U.S. Supreme Court declines to expand securities fraud liability

In the latest in a string of rulings favoring business interests, the U.S. Supreme Court held today that parties who did not directly mislead investors cannot be liable for securities fraud under SEC Rule 10b-5.  By a 5-3 vote, the court refused to recognize the concept of "scheme liability" as to third parties who participate in a fraudulent scheme but do not themselves issue a false statement.

See Justice Anthony Kennedy's opinion in Stoneridge Investment Partners v. Scientific-Atlanta here.  And see earlier discussion of the case in the Oregon Business Litigation Blog here.

U.S. Supreme Court considers landmark securities fraud case

On October 9, the U.S. Supreme Court hears oral argument in Stoneridge Investment Partners v. Scientific-Atlanta, which many view as the most important securities case in years.  At issue is the validity of "scheme liability" and whether third parties, such as financial advisors, auditors, attorneys, or vendors, who engage in allegedly fraudulent transactions with a public corporation, but who do not speak or provide financial statements or other disclosures to investors, can be held liable under SEC Rule 10b-5.

The bottom line is that a decision recognizing expanded liability under 10b-5 for third parties could have a potentially far-reaching impact, especially for auditors and lawyers who advise public corporations.  Find further discussion of the case and its implications here and here.

Defective notice blocks securities class action settlement

The Ninth Circuit today tossed out a $35 million securities class action settlement involving Veritas Software Corporation over a defective notice to class members.  In Petrone v. Malone, the court addressed a novel issue under the Private Securities Litigation Reform Act:  how must the notice of settlement describe the damages each member of the class will receive? 
Under the PSLRA, the notice must state the amount of settlement funds to be distributed on a per-share basis.  The notice at issue in Petrone calculated the per-share recovery with the unstated assumption that only 43% of the class members would file a claim for damages.  By failing to calculate the recovery based on all of the shares held by the class, the notice overstated the potential per-share recovery and violated the PSLRA. 

See our other coverage of securities fraud and the PSLRA here and here.

Supreme Court tightens pleading standards for securities fraud

On June 21, 2007, the United States Supreme Court issued an opinion in Tellabs, Inc v. Makor Issues & Rights, Ltd. which makes it more difficult for plaintiffs to state a claim for securities fraud under Section 10(b) of the Securities Exchange Act of 1934.  The Private Securities Litigation Reform Act of 1995 requires plaintiffs to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind" - i.e., an intent "to deceive, manipulate, or defraud."  In Tellabs, the Court stated that, to qualify as "strong," an inference of fraudulent intent must be more than merely plausible or reasonable - it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.  Accordingly, the Court must take into account plausible, nonculpable explanations for the defendant's conduct as well as inferences favoring the plaintiff.  In sum, "[a] complaint will survive . . . only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged."

The Court rejected the argument that, by engaging in a comparative assessment of competing inferences, a court reviewing a securities complaint would usurp the role of the jury.  The Court explained that Congress, as creator of federal statutory claims, "has the power to prescribe what must be pleaded to state the claim, just as it has power to determine what must be proved to prevail on the merits."

From the plaintiffs' view, the decision is not as bad as it could have been.  Justice Scalia, in dissent, would have upheld an even stricter pleading standard.  Instead of letting plaintiffs proceed on the basis of an inference "at least as compelling as any opposing inference," Justice Scalia would have adopted a test of "whether the inference of scienter (if any) is more plausible than the inference of innocence."

Securities regulation trumps antitrust law, the Supreme Court holds

On Monday the U.S. Supreme Court held that joint activity in the underwriting of an initial public stock offering is immune from scrutiny under the antitrust laws.  In Credit Suisse Securities v. Billing, plaintiffs claimed that the underwriters of hundreds of IPOs acted together to drive up the fees they earned, in violation of federal antitrust law.  Justice Stephen Breyer, writing for the court, held that extensive regulation by the Securities and Exchange Commission of the underwriters' activities precluded the application of antitrust law. 

Justice Clarence Thomas was the sole dissenter.  He wrote that the claims must proceed because, according to the Securities Act of 1933, securities law remedies do not preempt other existing remedies, including those under the antitrust law.

See our earlier coverage of the case here.

Securities fraud: Ninth Circuit clarifies the test for triggering the statute of limitations

Last week in Betz v. Trainer Wortham & Co., the Ninth Circuit clarified that "inquiry notice, and not merely actual notice, can cause the statute of limitations for securities fraud to begin to run."  The court also adopted the "inquiry-plus-reasonable-diligence test."  Under that standard, the court first determines when a plaintiff has "inquiry notice", i.e., has notice of facts "sufficiently probative of fraud - sufficiently advanced beyond the stage of a mere suspicion . . . to incite [him or her] to investigate."  Once a plaintiff has inquiry notice, the court asks when the investor, in the exercise of reasonable diligence, should have discovered the facts constituting the alleged fraud.  The answer to the second question determines when the statute of limitations began to run. 

The Court noted that, under the inquiry-plus-reasonable-diligence test, the defendant bears a "considerable burden" of showing an untimely claim at the summary judgment stage.  This means that a defendant is highly unlikely to obtain dismissal before trial of a securities fraud claim based on the running of the statute of limitations, if the plaintiff claims a delay in discovering the existence of the claim.

Pro-defendant securities fraud statute gets Supreme Court scrutiny

The U.S. Supreme Court on Wednesday takes on a 1995 federal statute that makes it harder for plaintiffs to pursue securities fraud lawsuits.  The Private Securities Litigation Reform Act requires plaintiffs in such cases to state facts sufficient to support a "strong inference" that  defendants acted with a culpable state of mind.  Plaintiffs who can't meet that high standard at the outset are left without a remedy.  In Telllabs, Inc. v. Makor Issues and Rights, Ltd., the issue is whether the Seventh Circuit Court of Appeals properly applied that pleading requirement.

See further coverage of the case here, here, here, and here.

Securities regulation and antitrust law slug it out before the U.S. Supreme Court

On Tuesday the U.S. Supreme Court will hear this week's second high-profile business law case.  In Credit Suisse First Boston Ltd. v. Billing, the issue is whether the highly-regulated securities industry is exempt from antitrust liability.  Plaintiffs allege that, in the 1990s, investment banks and institutional investors manipulated the aftermarket prices of a large number of IPOs in violation of antitrust law.  The court will decide whether antitrust principles must bow out, given the extensive regulation of the securities market by the SEC.

See detailed coverage of the case here, here, and here.

Plaintiffs' law firm ordered to pay fees in Enron-related litigation

The federal judge overseeing the Enron shareholders’ class-action lawsuit in Texas granted summary judgment dismissing a $1 billion claim brought by plaintiffs’ counsel William Lerach against investment firm Alliance Capital Management.  In an unusual move, the judge ordered that plaintiffs' counsel pay Alliance’s attorney’s fees under Section 11(e) of the Securities Act incurred in preparing the summary judgment motion.

The judge held: 

"As for attorney's fees and costs under section section 11(e), the Court finds that at the time this suit was filed, given the sophisticated concealment of Enron's financial condition, Plaintiffs' suspicions arising from Savage's dual-hat roles at Alliance were not unreasonable. Thus at its inception and at least through Savage's deposition in January 2005 and for a period of discovery thereafter, the Court finds that this case was not frivolous, without merit, and/or brought in bad faith.  It appears to this Court, however, that the summary judgment briefing should not have been necessary and the continuance of the claim against Alliance was at that point without merit." 

The order requires the attorneys, not their clients, to pay the award.  Apparently they have collected almost $7 billion in settlements for clients in Enron-related litigation so this small setback won't carry much sting.

Securities Fraud Provisions Apply to Settlement Agreements

In settling disputes with shareholders or former employees, businesses often repurchase the stock in the company owned by the settling shareholders or former employees.  When entering into these settlements, business lawyers need to remind themselves that these settlements are subject to the securities fraud provisions in state securities laws, and that the settlement transaction may result in future litigation if there is a significant increase in the value of the company shortly after these shares have been repurchased.

In Oregon, the key statute is ORS 59.115 which imposes liability for selling stock by means of an untrue statement or omission of material fact.  The key case is Towery v. Lucas, 128 Or App 555, 876 P2d 814 (1994), holding that the antifraud provisions apply to settlement agreements to the same extent as any other transaction that involves the sale of securities.

While Washington's securities antifraud states are different from those in Oregon, Washington courts also recognize that in certain circumstances a misrepresentation or omission in settlement negotiations can be actionable under its statutes.  In Guarino v. Interactive Objects, Inc., 122 Wash App 95, 86 P3d 1175 (2004), the dispute involved a claim to severance benefits by former officers of the company.  The company repurchased stock owned by the former officers as part of the settlement of the severance benefits claim without disclosing that the company had signed a letter of intent to merge with another company.  When that merger occurred, the value of the company's stock increased dramatically.  The appellate court found the failure to disclose the possible merger to be actionable under Washington's securities laws.

Washington Denies Shareholder Status to Credit Union Members

In an opinion issued July 25, 2006, the Washington Court of Appeals affirmed a trial court dismissal of certain claims brought by the group Save Columbia Credit Union. The court held that the group, composed of credit union members, did not have standing to bring direct claims for breach of fiduciary duty against directors, nor could the group avail itself of statutory entitlements to access to records afforded to shareholders in other corporations. Although the opinion examines a number of Washington statutes, the fiduciary duty analysis is based on common law principles that could be applicable in other jurisdictions, including Oregon. Case information: Docket Number: 32858-5-II Title of Case: Save Columbia CU Committee etal, Appellants v. Columbia Community Credit Union etal, Respondents File Date: 07/25/2006