On July 12, 2010, in one of the more high-profile investor actions filed as part of the subprime securities litigation wave, Southern District of New York Judge Sidney Stein substantially denied in part the defendants’ motions to dismiss in the Citigroup Bond Litigation. A copy of the opinion can be found here.

 

As detailed in greater detail here, Citigroup bondholders first filed their suits in September 2008 in connection with 48 different Citigroup bond offerings in which Citigroup raised over $71 billion between May 2006 and August 2008. (The first of these cases was filed in New York state court but later removed to federal court.) The defendants include the company itself and related corporate entities, as well 28 current or former Citigroup directors and officers and nearly eighty investment banks that served as offering underwriters in the bond offerings.

 

The plaintiffs, who purchased bonds in some of the offerings, alleged that the defendants had violated sections 11, 12 and 15 of the Securities Act of 1933 by failed to truthfully and fully disclose in the bond offering documents information concerning the company’s exposure to "toxic mortgage-linked documents."

 

Specifically, the plaintiffs alleged that Citigroup had failed to disclose Citigroup’s exposure to $66 billion worth of CDOs backed by subprime mortgage assets; Citigroup’s exposure to $100 billion in structured investment vehicles backed by subprime mortgage assets; that Citigroup "materially understated reserves" held for residential loan losses; Citigroup’s exposure to $11 billion of auction rate securities; that as result of these exposures, Citigroup was not, contrary to its representations, "well capitalized" and in fact required a massive government bailout.

 

In his July 12 order, Judge Stein first held that the plaintiffs had standing to assert claims in connection with all of the 48 offerings, even though plaintiffs had not purchased bonds in all offerings. Because the offerings were based common shelf registration document containing at least some common information, he found that the plaintiffs have standing to assert claims common to all purchasers.

 

But while he found that the plaintiffs has standing to assert Section 11 claims, he granted the defendants’ motions to dismiss the plaintiffs’ Section 12 for lack of standing, based on the insufficiency of plaintiffs’ allegations about whom the plaintiffs bought their investments from.

 

The centerpiece of the defendants’ dismissal motions was their argument that the plaintiffs had failed to allege any actionable misstatement or omission. Judge Stein found that that the plaintiffs’ had adequately alleged misrepresentation or omission as to Citigroup’s CDO exposure; with respect to plaintiffs’ allegations about Citigroup’s SIV exposure, at least with respect to statements made after those exposures were consolidated on Citigroup’s balance sheet; plaintiffs’ allegations about the adequacy of Citigroup’s residential mortgage loan loss reserves; with respect to Citigroup’s statements about the adequacy of its capitalization; and with respect to Citigroup’s statements that its financials were GAAP compliant.

 

However, Judge Stein also found that the plaintiffs had not sufficiently alleged misrepresentation or omission in connection with their allegations concerning Citigroup’s SIV exposure, at least those made prior to the consolidation of the SIV assets onto Citigroup’s financial statements; and about Citigroup’s exposure to auction rate securities.

 

Thus while a portion of plaintiffs’ claims did not survive defendants’ dismissal motions, a substantial portion of plaintiffs’ case will be going forward.

 

Both because of Citigroup’s prominence and because of the sheer magnitude of dollars involved in this case, this is a high profile decision. Though there is definitely a school of thought that defendants are faring better on the subprime securities cases in general, the plaintiffs are still managing to get some cases past the initial pleading hurdles, particularly in many of the highest profile cases (e.g., Countrywide, New Century, Washington Mutual, etc.).

 

In addition, Judge Stein’s decision in the Citigroup Bondholders case is the latest of several recent rulings in subprime related securities cases in the Southern District of New York that have favored the plaintiffs, including the recent decisions in the Ambac Financial subprime related case (about which refer here) and in the CIT Group subprime related securities case (about which refer here).

 

I have in any event added the July 12 decision in the Citigroup Bondholders’ suit to my running tally of subprime related securities class action lawsuit dismissal motion ruling, which can be accessed here.

 

Andrew Longstreth’s July 12, 2010 Am Law Litigation Daily article about the decision can be found here. A July 12, 2010 Bloomberg article about the decision can be found here.

 

Special thanks to a loyal reader for providing a copy of the opinion.

 

On July 2, 2010, in what is as far as I am aware the first suit by the FDIC against former directors and officers of a failed bank as part of the current wave of bank failures, the FDIC as receiver of IndyMac filed a lawsuit in the Central District of California against four former officers of IndyMac’s Homebuilder Division (HBD). 

 

Very special thanks to Peter Christensen of the Appraiser Law blog for providing links to the complaint.

 

The FDIC took control of IndyMac on July 11, 2008. At the time, the outstanding balance on HBD’s portfolio of homebuilder loans was nearly $900 million. The FDIC alleges in its complaint that IndyMac’s losses "are estimated to exceed $500 million."

 

The lawsuit is filed against Scott Van Dellen, HBD’s former President and CEO, who is alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who is alleged to have approved at least 40 of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is alleged to have approved at least 57 of the loans at issue; ;and William Rothman, who served as HBD’s Chief Lending Officer from mid-2006 and who is alleged to have approved at least 34 of the loans at issue.

 

The lawsuit seeks to recover damages from the four individual defendants for "negligence and breach of fiduciary duties." The lawsuit alleges "two significant departures from safe and sound banking practices."

 

First, the complaint alleges that HBD’s management "repeatedly disregarded HBD’s credit policies and approved loans to borrowers who were not creditworthy and/or for projects that provided insufficient collateral." The complaint further alleges that HBD’s compensation plans encouraged HBD’s management to "push for growth in loan production volume with little regard for credit quality."

 

Second, HBD’s management is alleged to have "continued to follow a strategy for growth at the tail-end of the longest appreciating real estate market in over four decades," despite management’s alleged "awareness that a significant downturn in the market was imminent and despite warnings from IndyMac’s upper management about the likelihood of a market decline." HBD’s management allegedly "unwisely continued operations in homebuilder lending in deteriorating markets even after becoming aware of the market decline.

 

The FDIC’s complaint, which sprawls to some 309 pages, details a litany of allegedly negligent lending practices, including approving loans where repayment sources were not likely to be sufficient; where the loans violated applicable laws and the Bank’s own internal policies; where the loans were made to borrowers who "were or should have been known to be not creditworthy and/or in financial distress; based on inadequate or inaccurate financial information; without taking proper and reasonable steps to insure that the loan proceeds would be used in accordance with the loan application.

 

The complaint is very detailed and reflects painstaking preparation. A lot of time and effort went into the preparation of this complaint, which may in and of itself explain why the FDIC has not up until this point filed other complaints against directors and officers of failed banks. If the FDIC is taking similar measures in connection with other claims that it might be considering, it is little wonder that there have been no claims up until this point. Complaints containing this level of specificity and painstaking detail will take a significant amount of time to prepare.

 

There are some particular reason why IndyMac attracted one of the first claims. First, the FDIC took control of IndyMac relatively early in the current round of bank failures – it has been almost exactly two years since IndyMac closed, meaning the FDIC has had a greater amount of time to review the circumstances that led up to IndyMac’s failure and consider potential claims. When the FDIC took control of IndyMac, it was only the fifth bank failure that year, meaning that IndyMac was among the earliest of the current bank failures.

 

But perhaps even more important that its timing was the sheer size of IndyMac’s failure. At the time of its closure, IndyMac had assets of about $32 billion, making its closure the second largest bank failure during the current wave of bank failures (exceeded only by the closure of Washington Mutual, which had assets of $307 billion).

 

More to the point, IndyMac’s failure triggered losses to the FDIC’s insurance fund of $8 billion, by far the largest amount of any bank failure during the current round. The magnitude of these losses suggests possible motivations for the FDIC to give priority to claims relating to IndyMac.

 

While the recently filed IndyMac claim may be the first claim the FDIC has filed against former directors and officers of a failed bank as part of the current bank failure wave, it is surely not the last. (Indeed, it may not even be the last filed against former IndyMac officials.) Statistics reported by the Alston & Bird firm suggest that during the last wave of bank failures in the S&L crisis, the FDIC filed claims in connection with about 24% of all bank failures.

 

The fact that the FDIC appears poised to pursue many additional claims against bank officials represents a threat both to the individuals themselves and to the bank’s D&O liability insurers. The extent to which the FDIC’s efforts result in significant recoveries will depend on a wide variety of factors, the most important of which is the extent to which the FDIC can successfully allege individual liability. But beyond that, the FDIC’s ability to actually recover money will depend on identifying and accessing funding sources.

 

The extent to which the FDIC will succeed in recovering substantial amounts of D&O insurance will depend on a host of factors, including in particular the terms and conditions of the applicable policies. Claims made and notice of claims issues will be highly relevant, as will potential policy exclusions, such as, for example, the regulatory exclusion, which insurers added to many policies in recent years. These insurance coverage questions suggest the likelihood that in addition to a round of claims against former officials of failed banks, we are also likely to see a parallel round of insurance coverage litigation.

 

In addition to the FDIC’s recent action, there has also been extensive litigation involving IndyMac’s shareholders, as detailed here. Most recently, on March 29, 2010, Central District of California Judge George Wu certified an interlocutory appeal to the Ninth Circuit of his denial of the defendants’ motion to dismiss the plaintiffs’ sixth amended complaint.

 

Bank Failure Wave Continues: Meanwhile, while the FDIC cranks up its litigation efforts, it is continuing to take control of additional banking institutions. This past Friday evening, July 9, 2010, the FDIC took control of four additional banks, bringing the 2010 total number of failed banks to 90.

 

Through June 30, 2010, the FDIC had closed 86 banks, which put the FDIC on pace to close 172 banks this year, compared to 140 in 2009 and only 25 in 2008. Indeed, by way of comparison, as of June 30, 2009, the FDIC had closed only 40 banks, as the pace of bank failures quickened substantially in the second half of 2009 and continued into 2010.

 

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.