Securities Litigation 2005 Developments

1.Mega Settlements


Worldcom decisions on summary judgment and final approval of settlement

Public reports of Enron settlements

Public reports of AOL TimeWarner settlement

Public reports of McKesson HBOC settlement (and of acquittal of CFO)

Public reports and case documents on other large settlements in 2005:  Bristol-Myers Squibb, Dynegy, Qwest Communications

ABD report on settlements through October 2005 (this is the most recent data)


2.Reversal of Arthur Andersen Conviction


Supreme Court decision

Fifth Circuit decision

Florida Circuit Court decision granting default judgment in Ronald Perelman lawsuit against Morgan Stanley re: Sunbeam


3.Loss Causation


Dura Pharmaceuticals decision

Morgan v. AXT, Inc. decision

NERA (Marcia Mayer) slide show on Dura Pharmaceuticals


4.Tougher Scrutiny on Class Certification


Bell v. Ascendant Solutions, Inc., 422 F.3d 307 (5th Cir. Aug. 23, 2005)

Krim v. pcOrder, 402 F.3d 489 (5th Cir. Mar. 1, 2005)

In re PolyMedica Corp. Sec. Litig., ___ F.3d ___, 2005 WL 3384083 (1st Cir. Dec. 13, 2005)

Unger v. Amedisys Inc., 401 F.3d 316 (5th Cir. Feb. 17, 2005)

In re Xcelera.com Sec. Litig., 430 F.3d 503 (1st Cir. Dec. 13, 2005)


5.Acquittal of Healthsouth CEO Richard Scrushy


Article on acquittal


6.Freeze of large severance payments to departing officers (SEC v. Gemstar)


Securities & Exchange Comm’n v. Gemstar-TV Guide Int’l, Inc., 401 F.3d 1031 (9th Cir. Mar. 22, 2005) (en banc)


1.Mega Settlements


a.Worldcom

i.Summary judgment had been denied in most part, upon high standards for due diligence, reliance on experts, and good faith defenses.  A key summary judgment opinion is attached.  In re WorldCom, Inc. Sec. Litig., 352 F. Supp. 2d 472 (S.D.N.Y. Jan. 18, 2005).

ii.The defendants (individual and entity) started settling.  The opinion approving the remaining settlements, and recounting history of the case and all the settlements, is attached.  In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288 (DLC), 2005 WL 2293190 (S.D.N.Y. Sept. 21, 2005).

iii.Total class settlements =   $6.133 billion plus interest

Citigroup (May 2004, just before close of fact discovery):  $2.575 billion

Directors (January 2005 and later):  $60.75 million ($24.75 million from directors, $36 million from insurer)

Bank of America and Fleet (March 2005, eve of trial):  $460.5 million

Lehman:  $62,713,582

CSFB, Goldman Sachs, UBS Warburg:  $12,542,716 each

ABN AMRO:  $278,365,600

Mitsubishi:  $75 million

BNP, Mizuho, Caboto:  $37.5 million each

Deutsche Bank:  $325 million

JP Morgan:  $2 billion

Blaylock:  $572,840

Utendahl:  $234,000

Arthur Andersen (during trial):  $65 million plus contingent payments

Myers [1 year + 1 day criminal] and Yates [1 year criminal[:  no money (they lack assets)

[5 years criminal]:  $200,000 (90% of 401(k)) plus proceeds of sale of assets between $4 million and $5 million

iv.As our article states, and Professor Grundfest emphasized in a talk earlier last year, a key is the ’33 Act \ strict liability claims – especially for registration statements that incorporate SEC filings by reference, and hence bring all of the text of all the SEC filings into play.

v.Opt-out settlement:  pension funds that had opted out of the class and sued separately (at the urging of Bill Lerach) are settling separately

Five New York City pension funds:  $78.9 million

67 institutional investors:  $651 million


b.Enron

i.Lead Plaintiff (U.C. Regents) has reached settlements with Lehman Brothers, Bank of America, the Outside Directors, Citigroup, JP Morgan Chase and CIBC totaling over $7 billion:

Banc of America:  $69 million

Lehman:  $222.5 million

Outside directors:  $168 million ($150 million insurance + $13 million from individuals who sold, at 20% of proceeds)

Citigroup:  $2 billion

JP Morgan Chase:  $2.2 billion

CIBC:  $2.4 billion

ii.The case remains active against Goldman Sachs, Arthur Andersen, key former officers (Lay, Skilling, Fastow, Causey, Buy), and some law firms


c.AOL TimeWarner

i.Lawsuit involves allegations of round trip \ swap transactions; motions to dismiss largely had been denied.

ii.July 2005:  tentative settlement of $2.4 billion plus $100 million from auditors (Ernst & Young) announced by Company.  See attached press release

iii.Preliminary approval granted September 30, 2005; final approval hearing February 22, 2006.


d.McKesson HBOC

i.Lawsuit involves substantial accounting fraud at HBO & Co., which was acquired by McKesson.  A motion to dismiss was denied.

ii.$960M class action settlement was preliminarily approved by Judge Ronald Whyte

iii.There is also a $30M derivative settlement

iv.The securities claims are still proceeding against Bear Stearns & Co. (which filed a separate declaratory judgment action to derail the settlement) and Arthur Andersen

v.The former CFO of HBO & Co., Richard Hawkins prevailed in a criminal securities fraud case (defended by Walt Brown), despite allegations from the CEO that he had been involved.  The case was decided by Judge Jenkins, not a jury.  See attached article.


e.Royal Ahold

i.Lawsuit involves major accounting fraud by US grocery subsidiaries of European conglomerate; I think we represent some of the defendants.  A motion to dismiss opinion, capturing the alleged facts, is attached.  In re Royal Ahold N.V. Sec. & ERISA Litig., 351 F. Supp. 2d 334 (D. Md. Dec. 21, 2004).

ii.A $1.1 billion settlement, covering all defendants, was given preliminary approval on January 9, 2006.  See attached press release.

iii.Note that the court had ordered the company to produce a massive number of interview memoranda for interviews conducted in an internal investigation.  In re Royal Ahold N.V. Sec. & ERISA Litig., 239 F.R.D. 433 (D. Md. Sept. 8, 2005).  The court held that the company had not shown that the documents qualified for opinion work product protection, for they were not created “because” of the lawsuit, even though the company undoubtedly also was preparing for litigation.  Rather, there was another “driving force” for the creation of the documents, namely that the outside auditors would not otherwise complete their audit work, and they would have been created even if there had not been a lawsuit.  Even if work product had been shown, the company had waived as to any subject matters publicly disclosed in SEC filings:  the information from the interviews largely had been made public in a Form 20-F, which was a detailed account of the fraud.  


f.IPO:  $1 billion (partial) settlement given preliminary approval in 2005


g.Other large settlements from the past year

i.Bristol-Myers Squibb (failed drug trial):  settled for $389 million on eve of trial.  Opinion granting summary judgment but only in part is attached.  In re Bristol-Meyers Squibb Sec. Litig., No. Civ. A. 00-1990 (SRC), 2005 WL 2007004 (D. N.J. Aug. 17, 2005).

ii.Dynegy (energy swap transactions):  $474.05 million.  Opinion granting motion to dismiss but only in part attached.  In re Dynegy, Inc. Sec. Litig., 339 F. Supp. 2d 804 (S.D. Tex. Oct. 7, 2004).  The case is before the same judge (Sim Lake) who is presiding over the Enron criminal trial.

iii.Qwest Communications (swap transactions mischaracterized as recurring revenue):  $400 million, including $10 million from Arthur Andersen.  One condition is that the $250 million that the company earlier agreed to pay the SEC to settle its complaint be distributed to investors.  Thus, the total settlement is really $650 million.


h.Added twist of individual liability in the first two cases.


1.Reversal of Arthur Andersen Conviction


a.Supreme Court decision is 125 S. Ct. 2129; reversed Fifth Circuit decision is at 374 F.3d 281; both are attached.


b.Can read it as vindication of Arthur Andersen, or to the contrary a lesson in how even the appearance of a problem becomes a real problem


c.Related case:  Perelman default judgment against Morgan Stanley in the Sunbeam case (Florida State court), based on evasive answers as to electronic document production.  See attached decision granting default judgment.  Subsequently, damages were assessed at $1.4 billion.  Morgan Stanley is appealing.


2.Loss Causation


a.Dura Pharmaceuticals (attached), narrowly read, holds that allegations of price inflation at the time of purchase does not plead loss causation.


b.Several subsequent cases have dismissed claims, in whole or in part.


i.Morgan v. AXT, Inc., Nos. C 04-4362 etc., 2005 WL 234125 (N.D. Cal. Sept. 23, 2005) (Jenkins, J.) (our case):  loss causation not alleged where the stock price dropped to $2.20 at the end of the lengthy class period after the first allegedly corrective disclosure, when it had had been below $2 per share for substantial portions of the class period.  The decision is attached.


ii.In re CIGNA Corp. Sec. Litig., No. Civ. A. 02-8088, 2005 WL 3536212 (E.D. Pa. Dec. 23, 2005):  claim based on a forecast that allegedly did not take the MIS difficulties into account did not plead loss causation and hence would not be allowed by amendment, where the MIS problems and resulting stock price drop were not disclosed until 18 months later; the court said that this span is simply too long to allow a new theory of liability and attendant additional discovery.


iii.Kingsway Financial Services, Inc. v. Pricewaterhouse Coopers, LLP, No. 03 Civ. 5560 (RMB), 2005 WL 3215135 (S.D.N.Y. Nov. 30, 2005):  loss causation not alleged for some plaintiffs that had sole their shares at a profit.


iv.Ray v. Citigroup Global Markets, Inc., No. 03 C 3157, 2005 WL 2659102 (N.D. Ill. Oct. 18, 2005):  motion for summary judgment granted on loss causation grounds, where Internet company’s stock price had declined from $80 to under $1 by the time of any disclosure of the falsity of misrepresentations (and was down to $2 when plaintiffs purchased), and competitors’ stock prices had precipitously declined as well. 


v.South Ferry LP #2 v. Killinger, 399 F. Supp. 2d 1121 (W.D. Wash. Nov. 17, 2005):  loss causation not pleaded for subclass that had sold put options.


vi.AIG Global Sec. Lending Corp. v. Banc of America Sec., LLC, No. 01 Civ. 11448 (JGK), 2005 WL 238584 (S.D.N.Y. Sept. 26, 2005):  allegation that retailer failed to disclose its lack of a centralized billing process and hence could not collect from customers lacked materiality as to the impact of the poor collections, and for the same reason did not plead loss causation.


vii.The Warnaco Group, Inc. Sec. Litig. (II), 388 F. Supp. 2d 307 (S.D.N.Y. Sept. 21, 2005):  alleged failure to disclose accounting errors regarding company’s Designer Holdings subsidiary failed to plead loss causation, as the complaint did not allege that this played any part in the company’s stock price decline or its bankruptcy. 


viii.In re Compuware Sec. Litig., 386 F. Supp. 2d 913 (E.D. Mich. Sept. 12, 2005):  judgment on pleading granted because analyst reports asserting that there was a causal connection between a defendant’s press release (announcing a write off in goodwill in key contract) and its alleged misrepresentations about the contract did not plead loss causation, as the alleged corrective disclosure actually had been announced a month earlier with no impact on the stock price; summary judgment granted because the name plaintiff had sold before the truth was disclosed and before the alleged inflation began to leak out of the stock price.


ix.Malin v. XL Capital Ltd., No. 3:03 CV 2001 PCD, 2005 WL 2146089 (D. Conn. Sept. 1, 2005):  supplemental motion to dismiss granted where defendants presented unspecified “evidence” (probably published stock prices, of which the court took judicial notice) that the stock price returned to the pre-disclosure trading price “shortly after” (actually four months after) the end of the class period, which negated plaintiffs’ proffered inference of an economic loss based on the price drop (where plaintiffs retained and did not sell their stock); a price fluctuation without any realization of an economic loss “is functionally equivalent to the Supreme Court’s rejection of an artificially inflated purchase price alone as economic loss.”


x.Davidoff v. Farina, No. 04 Civ. 7617 (NRB), 2005 WL 2030501 (S.D.N.Y. Aug. 22, 2005):  loss causation not pleaded as to three misrepresentations that had been pleaded with falsity and scienter, as there had been no public disclosure of the falsity of the representations.  Moreover, a claim that a contract was backdated and recognized one quarter early could not have misrepresented the company’s aggregate financial position to investors who held stock in both quarters.


xi.Collier v. Aksys Ltd., No. 3:04 CV 1232 (MRK), 2005 WL 1949868 (D. Conn. Aug. 15, 2005):  claim by short sellers of stock of healthcare services company dismissed for lack of loss causation:  the dramatic rise in the stock price during the class period hardly indicated that it was being kept artificially low, and it was not enough to contend that the price would have increased even faster but for the misrepresentations.  Moreover, the price declined when the truth of the position was disclosed, which was precisely the opposite reaction the plaintiffs required (and actually was a benefit to plaintiffs, who after all were short sellers).


xii.In re Cree, Inc. Sec. Litig., No. 01:03 CV 00549, 2005 WL 1847004 (M.D.N.C. Aug. 2, 2005):  the disclosure of a co-founder’s fraud lawsuit against the company precipitated the stock price decline and complained of losses, but the lawsuit did not reveal anything about the five of the six allegedly phony transactions challenged by plaintiffs, and the other transaction already had been disclosed in SEC filings; hence the complaint “discloses nothing new, but merely attributes an improper purpose to the previously disclosed facts,” and loss causation was not pleaded.  Moreover, it was doubtful that the uncorroborated, general assertions of wrongdoing in the complaint was a “disclosure” at all for these purposes:  disclosures must satisfy minimum standards of content, which the complaint lacked.


xiii.In re Acterna Corp. Sec. Litig., 378 F. Supp. 2d 561 (D. Md. July 26, 2005):  loss causation not pleaded where stock price dropped 94% during the class period, and the complaint not only failed to contend that the decline was caused by any misrepresentations or omissions:  it alleged that even prior to the class period, the global telecommunications industry suffered a severe slowdown, leading to lower sales by service companies such as the defendant and others in the same industry.


xiv.Schleicher v. Wendt, No. 1:02 CV 1332 DFHTAB, 2005 WL 1656871 (S.D. Ind. July 14, 2005):  loss causation not alleged where, before plaintiffs had bought any stock, the price had declined by more than 90%, to $5.62 per share.  Under new management (the defendants in this case), the stock reached as high as $19, but declined back to $5 in October 2001.  By the final day of the class period, it was at 34 cents; the bankruptcy filing knocked it to 11 cents.  The company’s SEC filings during the class period was “replete with other bad news,” apart from the various accounting allegations made by plaintiffs.  Those latter matters did not come out to the public until after the bankruptcy filing, months after the end of the class period.  Hence, “[t]his is not a case where plaintiffs can point to a sharp drop in the company’s stock price following announcement of the allegedly concealed truth.  The stock had long since hit bottom before these alleged misrepresentations became known.” 


xv.In re Tellium, Inc. Sec. Litig., No. Civ. A 02 CV5878 FLW, 2005 WL 1677467 (D. N.J. June 30, 2005):  complaint did not plead economic loss or loss causation where it did not allege that the misrepresentations proximately caused the lower price of the company’s stock, “as opposed to the ‘uncommonly severe decline in stock prices across all sectors of the U.S. economy and in the telecommunications sector in particular during the Class Period.’” 


xvi.McKowan Lowe & Co. v. Jasmine, Ltd., Nos. Civ. 94-5522 RBK etc., 2005 WL 1541062 (D. N.J. June 30, 2005):  summary judgment granted on loss causation grounds where expert opined an event study that the alleged nondisclosure of the problems cited by plaintiffs had not damaged them (because, in essence, the issues were not disclosed and hence did not effect the stock price). 


c.This has been true even in the ’33 Act context, where loss causation is not an element.


i.Azzolini v. Corts Trust II, 2005 WL 3448053 (E.D. Tenn. Dec. 14, 2005):  motion for judgment on pleadings granted on ’33 Act claim, as the facts alleged in the complaint showed that there was no question that defendants had an affirmative defense for lack of causation.  The alleged decline in stock price was caused by an announcement of investment losses in February 2003, but the due diligence investigation into the other offering that was the gravamen of the claim had been disclosed almost two years earlier.  After that disclosure, the price remained steady for over one year.  Thus, there was no relationship between the alleged losses and the alleged false statements or omissions.


d.This does not mean that every loss causation argument will succeed.


i.Adams v. Hyman Lippitt, P.C., No. 05-72171, 2005 WL 3556196 (E.D. Mich. Dec. 29, 2005):  loss causation pleaded where investment fund did not disclose risks inherent in its location (the Cook Islands) and the questionable background of a manager, because those risks materialized when the manager absconded with millions of dollars from the fund.


ii.Sekuk Global Enterprises v. KVH Industries, Inc., No. Civ. A. 04-306 ML, 2005 WL 1924202 (D. R.I. Aug. 11, 2005):  the court rejected a loss causation argument predicated on the theory that the miss at the end of the class period was not attributed publicly to poor sales of the new product whose prospects allegedly had been misrepresented, because the press release at issue could be read otherwise.


iii.In re Royal Dutch Shell Transport Sec. Litig., No. 04-374 (JWB), ___ F. Supp. 2d ___, 2005 WL 3356965 (D. N.J. Dec. 12, 2005):  Dura Pharmaceuticals did not require the subject securities be sold in order for a plaintiff to have sustained a cognizable economic loss, and hence loss causation; all it held was that inflation alone did not suffice.


iv.In re Parmalat Sec. Litig., 375 F. Supp. 2d 278 (S.D.N.Y. June 28, 2005):  an allegation that a corrective disclosure caused the plaintiffs’ losses is not necessary to plead loss causation.


v.Schuster v. Anderson, No. C 04-4089 MWB, ___ F. Supp. 2d ___, 2005 WL 3497787 (N.D. Iowa Dec. 22, 2005); Brashears v. 1717 Capital Mgmt., No. CIV. A. 02-1534-KAJ, 2005 WL 2585247 (D. Del. Oct. 13, 2005):  Dura Pharmaceuticals provides little guidance as to loss causation for cases that do not allege fraud on the market or publicly traded securities.


e.In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006 (9th Cir. June 21, 2005) is a subtle opinion because it shows the potential impact on damages.


i.Most read the amended decision in this case reflecting Dura Pharmaceuticals as setting low standards for pleading loss causation,


ii.However, because the complaint alleged that the stock price already had declined from a class period high of $34.375 per share to $18.50 before the first disclosure of the falsity of the financial statements, the court held that “any loss suffered  between $34.375 and $18.50 cannot be considered causally related to [the company’s] allegedly fraudulent accounting methods because before the revelations began in August 1998, the true nature of [the company’s] financial condition had not yet been disclosed.”


f.Attached in the binder is a recent slide show by Marcia Mayer of NERA, “Loss Causation and Rule 10b-5 Damages After Dura.”


i.Dr. Mayer, I think, goes too far in Slide 15 in speculating that companies will disclosed bad news with other bad news in order to obscure which disclosure caused economic loss.  Courts have said that plaintiffs do not have to plead that the disclosure of the truth (falsity of prior representations) was the only reason for an economic loss.


g.Impact:  it is pretty clear that even if a claim is stated, economic losses attributable to factors other than the belated disclosure of the falsity of prior inflationary statements are not recoverable damages.  This reduces the value of securities cases.


3.Tougher Scrutiny on Class Certification


a.Why the judicial interest in this topic?  Courts are requiring more evidentiary proof of requisites of certification (although not a full merits analysis), and Rule 23(f) exists as a mechanism for interlocutory appellate review of class certification decisions.


b.Unger v. Amedisys Inc., 401 F.3d 316 (5th Cir. Feb. 17, 2005):  not necessarily efficient market for over the counter traded company.


i.In this Rule 23(f) interlocutory appeal, class certification was vacated in a lawsuit against a home health care services company traded on the OTC Bulletin Board.  The key was that the district court had applied too lenient a standard in determining whether the fraud on the market presumption applied:  “careful certification inquiry is required,” and “findings must be made based on adequate admissible evidence to justify class certification.” 


ii.For small-cap stocks traded in less-organized markets, the efficient market is not a given, and this means that the indicia of market efficiency (such as the ability to use S-3s instead of S-1s or S-2s) must be considered analytically.  In this case, however, the district court merely looked at some of the Cammer factors, and not with real data.  For example, plaintiffs never proved the actual number of shares regularly traded; the court relied on two printouts from the Internet, which it conceded could have double counted trades.  The court also failed to consider the anti-efficiency factors, such as the lack of any analyst coverage.


c.Bell v. Ascendant Solutions, Inc., 422 F.3d 307 (5th Cir. Aug. 23, 2005):  no efficient market for NASDAQ traded company.


i.In this Rule 23(f) interlocutory appeal, denial of class certification was affirmed in a lawsuit against Internet services company that announced the loss of three of its seven largest customers within three months after its successful IPO.


ii.Defendants had submitted an expert report to the effect that the company’s stock did not trade in an efficient market – even though it was a NASDAQ company.  The key factors here are that the class period was a short period of time after the IPO – a time span that included the 25 day quiet period, when there was no analyst coverage; and the day of the IPO itself, when there was not a pre-existing efficient market.


iii.The appellate court rejected plaintiffs’ contentions that the lower court had impermissibly gone beyond the pleading stage.  To the contrary, courts are not to accept mere allegations of market efficiency at the class certification stag, under Unger v. Amedisys, which was not limited to just the small cap context.


iv.The district court had struck plaintiffs’ expert report, which was based on an event study, under Daubert, on the basis that the report was unreliable and had been designed to support its market-efficiency conclusion.   That ruling could not be challenged under Rule 23(f), which is limited to the decision to certify (!).


d.First Circuit companion decisions in In re PolyMedica Corp. Sec. Litig., ___ F.3d ___, 2005 WL 3384083 (1st Cir. Dec. 13, 2005); and In re Xcelera.com Sec. Litig., 430 F.3d 503 (1st Cir. Dec. 13, 2005).


i.In PolyMedica, Rule 23(f) interlocutory appeal was granted, and class certification vacated as to a portion of a class period challenged by defendants, in a lawsuit against a medical devices company.  The district court had improperly rejected the definition of the efficient market proffered by defendants:  “an efficient market is one in which the market price of the stock fully reflects all publicly available information.”  Hence, it had failed to consider defendants’ expert’s challenges to an efficient market based on factors outside of the standard Cammer test:  the expert opined that there were constraints in the availability of shares to short, and hence for the mechanisms of the efficient market to operate.   However, plaintiffs need not show “fundamental value” efficiency – i.e., that the market reflects all information not only quickly but accurately and hence prices the stocks correctly.  Rather, all that need be shown is “informational efficiency,” which requires an inquiry into the structure of the market and the speed with which all publicly available information is impounded in price.


ii.In Xcelera, Rule 23(f) interlocutory appeal was granted, and class certification affirmed, in a lawsuit alleging that company failed to disclose contingent liabilities in its acquisition of an Internet portal.  The district court had conducted a two day hearing and considered hundreds of pages of briefs before agreeing to certify, care that distinguished the case from Unger.  The district court’s decision was not erroneous because defendants’ anti-certification arguments, which the court rejected, explicitly were addressed to the notion that the market was not fundamentally value efficient.  The district court did not err in resolving the competing evidence in plaintiffs’ favor and finding that the a correlation between stock price movements and the release of publicly available information about a company (the most important Cammer factor) had been shown by plaintiffs’ expert’s detailed and sophisticated event study.  The finding of an efficient market also could be supported even though there was only one analyst that followed the company.


e.Related topic:  increasing difficulty to certify Section 11 classes.


i.In re Initial Public Offering Sec. Litig., No. 21 MC 92 (SAS) etc., 2004 WL 2297401  (S.D.N.Y. Oct. 13, 2004):  the court granted a motion to certify classes in the IPO laddering test cases.  However, for the ’33 Act claims, the court limited the class period in each case for the from the date of an issuer’s IPO to the date on which unregistered shares of the issuer first entered the market, which at the latest is the date the lock-up expires.  Moreover, the court allowed the underwriters to show that shares not registered in the IPO had ntered the market earlier, and implied that if even one such share was released to the market, that would end the class period.  The plaintiffs had contended that it was reasonable to assume that purchasers could trace up until that point in time in which half of the shares in the public market were issued pursuant to an IPO registration statement.


ii.Krim v. pcOrder, 402 F.3d 489 (5th Cir. Mar. 1, 2005) (DLA Piper Rudnick Gray Cary case):  dismissal for lack of standing and denial of intervention in ’33 Act lawsuit against computer company and affiliates affirmed.  One of the three lead plaintiffs purchased shares at a time when all shares in the market necessarily had been issued pursuant to the registration statement (in the form of a 2.5 million share stock certificate at Cede & Co.).  By the time the other two plaintiffs purchased (two months later), insider shares not registered in the offering had entered the Cede certificate, and plaintiffs’ expert “acknowledged that there is no way to track individual shares within a pool once it becomes contaminated with outside shares.”  The district court concluded that this meant that these plaintiffs could not trace all of their shares to the public offering, as required, even though the probability that each plaintiff owned at least one share of PO stock was very nearly 100%.  The defendants offered the viable plaintiff a 100% recovery under the statute, which the court imposed as an “involuntary settlement.”  This left no lead plaintiff with standing and hence no subject matter jurisdiction.  Plaintiffs appealed the dismissal for lack of subject matter jurisdiction (standing) and of intervention to bring in proposed substitute class representatives (who had the same tracing issue); they did not appeal the denial of class certification.  The appellate court agreed with the district court that a very high statistical probability alone could not demonstrate §11 standing.  Accepting that logic would mean that every aftermarket purchaser would have standing for every share, despite the language of §11 limiting suit to “any person acquiring such security” (ones issued pursuant to a false or misleading registration statement).  This would be the case if the standard was 50% (that it was more likely than not that a particular share was issued pursuant to a registration statement), and even at lower percentages (since a plaintiff could purchase multiple shares, with a good chance that at least one share had been issued in the public offering).  The court rejected plaintiffs’ plea to ignore or rewrite the statute based on the argument that “given the fungible nature of stocks within a street name certificate, it is virtually impossible to differentiate PO shares from non-PO shares.”  Denying this form of “proof” did not amount to a rejection of statistical proof methods across the board (such as the use of DNA evidence).  In contrast to those methods, the statistics proffered in this case “say nothing about the shares that a specific person actually owns and have no ability to separate those shares upon which standing can be based from those for which standing is improper.”


f.Impact:  do not treat class certification as a formality.


4.Acquittal of Healthsouth CEO Richard Scrushy


a.See enclosed article about the acquittal, which as announced on June 28.


b.All five CFOs who had served under Scrushy pleaded guilty of criminal charges in a $2.7 billion securities fraud, but the jury did not find beyond a reasonable doubt that the CEO was in on the fraud


c.The private civil case against him (the company settled for $100 million) and an SEC action continue.  Will this be an OJ / Robert Blake- type resolution?


i.New development:  on January 4, 2006, a judge ordered Scrushy to repay the $47 million in bonuses he had received.


d.The acquittal followed on the heels of the acquittal of former HBO & Co. CFO Hawkins, as referenced above.


e.Of course, not all corporate defendants won – ask Dennis Kozlowski or John Rigas.


5.Freeze of large severance payments to departing officers:  Ninth Circuit reversal en banc in Securities & Exchange Comm’n v. Gemstar-TV Guide Int’l, Inc., 401 F.3d 1031 (9th Cir. Mar. 22, 2005) (en banc).


a.An earlier interlocutory appeal reversing determination and injunction(s) that termination payments to former CEO and CFO constituted “extraordinary payments” under Section 1103 of the Sarbanes-Oxley Act, warranting an escrow of those payments (as obtained by the SEC), was reversed by nearly unanimous en banc court.


b.Only four days before the revelation to the public about the company’s inaccurate revenue claims, the CEO disposed of 7 million shares, receiving an initial payment of $59 million – and “[n]o doubt the purchasers of these shares believed they were getting fair value for their money, only to see the roof fall in when the facts became public.”  “Simultaneous with the internal and external unraveling of this creative accounting mess,” the CEO and CFO were cutting a new deal with the Board to “resign” from their respective executive positions--but remain as employees--in return for huge cash payments.


c.The majority opinion held that the statute was not unconstitutionally vague, and that the payments were extraordinary.  This was a “textbook example” of the problem Congress sought to address, as the amount and unusual nature of the payments rendered them extraordinary.  “In the context of a statute aimed at preventing the raiding of corporate assets, ‘out of the ordinary’ means a payment that would not typically be made by a company in its customary course of business.  The standard of comparison is the company’s common or regular behavior,” judged by a variety of factors.   The district court had it exactly right when it focused on the nature, purpose, and circumstances of the payments and determined that they had nothing to do with the company’s ordinary business.  The CEO had taken the Fifth in refusing to testify about the payments, and the officers were paid much more than they otherwise would have received in compensation had they stayed on (as well as accrued vacation pay).


d.A concurring opinion would have applied an easier test:  “employing a well-established meaning of the word ‘extraordinary,’ I would hold that all severance packages due top corporate officers and officials, and any other substantial non-routine payments to which they may be entitled, constitute ‘extraordinary payments’ that the district court may order placed in escrow temporarily.” 


e.Judge Bea, the author of the original opinion, dissented.  In his opinion, the majority standard rendered suspect any payment, no matter how small, made by a company for the first time – an unworkable and vague standard.  Drilling into the record, there appeared good reasons for large payments, and the invocation of the Fifth said nothing about whether the payments were extraordinary.



© David Priebe 2017