Last week the U.S. Supreme Court held that a securities fraud plaintiff need not prove the materiality of defendant's alleged misrepresentations or omissions in order to obtain class certification. While materiality is a necessary element of a securities fraud claim, the issue before the Court in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds was whether materiality must be proven at the early stages of the case, when the trial court decides whether to allow it to proceed as a class action. The Court affirmed the Ninth Circuit, and resolved a split in the circuits, when it concluded that proof of materiality is not necessary to insure that common questions of law or fact predominate.
The Ninth Circuit last week addressed the standards for certifying a plaintiff's class action in a securities fraud case. The Ninth Circuit joined the Third and Seventh Circuits in holding that a plaintiff seeking to invoke the fraud-on-the-market presumption need not prove at the class certification stage that the defendant's misrepresentation was material.
In Connecticut Retirement Plans v. Amgen, Inc., the plaintiff alleged that misstatements and failure to disclose by defendants illegally inflated the value of Amgen stock. Plaintiff sought to certify a class action by showing that questions common to class members -- purchasers of Amgen stock -- predominated over questions affecting only individual members, under Fed. R. Civ. Proc. 23(a). To show that the element of reliance was common to the class, plaintiff invoked the fraud-on-the-market presumption, which is the principle that the market price of a publicly-traded security reflects all public information and a buyer is presumed to have relied on the truthfulness of that information. The Ninth Circuit held that, to invoke the presumption, plaintiff must show that the stock was traded in an efficient market, and that the alleged misstatements were public, but plaintiff need not prove that the misstatements were material. Instead, to gain class certification, plaintiff must simply plausibly allege materiality. The Ninth Circuit rejected the view of the First, Second, and Fifth Circuits that materiality must be proven in order to certify a class action.
The Oregon Court of Appeals last week revived a plaintiff's common law wrongful discharge claim against his former employer, based on his claim of retaliation for making complaints to his supervisors about management conduct and threatening to take his complaints to the corporate directors, and also for exercising his right to complain that his bonus was cut. The trial court had dismissed the complaint for failure to state a claim.
In De Bay v. Wild Oats Market, Inc., the plaintiff alleged that he gave his supervisors a detailed written report questioning the management team's actions and motives in deviating from the company's strategic growth plan. Plaintiff also alleged that his bonus was cut in half after he made the report, and that he was subsequently fired for threatening to bring his concerns to the board. Plaintiff argued on appeal that these allegations were sufficient to state a wrongful discharge claim for exercising important societal rights and obligations protected under state and federal laws, specifically ORS 659A.230, ORS 652.355, and section 806 of the Sabanes-Oxley Act, 18 USC § 1514A.
The Court of Appeals found that a wrongful discharge claim based on "whistleblowing" under ORS 659A.230 requires that the employee complain to a recognized outside authority with the power to take action on such complaints. Plaintiff had not alleged a report to any outside authority and therefore failed to state a claim under that statute.
Likewise, the court found that ORS 652.355, which prohibits retaliation for making a wage claim, did not apply to plaintiff's circumstances because he did not allege that he had filed or even discussed a "wage claim."
However, for the purpose of a motion to dismiss, plaintiff's allegation that he was fired for reporting managerial wrongdoing to his supervisors fell within the scope of conduct protected by Sarbanes-Oxley, which prohibits a publicly-traded company from discharging an employee for reporting to a supervisor a violation securities laws or any federal law relating to fraud against shareholders. In addition, the court found that Sabanes-Oxley did not provide the exclusive remedy for the alleged conduct because, unlike a wrongful discharge claim, the statute did not allow for the recovery of noneconomic or punitive damages. On that basis, plaintiff was entitled to pursue a claim for common law wrongful discharge.
The opinion provides another reminder to employers that firing employees for internal reports of wrongdoing may provide the basis for "whistleblower" claims under both statutory and common law.
On Tuesday, the U.S. Supreme Court refused to dismiss a complaint alleging securities fraud based on a company's failure to disclose reports that its cold remedy product caused consumers to lose their sense of smell. In Matrixx Initiatives, Inc. v. Siracusano, plaintiffs claimed that the manufacturer made optimistic statements about expected sales of its product, Zicam, and didn't disclose that some doctors and consumers had reported adverse impacts.
The company argued that the law requires disclosure only when it knows of sufficient adverse events to establish a statistically significant risk that the product is in fact causing the events. The Supreme Court, affirming the Ninth Circuit, refused to adopt a bright-line rule that adverse events that are less than statistically significant need not be disclosed. Instead, the relevant inquiry continues to be whether a reasonable investor would view the undisclosed information as altering the "total mix" of information made available.
Last week the Oregon Court of Appeals held that a plaintiff making a claim under the state's securities fraud statute must prove reliance as an element of the claim. In State of Oregon v. Marsh & McLennan Companies, Inc., the state filed suit to recover losses to the Public Employees Retirement Fund in connection with the drop in the value of stock in Marsh & McLennan. The state claimed that Marsh & McLennan issued statements about its business ethics and sources of income that proved to be false once certain executives pleaded guilty to various corporate misdeeds. Plaintiff sued under ORS 59.135 (prohibiting fraud and misrepresentation in security transactions) and ORS 59.137 (creating cause of action for violating ORS 59.135).
Defendant obtained summary judgment on the ground that the state could not provide evidence that the retirement fund's agents purchased the stock in reliance on Marsh & McLennan's fraudulent misrepresentations. The Court of Appeals affirmed, holding that, even though the statute does not expressly call out reliance as an element of the claim, use of the terms "fraud" and "defraud" in the statute necessarily implies reliance.
Last week the U.S. Supreme Court excised a relatively minor portion of the Sarbanes-Oxley Act, leaving intact much of that wide-ranging corporate reform law. In Free Enterprise Fund v. Public Company Accounting Oversight Bd., the Court declared the legal structure of the Act's enforcement body, the Public Company Accounting Oversight Board ("PCAOB"), unconstitutional as violating separation of powers.
Under the Sarbanes-Oxley Act, members of the PCAOB may be removed from office by members of the Securities and Exchange Commission ("SEC") only for good cause. Members of the SEC, in turn, may be removed by the President only for good cause. The Court found that Congress violated the Constitution by placing these "two layers" of protection from removal between the President and the members of the PCAOB. Chief Justice John Robers, writing for the Court, stated:
"[S]uch multilevel protection from removal is contrary to Article II’s vesting of the executive power in the President. The President cannot 'take Care that the Laws be faithfully executed' if he cannot oversee the faithfulness of the officers who execute them. Here the President cannot remove an officer who enjoys more than one level of good-cause protection, even if the President determines that the officer is neglecting his duties or discharging them improperly. That judgment is instead committed to another officer, who may or may not agree with the President’s determination, and whom the President cannot remove simply because that officer disagrees with him. This contravenes the President’s 'constitutional obligation to ensure the faithful execution of the laws.' ”
Despite the constitutional flaw in the PCAOB's make-up, the court did not do away with the board. Instead, it ordered that PCAOB members must now be subject to removal at will by the SEC.
On Tuesday the U.S. Supreme Court addressed when a securites fraud claim accrues and the statute of limitations begins to run. The plaintiff investors in Merck & Co. v Reynolds alleged that Merck & Co. knowingly misrepresented the heart attack risks associated with Vioxx. Justice Breyer, writing for the majority, held that, due to delayed discovery of the claim, the two-year statute of limitations did not bar the investors from bringing a securities fraud action under Section 10(b) of the Securities Exchange Act.
Claims by private plaintiffs under Section 10(b) must be brought no later than the earlier of "two years after the discovery of the facts constituting the violation," or five years after the violation. 28 U.S.C. § 1658(b). The Court held that the two-year period begins to run when a plaintiff actually discovers “the facts constituting the violation,” or when a reasonably diligent plaintiff would have discovered such facts—whichever comes first. The court held that the limitations period does not begin to run at “inquiry notice,” or the point at which a reasonably diligent plaintiff would investigate the facts, because the point at which a plaintiff would begin investigating is not necessarily the point at which a plaintiff would discover “the facts constituting the violation.”
The Court rejected Merck’s argument that facts showing scienter—“a mental state embracing the intent to deceive, manipulate, or defraud”—are not among “the facts constituting the violation” for purposes of delayed accrual under § 1658(b). Noting that “the state of a man’s mind is as much a fact as the state of his digestion,” the Court held that the “‘fact’ of scienter ‘constitut[es]’ an important and necessary element of a § 10(b) ‘violation.’” The court held that it would frustrate the purpose of the discovery rule if the limitations period began to run before the plaintiff discovered any facts related to scienter. The court also held that facts tending to show a materially false or misleading statement were ordinarily insufficient to establish scienter; instead it is often necessary for plaintiffs to discover facts specifically related to a defendant’s state of mind.
Justice Scalia, joined by Justice Thomas, concurred in part and concurred in the judgment. Justice Scalia argued for an even more plaintiff-friendly result, stating that the statute of limitations should begin to run when a plaintiff actually discovers facts constituting the violation, rather than when a reasonably diligent plaintiff should have known such facts.
In a case originating in the District of Oregon, the Ninth Circuit recently held there is no private right of action under Section 304 of the Sarbanes-Oxley Act, which provides for the forfeiture of bonuses and profits when corporate officers fail to comply with securities law reporting requirements. In Diaz v. Davis, plaintiff asserted shareholder derivative claims against Digimarc Corporation and its officers and directors arising from accounting errors and a resulting restatement of earnings. The Ninth Circuit is the first federal circuit court to address whether Section 304 creates a private right of action.
The Ninth Circuit also resolved an issue of subject matter jurisdiction in a derivative case. While District Court Judge Ancer Haggerty correctly held that plaintiff had no claim under Section 304, the Ninth Circuit concluded that he erred in aligning the corporation with the plaintiffs, thereby eliminating diversity jurisdiction of the remaining state law claims. Assessing the facts as of the date the suit was filed, the Ninth Circuit held there was antagonism between the derivative plaintiffs and the controlling members of Digimarc which required Digimarc to continue as a defendant.
Today the Ninth Circuit Court of Appeals issued an opinion stating that an attorney who undertakes to make representations to prospective purchasers of securities can be liable for securities fraud under federal law if the representations turn out to be false.
In Thompson v. Paul, the defendant attorney represented a company that was preparing to issue stock to plaintiff as part of a litigation settlement. Plaintiff claimed she agreed to accept the stock based on a representation by the attorney that the company's CEO was not under criminal investigation. When the CEO was indicted three days later, the stock price dropped and plaintiff sued the attorney for securities fraud. The attorney argued that he owed no duty to plaintiff, but only to his client, the issuer of the stock. The Ninth Circuit disagreed, holding that the attorney-client relationship does not shield an attorney from liability to third parties under Section 10(b) of the Securities Exchange Act.
Last week, the Ninth Circuit, in South Ferry LP v. Killinger, limited the use of the "core operations inference" to meet the heightened pleading standard of the Private Securities Litigation Reform Act in alleging securities fraud by a corporation's management.
The "core operations inference" is the principle that facts critical to a business's "core operations" or important transactions are known to key company officers when making statements about company operations that later turn out to be wrong or misleading. Plaintiffs in a securities fraud case may seek to use that inference to show defendants' state of mind in making the false statements. However, as explained by the Supreme Court in the 2007 case Tellabs, Inc. v. Makor Issues and Rights, Ltd., the PSLRA requires plaintiffs alleging securities fraud to plead facts that give rise to a "strong inference" of knowing or intentional misconduct that "must be cogent and compelling, thus strong in light of other explanations." Given this guidance from the Supreme Court, the Ninth Circuit held that, in most circumstances, plaintiffs could not rely on the core operations inference alone to meet the PSLRA pleading standard. Instead, the inference may be one of several factors that a district court considers as part of a holistic approach to evaluating a complaint. In limited cases the inference might independently satisfy the PSLRA. The court explained:
"In summary, allegations regarding management's role in a company may be relevant and help to satisfy the PSLRA scienter requirement in three circumstances. First, the allegations may be used in any form along with other allegations that, when read together, raise an inference of scienter that is 'cogent and compelling, thus strong in light of other explanations.' * * * This view takes such allegations into account when evaluating all circumstances together. Second such allegations may independently satisfy the PSLRA where they are particular and suggest that defendants had actual access to the disputed information[.] * * * Finally, such allegations may conceivably satisfy the PSLRA standard in a more bare form, without accompanying particularized allegations, in rare circumstances where the nature of the relevant fact is of such prominence that it would be 'absurd' to suggest that management was without knowledge of the matter. "