Suit Against Auction Rate Securities Investor Dismissed: When plaintiff investors first sued Mind M.T.I. and certain of its directors and officers in the Southern District of New York in August 2009, I noted at the time that the new suit seemed to reflect two securities class action lawsuit filing trends: first, the case presented an example of a "belated" lawsuit filing, where the initial filing came more than a year after the proposed lawsuit date; and second, the case represented another instance where a company’s shareholders had filed suit due to their company’s investment auction rate securities.

 

The case, however, failed to surmount initial pleading thresholds, and July 2, 2010 was dismissed with prejudice.

 

Unlike many auction rate securities cases, which typically were brought against the firm that had sold the plaintiffs the securities, this suit (like others, refer here) was brought against a company that had invested in the auction rate securities.

 

The lawsuit pertained to the company’s 2006 purchase of $22.8 million in auction rate securities. The securities the company purchased were issued by the now-infamous Mantoloking CDO, about which refer here.

 

The plaintiffs alleged that the defendants "knowingly and recklessly concealed that most of Mind’s reported cash position was comprised of illiquid Auction Rate Securities (ARS)" and that the company’s internal controls for monitoring, accounting and reporting of the Company’s investments in cash equivalents and/or short-term investments were materially deficient." The defendants moved to dismiss on the grounds that plaintiffs’ had not sufficiently pled scienter.

 

In a July 2, 2010 order (here), Southern District of New York Judge Richard M. Berman, granted the defendants’ motion to dismiss with prejudice, holding that the plaintiffs had failed to allege sufficient facts showing a motive and opportunity for the fraud, and also had failed to alleged facts sufficient to constitute strong circumstantial evidence of conscious misbehavior or recklessness.

 

In concluding that the plaintiffs had not sufficiently alleged scienter, the court noted that the defendants had argued that the company "rather than acting with scienter, was itself defrauded by its investment bankers into believing its investment was a safe, liquid alternative to bank deposits." Judge Berman found that the plaintiffs allegation do not offer any factual explanation in contradiction of this contention. According, he concluded that the plaintiff had failed to raise an inference of scienter that is cogent and at least as compelling as any opposing inference of nonfraudulent intent.

 

After the marketplace for auction rate securities froze in February 2008, plaintiffs’ lawyers launched a barrage of lawsuits against the investment banks and other firms that had sold investors these securities. By and large, these cases against the auction rate securities have fared poorly, particularly with respect to the financial firms that separately entered regulatory settlements intended to provide small investors relief regarding their illiquid securities investments.

 

For example, the securities suit filed on behalf of auction rate securities investors against UBS, which had entered into a auction rate securities-related regulatory settlement was initially dismissed with prejudice. After the plaintiffs amended their pleading, the court granted the defendants’ renewed dismissal motion but allowed the plaintiffs leave to attempt to further amend their pleadings. However, on July 7, 2010, after the plaintiffs failed to file further amendments within the allotted time, the court entered judgment on behalf of the defendants.

 

The poor track record in the auction rate securities cases has not been limited just to companies that had entered regulatory settlements, as was demonstrated, for example, in the dismissal granted in auction rate securities suit filed against Raymond James (about which refer here).

 

Similarly, the dismissal granted on the Merrill Lynch auction rate securities suit in March 2010 (about which refer here) did not depend on Merrill’s entry into a regulatory settlement, but was on the merits.

 

But the suits filed against the financial firms that had sold the auction rate securities represented only one type of auction rate securities lawsuit. In addition, there were a number of suits filed against the companies that had purchased the securities, in which it was alleged that the companies had misrepresented the companies’ financial condition by failing to disclose its investment. The dismissal of the Mind C.T.I. suggests that these suits against auction rate investors may fare not better than the many suits filed against the auction rate securities investors.

 

2010 Securities Suit Filings at the Year’s Midpoint: In a publication issued this past week, Charles River Associates issued its review of the Second Quarter 2010 securities lawsuit filings, including an analysis of the 2010 filings for the first half of the year. Though different in some details, the Charles River report is directly consistent with the observations noted on my recent post (here) on first half filings.

 

Among other things, the report notes that though second quarter 2010 filings were up 25% compared to the second quarter of 2009, the filings in the first half of 2010 were down 9% compared to the first half of 2009, and down 38% compared to the first half of 2008.

 

The report also notes that though the second quarter filings involved companies in a wide range of industries, the filings were "primarily concentrated in the financial services and oil and gas sectors." The report also notes that a number of the second quarter filings involved class periods that ended more than a year prior.

 

Special thanks to Christopher Noe of Charles River for providing a copy of the report.

 

The Dodd-Frank Bill and Securities Litigation: If the Dodd-Frank Wall Street Reform and Consumer Protection Act is finally enacted into law, we can all look forward to months of commentaries beginning like this: "A little noticed provision of the financial reform legislation may have unexpected implications." The sheer sweep of the Bill’s 2,500-plus pages and countless provisions virtually ensures that for months and years the legislation will be slowly revealing sometimes unexpected implications.

 

Among many other subjects that the Bill touches upon is securities litigation. Though the Bill does not reach as far as it initially appeared it might, the Bill does contain a number of provisions with securities litigation implications. These implications are helpfully catalogued in a couple of recent law firm memos.

 

First, in a July 9, 2010 article entitled "The Impact of Financial Reform on Securities Litigation Enforcement" and posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog (here), several attorneys from the Wachtell Lipton firm catalogue the Bill’s various provisions.

 

Second, in a July 9, 2010 memo entitled "Securities Litigation Implications of the Dodd-Frank Bill," the Paul Weiss firm takes a look at the Bill’s securities litigation provisions and also review the various additional proposed provisions that did not make it into the Bill’s final version.

 

Finally, a July 6, 2010 memo by the Katten Muchin law firm entitled "Dodd-Frank Wall Street Reform and Consumer Protection Act Corporate Governance and Disclosure Provisions" reviews the Bill’s various provisions relating to corporate governance and disclosure practices.

 

These memos are detailed and helpful. Just the same, the massive Bill seem likely to have yet other sections that may involved undiscovered implications that will only be revealed in the fullness of time.

 

World Cup Final Notes:

1. I agree with my sixteen year old son’s assessment — I am sorry the World Cup is over. Notwithstanding those damn vuvuzelas.

 

2. The Spaniards should be proud, they scored and they won. Iker Casillas, Spain’s goalie, played just well enough to allow his team to win. But truth be told, the tournament’s final match was not a very good game. It was marred by unnecessary violance and poor sportsmanship, not to mention astonishing failures by both teams to capitalize on scoring opportunities.

 

3. The consolation round game on Saturday was a much better game, which I am very glad I watched. It was an exciting, fair match well played by both Uraguay and Germany. And it literally came down to the last tick of the clock. A great game all the way around.

 

4  I aboslutely concur in the award of the golden ball to Diego Forlan of Uraguay. He had a great tournament and he is an exciting player to watch. Rumors that he is about to sign with the Miami Heat apparently are totally unfounded.

 

In a June 30, 2010 opinion (here), a three-judge panel of the Second Circuit reversed the lower court’s ruling that coverage under a directors and officers liability insurance policy for an underlying claim was precluded by the policy’s "insured vs. insured" exclusion, holding that the D&O policy at issue was "ambiguous" under Virginia law.

 

Background

Prior to May 2004, Community Research Associates, an Illinois corporation, was controlled by three shareholders, referred to in the coverage action as the Legacy Shareholders. In May 2004, CRA was reorganized as a Delaware corporation as part of a stock purchase agreement by which Sterling Investment Partners became the majority shareholder, and the Legacy Shareholders became minority shareholders. The pre-transaction entity was referred to in the coverage litigation as CRA-Illinois and post-transaction entity was referred to as CRA-Delaware.

 

The May 2004 transaction contemplated several events occurring simultaneously at the time of the transaction closing. Among other things, the Legacy Shareholders were to assume positions as officers or directors of CRA-Delaware in order to sign the paperwork to complete the reorganization plan. In addition, as a condition of closing, the Legacy Shareholders were required to resign their positions as directors of CRA-Delaware in order to close the merger.

 

In October 2004, CRA-Delaware purchased D&O Insurance policy. In its application for insurance, CRA-Delaware stated, among other things:

 

On May 3, 2004, the company had a merger with an investment entity. A new Chairman and Chief Executive Officer was installed. The prior ownership remained in a minority capacity but were no longer participants on the Board or officers of the corporation. On August 2, 2004 a new Chief Financial Officer was hired.

　

In August 2005, CRA-Delaware approved a merger whereby all of CRA-Delaware’s stock was sold to a third-party, CRA Acquisitions Corp. The Legacy Shareholders filed a lawsuit against certain directors and officers of CRA-Delaware, alleging a breach of fiduciary duty in connection with the August 2005 merger. The breach of fiduciary duty action ultimately settled for $3 million.

 

The CRA-Delaware directors who were sued in the breach of fiduciary duty action filed a claim under the company’s D&O insurance policy for the losses incurred in connection with the claim. The D&O insurer denied coverage for the claim in reliance on the policy’s "insured vs. insured" exclusion, and coverage litigation ensued.

 

The district court in the coverage action granted the carrier’s motion for summary judgment, holding that the "insured vs. insured" exclusion was unambiguous and that because the Legacy Shareholders were all former directors and officers of CRA-Delaware, having assumed those roles briefly in order to effectuate the merger, the losses from their claim fell within the Policy’s exclusion.

 

The Second Circuit’s Opinion

The Second Circuit first found that when the district court had concluded that the Legacy Shareholders "briefly assumed" the role of directors of CRA-Delaware in order to effectuate the merger, the district court "assumed[ed] the answer without addressing the parties’ argument."

 

The coverage claimants argued that CRA-Delaware "did not exist as an entity until after the closing of the merger." The Second Circuit said that "at the very least, the question should have gone to a jury to determine whether CRA-Delaware existed prior to the merger or, if it did, whether it was the same entity that existed after the merger for purposes of policy coverage."

 

In reaching this conclusion the Second Circuit, referenced CRA-Delaware’s policy application, which was attached to and, by the Policy’s terms, incorporated into the policy. The Second Circuit found that the application, which the Court emphasized was part of the policy, described the May 2004 transaction in a way that raised these questions about when CRA-Delaware came into existence, and in particular about whether the Legacy Shareholders were ever officers or directors of CRA-Delaware as such.

 

Citing Virginia law, the Second Circuit held that "the Policy, when read in its entirety, can reasonably be ‘understood in more than one way’ and is thus ambiguous." Both of the parties’ interpretations of when CRA-Delaware came into existence "rely only on language of the Policy and are reasonable in light of the various provisions of the Policy."

 

Accordingly, the Second Circuit remanded the case to the district court "to undertake any additional fact finding to interpret the Policy provisions in light of the facts to be found."

 

Discussion

At first impression, this case is a bit of head-scratcher, since the record does seem to suggest that the Legacy Shareholders were briefly directors of CRA-Delaware in order to effectuate the merger, which is exactly what the district court found.

 

On further reflection, however, the question may not be quite as straightforward as the first impression might suggest. There is a question about exactly when CRA-Delaware first came into existence, and whether the Legacy Shareholders were ever directors of CRA-Delaware when it came into existence. The application itself, which was incorporated in to the policy, seemingly suggests that the Legacy Shareholders were not officers or directors of CRA-Delaware as such.

 

Significantly, the Second Circuit did not affirmatively say that there was coverage here under the D&O policy, only that further findings of fact were required before it could be determined whether or not the insured vs. insured exclusion applied.

 

At some level, this coverage dispute may simply be a reflection of a very specific and arguably unique set of facts. However, the parties’ dispute is a reminder of the complexities that can sometimes arise in connection with the application of the "insured vs. insured" exclusion, which is frequently the source of contentious coverage issues.

 

That said, I don’t think the Second Circuit was saying the insured vs. insured clause in and of itself was ambiguous. Rather, the finding of ambiguity turned on the fact that the policy application was incorporated into the Policy – that is, by the Policy’s terms, the application was a part of the policy. The finding of ambiguity related to the interaction between the application as part of the policy and the insured vs. insured exclusion. In essence, the Second Circuit said that because of the ambiguous relation between these two parts of the policy, further fact finding is required.

 

My prior posts on the Insured vs. Insured exclusion can be found here and here.

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In the latest appellate decision to affirm the dismissal of a subprime-related securities class action lawsuit, on June 29, 2010, a three-judge panel of the Ninth Circuit issued an opinion (designated "not for publication") affirming the dismissal of the securities suit that had been filed against Impac Mortgage Holdings and certain of its directors and officers.

 

As discussed in greater detail here, investors first filed their suit in August 2007, alleging that contrary to Impac’s representations the company’s Alt-A loans were being sold to less creditworthy borrowers, so that the loan portfolio was experiencing the same risks and discounts in securitization as sub-prime mortgages.

 

The plaintiffs alleged further that the defendants deceived investors by representing that Impac’s underwriting guidelines were strict and that its loans were high-quality, which in fact the executives were overriding the underwriting guidelines to originate and purchase poor-quality loans.

 

In a March 9, 2009 order (here), Central District of California Judge Andrew Guilford granted with prejudice the defendants’ motion to dismiss the plaintiffs’ Third Amended Complaint, and the plaintiffs appealed. My prior post about the district court proceedings can be found here.

 

In the Ninth Circuit’s June 29 opinion affirming the district courts dismissal, the panel found that the plaintiffs had "stated insufficient facts to create a strong inference of scienter." The panel found that none of the plaintiffs’ allegations taken individually "describe any underwriting-guideline violations or tie those violations to the class period with the ‘great detail’ required to give rise to a strong inferences of scienter."

 

Taking the plaintiffs allegations as a whole, the panel concluded that "the inference that the defendants intended to deceive investors is still less compelling than a competing inference of non-fraudulent intent." The court went on to observe that "at bottom, a non-fraudulent inference – namely that Impact’s efforts to minimize risk exposure in the mortgage industry came too late to avoid large losses – is more compelling than an inference that Impac’s officers intended to defraud investors by falsely claiming to tighten its underwriting guidelines."

 

The Ninth Circuit’s opinion in the Impac case is the third appellate decision issued in connection with the subprime and credit crisis-related litigation wave, joining the Second Circuit’s decision in the Centerline case (about which refer here) and the Eighth Circuit’s decision in the NovaStar case (about which refer here). In each of these decisions, the appellate courts have affirmed the lower court’s dismissal of the complaint.

 

While three cases represents far too small of a data set to draw any conclusions, at least so far it seems that plaintiffs have not been rewarded for appealing the lower court dismissals.

 

I was somewhat curious about the significance of the fact that the Ninth Circuit’s opinion was designated "not for publication." Although I have never been able to figure out why Courts bother with that sort of thing in this day and age (obviously it is public so why bother with the designation), it is clear that the Ninth Circuit cannot bar participants from referencing the case, as Federal Rule of Appellate Procedure 32.1 expressly provides that courts may not "prohibit or restrict" the citation to appellate opinions by designating them as, for example, "not for publication." So why bother designating an opinion as not for publication?

 

In any event, I have adjusted my running tally of subprime related case dispositions (which can be accessed here) to reflect the appellate decision in the Impac case.

 

While there were a number of significant, high-profile securities class action lawsuits filed during the first-half of 2010, overall filing levels for the year’s first six months, annualized for a full year, were well below last year’s filings and historical averages.

 

In the first half of 2010, there were 76 new securities class action lawsuits. This figure, if annualized, would mean 152 new securities class action lawsuits for the year, which is below the 169 that were filed in 2009, and about 29% below the 1997-2008 average of 197 filing per year.

 

The lawsuits were filed against companies in 41 different SIC Code categories, although as has been the case for the past several years, the first six months’ filings were again weighted toward the financial sector. 13 of the 72 first half filings were in the 6000 SIC Code category (Finance, Insurance and Real Estate), and another ten filings were against entities that lacked SIC Codes that were all financially related. This total of 23 first half filings against financially related filings represents 32% of the filings in the first six months.

 

Among these lawsuits filed against financially related targets were six new lawsuits filed against Exchange Traded Funds and six lawsuits filed against commercial banks. The filings against the ETFs is a trend that began in the second half of 2009. The suits filed against the commercial banks reflect in part the wave of bank failures that has been sweeping across the sector.

 

As in the past, life sciences companies also continue to be targeted. There were 7 lawsuits filed in the first half against companies in the 283 SIC Code group (Drugs) and 5 against companies in the 384 SIC Code group (Surgical, Medical and Dental Instruments and Supplies). These 12 lawsuits represent 16.6% of the first half filings.

 

In recent years, filings against foreign-domiciled companies have been an important part of total filings. For example, in 2008, lawsuits against companies from outside the U.S. represented 15% of all filings, and in 2009 they were 12.7% of all filings. However, so far in 2010, there have been relatively fewer securities suits filed against foreign companies. Four of the first half lawsuits were filed against foreign companies, representing only about 5.18% of the suits filed.

 

Even if, as I have speculated might be the case, the Supreme Court’s ruling in the Morrison v. National Australia Bank case might have the effect of discouraging suits against foreign domiciled companies (particularly those whose shares do not trade on U.S. exchanges), it already seems that filings against foreign domiciled companies are now a relatively less significant part of all filings than they have been in recent years.

 

The first half lawsuits were filed in 31 different federal district courts, although a significant number of the lawsuits were filed in the S.D.N.Y. There were 21 new securities class action lawsuits filed in the Southern District of New York in the first half of 2010, largely as a result of the concentration of cases filed against companies in the financial sector. The district court with the second most number of first half filings was the District of Massachusetts, which had four.

 

As I noted last year, there has been an increase in what I have described as "belated filings" – that is, new lawsuits where there is a gap between the proposed class period cutoff date of a year or more. By my count there were 14 of these belated cases filed in the first half, and they continued to be filed as the period progressed. It will be interesting to see what impact, if any, the Supreme Court’s statute of limitations ruling the Merck case (about which here) will have on the continued filing of these belated cases.

 

The subprime litigation wave began in early 2007. Though it is now in its fourth year, the subprime related and credit crisis related cases continue to come in. By my count, there were 13 subprime and credit crisis related lawsuits filed in the first half of 2010, many of them (such as the securities lawsuit filed against Goldman Sachs) related to mortgage securitizations that went bad. For a listing of the subprime and credit crisis related securities suits, including those filed in 2010, refer here.

 

As I have noted elsewhere, the plaintiffs have seemed particularly interested in pursuing claims in the wake of headline crises that various companies have suffered. Indeed, the Deepwater Horizon oil spill alone has generated securities class action lawsuits against BP, Transocean, and Anadarako. Other headline related securities suits in the first half include those filed against Goldman Sachs, Massey Energy and Toyota.

 

Though the number of new securities class action lawsuits are relatively down compared to historical levels, that does not necessarily mean that overall claims activity has declined. Indeed, analysis by Advisen (refer here) suggests that securities class action lawsuits represent an increasingly smaller percentage of all claims, a trend that began in 2006 and that increased in the first half of 2010.

 

In addition to the securities class action lawsuits, claimants are filing individual lawsuits (rather than class actions), a phenomenon that has been particularly evident with respect to many of the subprime and credit crisis-related claims. Claimants are also filing shareholders derivative suits or otherwise proceeding on different theories.

 

But this diversification notwithstanding, it is evident that securities class action filings were down in the first half of 2010, relative to historical levels, as they have been since about the second quarter of 2009.

　

It was possible to overlook it amongst the flurry of high profile opinions the Supreme Court released on the final day of the 2009 court term, but on June 28, 2010 the Court granted yet another petition for writ of certiorari in a case arising under the securities laws. Although the case arises out of the specific context of a mutual fund market timing case, it raises fundamental issues about who may be a "primary violator" under the securities laws. The Court seems poised to delve yet again into critical issues under the federal securities laws.

　

Background

Janus Capital Group (JCG) is the holding company for a family of mutual funds. Janus Capital Management (JCM) is the funds’ investment advisor. In November 2003, JCG investors filed a complaint in the District of Maryland alleging that the two firms were responsible for misleading statements in the certain funds’ prospectuses. The allegedly misleading statements represented that the funds’ managers did not permit, and took active measure to prevent, "market timing" of the funds. The investors claim they lost money when market timing practices JCG and JCM allegedly authorized were made public.

 

In 2004, JCM reached a settlement with the SEC in connection with the market timing allegations in which the firm paid a disgorgement of $50 million and an additional $50 million in civil penalties. Information regarding the settlement can be found here.

 

The district court dismissed the shareholders suit in May 2007. The shareholders appealed to the United States Court of Appeals for the Fourth Circuit. In a May 7, 2009 opinion (here), the Fourth Circuit reversed the district court, finding that the shareholders had adequately stated a claim under the securities laws. The defendants’ filed a petition for writ of certiorari, which the Supreme Court granted on June 28, 2010.

 

Issues Involved

As the Supreme Court itself recently affirmed in its Stoneridge case (about which refer here), there is no private action for aiding and abetting liability under the federal securities laws. Accordingly, the defendants can be liable if at all if they are "primary violators," that is, if they are directly responsible for the allegedly wrongful conduct. The Janus entities contend that as mere service entities for the actual funds, they cannot be held primarily liable.

 

The plaintiffs argue that JCM was not a "mere service provider" contending that the firm handles all of the funds’ operations, "including preparation, filing, and dissemination of the Fund prospectuses and prospectus statements" and that all of the funds’ officers were executives at the advisor. The investors contend that they had every reason to believe that the Fund prospectus statements were JCM’s work.

 

The Fourth Circuit ruled that "a service provider can be held primarily liable in a private securities fraud action for ‘helping’ or ‘participating’ in another company’s misstatements." The Fourth Circuit’s ruling is at odds with the decisions of other Circuit courts. Some courts hold that only someone that "makes" a statement and has it attributed to him can be held liable as a primary violator. Other courts, similarly to the Fourth Circuit, have held that someone that "substantially participates" in the activities that led to the creation of the allegedly misleading statement can be held liable as a primary violator, even if the statement is not attributed to him or her.

 

Discussion

Though this case nominally is just about whether or not a service provider can be held liable, fundamentally it is about who can be held liable as a primary violator. A bright line test would limit primary violator liability to those who speak or who have statements attributed to them. However, a broader "substantial participation" test would substantially widen the scope of persons who potentially could be held liable. The scope of liability could potentially extend to a wide range of persons who are involved in the preparation of public statements, including, for example, potentially even the issuers’ attorneys and accountants.

 

Indeed, at some level, this "substantial participation" test starts to sound a lot like the "aiding and abetting liability" that the Supreme Court had rejected in connection with private lawsuits in the Stoneridge case. That may, in fact, be why the Supreme Court took up the case – not just to reconcile an apparent split in the Circuits, but to align the principles of primary violator liability with those of the secondary violator jurisprudence. In a June 29, 2009 Am Law Litigation Daily article (here), Susan Beck furhter develops these issues relating to the tension between the Fourth Circuit’s standard and the case law relating to secondary liabiltiy.

 

I have absolutely no way of knowing how this case ultimately will turn out, and indeed the case has yet to be fully briefed or argued. But if I were a betting man, I would bet that the principles on which the Fourth Circuit based its decision are unlikely to survive Supreme Court scrutiny. (I could also be wrong, which is why I don’t gamble.)

 

It is worth noting that the Court suddenly seems particularly keen to take up securities cases. As I recently noted here while discussing the Court’s cert grant in the Matrixx Intiaitves case, there was a time when the Court would go many terms without taking up any securities cases. For several years now, the Supreme Court has taken up one or two securities cases. The Court’s increased interest in securities cases make great blog fodder, but it also creates the potential for disruptive alterations of the settled litigation landscape.

 

The Court’s sudden heightened interest in securities cases must be particularly unnerving for plaintiffs’ lawyers as the Court, with its current lineup, has generally proven to be less than entirely plaintiff friendly. There is some considerable risk that the Janus case will provide yet another opportunity for the Court to deliver an opinion the plaintiffs’ bar finds unhelpful.

 

In any event, the Supreme Court will now have two potentially significant securities cases on its docket next term. I really do find it surprising, given this blog’s topical focus, how often I find myself writing about Supreme Court-related issues –especially lately. I never expected that. I do find it all very fascinating though

 

Special thanks to the several readers who sent me links and other materials about this case. Special thanks to the SCOTUS Wiki blog (here) for links to some of the key documents to which I linked above.

 

Surprising Stuff Under the Hood of the Financial Reform Act: In recent posts (most recently here) I noted the possibility that the Supreme Court’s decision in the Morrison v. National Australia Bank case could well trigger Congressional action, particularly with respect to the SEC’s authority over conduct in the U.S. even if the transaction occurred outside the U.S.

 

An alert reader who clearly has a lot of patience managed to sift through the thousands of pages of the Conference Committee version of the financial reform bill (the "Dodd-Frank Wall Street Reform and Consumer Protection Act," which can be found here), and he reports (and my review of the Bill confirms) that the Conference Bill actually addresses the extraterritorial question.

 

First, Section 929P(b) authorizes an action brought by the Commission, inter alia, based on "conduct within the United States in furtherance of the violation," in effect allowing the Commission to take enforcement action based on conduct in the U.S. even if the transaction took place outside the U.S. (if all the provision’s conditions are met).

 

Second, Section 929Y, entitled "Study of Extraterritoral Private Rights of Action," directs the Commission to study whether private rights of action should be allowed on the same basis as authorized for the Commission in Section 929P(b). The provision directs the Commission to deliver the report to Congress within 18 months of the statute’s enactment.

 

In other words, if the Bill is enacted in its current form, the Commission will have the ability to bring cases involving foreign companies and even involving transactions outside the U.S., if the conduct meets the standards defined in the provision, and the Commission will study and report to Congress on whether private claimants should have the same right.

 

Very special thanks to the alert reader who found these provisions and pointed them out to me.

 

Bank Shot: Regular readers know I have been reporting frequently on the possibility of litigation arising in the wake of the wave of failed banks. The July 2010 issue of U.S. Banker has an article entitled "First the Failures, Then the Lawsuits" (here) which takes a very interesting look at this possibility.

 

The article reports that the FDIC "has begun laying the groundwork for potentially years of lawsuits against senior executives and directors it claims may have been responsible for their bank’s collapse." The article notes that the FDIC has sent "hundreds of demand letters," which the article describes as "the necessary first steps in assessing accountability."

 

Among other things, the article reflects a dispute over who the FDIC is targeting with the demand letters. On the one hand, the article quotes the executive director of the American Association of Bank Directors as saying that the "where there’s money to go after," the FDIC is pursuing the claim, "whether there is a good case or not." On the other hand, the article quotes an agency attorney as saying "How far we go depends on the facts and circumstances of each case…If … there’s nothing there, then we close out the investigation."

 

The article points out that while the FDIC has not filed any director or officer lawsuits during the current crisis, "but observers say that will likely change soon," particularly in light of the three-year statute of limitation. One attorney is quoted as saying we may start to see the suits in 2011 with more in 2012.

 

The article quotes an agency official as saying that the purpose of the demand letters "is simply to preserve insurance," adding that "we try to make enough of a preliminary investigation to make sure that when we send the letter we’re sending it to the right people and we have a basis for the claim."

 

Special thanks to a loyal reader for sending a link to the article.

One of the recurring D&O insurance coverage issues is the question of excess D&O insurers’ obligations when the underlying insurers have paid less than their full policy limits as a result of a compromise between the underlying insurers and the policyholder.

 

In the latest of a growing line of recent cases examining these issues, Judge Wayne Anderson of the Northern District of Illinois, in a June 22, 2010 opinion applying Illinois law, held that the "plain language" of the excess D&O insurance policies at issue required the actual payments of full policy limits in covered claims before the insureds could access the excess insurance.

 

Background

During the relevant period, Bally Total Fitness Holding Corporation carried a total of $50 million in D&O insurance arranged in five layers of $10 million each, between a primary insurer and four excess insurers. Bally and certain of its directors and officers were named as defendants in a securities class action lawsuit (about which refer here) in connection with which Bally incurred $33 million in defense expenses, for which Bally sought coverage under from its D&O insurers.

 

The primary insurer initiated an action in the Northern District of Illinois seeking a judicial declaration of noncoverage. Bally joined the excess insurers to the action as third-party defendants. Ultimately the primary insurer and the first and second level excess insurers reached a compromise by which they agreed to contribute a total of $19.5 million toward Bally’s defense expenses. The first level excess insurer settled for $8 million, $2 million less than its full policy limit. The second level excess insurer settled for $1.5 million.

 

The third and fourth level excess insurers refused to settle or otherwise contribute toward Bally’s defense expense. These two excess insures argued that the conditions precedent to coverage in their excess insurance policies had not been triggered. In making this argument, the third level excess insurer relied on its policy’s language that its payment obligations are triggered "only after the insurers of the Underlying Policies shall have paid, in the applicable legal currency, the full amount of the Underlying Limit." The fourth level excess insurer relied on language in its policy specifying that its payment obligations apply "only after all Underlying Insurance has been exhausted by payment of the total underlying limit of insurance."

 

The Court’s June 22 Opinion

In his June 22 opinion, Judge Anderson granted the third and fourth level excess insurers’ motions for summary judgment, finding that the plain language of their policies requires that the underlying insurers each "make actual payments of $10 million each in covered claims before Insureds can access coverage provided by the Third and Fourth Layer Excess Policies."

 

The insureds had argued that the third and fourth level excess policies were "ambiguous" as to whether the underlying policies had to make actual payment of a full $10 million each to trigger the top level excess carriers’ coverage. The insureds argued that the third and fourth level excess carriers had contracted to pay claims in excess of specified levels "regardless of who makes payment for covered claims" below those levels.

 

Judge Anderson considered the case law on which the insureds relied, particularly the 1928 Second Circuit decision in Zeig v. Massachusetts Bonding & Ins. Co.. In examining this line of cases, Judge Anderson concluded that "if an excess insurance policy ambiguously defines exhaustion, as in Zeig, courts generally find that settlement with an underlying insurer exhausts the underlying policies." However, Judge Anderson went on, "in cases where the policy language clearly defines exhaustion, the courts tend to enforce the policy as written."

 

Judge Anderson went on to find that the third and fourth level excess policies clearly defined how the underlying insurance must be exhausted prior to the insureds accessing coverage. Accordingly, and because the underlying insurance had not been exhausted by the underlying insurers’ payment of covered loss, Judge Anderson granted summary judgment in the third and fourth excess insurers’ favor.

 

Discussion

As a result of rising settlement levels and escalating defense costs, excess D&O insurance has become increasingly important in D&O claims resolutions. As more and more claims get pushed into the excess layers, more and more questions are arising, including this recurring question of whether the excess carriers’ payment obligations are triggered when the policyholder has compromised with the underlying carriers.

 

Judge Anderson’s holding in the Bally Total Fitness case joins a line of several recent cases in which courts have similarly held that, given the excess policy language at issue, the excess carriers’ payment obligation were not triggered when the underlying carriers paid less than their full policy limits as a result of a compromise with the policyholder. These recent cases include the July 2007 Eastern District of Michigan decision in the Comerica case (about which refer here) and the March 2008 California intermediate appellate court decision in the Qualcomm case (about which refer here).

 

The outcome of these various coverage disputes is a direct reflection of the excess policy language involved, and in particular the language specifying what is required in order for excess insurers’ payment obligations to be triggered. These cases underscore the critical importance of the language describing the payment trigger in the excess policy.

 

In recent months, and in large part as a reaction to these cases, excess carriers increasingly have been willing to provide language that allows the excess carriers’ payment obligations to be triggered regardless whether the underlying amounts were paid by the underlying insurer or by the insured. (I note as an aside that this language was not generally available at the time that Bally Total Fitness purchased the D&O insurance at issue in this case.)

 

The potential importance of the excess insurance payment trigger language, and the availability of language alternatives in the current insurance marketplace, in turn underscores the importance for policyholders of involving a knowledgeable and experienced D&O insurance broker in their acquisition of D&O insurance. The presence of the most favorable excess trigger language, among many other critically important policy language issues, could make a significant difference in the availability of coverage in the event of a claim.

 

Speedy Justice: According to Judge Wayne Anderson’s official biography (here), the Judge is the co-holder of the record for the 100-yard dash at Harvard University, from which he graduated in 1967.

　

　

In a June 28, 2010 decision (here), the Supreme Court issued its opinion in Free Enterprise Fund v. Public Company Accounting Oversight Board case. This case had been widely followed because the petitioners challenged the constitutionality of the Sarbanes-Oxley Act and of the Public Company Accounting Oversight Board (PCAOB).

 

The petitioners prevailed before the Supreme Court, and a majority of the Court held that restrictions on the removal of PCAOB board members were unconstitutional, but the Court declined to hold either that the Sarbanes Oxley Act itself or the PCAOB are unconstitutional. The net effect is that Sarbanes-Oxley remains fully operational, other than the provisions governing the removal of PCAOB members.

 

Background

This case arises out of a dispute involving a small Nevada accounting firm, Beckstead and Watts. In September 2005, the PCAOB disclosed that it was investigating the firm and that it had found "deficiencies" eight of sixteen of the firm’s audits. In response, the firm sued the PCAOB and the federal government, seeking an order blocking the PCAOB from taking any further action. The firm was joined in the action by the Free Enterprise Fund, which according to its website, is a nonprofit advocacy group "dedicated to fighting the so-called Sarbanes-Oxley law."

 

The plaintiffs contended that in creating the PCAOB in the Sarbanes Oxley Act, Congress set up a private corporation that exercised governmental authority. The plaintiffs argued that this arrangement and in particular SOX’s statutory provision for the SEC’s appointment of the PCAOB’s five members, and more particularly specifying that the members can only be removed by the Commission for just cause, contravened the separation of powers in the U.S. Constitution by conferring wide-ranging executive power on Board members without subjecting them to Presidential control.

 

In a March 21, 2007 decision, Judge James Robertson of the District Court for the District of Columbia rejected the plaintiffs’ arguments, and on August 22, 2008, the D.C. Circuit Court affirmed the lower court’s dismissal. The Circuit Court later denied an en banc review, and the plaintiffs filed a petition for a writ of certiorari to the Supreme Court, which the Court granted.

 

An excellent summary of the background regarding the case and the parties’ arguments can be found on the SCOTUSWiki site, here. My prior post about the case can be found here.

 

The Supreme Court’s Opinion

In a 5-4 majority opinion written by Chief Justice John Roberts, the Court focused on the Sarbanes Oxley’s Act’s provisions for the removal of the PCAOB members. The removal provision provides that members can only be removed by the SEC Commissioners for good cause shown and then only pursuant to rigorous procedural requirements. The Court said the arrangement "not only protects Board members from removal except for good cause, but withdraws from the President any decision on whether that good cause exists."

 

The result of what the Court described as "a second level of tenure protection," in the form of the procedural requirements, is that the Commission "cannot remove a Board member at will" and the President therefore "cannot hold the Commission fully accountable." This arrangement, the majority found, is "contrary to Article II’s vesting of the executive power in the President." The majority opinion added:

 

By granting the Board executive power without the Executive’s oversight, this Act subverts the President’s ability to ensure that the laws are faithfully executed – as well as the public’s ability to pass judgment on his efforts. The Act’s restrictions are incompatible with the Constitution’s separation of powers.

 

However, having found a provision of Sarbanes Oxley Act to be unconstitutional, the majority drew back from finding either the entire Act or the PCAOB itself to be unconstitutional. The Court found that the "unconstitutional tenure provisions are severable from the remainder of the statute" and that even if board removal provisions violate the Constitution, the "existence of the Board does not." The Act itself "remains fully operative as a law with these tenure restrictions excised," since the "remaining provisions are "not incapable of functioning independently."

 

The majority opinion reversed the Court of Appeals opinion in part and remanded the case for further proceedings.

 

A dissenting opinion written by Justice Breyer asserted that the removal provisions violated no separation of power principles and contended that the majority’s ruling "threatens to disrupt severely the fair and efficient administration of the laws" because it is inconsistent with the structure of many administrative agencies.

 

Discussion

Though the majority found a portion of the Sarbanes Oxley Act to be unconstitutional, its holding was about as limited and as nondisruptive (at least as to the continued operation of the Act) as might be hoped for, given the finding of constitutionality. Certainly the finding that Act remains otherwise fully operational fell well short of the plaintiffs’ objective so trying to have the entire Act set aside.

 

Indeed the relief provided seems like pretty weak beer. The majority said only that "petitioners are not entitled to broad injunctive relief against the Board’s continued operations. But they are entitled to declaratory relief sufficient to ensure that the reporting requirements and auditing standards to which they are subject will be enforced only by a constitutional agency accountable to the Executive."

 

The Court’s refusal to declare the entire Act unconstitutional, despite finding one part to be unconstitutional, might have surprised and disappointed some advocates and Court watchers, who, as discussed here, had contended that the absence from the Act of a "savings clause" preserving the rest of the statute if one part was disallowed, should have required the entire Act to be found improper. The Court clearly strained to avoid this result, relying on prudential and precedential principles to steer clear of a disruptive result that arguably might otherwise have been required by absence of a statutory savings clause.

 

As the Conglomerate blog commented, the majority opinion "illustrated how to hold an agency to be unconstitutional without really doing anything important at all." CFO.com quotes one commentator as saying that the decision against the PCAOB "was about as gentle a finding as you could expect." The Volokh Conspiracy blog said "The Court drew a line in the sand to safeguard executive power and ensure greater accountability, but did so without picking much of a fight."

 

The net effect of the Court’s holding is that the SEC now may remove the PCAOB board members at will, rather than having to go through the removal procedures that had been defined in the Sarbanes Oxley Act. The SEC issued a statement after the opinion was published in which the SEC said that "the Act ‘remains fully operative as a law’ with the for-cause restrictions excised, leaving the members of the PCAOB subject to removal by the Commission without restriction. The opinion does not call into question any action taken by the PCAOB since its inception." 

 

Professor Stephen Bainbridge has an interesting commentary on his eponymous blog (here) commenting that he is "unpersuaded" by the majority opinion, agreeing with the dissent that there is nothing about the effective result of the Court’s ruling that actually validates the President’s actual right or authority to oversee the PCAOB.

　

In a nice piece of ironic timing, the Court released its opinion in the case on the first day of the Senate Judiciary Committee confirmation hearings for Supreme Court nominee Elena Kagan. The Court’s ruling represents a defeat for Kagan, who as Solicitor General had argued the case for the government. (A transcript of the oral argument in the case can be found here.)

 

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

 

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

　

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

　

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

　

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

　

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

　

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

　

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

　

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

 

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

　

It was obvious from the first reading that the U.S. Supreme Court’s decision in Morrison v. National Australia Bank represents a sweeping victory for the defendants. As I noted in my initial post after the decision came down, the Court’s holding that plaintiffs can’t pursue fraud claims for securities purchased on foreign exchanges will have a significant impact both on pending cases and on future filings.

 

On further reflection, it seems the case could have even more significant implications.

 

First, with respect to pending cases, it is worth noting that Vivendi itself believes, as I suggested in my prior post, that National Australia Bank ruling has significant implications concerning the jury verdict entered against the company in January 2010. Indeed, Vivendi issued a June 25, 2010 press release (here), in which it said that the company is "very satisfied" with the decision, commenting further that the Court’s ruling is "totally in line with the position defended all along by the Group in the American and French Courts."

 

According to prior press reports (here), as many as two-thirds of Vivendi’s investors live in France, and undoubtedly many of them, as well as many of Vivendi’s other investors that reside outside the United States, likely bought their shares on securities exchanges outside the United States. Under the transactional test the Court enunciated in the National Australia Bank decision, investors who bought their share on non-U.S. exchanges cannot pursue a claim under U.S. securities laws. It seems likely that the class of persons entitled to claim injury in the Vivendi case necessarily will be dramatically narrowed.

 

There are many other pending cases that are likely to be similarly affected. In a June 25, 2010 AmLaw Litigation Daily article (here), Andrew Longstreth examines the likely impact of the National Australia Bank case on the securities class action litigation filed under U.S. securities law against BP and certain of its directors and officers. BP’s common shares trade on the London Stock Exchange, and though many investors likely bought American Depositary Receipts for BP on U.S. exchanges, many of its shareholders more likely bought their shares in the U.K. (The AmLaw article notes that 28% of BP’s equity is in ADRs, so those shares are unlikely to be affected by the Supreme Court’s recent decision.)

 

Other cases that are likely to be affected by the Supreme Court’s decision include the action brought against Porsche, which was sued in January 2010 by short sellers of Volkswagen stock who claimed Porsche secretly cornered the market in Volkswagen shares but denied that it intended to acquire Volkswagen. According to a June 25, 2010 Bloomberg article (here) discussing the impact of the National Australia Bank decision on the Porsche case, the plaintiffs claims in the case are likely reduced only to "causes of action based on low-volume American depositary shares."

 

A number of foreign-domiciled companies that have been the target of securities class action litigation under U.S. securities laws filed amicus briefs in the National Australia Bank case; the cases filed against many of these companies, including EADS and Alstom, seem likely to be substantially affect by the Court’s holding.

 

Other recently filed cases also seem likely to be affected, including the cases recently filed against Toyota,

 

Securities suits against foreign companies have in recent years been a significant part of overall securities lawsuit filings in recent years. For example, 24 (or 12.7%) of the 2009 securities lawsuit filings involved companies that are domiciled outside the United States. In 2008, there were 34 foreign domiciled companies sued in securities class action lawsuit, or about 15% of all filings that year.

　

Not all of these securities suits are necessarily going to be affected by the National Australia Bank case. For example, the lawsuit filed earlier this year against Nokia was at the very outset brought only on behalf of investors who bought their American Depositary Shares in the company on U.S. exchanges. Similarly the lawsuit filed late last year against Siemens was brought solely on behalf of purchasers of the company’s American Depositary Receipt shares.

 

The fact that cases against foreign companies with securities trading on U.S. exchanges may still be susceptible to securities class action litigation in U.S. court because their securities trade on U.S. exchanges could well discourage some overseas companies from having their shares trade here.

While there will still be circumstance even after National Australia Bank in which securities suits in U.S. courts against foreign-domiciled companies will still be filed and will still go forward, it seems probable that many other cases that might have been filed in the past will now simply go unfiled, at least in the U.S — particularly in those cases where the foreign companies do not have significant numbers of ADRs or other securities trading on U.S. exchanges.

 

Given what a significant percentage of total U.S.-based securities class action filings these actions against foreign companies have become in recent years, the reduction in these filings could mean a material reduction in the overall level of securities class action filings (although please see my comments below about some other possibilities for U.S.-based litigation.)

 

The fact that investors who bought shares on foreign exchanges can no longer access U.S. courts clearly creates a problem these investors. As the filing levels described above demonstrate, these investors increasingly had come to rely on the U.S processes and remedies as a way to seek redress when they felt they had been misled, at least where the alleged fraud involved U.S-based conduct.

 

Indeed, numerous foreign institutional investors had filed amicus briefs in the National Australia Bank case (refer for example here), arguing that "both foreign and domestic investors alike rely on American Law to ensure that corporations doing business in America are not tainted by fraud."

 

Now that these investors can no longer "rely on American Law" in many instances, these investors will have to consider their alternatives. One possibility is that these investors will increasingly rely on remedies in their own country. Without access to U.S. courts, these and similarly situated investors may find action in their domestic courts more attractive.

 

For that matter, without access to U.S remedies and processes, investors in foreign countries may press for the implantation of legal reforms in their home countries to permit them better means of attempting to recoup losses based on alleged fraud.

 

Of course, resourceful plaintiffs’ lawyers in this country are now highly motivated to try to find ways around the National Australia Bank decision. Some possible ways it might be circumvented include filing individual lawsuits in state court under state law, and filing federal court class actions alleging state law violations. Claimants in these kinds of cases arguably may face the same hurdles of trying to show that the relevant law provides remedies regarding securities transactions on foreign exchanges, but the existence of U.S.-based fraudulent conduct potentially could provide a sufficient basis for relief under many legal theories, even if not under the federal securities laws.

 

Another possibility is that the foreign institutional investors and others may seek legislative change in the U.S. in order to establish a new statutory basis for relief in U.S. courts for investors who bought shares overseas, at least where there is U.S.-based conduct involved in the alleged fraud. As I pointed out in my prior post, legislative initiatives in the current Congress proposed to do that very thing.

 

As Luke Green points out in his post on the Risk Metrics Securities Litigation blog (here), the National Australia Bank case does not carve out an exception for the SEC and the DoJ, and there may be considerable interest providing statutory means for these agencies to pursue remedies for U.S.-based fraudulent conduct even if in connection with transactions on foreign exchanges. (Green also has a number of other interesting thoughts and comments about the decision.)

 

UPDATE: An alert reader points out that in the Conference Committee of the financial reform bill (called "The Dodd-Frank Wall Street Reform and Consumer Protection Act", here ) there are provisions addressing these questions of extraterritoriality. First, Section 929P(b) authorizes an action brought by the Commission based on a statutorily defined conduct and effects test. Second, Section 929Y directs the Commission to study whether private rights of action should be allowed on the same basis as authorized for the Commission in 929P(b). The Commission is to report to Congress within 18 months of the statute’s enactment.

 

The bottom line is that National Australia Bank is an important decision that will have a number of significant impacts, some immediately and some in the months and years to come. Some of the impacts are obvious and apparent now, and some will only become apparent over time.

 

The National Australia Bank case does underscore how significant it is when the U.S. Supreme Court decides to take up a securities case. Each occasion represents a context within very significant changes in the interpretation or application of the U.S. securities laws potentially could occur, as proved to be the case here. Full consideration of this possibility makes it all the more interesting and potentially significant that the Supreme Court recently agreed to hear the Matrixx Initiative securities suit. This development raises the possibility for even further landscape altering case law from the U.S. Supreme Court in its next term.

 

It’s Not Over Yet, Folks: While it is not too early to start looking ahead to the Supreme Court’s next term, it is also worth noting that this current term is not yet complete, as the Court has yet to issue decisions in four high profile cases. As noted on the WSJ.com Law Blog (here), these four decisions are likely to be issued on Monday, June 28, 2010.

 

Among the four cases yet to be decided is Free Enterprise Fund v. PCAOB, which will address the question whether it was appropriate for Congress to give authority to the SEC to name the members of the Public Company Accounting Oversight Board. The case raises basic questions about the separation of powers between the Executive and Legislative branches and potentially could address the question of the constitutionality of the Sarbanes Oxley Act.

 

Depending on how the Court rules, this case could potentially be very significant, particularly if the Court reaches the constitutionality question. As the WSJ.com Law Blog comments, "If the justices agree that the accounting board isn’t constitutional, it could force Congress to revisit Sarbanes-Oxley, or at least the portion of it that creates the accounting board. It could also call into question other independent agencies and how they appoint members of similar boards."

 

More World Cup Notes:

1. A tip of the hat to the Ghanians, who played with speed, skill and opportunism and did what they had to do to win an exhausting, exciting game.

 

2. A final salute to the Americans, too, who played all four of their games with heart and class and who are going home simply because there is a limit to how many times a team can come from behind. Landon Donovan’s winning goal in extra time last Wednesday against Algeria is one of the great moments of this World Cup.

 

3. England’s fans have to be beside themselves over Frank Lampard’s disallowed goal late in the first half of their game against Germany. On the other hand, as unjust as the disallowance was, England pretty much got beat, by a clearly better team. .

 

4. The Mexicans have a legitimate gripe about Argentina’s first goal on Sunday. Carlos Tevez was clearly offsides. However, poor officiating had nothing to do with the total defensive breakdown that allowed Gonzalo Higuain’s goal for Argentina’s second score, and the Argentiines’ third goal was a magnificent strike from Tevez. The Germany/Argentina game next week should be terrific.

 

5. If, as seems likely at this point, FIFA spends the next four years trying to figure out how to improve  the offciating at the next World Cup, I hope they will also take a hard look at ways to better enforce the rules against embellishment. Too many players seem more inclined to flop than to play. It really is revolting.

 

6. The French don’t have to worry about anybody disrespecting them, because there’s really no need — the French have done such a masterful job of it themselves. The Irish can be excused for any pleasure they might be taking from the French team’s embarrassment.

 

In a long-awaited ruling, the U.S. Supreme Court on June 24, 2010 issued an opinion affirming dismissal of the Morrison v. National Australia Bank case. Among other things, the Court’s opinion will limit securities claims by investors who bought their shares on foreign exchanges. This ruling could have a dramatic impact on many pending cases as well as on future filings.

 

Background

NAB is Australia’s largest bank. Its shares trade on securities exchanges in Australia, London, Tokyo and New Zealand. Its American Depositary Receipts trade on the New York Stock Exchange. NAB has a mortgage servicing subsidiary, HomeSide, based in Florida. In 2001, NAB disclosed that it was taking a significant write-down due to a recalculation of the amortized valuating of HomeSide’s mortgage servicing rights. Following this announcement, the price of NAB’s shares and ADRs declined, and investors filed a securities class action lawsuit in the Southern District of New York.

 

The claim was initially brought by four plaintiffs. One of the four purported to represent domestic purchasers of NAB’s securities. The three other plaintiffs bought their shares abroad and sought to represent a class of non-U.S. purchasers. Background regarding the case can be found here.　

 

On October 25, 2006, the District Court granted defendants’ motion to dismiss the complaint. The District Court held that it lacked subject matter jurisdiction over the foreign claimants claim. The court dismissed the domestic plaintiff’s action for failure to state a claim because the domestic plaintiff failed to allege that he suffered damages. The three foreign plaintiffs appealed. The domestic plaintiff’s claim was not before the Second Circuit, and so the appellate court was exclusively concerned with the jurisdictional issue.

 

As discussed at greater length here, on October 23, 2008, the Second Circuit ruled (here) that U.S. courts lack subject matter jurisdiction over the claims of foreign claimants in that case who bought their NAB shares on a foreign exchange and affirmed the district court’s dismissal of the case. The Second Circuit found that the U.S. based conduct was not sufficient to support jurisdiction under the Circuit’s long-standing two-part test measuring whether there were sufficient domestic actions or effect to support jurisdiction. The plaintiffs filed a petition for writ of certiorari.

 

The Supreme Court’s Opinion

In an opinion written by Justice Antonin Scalia, the Court affirmed the Second Circuit’s holding, but overturned decades of jurisprudence on the question of the extraterritorial reach of the U.S. securities laws, holding that the U.S. securities laws do not apply extraterritorially.

 

The opinion opens with a recitation of the "longstanding principle of American law" that "when a statute gives no clear indication of an extraterritorial application, it has none." The opinion notes that despite this presumption, the Second Circuit over the course of many years developed an extensive body of case law intended to "discern" when Congress would have wanted the statute to apply. The opinion notes that "the Second Circuit never put forward a textual or even extratextual basis for these tests."

 

The opinion completely rejected this entire body of case law and the two-part test on which the Second Circuit had relied in this case, noting that "the results of this judicial-speculation-made-law – diving what Congress would have wanted if it had thought the situation before the court –demonstrate the wisdom of the presumption against extraterritoriality. Rather than guess anew in each case, we apply the presumption in all cases, preserving a stable background against which Congress can legislate with predictable effects."

 

The majority opinion rejected the arguments of the claimants and of the Solicitor General (that would be Solicitor General Elena Kagan, the current Court nominee) that the securities laws contained statutory support for extraterritorial application, finding that "there is no clear indication in the Exchange Act that Section 10(b) applies extraterritorially, and we therefore conclude that it does not."

 

The opinion also specifically rejected the argument that the domestic conduct was sufficient to support jurisdiction, observing that "it is a rare case of prohibited extraterritorial application that lacks all contact with the territory of the United States."

 

What matters is not where alleged deceptive conduct occurred but where the securities were purchased:

 

The focus of the Exchange Act is not upon the place where the deception originated but upon purchases and sales of securities in the United States. Section 10(b) does not punish deceptive conduct, but only deceptive conduct "in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered."

 

Based on this analysis, the Court concluded that "only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which Section 10(b) applies."

 

The Court also noted another reason for rejecting a standard that would allow jurisdiction for securities cases solely on the basis that the deceptive conduct took place in the U.S. That is, "some fear that [the U.S.] has become the Shangri-La of class-action litigation for lawyer representing those allegedly cheated in foreign securities markets."

 

Because this case "involves no securities listed on a domestic exchange, and all aspects of the purchases complained of by those petitioners who still have live claims occurred outside the United States" the Petitioners have "failed to state a claim on which relief can be granted" and the Court therefore affirmed the dismissal.

 

Justice Breyer wrote a separate opinion concurring in part in the opinion and concurring in the judgment, saying in effect it was sufficient for him that the securities involved in this case were not purchased in the U.S.

 

Justice Stevens wrote a separate concurring opinion, joining in the judgment, by rejecting the majority’s "transaction test." He would not have rejected the Second Circuit’s two-prong test, saying that the Second Circuit has "refined its test over several decades and dozens of cases, with the tacit approval of Congress and the Commission and with the general assent of its sister Circuits."

 

Justice Sotomayor did not take part in the case.

 

Discussion

The Supreme Court’s opinion in the NAB case seems to put an end to the so-called "f-cubed" cases – that is, claims brought in U.S. courts under U.S. securities laws by foreign domiciled claimants who bought their share in foreign companies on foreign exchanges. Indeed, the opinion seems to sound the death knell for any would-be claimants under the U.S. securities laws who bought their shares on foreign exchanges.

 

The opinion would seem to have very significant implications for the many pending cases in which the claims of claimants who bought shares on foreign exchanges are involved. Among other very high profile cases, the Vivendi case, which involved primarily foreign domiciled claimants and recently resulted in a plaintiff’s verdict, would seem to be subject to substantial reconsideration in light of this opinion. (UPDATE: At least one reader has raised the question whether the Court’s holding will or even can be applied retroactively. to damages suffered before and purchases made before. I am not sure general prohibitions on retroactive application apply here, as this decision is about the basic reach of the securities laws, but I thought it was worth noting this question here.)

 

The Supreme Court’s transactional test would also seem to suggest that we have seen the end of filings in U.S. court against foreign companies, except those whose shares are traded on U.S. securities exchanges. (UPDATE: One reader has noted that the "except" clause in the prior sentence does raise the question about whether there might still be jurisdiction over "f-squared" cases, that is those that involve either foreign domiciled companies and foreign investors who bought their shares on U.S. exchanges, or foreign domiciled companies and U.S. investors who bought their shares on foreign exchanges. The first of these two categories seems to meet the test of the NAB case, the second category is a more interesting question. In any event these kinds of issues will have to be sorted out in lower courts in the wake of the NAB decision.)

 

My concern with that possibility is that it could lead foreign companies to decide not to list their shares on U.S. exchanges, or to delist their shares, as a way to avoid the burden and expense of U.S.-based litigation exposure.

 

It is entirely possible that this entire debate will now shift to Congress. Indeed, during the current Congressional term, there were specific proposals to incorporate a version of the two-prong test directly in the securities laws. While these proposals had been languishing, it is possible that the NAB opinion could give these proposals new life.

 

While Congress might now reconsider these proposals, one portion of the NAB opinion might weigh against these kinds of statutory revisions. The majority opinion specifically refers to the arguments of many foreign countries in amicus briefs that the extraterritorial application of U.S. securities laws would result in "interference with foreign securities regulation." These concerns and the requirements of comity, which are detailed in the majority opinion, could well weigh against the legislative reform.

 

But in any event, the Supreme Court’s opinion in the NAB case must now be applied in the lower courts. There are dozens of cases pending in the lower courts involving claimants who purchased their shares on foreign exchanges. These claimants will now be scrambling to try to establish some basis for their cases to be preserved notwithstanding the Supreme Court’s ruling in the NAB case. However, it seems probable that the foreign purchasers’ claims are likely to be dismissed. This will have significant implications for Vivendi and many other pending cases.

 

Andrew Longstreth’s June 24, 2010 Am Law Litigation Daily artice about the decision can be found here.

 

Many thanks to the several loyal readers who send me copies of the Supreme Court’s opinion.