and with the U.K. serious fraud office, but also recognized the helpful assistance of investigative bodies in Greece and Poland. These circumstances highlight both the collaborative international scale of the investigations but also how seriously the matters are being taken by a wide variety of governments and governmental authorities.

 

Finally in light of the magnitude of the Johnson & Johnson settlement (and the fact that the settlement made the Top 10 List) it is probably worth reflecting that the company reached this settlement while, at least according to the DoJ, receiving a reduction in its penalties not only because of the cooperation noted above, but also because of the company’s “pre-existing compliance and ethics programs, extensive remediation, and improvement of its compliance systems.” That the company should still face fines and penalties of the magnitude to which it agreed notwithstanding the credits the company received for these efforts is a striking development.

 

You may have seen May 2, 2011 Wall Street Journal article entitled “Overhaul Grows and Slow” (here), which described the backlog developing as regulators struggle to meet the rule-making deadlines mandated by the Dodd-Frank Act. The article itself was interesting enough, but if you really want to appreciate the daunting task regulators face, you may want to take a look at the law firm memo on which the article was based.

 

The May 1, 2011 memo from the Davis Polk law firm, entitled “Dodd-Frank Rulemaking Report” (here) provides a much more detailed look at the regulators’ massive burden.

 

As the memo details, Dodd-Frank (which was massive enough itself) mandated 387 different rulemakings from 20 different regulatory agencies. (Some of the mandates require multiple agencies to issue rules on a given topic or item; if the joint rules are not double-counted, the number drops from 387 to 243.)  Congress not only required the rulemakings, but it specified the rulemaking schedule for many of the mandates as well. Of the 387 required rulemakings, 275 have specified rulemaking deadlines or annual requirements.

 

The bad news for regulators is that with most of the regulatory deadlines yet to come, they have already fallen behind. For example, not a single one of the agencies involved met any of the 26 deadlines that fell in April 2011. Cumulatively, the agencies collectively have now missed more than 30 deadlines.

 

The worse news for regulators is that most of the deadlines are yet to come. As the chart on page 8 of the law firm memo shows, only 40 of the 387 deadlines will have occurred through the end of the 2nd quarter 2011. The real problems will arise during the 3rd quarter of 2011 (which will coincide with the first anniversary of Dodd-Frank’s passage). In the third quarter alone the agencies will face 108 different rulemaking deadlines, about 28% of the total. There is no relief after that, either, as 37 more deadlines fall in the fourth quarter.

 

The agency that will face the biggest challenge is the SEC. Of the 387 rulemaking mandates, 95 (or about one quarter of the total) are directed to the SEC. Of those 95 SEC mandated rulemakings, 75 have deadline requirements, and 45 have deadlines that fall in the third quarter of 2011. As of today, the SEC has completed new regulations only six required items, proposed 28 additional rules and missed deadlines on 11. In the second half of 2011, the SEC will have to complete a total of 52 more rulemaking — and that doesn’t even take into account the deadlines on which the SEC has already fallen behind.

 

The authors of the law firm memo are not optimistic that the regulatory agencies will much greater success meeting these upcoming deadlines than they did with the deadlines that have occurred so far. As graphics in the memo depict very vividly, the commentary period that follows a proposed rulemaking produces a “mountain” of comments. Working their way through that mountain required regulators to read many comments in a short timeframe. Missed deadlines seem likely.

 

The rulemakings that have been delayed already include some of those relating to the Dodd-Frank Act’s most closely watched provisions. For example, the rules relating to the Act’s new whistleblower provisions, which had been due April 21, now reportedly will not be available until late July. The SEC also delayed the release of its proposed regulations on resource extraction and conflict minerals disclosure, which had been required earlier in April.

 

The problem is not just the sheer magnitude of the task; it is also the political pressure that interested groups are applying to the process. The Journal article cites Stanford Law Professor (and former SEC Commissioner) Joseph Grundfest as saying that “the problem is not just the number of the rules, It’s the complexity of them, and it’s the political power of the various constituencies that are affected by these rules.”

 

Whatever the reason for the delay, it seems like the day by which we will finally be able to assess the overall impact of the Dodd-Frank Act may now be even further off into the future.

 

Legal  History: The Davis in the Davis Polk law firm’s name refers to John W. Davis, who was the Democratic party candidate for President in 1924. Davis  lost the election to Calvin Coolidge.  The firm can boast of a former President among its alumni, as Grover Cleveland was a member of a predecessor firm during the period between his two separate Presidential terms.

 

The wave of new securities class action lawsuits involving accounting scandals at U.S-listed Chinese firms is already a well-established phenomenon. But in the latest twist on the tale, Deer Consumer Products, one of the U.S.-listed Chinese companies most recently sued based on allegations of accounting fraud, has gone on the warpath and is publicly alleging that the lawsuit against the firm is part of an elaborate scheme by “illegal” short sellers to manipulate the company’s share price. And according to press reports, a different  Chinese firm that also  has been hit with a lawsuit also have raised the question whether short sellers might be behind the accounting fraud allegations.

 

The latest story involving Deer Consumer Products began on April 30, 2011, when plaintiffs’ lawyers announced in a press release that they had filed a securities class action lawsuit in the Central District of California against the company and certain of its directors and officers. Among other the plaintiffs’ attorney’s press release states that:

 

Deer misrepresented its financial performance, business prospects, and financial condition to investors, citing inconsistent Chinese regulatory filings. The Complaint also alleges that Deer improperly recognized revenue in violation of Generally Accepted Accounting Principles (“GAAP”). On March 9, 14, and 17, 2011, analyst Alfred Little issued a series of reports disclosing defendants’ alleged fraud, which caused the stock price to drop, damaging investors.

 

On May 2, 2011, Deer Consumer Products issued its own  press release (here) in which the company asserted that it has “evidence of continuing illegal short selling” in its stock, and also  asserted that its “common stock has been manipulated in collusion among ‘naked’ short sellers.” The press release goes on to assert that the class action lawsuit itself is “part of the attempted manipulation.”

 

Now, it is nothing new for companies to assert that the bad news circulating about them is based on rumors from profit-motivated short sellers. But the Deer Consumer Products takes this common gripe quite a bit further. The company asserts that the supposed analyst, Alfred Little, whose reports are the source of the rumors and are relied on in the complaint is “a fictitious character” whose phony identity is “a disguise used by one or more illegal short sellers in the short sale scheme.” The purported reports of Alfred Little were “published in collusion with short sellers” to “intentionally create fear in the general public to drive down DEER’s share price.”

 

The press release goes on to assert that all of the allegations in the supposed Alfred Little reports are false and that the company intends to seek sanctions against the law firm that filed the lawsuit.

 

Deer is not the first U.S.-listed Chinese company to charge that the allegations of accounting fraud originated with short sellers. U.S. shareholders in another U.S- listed Chinese company that has also been hit with a securities class action lawsuit, China Agritech, are also alleging that stories circulating about the company and that are behind the lawsuit are the result of the actions of short sellers. (Background on the China Agritech lawsuit can be found here).

 

A very interesting April 26, 2011 Bloomberg article entitled “Wall Street Scion Lost in China Agritech as Shorts Cry ‘Scam’”(here) contains the allegations of one U.S. investor in China Agritech that “someone blatantly lied to short the stock.” The U.S. investor, Jesse Glickenhaus, troubled by an analyst’s report that the company was a scam with no real operations, went to China himself and toured company facilities with company executives, to verify the existence of claimed business operations and facilities.

 

Or at least Glickenhaus thinks he toured company facilities. In yet another twist to the story, after Glickenhaus published his account of his Chinese factories tours on his own investment company’s website, other short sellers  asserted that Glickenhaus  had been duped, and that rather than touring the company’s factory, Gliockenhaus had been taken to a state-owned plant at a different address than the one listed in China Agritech’s filings.

 

With all of these levels of confusion and disinformation, it is hard to tell who is scamming whom and what version of the truth actually corresponds to reality. Are the Chinese companies scamming investors by misrepresenting their true financial condition? Or are investors being misled by short sellers who have an incentive to cast doubt on the companies and drive down the share price?

 

You do start to wonder why any investors would invest in U.S.-listed Chinese companies. The Bloomberg article about Glickenhaus provides some of the answers. Glickenhaus is the 29-year old grandson of his investment firm’s founder, who invested in China Agritech without even knowing that the company had obtained its U.S. listing through a reverse merger. He seemed particularly persuaded by the fact that the Carlyle Group had previously invested in the company.

 

Even if he was not duped during his recent China visit about China Agritech’s operations, Glickenhaus seems like a remarkably uncritical investor. He remains committed to the company and to his investment even though the company has fired two auditors in four months and still has not filed its 2010 financial data. Carlyle’s representative on the company’s board has also resigned.  Glickenhaus does concede that “in the future, if I find a company in China, I’ll probably stick to those that have had a major, well-known auditor for several years.” 

 

Whether the accounting fraud allegations have substance or are the product of short-sellers’ profit-motivated imaginations, it is clear that the existence of the allegations is continuing to drive securities class action litigation against U.S.-listed Chinese companies. In addition to the new lawsuit against Deer, plaintiffs’ lawyers have in the last week and a half also filed lawsuits against these other U.S.-listed Chinese companies: Gulf Resources (refer here); ZST Digital Networks (refer here); and SkyPeople Fruit Juice (refer here). Interestingly, the same law firm that filed the Deer lawsuit filed these three others as well.

 

Another U.S.-listed company with its fish farming operations in China but its headquarters in Washington State, HQ Sustainable Maritime Operations, was also hit with a securities lawsuit last week (refer here).

 

With the arrival of these latest lawsuits, a total of 19 new securities class action lawsuits have been filed against Chinese companies so far in 2011. That is out of a total of about 79 lawsuits  this year, meaning that the China-related lawsuits represent about one-quarter of all2011 YTD  class action securities lawsuits. That is on top of the ten lawsuits that were fled against Chinese companies in 2010.

 

Signs are that there are more lawsuits yet to come, as well. Plaintiffs’ firms have issued press releases that they are investigating other China-linked companies, including Longtop Financial (refer here) and Sino-Clean Energy (refer here). Interestingly, the press release announcing the Sino-Clean investigation was issued by the same law firm that filed the Deer lawsuit described above, and the press release also references an analyst report by Alfred Little (the same analyst whom Deer claims is fictitious).

 

In addition to the securities class action lawsuit describe above, investors have also filed at least one shareholder derivative recently involving a Chinese company. On April 27, 2011, plaintiffs filed a derivative lawsuit in the District of Wyoming against Duoyuan Printing, as nominal defendant, and certain of its directors and officers, alleging that the individuals breached their fiduciary duties b, among other things, issuing false and misleading statements regarding the company’s financial results. A copy of the complaint can be found here. The company itself is a Wyoming corporation with its principal place of business in China.

 

An April 4, 2011 speech by SEC Commissioner Luis Aguilar (here) reported that there were 150 reverse merger transactions between 2007 and the present in which Chinese companies merged with U.S.-domiciled shells to obtain a listing on a U.S. exchange. I am sure not all of these 150 companies have accounting problems (or will otherwise be targeted by short sellers). But I am guessing that before all is said and done, a lot more of them may wind up as defendants in class action lawsuits filed in U.S. courts.

 

In any event, it does seem like the SEC is finally getting around to doing  something about all of this. On April 29, 2011, the SEC announced (here) that it had halted a Ponzi scheme involving China Voice Holding Company in which company officials were using proceeds from later offerings to pay off those who invested in earlier offerings.

 

It’s All There in Black and White: The illustration at the outset of this post of course depicts the characters from the classic Spy v. Spy comic that first appeared in Mad Magazine. For those so culturally deprived as to be unfamiliar with the comic, the basic premise was that the two spies were identical, except that one was dressed in while and one was dressed in black, and they were endlessly trying to take each other out. The comic incorporated all of the requisite cartoon elements – bombs, blond bombshells, missiles, anvils, rocket ships, trapdoors, dynamite, electrified door knobs and so on. Here’s a short video clip capturing a classic moment from the comic:

  

https://youtube.com/watch?v=3fifItoMPTw

In a few days I will celebrate the fifth anniversary of the day I published my first post on this blog.  I had no idea what was going to follow after that first post, but having come so far after so long, it seemed appropriate on this occasion to reflect on the enterprise. It has been an interesting, unexpected, and ultimately rewarding experience.

 

In May 2006, I was still in the early stages of my current job. The phone had not yet started to ring, so to fill my time I started fooling around with the Blogger application on Google. I launched The D&O Diary with little planning and no expectation that it would amount to anything. That first step pretty much characterizes the approach I have taken all along since that first post – I just keep putting one foot in front of the other and I wait to see where the path will take me.

 

The timing of my blog launch was fortunate, as it turned out. Shortly after I got the blog set up and organized, the whole options backdating scandal broke. And after that in quick succession came the mortgage meltdown, the credit crisis, Madoff, the wave of bank failures, a host of Supreme Court decisions, Dodd-Frank, and a multitude of other scandals and events large and small.  Many of these developments involve truly terrible news, but they all provided great grist for the blogging mill. Even now, a bunch of Chinese companies are enmeshed in a terrible accounting scandal, which is bad news for them, but quite helpful to me (at least in my blogging capacity).

 

I have been fortunate in another way, which is that I have acquired a loyal and supportive readership that keeps me supplied (usually with accompanying requests for anonymity) with a steady stream of case decisions, pleadings, news article, books, academic articles, questions, comments and queries. I get my best material from readers, and I could never have kept this project alive without the regular contributions from readers.

 

I have been even more fortunate to be able to publish guest posts from and interviews with leading attorneys (both plaintiff and defense), academics, and journalists. These individuals’ willingness to publish their articles or comments has added both depth and breadth – not to mention variety – to this site.

 

And so with all of these fortunate things  going for me, here I am, five years into this crazy experiment, with over 2,000 email subscribers, another 1200 RSS subscribers, and countless other readers who access the blog through one of several aggregation services that pick up my content. The site itself has had over 2.5 million page views. It is fair to say that I didn’t anticipate any of this. The blog’s reach never ceases to amaze me.

 

From time to time, I get notes from readers with kind words about the blog, which I very much appreciate. (I also get notes with, shall we say, constructive criticism as well). But truthfully, no one gets more out of the blog than I do. It is not just that writing the blog is a regular source of amusement and an avenue of creative expression for me. It is rather that the blog has done so much for me personally and professionally.

 

First, on the most practical level, maintaining the blog has ensured that I am always up to speed on the latest developments in my field. The blog’s constant content requirements mean that I am aware of and have usually written and thought about  just about everything of importance out there.

 

Second, and more importantly, the blog has allowed me to form innumerable connections around the world. I have email pen pals on almost every continent (no readers in Antarctica that I know of – yet). I have regular communications with a large number of lawyers, academics, journalists, financial analysts and regulators. I have also formed fast friendships with many of my fellow bloggers, all of whom have been supportive and helpful over the years. These friendships and communications have not only enriched the blog, but they have expanded my own horizons and enhanced my awareness of and appreciation for important trends and developments.

 

Third, I have the recurring delight of hearing from completely unexpected sources that they have read my blog. Once I was stopped while walking through Times Square by a total stranger who wanted to tell me that he reads my blog every day. Several different times I have had people come up to me in airports to say they recognized me from my blog. (That’s why the picture is up there in the upper right hand corner.) I have even had guys at my golf club comment to me about posts on my blog. And I have to say that is about the last thing I ever expected, that I would get recognition at my country club for, of all things, having a blog.

 

But the most important thing for me about my blog is that I enjoy doing it. For me, the blog itself is like having my own personal  Fourth Plinth  (pictured above) – that is, I can put anything up there I want. A blog post can take just about any form – it can be a case note, a news report, an editorial, an interview, a book review, a statistical analysis, or anything else that I choose. My imagination is the only limitation.

 

The ability to imbed pictures, videos and hyperlinks to other sources affords a richness and depth that simply is not possible with the traditional written document. And the ability to publish content immediately means that I can quickly reach out to a vast audience of friends, peers, colleagues and casual readers. I get a big charge every single time I post an item.

 

All of this comes at a price, however. The actual content posted on the site is the culmination of a lengthy process that can take hours and hours and hours. The hardest step in the process is the first one, which is deciding what to write about. Blog topics are not self-revealing. Occasionally, somebody has sent me something that obviously needs to go up right away. But the rest of the time, blog topics have to be hunted down in the endless ocean of information and conversation that surrounds us all. The search for blogworthy topics is never-ending – the worst part about adding a new post is that at the moment of publication the pressure to find another topic starts all over again.

 

And the actual blog content is only a small part of the operation. The fact is that I am for all practical purposes in the publishing business. I am not only responsible for content, but I am the copy editor, the fact checker, the proofreader, the typesetter and the art editor. I am the research department, the customer service department, and the subscription department. I am the managing editor, the business manager, and the chief operating officer. With all of these duties, the process of maintaining the blog takes an insane amount of time.

 

Another problem is that the blog has required me to dwell among the demons of technology. No one would ever believe (except perhaps another blogger) how many weird technological challenges I have had to confront. To cite just one example, one day out of the blue, for no apparent reason and without any warning, our firm’s IT manager changed the IP address of the server on which I housed all of the self-hosted documents to which I had linked on my site. That meant that every single one of the hundreds and hundreds of links on my site to self-hosted documents (pleadings, case decisions, etc.) was broken. I was on suicide watch for several weeks. I eventually repaired the links in the most recent posts but the links in many older posts simply don’t work, and at this point, alas, probably never will again.

 

Sometimes the blog can feel like a full-time job, but the fact is that my job is my job. And my job is often demanding, stressful and time-consuming. Finding the time, energy and intellectual residue to work on the blog after a long day dealing with my real job can be very difficult at times.

 

The point I am trying to make is that maintaining a blog is a lot harder than it looks. A blog is a harsh mistress – and she can be a needy and temperamental bitch too.

 

Just the same, I can’t imagine stopping the blog. When I have my teeth into something I really want to write about, I am fully engaged. I get a great deal of satisfaction out of creating a blog post on a topic that has captured my imagination or sparked my creative energy. And when I hear someone refer to the blog, even to challenge something I have written, I get a huge charge. And so I intend to keep right on blogging, damn the torpedoes.

 

Even though this project is five years old, there are still a lot of things I want to try to do with the blog. I would like to attract more guest posts, particularly from attorneys, academics and even regulators .I would like to publish a lot more interviews, with practitioners and observers who have an interesting perspective toa dd.   I would like to introduce more international topics, particularly with respect to Asia. I would like to do more book reviews and I would like to include more posts with observations on other topics, like movies, wine and travel.  And wouldn’t it be cool if there was a way to imbed sound on the site? How about smell – maybe a scratch and sniff version. Hmmm…

 

The one thing I know for sure is that I will have to continue to try new things, because the blogging environment is changing all the time. One way the environment has already changed during the years I have been blogging is the rise of the social networking sites, particularly Twitter and Facebook. These outlets have for many readers occupied the space and time that other media (including blogs) used to inhabit. I also think they have resulted in shortened attention spans. By contrast to these newer media, blogs (especially one like mine) can look slow, bloated and out-of-date. At the same time, I sometimes worry that the constant chatter can be deafening. Or at least numbing. I worry that in that kind of environment, I become one more ditto head in the chattering class choir.

 

As I said at the outset, one of the great advantages I have had from almost the very beginning is that I have gotten a lot of support from my readers. As I look forward to this blog’s next phase whatever it might be, I could really use some advice. I want to stay (or perhaps, become) relevant. I want to provide content that is useful, interesting and entertaining for my readers.

 

So as I wind up this retrospective essay, I want to ask everyone to let me know what they would suggest for me to develop this site and make it better. I welcome everyone’s thoughts on possible topics, books I should review, persons I should interview, possible alternative approaches, analyses or formats, anything and everything that could add the content on this site. And in particular, I would really like to encourage anyone who has ever given a thought to submitting a guest post for publication on this site to put their post together and sent it to me any time.

 

There are many rewarding things about having this blog, and without a doubt one of the best is the sense of community I feel with my readers. When I hit that “publish” button, I know that readers around the world are going to open their emails and click through to the blog and read what I have written. The idea that I have my own little corner of the Internet that thousands of people willingly visit every day is absolutely amazing to me.

 

Thanks to every one for stopping by during the last five years. I look forward to having you visit again – frequently – in the future.

 

Finally, I would be remiss is I did not thank my colleagues at OakBridge and at RT Specialty for all of the support they have given me and this project over the years. This thing would never have gotten off the ground without their help and I would never have been able to keep it going without their backing. Thanks for everything, guys.

 

Prepare Ye, The Harmonic Convergence Approacheth!: : The Cleveland Indians are in first place in the Central Division with the best record in all of baseball. The have won six straight games and thirteen in a row at home. They won their last three games in their final at bats. No one, and I mean absolutely no one, saw any of this coming. (Hello? Hello? Is this thing on? [Tap, tap] Testing, testing, one, two, three…)

 

I am pleased to reprint below as a guest post a detailed article about the oral argument this past week before the United States Supreme Court in the case of Erica P. John Fund v. Halliburton Co., No. 09-1403. This guest post was submitted by my friend Kimberly M. Melvin. Kim is a partner in the Wiley Rein law firm in Washington D.C. Background regarding the Halliburton case can be found here. The parties’ briefs in the case, including briefs from amici curiae, can be found here.

 

I would like to thank Kim for her willingness to publish her article on this site. I welcome guest post from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly.

 

Here is Kim’s guest post: 

 

This week, the United States Supreme Court heard oral argument in Erica P. John Fund v. Halliburton Co., No. 09-1403 (U.S.). The case involves the denial of a motion for class certification in a securities fraud suit that was affirmed by the United States Court of Appeals for the Fifth Circuit. The argument signals that the Justices are virtually certain to reverse the Fifth Circuit’s decision. Even Halliburton’s attorney, David Sterling of Baker Botts LLP, distanced himself from the Fifth Circuit’s holding that loss causation must be proven at the class certification stage to invoke the fraud-on-the-market presumption of reliance. Yet the Justices’ questions reveal the challenges of determining the specific contours of plaintiffs’ burden of proof at the class certification stage under Basic, Inc. v. Levinson, 485 U.S. 224 (1988), given the scope of inquiry under Federal Rule of Civil Procedure 23. The Supreme Court’s ruling in this case therefore should provide greater guidance to lower courts regarding: (1) what elements plaintiffs must prove to trigger the presumption of reliance at the class certification stage, including whether plaintiffs must prove stock price impact tied to the operative misleading statements; and (2) the contours of plaintiffs’ initial burden of production and ultimate burden of persuasion when defendants present rebuttal evidence.

 

Factual Background

In Halliburton, the shareholder plaintiffs maintain that from 1999 to 2001, Halliburton made false and misleading statements that understated its asbestos liability and overstated its revenues. At the class certification stage, plaintiffs argued that that a class-wide presumption of reliance applied based on the fraud-on-the-market theory. Defendants countered that plaintiffs could not show any statistically significant price movements in response to either the allegedly false statements or the so-called “corrective disclosures” that assertedly revealed the truth about the prior misstatements. As such, they argued that plaintiffs had not satisfied their burden of proving the operative facts necessary to establish the applicability of the fraud-on-the-market presumption of reliance. Without the presumption, plaintiffs would need to show individual reliance by each class member on the alleged misrepresentation to proceed, and therefore common issues would not predominate over individual issues as required to certify a class under Rule 23. 

 

The district court agreed, denying plaintiffs’ motion for class certification based on the Fifth Circuit’s holding in Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F. 3d 261 (5th Cir. 2007). According to the district court, plaintiffs were unable to employ the fraud-on-the-market presumption of reliance because they failed to show any price distortion as a result of defendants’ alleged misrepresentations. The district court reasoned that plaintiffs presented no evidence that “‘false, non-confirmatory positive statements caused a positive effect on the stock price.’” Archdiocese of Milwaukee Supporting Fund, et al. v. Halliburton Co., et al., No. 3:02-CV-1152-M, 2008 WL 4791492, at *3 (N.D. Tex. Nov. 4, 2008) (quoting Ryan v. Flowserve Corp., 245 F.R.D. 560, 569 (N.D. Tex. 2007)). They also did not show: “‘(1) that an alleged corrective disclosure causing the decrease in price is related to the false, non-confirmatory positive statement made earlier, and (2) that it is more probable than not that it was this related corrective disclosure, and not any other unrelated negative statement, that caused the stock price decline.’”  Id. 

 

The Fifth Circuit affirmed, reasoning that plaintiffs could not invoke the fraud-on-the-market presumption of reliance because they had not proven loss causation. According to the Fifth Circuit, “because loss causation speaks to the semi-strong efficient market hypothesis upon which class wide reliance depends,” loss causation must be proven to determine whether class wide reliance may be presumed so that common issues predominate over individual issues under Rule 23. Oscar, 487 F.3d at 269. The Fifth Circuit requires “this showing ‘at the class certification stage by a preponderance of all admissible evidence.’” Archdiocese of Milwaukee Supporting Fund, et al. v. Halliburton Co., et al., 597 F.3d 330, 335 (5th Cir. 2010) (citation omitted).

 

On appeal to the Supreme Court, plaintiffs maintain that the Fifth Circuit imposed an improper burden on them because loss causation is a merits issue that is not relevant to the class certification inquiry under Rule 23. Halliburton and its CEO contend that under Basic, defendants are entitled to rebut the presumption of reliance based on lack of market impact, and that the outcome of the Fifth Circuit’s decision is consistent with that theory.

 

Summary of the Oral Argument

            Plaintiff’s Opening Argument

Counsel for the shareholder plaintiffs, David Boies of Boise Schiller & Flexner, led off the argument by focusing on the limited nature of the inquiry to certify a class under Rule 23. Nearly immediately, however, Mr. Boies was stopped by Chief Justice Roberts, who asked whether the existence of an efficient market could be disputed at the class certification stage.  While noting that the issue had been conceded by defendants below, Mr. Boies responded affirmatively that the efficient market issue is properly addressed at the class certification stage because “the issue of [an] efficient market goes to the presumption of reliance,” and if the court holds that the presumption is not available, “you can have a situation in which the common issues do not predominate over the individualized issues.” Transcript of April 25, 2011 Oral Argument in Erica P. John Fund v. Halliburton Co., No. 09-1403 (U.S. Apr. 25, 2011) (“Tr.”) at 4. 

 

This concession shaped the remainder of Mr. Boies’s argument. Thereafter Justices Alito, Kagan, Scalia and Sotomayor posed questions largely focused on why a court could address the efficient market issue at the class certification stage but not the issue of price impact. Mr. Boies repeatedly responded that loss causation was a merits issue only because it is a class-wide common issue whereas market efficiency addresses the reliance issue, which could raise individualized issues if plaintiffs could not invoke the fraud-on-the-market presumption. As such, Mr. Boies maintained that Basic provides that defendants can only rebut the reliance presumption at the class certification stage with “proof generally disproving the efficiency of the market” and other proof (such as a lack of market impact) must be “reserved for trial,” relying on footnote 29 in Basic. Tr. at 6. 

 

During Mr. Boies’s argument, Justice Scalia honed in on defendants’ position that although the Fifth Circuit used the term loss causation, the court was focused on market impact as a means of rebutting the fraud-on-the-market presumption of reliance. In this regard, Justice Scalia inquired: “Would you be satisfied if we just said we agree with you that the requirement to prove loss causation is — no good, and sent it back to the Fifth Circuit and then let the Fifth Circuit adopt the theory that Respondents assert they have already adopted?  I mean, it’s sort of a Pyrrhic victory, it seems to me, if you haven’t just disapproved loss causation.” Tr. at 9. Mr. Boies acknowledged in responding that “if [the Fifth Circuit] simply changed the wording and called loss causation reliance, obviously it wouldn’t make any difference.” Id. However, Mr. Boies did reply that loss causation and reliance are distinct elements, and that loss causation could only be a class-wide common issue. Tr. at 9-10. 

 

            Argument on Behalf of the United States as Amicus Curiae

Nicole A. Saharsky for the government was up next. She focused on three asserted deficiencies in the Fifth Circuit’s decision: “First, the Fifth Circuit [is] conducting a merits inquiry that’s not tethered to the Rule 23 requirements; second, it’s taking a presumption and requiring plaintiffs to prove it; and third, it’s confusing the distinct elements of reliance and loss causation.” Tr. at 15. In addressing the questions posed to Mr. Boies, she affirmed that “[t]he Fifth Circuit could not be more clear” that it “is not talking about rebutting the presumption of reliance . . . [i]t is putting an affirmative burden on plaintiffs [of proving loss causation] that they have to meet in every single case, even if the defendants do not come to court with any evidence.” Tr. at 15. 

 

Justice Scalia quickly focused Ms. Saharsky on price impact and secured the concession that defendants can rebut the efficient market issue. Ms. Saharsky, however, reiterated Mr. Boies’s view that the rebuttal evidence could not include loss causation-related proof because loss causation raises merits issues that “stand or fall on a class-wide basis.” The response prompted Justice Kennedy to posit, “[t]he rule isn’t . . . that simply because the issue is on a class-wide basis, it can’t be challenged at the certification stage. We don’t have a rule that’s that broad, do we?” Tr. at 17. He, together with the Chief Justice, went on to suggest through further questioning that if a class-wide, merits-based issue must be proven to show that common issues predominate (i.e., to invoke the fraud-on-the-market presumption of reliance), like an efficient market, then inquiry as to that issue is appropriate under Rule 23. Tr. at 17-18. 

 

Attempting to address this suggestion, Ms. Saharsky replied that the inquiry is more limited: “when the plaintiffs invoke fraud on the market and they show that there is an efficient market, this Court said in Basic, they can all proceed together because they are showing that . . . the material misstatement was reflected in the stock price. This is an impersonal market in which you rely on the stock price. They all rely on it the same way.” Tr. at 19. Justice Alito seized on this response raising the critical issue to be addressed in the Court’s decision: “And if they show that the statement was not incorporated in the price . . . , then why doesn’t reliance cease to be a common issue and become a question of an individual issue that would have to be proved by each . . . member of the class?” Tr. at 19-20. Ignoring that in such a circumstance individual plaintiffs may still be able to prove direct reliance, Ms. Saharsky responded “[w]ell, in that circumstance reliance ceases to be and the case cannot be established on the merits. They stand or fall together on the merits.” Tr. at 20. Justice Alito followed up, questioning: “[B]ut the fact that they would lose on the merits doesn’t necessarily mean that they are entitled to class certification.” Tr. at 20. Ms. Saharsky rejoined, “They’re entitled to class certification if they have a common issue.” Tr. at 20. 

 

At the end of Ms. Saharsky’s argument, Justice Scalia asked a series of question trying to show that reserving price movement for consideration later because it is a “class-wide common issue” makes little sense when the efficient market issue itself is a common issue: “Instead of proving the efficient market,” what if plaintiff “can prove that there was a statement correcting the alleged misrepresentation, the price of stock went down . . . and they can certify the class.” Tr. at 22.  Ms. Saharsky responded that such an approach does not square with Basic, which provided that “in order to establish the presumption that you need to show the efficiency of the market.” Tr. at 22. Scalia pressed further, “They’re not relying on that assumption. . . . [T]hey come in and show that there was a correction of what we alleged was a misstatement and the market went down. . . . And of course, that proves anything only if there’s an efficient market. But that will be a common question to the whole class, so we’ll . . . save that for later.” Tr. at 22. Ms. Saharsky simply responded “Certainly in the courts of appeals now, that’s not the way the plaintiffs proceed. The way they proceed is on the Basic theory.” Tr. at 23. Justice Scalia rejoined, “I understand that. I’m just saying that seems to me it’s a crazy way to run a railroad.” Tr. at 23. Ms. Saharsky concluded by indicating that the courts have applied Basic for 20 years, Congress “has not seen fit to change it,” and respondents have never suggested that it should be revisited. Tr. at 24. The “problem in this case,” according to Ms. Saharsky, is that the Fifth Circuit “was not satisfied with the rules as they exist, and it took the class certification stage and turned it into a merits inquiry stage.” Tr. at 24. 

 

            Defendants’ Argument

Mr. Sterling then faced the Court. Almost immediately, he conceded that defendants “are not defending all of the language in Oscar, clearly, but the basic test in the Fifth Circuit . . . is not loss causation; it’s price impact, because Basic says . . . any showing that severs the link between the misrepresentation and the stock price defeats the presumption.” Tr. at 26 (citing Basic, 485 U.S. at 248). According to Mr. Sterling, “Basic makes clear . . . that a showing that the stock price was not distorted by the misrepresentation defeats the presumption.” Tr. at 26. He also acknowledged that “the Fifth Circuit put the initial burden on plaintiff and that’s contrary to Basic.” Tr. at 29. 

 

In response to Justice Kagan’s questions, Mr. Sterling described the Fifth Circuit’s essential test espoused by defendants: The test is “not loss causation as this Court knows it in Dura; the test is simply price impact,” meaning plaintiffs had to show price impact to invoke the presumption of reliance. Tr. at 27. This showing can be made one of two ways. First, “[t]hey can show price inflation upon a misrepresentation, which, as this Court made clear in Dura, is not synonymous with loss causation.” Second, they can “show a price decline following a corrective disclosure.” Drawing the distinction between this showing and loss causation, Mr. Sterling posited “while [the price impact] showing is similar to loss causation, it’s an easier, less rigorous showing of loss causation, because under the price impact test at the Fifth Circuit, all the plaintiff needs show is that it’s reasonable to infer that some portion of the decline was attributable to the revelation of the truth.” 

 

In an interesting exchange, Justice Breyer interposed a hypothetical in which a Company issues a false statement saying it found oil in a well, numerous people buy the company’s stock and when it turns out there is no oil, those people lose their money. Tr. at 30. Under his hypothetical, Breyer explains that the presumption of reliance says to a typical plaintiff, “[w]e’re going to say what happened to the typical person on the stock market during that period happened to you, and there are a lot of people who bought and sold on the stock market. And that’s why efficient markets is needed to show at the certification stage.” Tr. at 30. Turning to defendants’ position, Justice Breyer opined, “[b]ut what you’re just saying in terms of whether the revelation lowered the price has nothing to do with the question of what happened to the typical person. . . . It has to do with whether anybody was hurt” and “that has nothing to do with the certification stage.” Tr. at 20. 

 

Mr. Sterling replied that Basic created “an exception to the long understood rule that fraud cases were not appropriate vehicles for class actions because each individual would have to say . . . I read Halliburton’s statement and I relied upon it.” Because such proof would be impractical in most cases, the presumption assumes the entire stock market is like the typical plaintiff and relies on the integrity of the stock price when the stock price is distorted by the misrepresentation.  But if the stock price was not in fact distorted by the misrepresentation, it makes no sense to say everybody relied on the misrepresentation through its effect on the stock price.” Tr. at 31. Mr. Sterling further stressed, “it’s not just enough to allege the operative facts” to invoke the presumption, Basic says plaintiffs “have to plead and prove them” subject to rebuttal proof. Tr. at 32. Ultimately, he explained these operative facts are “just surrogates of whether it is reasonable to believe or to infer that the stock price was in fact distorted by the misrepresentation.”  Tr. at 33. In contrast to “circumstantial proof” of general market efficiency or the other operative facts, proof of no market impact is “direct proof” undermining “the whole premise of the Basic class-wide presumption of reliance.” According to Mr. Sterling, the lack of price movement “is the DNA proof” and “it makes no sense for district courts to be certifying class actions based upon this indirect or circumstantial proof while ignoring the direct proof of the absence of price impact.” Tr. at 35. Appealing to the Court’s conservative Justices, Mr. Sterling opined that “it would do violence to [the Court’s] admonition [in Stoneridge Investment Partners v. Scientific-Atlanta, 552 U.S. 148 (2008),] that the 10b cause of action ought not be further expanded to make [the] rebuttable presumption of reliance irrebuttable at the class certification stage.” Tr. at 35. 

 

In response to Justices Ginsburg’s and Kagan’s questions regarding what would be left to decide on the merits after the class certification inquiry, Mr. Sterling argues that “falsity, scienter, actual proof of loss causation and damages” would all be undetermined at class certification. Tr. at 37. Along the same lines, Justice Kagan expressed concern about permitting defendants to rebut the presumption by putting an expert on the stand, and then the “Basic presumption falls away, and the plaintiffs have to actually prove their case at the very early stage.” Tr. at 40. Mr. Sterling explained, however, that showing price impact is “not a hard burden to show”: plaintiffs needed only to show a statistically significant price movement in response to any one of the 22 alleged misstatements or one of the alleged corrective disclosures. Tr. at 40. 

 

Mr. Sterling also attempted to address the concern regarding an early hearing on merits issues by indicating that Rule 23 provides district courts with discretion to permit discovery into the merits to the extent such discovery is relevant to the class certification issue, noting that plaintiffs asked for no such discovery in the instant case. Tr. at 41-42. This response drew sharp questioning from the Chief Justice and Justice Scalia, who asked why defendants would want to move up discovery if the class certification stage is so significant because of its in terrorem effect. Mr. Sterling responded that the grant of class certification is indeed a “seminal event” with “huge repercussions for the defendant.” Tr. at 43. The Chief Justice further posited that if one of Halliburton’s objections to plaintiffs’ view is that “it would just postpone the defendant’s ability to rebut the presumption” and “result in countless classes being certified with the certain knowledge that they would have to be decertified later,” if it is so certain, why is there an in terrorem effect? Tr. at 43. Mr. Sterling aptly replied that the Chief Justice’s question assumed “that the defendant has the wherewithal to stick it out through it all, but the sheer grant of class certification which aggregates hundreds . . . tens of thousands of these claims together in one big case makes every one of these cases, in effect, a company case, and it puts huge settlement pressure on the defendant.” Tr. at 43. 

 

            Plaintiffs’ Rebuttal Argument

Mr. Boies’ rebuttal attacked Mr. Sterling’s recitation of plaintiffs’ burden of proof under the price movement test as overly simplistic. In this regard, he pointed to the fact that plaintiffs showed a 42% stock price drop in response to a Halliburton asbestos-related statement that plaintiffs’ alleged was a corrective disclosure, which, as defendants’ expert conceded, did not disclose any other unrelated information. Tr. at 46. Nevertheless, the Fifth Circuit held such a showing was not sufficient because the statement did not specifically reference the prior announcement it was alleged to have corrected and therefore that statement was not a corrective disclosure. Tr. at 47. According to Mr. Boies, the Fifth Circuit therefore looked at more than just price movement in rejecting class certification; it looked at merits issues. 

 

Key Takeaways

Predicting how the Supreme Court will rule in a case by reading the tea leaves from oral argument is no easy feat. Yet, a few observations can be gleaned from the argument:

 

1. The Supreme Court appears likely to overturn the aspects of Oscar that require plaintiffs to prove loss causation (as opposed to price impact) at the class certification stage. 

 

2. The fundamental issue to be decided by the court is whether defendants are permitted to rebut plaintiffs’ evidence of an efficient market solely with proof that generally disproves the efficiency of the market. Mr. Boies conceded that the sole basis for plaintiffs’ position that defendants’ proof is limited to such evidence is footnote 29 of Basic, which Justice Alito described as “thin” support since the footnote was dictum and Basic was “issued at a time when conditional class certification was permitted.” Tr. at 6. A number of other Justices also seemed to struggle with why the inquiry should be so limited when the lack of price movement itself may at least be an indicator of an inefficient market and, even more, may in fact be direct evidence that the fraud-on-the-market presumption does not apply. Yet the challenge for the Court, if it does not stand on Basic’s footnote 29, will be in drawing the line between what proof should and should not be considered at class certification. For example, as raised in Mr. Boies’s rebuttal, will plaintiffs have to prove that certain statements were in fact corrective disclosures or will it suffice to allege that a statement was a corrective disclosure?  

 

3. Finally, the Justices will have to determine whether on the record before it, they can apply their ruling to the instant case or whether they will remand it. If the court adopts plaintiffs’ more limited class certification inquiry, it appears the Court could reverse the Fifth Circuit and grant class certification given Halliburton’s concession that the market for its stock was efficient. If the Court, however, adopts a middle ground approach, it is likely to remand the case to the Fifth Circuit even if such a result may only be a “Pyrrhic victory,” as Justice Scalia suggests.  

 

No matter how the Court rules, the decision should have a significant impact on the large number securities class actions working their way through the courts. By determining whether class certification will give defendants a real opportunity to test plaintiffs’ claims that the class wide presumption of reliance should apply, the Court’s decision will determine whether class certification can be an important event for settlement and will provide defendants with an opportunity to bring an early appeal. The threat of a negative ruling on the merits at the class certification stage or of an early appeal provides companies, their directors and officers and their insurers with additional leverage and an incentive to “stick it out,” as Mr. Sterling suggested, if a motion to dismiss is denied. 

Berkshire Hathaway’s Audit Committee has determined that David Sokol’s trades in Lubrizol shares prior to Berkshire’s announced acquisition of the company “violated company policies.” It also determined that his “misleadingly incomplete disclosures” to Berkshire management “violated the duty of candor he owed the Company.”  The Audit Committee reported these findings in an April 26 report to the Berkshire board, which released on its website on April 27, 2011. The report and accompanying press release can be found here. (Full disclosure: I own BRK shares.)

 

The report is the product of three Audit Committee meetings on April 6, 21 and 16, as well as a meeting of the full board in late March, and communications between the audit committee chair and company management and company counsel. In other words, while the rabble rousers outside the company were raising a ruckus about Sokol’s trades, the Audit Committee was conducting its own investigation. And it is pretty clear that as a result of this investigation, the Audit Committee is, in the words of UCLA Law Professor Stephen Bainbridge, “throwing Sokol to the wolves.”

 

The report specifically concludes that Sokol’s trading activity and his statements to Berkshire management about his trading violated the company’s Code of Business Conduct and Ethics and its Insider Trading Policies and Procedures. It also found that his conduct violated the company’s standards as articulated by its Chairman, Warren Buffett, to “zealously guard Berkshire’s reputation.” It also concluded that Sokol violated his duty of full disclosure to the Company.

 

The report specifically concludes that by trading in the Lubrizol shares, Sokol had misappropriated an opportunity that was Berkshire’s and that Sokol was only able to exploit by virtue of his position acting as Berkshire’s representative in connection with the negotiations and the transaction.

 

The report points out that Sokol’s voluntary resignation “had the effect of preventing him from receiving any severance-related benefit substantially different from those to which he would have been entitled if he were terminated for cause on the same effective date. He has thus suffered a sever consequence from his violations of Company policy.”

 

Nevertheless, the report concludes, the board is considering “possible legal action against Mr. Sokol to recover any damage the Company has sustained, or his trading profits, or both, and … whether the Company is obligated to advance Mr. Sokol’s legal fees associated with proceedings in which he is named.”

 

Finally, the company’s press release notes that it will post on its website a “complete transcript” of any questions or answers related to David Sokol at the upcoming April 30 meeting of Berkshire’s shareholders. (There might be a question or two on the topic…)

 

Among other things that the Audit Committee’s report does is that it makes it difficult for the plaintiff in the recently filed derivative action relating to these matters to be able to contend that a demand to the Berkshire board to take up this claim would have been futile. The board and its Audit Committee are quite capable of taking up these questions, thank you very much. (Among other reasons the plaintiff cited in support of his demand futilty allegatoin is that the company lacks "traditional corporate infrastructure" — that contention look particularly wrongfooted in light of the Audit Committe’s report).

 

The report’s final note about the board’s consideration of whether or not the company must advance Sokol’s legal fees is an interesting one to me. Buffett has been very public about the fact that Berkshire does not buy D&O insurance. In his most recent letter to shareholders, Buffett said, by way of explanation of why the company does not buy D&O insurance, “If they mess up with your money, they will lose their money as well.”

 

So if the company withholds defense expense advancement from Sokol, his choices are to defend himself out of his own pocket or to try to sue the company to enforce its advancement obligations. Neither is a particularly attractive choice for Sokol, as it will either cost him a fortune or put him in the very unattractive position of suing his former company.

 

I know the audit committee’s report does not include Sokol’s side of the story. (The report does not state specifically whether or not the audit committee interviewed Sokol in connection with its investigation and report). He likely has a different perspective on these events. But it seems to me that Sokol could go along way toward rehabilitating himself and his public reputation by offering to pay Berkshire trading profits he made for the Lubrizol trades and by offering  to reimburse the company for its legal expenses in investigating the trades. Any other path means more expense for the company and for Sokol and merely increases the amount that Sokol might have to pay to extricate himself from this situation later on. It just seems to me that this situation is unlikely to get better for Sokol, it will only get worse, and it won’t help Berkshire either.  

 

Lost among all this hoopla is that the Lubrizol transaction still has not closed and indeed the Lubrizol shareholders have not yet had their vote — the Lubrizol shareholder vote  is set for June 9, 2011. Lubrizol is located outside Cleveland, and I can tell you that here in Cleveland , no one is talking about Sokol’s trades. Rather, they are talking about the $97 million that Lubrizol CEO James Hambrick stands to reap if the deal goes through. Indeed, the lead article on the front page of the April 26, 2011 Cleveland Plain Dealer was captioned “Lubrizol CEO Poised to Soar on Fabulous Golden Parachute.”  (Fulll disclosure: I have met Hambrick socially here in Cleveland.)

 

I guess a lot of questions are being asked about who will be making how much as a result of this transaction. Somewhere amidst all these issues is the larger question of whether or not the transaction itself is in the interests of the shareholders of both companies. Of course, shareholders might feel more comfortable about their interests if individuals involved in the transaction were not profiting individually from the deal.

 

Speakers’ Corner: On May 11, 2011, I will be moderting a session in Menlo Park, California entitled "Dodd-Frank and the Rise of Shareholder Empowerment." The session is sponsored by the Orrick law firm, The Directors Network and Deloitte, and will take at place at the Orrick law firm’s Menlo Park offices. The program, which is free and which will run from 8:45 am to 11:45 am, will provide insights and practical advice regarding fundamental changes in the corporate governance environment and the emerging role of shareholders in the U.S. corporation.

 

The session includes an all-star cast of panelists, including Roel Campos, who served as an SEC Commissioner from 2002-2007; Consuelo Hitchcock, Principal, Regulatory and Public Policy at Deloitte; Marc Gross, of the Pomerantz, Haudek, Grossman & Gross law firm; Anne Sheehan, Director of Corporate Governance at CalSTRS; Marc  Schneider, Associate General Counsel at SEIU; George Paulin, the President of George Cook & Co.; and Jonathan Ocker and Bob Varian of the Orrick law firm.

 

Furher information about the program, including regiistration information, can be found here.

 

 

One of the many changes introduced by the Dodd-Frank Act was the requirement for a shareholder vote to approve executive compensation. Under the Act’s provisions, the vote is not binding on the company or its board, but is purely advisory. Nevertheless, companies whose shareholders vote against their “Say on Pay” resolutions are finding that lawsuits are following in the wake of the vote, according to Broc Romanek’s April 26, 2011 post on the TheCorporateCounel.net blog (here). 

 

Section 951 of the Dodd Frank Act provides that not less frequently than every three years public companies must provide their shareholders with an opportunity for an advisory vote on the compensation of the most-highly compensated employees. On January 25, 2011, the SEC adopted rules (here) implementing the requirements of Section 951. All public companies must hold Say-on-Pay votes at shareholder meetings starting on January 21, 2011. The rules are delayed for two years for companies with public float of less than $75 million. A March 2011 Investor Bulletin describing the Say on Pay requirements can be found here.

 

In view of public sentiment regarding executive compensation, it may not be a surprise that at some public companies the shareholders have voted against the Say on Pay resolution. According to Romanek’s April 25, 2011 post on the TheCorporateCounsel.net blog (here), a total of eight companies so far during this proxy season have seen their shareholders vote against the Say on Pay resolution. The most recent companies to have shareholders vote against their say on pay resolutions are Black and Decker (refer here) and Umpqua Holdings (refer here).

 

Umpqua Holdings filing on Form 8-K describing the shareholder vote on the say on pay resolution includes some interesting commentary, including among other things a statement that “our board of directors takes the results of this vote seriously and is considering ways to address this concern. “ The filing also states that “the vote against the ‘say on pay’ resolution was primarily the result of votes cast by institutional investors that followed the recommendation of Institutional Shareholder Services (ISS), a proxy advisory service,” adding that  “the ISS report found a ‘disconnect’ between our CEO’s compensation in 2010 and the company’s total shareholder return.” The company then went on to explain why it disagreed with the ISS position.

 

What has started to happen now that the “no” votes are starting to accumulate is that some of the company’s whose shareholders voted against the lawsuits are now finding that the lawsuits are following along after the vote. These lawsuits are being filed in the form of shareholders derivative suits against the individual board of directors, the members of the board compensation committee, and in some instances even the company’s compensation consultants.

 

One example where a lawsuit followed after shareholders voted no on a say on pay resolution involves Beazer Homes. As Ted Allen noted on the Risk Metrics Group Insights blog (here), at   the company’s February 2, 2011 annual meeting, over 53% of its shareholders voted against the company’s say-on-pay resolution. The company’s filing of Form 8-K discussing the vote can be found here.

 

On March 15, 2011, a Beazer shareholder filed a derivative lawsuit in Fulton County (Georgia) Superior Court, against the company, as nominal defendant, the company’s board, its accountant and its compensation consultant. A copy of the court’s docket can be found here. A copy of a March 15, 2011 Bloomberg article about the lawsuit can be found here. The lawsuit alleges that compensation increases for executives “violated the company’s pay-for-performance policy and favored Beazer’s CEO and top executives at the expense of the corporation.”

 

Another company that became involved in a shareholder suit after a say-on-pay vote, albeit before the Dodd Frank Act was enacted, was Occidental Petroleum. As described in its February 24, 2011  filing on Form 10-K (here) , the company was involved in a total of three different shareholder suits relating to compensation issues after shareholders voted on a compensation resolution. The first lawsuit, filed in federal court in Delaware in May 2010, alleged that the company’s board and certain of its executive officers had made a “false and misleading proxy solicitation” in connection with seeking shareholder approval of bonus compensation standards. All three lawsuits alleged corporate waste and breach of fiduciary duty for excessive compensation. The 10-K states that the first of the two suits was settled and the other two suits were dismissed with prejudice. However the filing does not disclosure the terms of the settlement. 

 

In an April 17, 2011 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog (here), attorneys from the Schulte Ross & Zabel law firm note that there are a number of negative consequences that follow in the wake of a negative say on pay vote, obviously referring to the Occidental case described above as well as other possible litigation:

 

The vote may translate into votes against directors. It also is likely to result in significant unfavorable publicity, which was the case at all 3 of the companies that received negative votes on [Say on Pay] iin 2010. In addition, lawsuits alleging breach of fiduciary duty and corporate waste were filed against directors at 2 of the companies that received a negative SOP vote in 2010. In one case, the lawsuit was settled, while it is still pending at the other company. At both of these companies, there also were changes to executive compensation policies and/or leadership.

 

At the 2 companies that have thus far had negative outcomes on SOP resolutions in 2011, in preparation for a possible lawsuit, plaintiffs’ firms already have announced investigations on behalf of shareholders concerning breaches of fiduciary duty …

 

The fact that there is litigation relating to executive compensation is not all that surprising, given what a hot button issue executive compensation as been in recent years. What is surprising is that the litigation is attempting to capitalize on the say on pay vote. For starters, the statute is quite clear that the required vote is not binding on the company or its board. Moreover, Section 951(c) expressly states, among other things that the shareholder vote “may not be construed” to “create or imply any change to the fiduciary duties of such issuer or board of directors” or to “create or imply any additional fiduciary duties for such issuer or board of directors.”

 

But even with the seeming limitations in the statute, the simple fact is that the vote is required and shareholders get to say that they disapprove of the company’s compensation practices. In April 26, 2011 post on his eponymous blog (here), UCLA Law Professor Stephen Bainbridge states that he knew these kinds of problems were coming when Congress incorporated the advisory say on pay provision in the legislation, having warned that the process “would be abused and turned from a supposed non-binding voting exercise into a club to beat directors with.” As Professor Bainbridge notes, that appears to be exactly what is happening.

 

Of course, merely because lawsuits are filed does not mean the suits are meritorious, and there is nothing that says that these cases are necessarily going anywhere. But they will still be costly to defend. And the fact that the Occidental case noted above was settled (albeit under undisclosed provisions) suggests that there could at least potentially be expense involved in trying to resolve these cases as well.

 

The defense expense involved as well as the possible costs of resolution make these kinds of cases a problem for D&O insurers. (Indeed, at least one observer noting the arrival of these kinds of suits expressly stated  that the D&O insurers had “better start watching what happens with Say on Pay.”).

 

One of the recurring discussions amongst D&O insurance professionals since the enactment of the Dodd Frank Act has been the extent to which the Act may increase or exacerbate D&O claims activity. The full impact of the Dodd Frank Act will only be revealed in the fullness of time. But while the full picture develops, one thing that is clear is that the Act’s Say on Pay provisions could be contributing to increased  D&O claims activity.

 

Maybe You Can’t Save the World, But You Can Help People Help Themselves: The Hesperian Foundation is a non-profit organization that publishes a book for people who do not have access to professional medical care called “Where the Is No Doctor.” The book has been translated into many languages and has been distributed around the world.

 

Here is a letter that was recently sent to the Foundation from someone who had received one of the books years ago:

 

About sixteen years ago, I was honored to receive from your august foundation the 1992/94 revised and reprinted precious book …”Where There is No Doctor.” I learn with great pleasure that you’ve published the 2010 revised edition…

 

I’m thus applying to you once again to kindly post me one book of this 2010 revised edition. I’m a teacher living and working in this densely populated suburb of Dakar where illiteracy and poverty rates are still very high. Infectious diseases like malaria, TB, STDs and influenza, and contagious but still deadly diseases like cancer, high blood pressure, diabetes, asthma, sickle cells, kidney failure, hepatitis, ulcers, general and particularly joint pains, etc., are widespread here. Dermatosis, worms, eye problems (cataract, glaucoma), teeth ache and depression or stress-related psychiatric disorders are also very frequent. In the neighboring countries, heavy rainfall forest nations like Sierra Leone, Liberia and the two Guineas …deadly diseases like typhoid, cholera and AIDS add up to the above mentioned somber list.

 

I’m persuaded that your in-depth and well illustrated book will again be of great help to us. As an underdeveloped country, the vast majority of people here don’t have access to computers and to the Internet. We thus very largely still depend on books like yours to learn from and to teach people in the community. We shall thus be very grateful to you and your Foundation to receive one from you…

 

The first thing I did when I read this letter was that I got out a checkbook and wrote the Foundation a check for $50, which is the all-in cost for processing and shipping the book to East Africa. If one book can help with so many different kinds of problems then it needs to be provided to as many people as possible.

 

The Foundation gets letters like this all the time, asking for copies of the book in specific languages or addressing specific situations. Among other things, the Foundation recently posted a Japanese language version of the book online, because so many earthquake victims, who may previously have the best medical care in the world, now do not have access to a doctor. Victims of the Haiti earthquake continue to depend on the book as a guide to the prevention of the spread of cholera.

 

The thing I particularly like about this book is that it is not a mere handout; it is a form of personal empowerment. The people who have access to one of these books can learn what they need to do to care for themselves, which is the first and most important step of self-improvement.

 

I was absolutely delighted to be able to make a donation so that a book could be sent to the Senegalese teacher whose letter I reproduced above. If you would like to help others just like him, please consider making a donation by visiting the Foundation’s website, here.

 

The jury verdict entered in favor of the plaintiffs in the BankAtlantic subprime-related securities suit has been set aside by the court in a post-trial ruling. On April 25, 2011, Southern District of Florida Judge Ursula Ungaro, in a 112-page opinion (here), granted the defendants’ motion for judgment as a matter of law and indicated that she will enter judgment in defendants’ favor following remaining procedural issues.

 

BankAtlantic’s shareholders had first sued the company and five of its directors and officers in October 2007. The plaintiffs essentially alleged that the defendants had violated the securities laws through misrepresentations and omissions about the poor or deteriorating credit-quality of BankAtlantic’s land loan portfolio; misrepresentations or omissions of its poor underwriting practices; and misrepresentations and omissions about the adequacy of its loan loss reserves and the accuracy of its financial statements. The claims were divided into two separate alleged damages periods corresponding with declines in the company’s share price on April 26, 2007 and October 26, 2007.

 

Judge Ungaro had initially granted the defendants’ motion to dismiss  but she denied their renewed dismissal motion after the plaintiffs amended their pleadings (refer here), and the case went to trial. On November 18, 2010, the jury returned its verdict, as discussed here.

 

As Judge Ungaro summarized the verdict in her April 25 opinion, “the Jury returned a verdict mainly in Defendants’ favor.” The jury found no liability as to any defendant with respect to the first alleged damages period. However, with respect to five alleged misstatements in the second period, the Jury concluded with respect to four alleged misstatements that the company it s former Chairman and CEO had violated the securities laws. The jury also concluded that the company, the Chairman and the company’s CFO violated the securities laws with respect to a fifth alleged misrepresentation.

 

The jury made a specific finding that one the alleged misrepresentations had caused damages of $2.41. At the time of the verdict there were statements in the press suggesting that this damages measure implied total damages of as much as $42 million.

 

The defendants moved to have the verdict set aside on a number of grounds. However, in granting the defendants’ motion, Judge Ungaro focused on one specific issue, whether the plaintiffs had presented sufficient evidence of loss causation and damages. Specifically, she addressed the question whether or not the plaintiffs had presented sufficient evidence that the plaintiffs alleged damages were caused by the concealment of risks about the bank’s real estate loan portfolio.

 

Judge Ungaro granted the defendants’ motion because she found that the plaintiffs’ damages expert had failed to “disaggregate” the effect on the company’s share price decline of the other negative information that was revealed at the same time the supposedly fraudulent information was revealed.

 

Judge Ungaro found that the Bank announced a “bundle” of negative information including negative information regarding the bank’s “builder land bank” (BLB) loan portfolio and non-BLB loan portfolio. Because the plaintiffs’ damages expert did not provide testimony providing this disaggregation, Judge Ungaro concluded that the plaintiffs’ had failed to produce sufficient evidence at trial of the loss caused by the disclosure of defendants’ misrepresentations and of the damages attributable to the misrepresentations.

 

Although Judge Ungaro’s conclusion may be stated simply, her April 25 opinion is complex and multilayered, largely as a result of problems arising out of the jury verdict form. The jury verdict from was, according to Judge Ungaro, “lengthy and complex – it was 75 pages long and contained over 150 questions.” As Judge Ungaro noted in her April 25 opinion, the form’s complexity was a result of “the intricate demands of the Reform Act as they applied to this case — a numerous statement, varying-defendant, Rule 10b-5 class action involving two separate damages periods atop which was layered a varying-defendant Section 20(a) class action.”

 

It appears that, perhaps as a result of the form’s length and complexity, the jury had problems with the form. As discussed at length in Judge Ungaro’s April 25 opinion, the jury’s specific findings with respect to one of the alleged misstatements on which liability was based were inconsistent. And with respect to other misstatements on which liability had been based, there were no specific damages findings. As a result, the jury’s verdict makes for somewhat messy post-verdict analysis – hence the length and sprawling scope of Judge Ungaro’s opinion ruling on the post trial motions.

 

I suspect strongly that there will be further proceedings in this case, at a minimum including an appeal to the Eleventh Circuit. The plaintiffs undoubtedly will recall that in the Apollo Group securities lawsuit , in which the court had granted the defendants’ post-trial motion and set aside the jury verdict, the plaintiffs succeeded on appeal in having the post-trial ruling overturned and having the plaintiffs’ verdict reinstated. (The U.S. Supreme Court recently turned down the defendants’ petition for writ of certiorari in the Apollo Group case.)

 

But in any event, as a result of Judge Ungaro’s ruling, the post-Reform Act securities lawsuit trial scoreboard needs to be revised. Based on information compiled by Adam Savett of the Claims Compensation Bureau, there have been a total of only eleven  securities post-Reform Act lawsuits involving post-Reform Act conduct that have gone to trial. With the adjustments to reflect Judge Ungaro’s April 25 ruling, the scoreboard now stands at Plaintiffs 6, Defendants 5. (A tip of the hat to Savett for having already updated his scoreboard when I went and looked at it this morning.)

 

Special thanks to the loyal readers who alerted me to Judge Ungaro’s ruling.