Securities Litigation Syllabus
Prepared for class lectures on "Private Section 10(b) and Rule 10b-5 Actions For Corporate Misstatements" for a Securities Regulation class at McGeorge School of Law (2007)
A. Private Enforcement \ the Securities Litigation Industry
The major players, in order of significance: plaintiffs' bar, defense bar, SEC, D & O insurers, academics, politicians and activist institutional plaintiffs.
B. The Implied Private Right of Action
Introductory paragraph, at p. 550. There's no explicit private right of action.
Notes 1-3, at pp. 551-52. As note 1 relates, the existence of the implied right of action was recognized without analysis in footnote 10 of Superintendent of Insurance v. Bankers Life & Cas., 404 U.S. 6 (1971) [pp. 539-541]
Notes 1, 2, 4, at p. 555. A case the book does not mention, Cort v. Ash (1975), was the turning point as to implication of causes of action. It replaced a focus on what is necessary to enforce the statute, with a textual analysis.
Central Bank v. First Interstate Bank, 511 U.S. 164 (1994) [pp. 583-88], is the result of the new textual approach. What the dissent is talking about is the fact that the Circuit Courts unanimously had held that there is a private aiding and abetting cause of action. Notes 1-4.
So why is there still a private right of action - I mean, it's so clear that the lack of such a right is no longer cited by the defense in answers?
Congress has acquiesced to the continued existence of the private action, and indeed stepped in to fill in interstices in the claim.
Examples: the aborted effort to create a statute of limitations; the pleading standards of the Reform Act; and Section 804 of the Sarbanes-Oxley Act, which extended the statute of limitations.
Still, Congress has been careful not to create the cause of action. We see this in the indirect language used in the Reform Act and Section 804.
C. Elements of A Private §10(b) False Statement Claim
Introduction, at pp. 525-528
Ch 8 § B(8), "Litigation Reform" [pp. 592-95]
Ch 10 § B, "Litigation Reform" [pp. 746-49]
What we see is that almost every element has issues that have divided the courts and commentators. Here is where lawyers earn their pay.
1. The defendant made
Central Bank v. First Interstate Bank, 511 U.S. 164 (1994) [pp. 583-88] & Notes 1-4
Note 4: the Reform Act addresses some of the issues by providing for proportionate liability - at least for not knowing violators.
One point the book does not cite: Section 20(a) control person liability. There is severe disagreement, even within Circuits, as to what this means.
Issues as to this element:
•Did Central Bank eliminate all non-statutory forms of secondary liability, namely the common law concepts of agency and respondeat superior? The Ninth Circuit held in GlenFed II that it eliminated conspiracy liability.
•What is required to render a defendant a primary actor? Is it participation in the preparation of a statement (Software Toolworks, Enron) or must be defendant make a statement \ be identified as a speaker (Wright v. Ernst & Young)?
•At the pleading stage, the group pleading doctrine. How does one treat the statements under the name of the corporation?
2. A materially false or misleading statement
Introduction to "Corporate Misstatements," at p. 728
This is really the key. What is fraud? Some surprising rules, and little consensus.
Gallagher v. Abbott Labs., 269 F.3d 251 (7th Cir. 2001) [pp. 251-55]
This is a good example of both. Gallagher reminds us that there is no generalized duty to disclose material nonpublic information, and no duty to disclose in real time. It cites Basic, Inc. v. Levinson on this, and the famous proposition from that case is, "silence absent a duty to disclose cannot give rise to liability." Gallagher also claims a lack of a duty to update.
Lack of consensus: I, personally, would find for defendants on 12(b)(6). It's not fraud to make general statements about producing biotech products, even if it's in the middle of discussions with the FDA.
* In re GlenFed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir. 1994) (en banc)
I don't think most securities attorneys like this opinion, because it gave a little to both sides. I think it's an earnest effort to get to the essential dilemmas of business and securities fraud lawsuits. How does a company know it's in the landfill and on the way down? My personal view: the future is so volatile and contingent that fraud is an unnecessary explanation for business failure.
I'd part company with the Court's application of law to facts, at 1550-51 - if there is ambiguity in the situation, it's not fraud to not announce failure.
* Brody v. Transitional Hospitals Corp., 280 F.3d 997 (9th Cir. 2002)
This reaches a point Gallagher said it did not have to consider: when does an omission render an affirmative statement false or misleading? Only when the statement implies X and the omission means that non-X is true. There is no duty to be complete, to disclose everything.
Issues as to this element:
•Puffery. Can courts decide as a matter of law that some statements are so obviously immaterial to investors as not to give rise to liability even if they are lies? Gallagher refers to this, at page 254.
Question: what if the CEO lies on his resume, claims a degree from Syracuse University when really he skipped the final year? Greenhouse v. MGC Capital Corp., 392 F.3d 650 (4th Cir. 2004): immaterial as a matter of law
Question for class: what if a corporate official says the company is "on track"? Compare Warshaw x. XOMA Corp. (9th Cir. 1995) (actionable, in the context of a question), with In re Foundry Networks Sec. Litig. (N.D. Cal. 2003) (not actionable, where no specific context pleaded).
•My favorite proposition: is there a duty to give up? That is, is predicting success or at a minimum not admitting failure fraud if there is still time to fix a problem? In re Syntex (9th Cir. 1997): no
3. In connection with the purchase or sale of a security (aka standing),
Introduction, at p. 573
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975) [pp. 573-580] & Note 1
Must be a purchase or sale. As Professor Grundfest has said, "would coulda shoulda" does not count, at least under federal law.
This case shows the hostility to securities cases that has arisen from time to time, and has motivated reform efforts.
Issues as to this element:
•Is Blue Chip Stamps limited to the private litigation context? Or is the "in connection with" element broader for the SEC?
* Securities & Exch. Comm'n v. Zandford, 535 U.S. 813 (2002): seems to say that it is broader for the SEC. In that case, a broker who absconded with the funds garnered from his clients' securities transactions engaged in misconduct in connection with a purchase or sale. Do you think the Zandford standard is clear? Is the significance of this case that it's a scheme rather than mispresentations?
The significance of this comes with ** Small v. Fritz Cos., 30 Cal. 4th 167 (2003), and the Uniform Standards Act. If State law does not recognize the Blue Chip Stamps rule and the Uniform Standards Act preempts State law "in connection with" class actions, does the Uniform Standards Act not bar State law holders claims? Several Circuits have held that that the scope of the Uniform Standards Act preemption is to the broader, Zandford in connection with. Really just another example of the indirect language point I mentioned at the start.
•THE DAY BEFORE THE SECOND CLASS, the Supreme Court issued the Merrill Lynch v. Dabit decision, which clarified that the in connection with requirement is broad, as in Zandford; and that Blue Chip Stamps' requirement that there actually be a purchase or sale is a policy limitation on private actions.
•Are there types of transactions that are not purchases or sales? A Note refers to so-called forced sales, although it doesn't recognize that the doctrine is on the last legs. What about stock splits? Spin-offs?
•Can an investment advisor sue on behalf of his clients? Ezra Charitable Trust v. Rent-Way, Inc., 136 F. Supp. 2d 435 (W.D. Pa. 2001): an "investment advisor" that purchased stock for the accounts of its clients rather than for its own account, had complete investment discretion as to which securities to buy, and acted "as attorney-in-fact for its clients and is authorized to bring suit to recover for, among other things, investment losses," was appointed lead plaintiff.
•An issue left open by Gallagher at page 251: what about purchasers of different securities than the subject of the false or misleading statement? (In that case, the court assumed that purchasers of Alza, which was going to be acquired by Abbott Labs, had standing.)
4. With scienter,
Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) [pp. 528-534] & Notes 1, 2, 5, 6; "Litigation Reform"
Important point is that there is two standards of scienter: clearly actual knowledge of falsity for forward-looking statement, and probably recklessness for other statements.
In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970 (9th Cir. 1999) [pp. 595-599]
This is a controversial case. As I was on it, of course it's correct.
Not controversial point: shows how the Reform Act abrogates the second part of GlenFed, imposing a pleading standard for scienter.
Controversial point: strong inference of scienter - what does that mean?
Omitted by the portion cited in the book: stringent standard as to purported internal reports \ adverse information, under the "all facts" requirement.
Issues as to this element:
•The Silicon Graphics issue: can motive and opportunity allegations alone suffice to plead a strong inference of scienter?
•Must anti-scienter allegations be drawn against a complaint at the pleading stage? Gompper v. VISX (9th Cir. 2002) says yes, and it makes sense to me.
5. That was relied upon by the plaintiff (class)
Introductory Note to "Civil Liability" (Ch. 10 §B), at pp. 730-31
Basic, Inc. v. Levinson, 485 U.S. 224 (1988) [pp. 735-41]
This is what makes securities litigation a big business. The (limited) efficient market doctrine creates a presumption that investors relied on the integrity of the market and all information that went into it, and if there is a fraud on the market there can be liability to a large class.
Criticized by academics, but no rush to change.
In re Apple Computer, Inc. Sec. Litig., 886 F.2d 1109 (9th Cir. 1989) [pp. 743-46]
Shows a corollary to the fraud on the market doctrine: truth on the market.
A close cousin is the bespeaks caution doctrine. In re Trump (3d Cir.) is the seminal case.
Issues as to this element:
•Huge academic and economic interest in the efficiency of the market, and forms of the efficient market hypothesis. We see this in Justice White's dissent, a skepticism in writing an economic theory into law.
•Clearly, this is a rebuttable presumption. What must be shown to rebut it at the pleading - or, more accurately, class certification - stage? For example, what if the stock is not traded on the NYSE or Nasdaq? Unger v. Amedysis, a 2005 Fifth Circuit case in the Supplement, is skeptical as to whether the efficient market exists in that situation. Another tactic: expert reports to show that market does not in fact react to information.
•Is there an efficient market when there's been no market history - in other words, at the time of the IPO?
Most court say there's sufficient efficiency.
** Bell v. Ascendant Solutions, Inc., 422 F.3d 307 (5th Cir. 2005): good lawyering challenges and undermines that presumption.
•If the fraud on the market presumption of reliance is a pleading presumption, can an aggregate, class wide damages judgment be issued? Most courts say yes; for example, this came up in the motions in limine leading up to the Worldcom trial.
6. In purchasing or selling the security (aka transaction causation)
Introductory Note, at p. 599
This is usually not an issue in class actions. In individual actions, it may be. For example: Mercury Air Group, Inc. v. Mansour, 237 F.3d 542 (5th Cir 2001): summary judgment and award of sanctions affirmed. Plaintiff, a $250 million per year corporation that provides airplane fuel to small airlines and usually invests in its customers in order to gain contracts, sued a private airline and its executives. The district court entered summary judgment for defendants. The Court of Appeals held that the airline's failure to update income projections by not providing its quarterly financial statements to the plaintiff did not violate 10b-5. Plaintiff's CEO admitted that he would have invested anyway had he known of the concealed financial results, that he did not conduct due diligence, and that he was aware of risk factors disclosed in a prospectus. Plaintiff also decided to double its planned investment even after it received the financial statements.
7. To his, her or its detriment (economic loss and loss causation)
Dura Pharmaceuticals, Inc. v. Broudo, __ U.S. ___, 125 S. Ct. 1627 (2005) [Supp. 55-59]