Update: Another Go-Around For Loss Causation In The Ninth Circuit

ATTORNEY: MICHELE S. CARINO
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2015

Ten years ago, in its seminal decision in Dura Pharmaceuticals, Inc. v. Broudo, the Supreme Court held that in a securities fraud case the plaintiffs must allege facts establishing “loss causation,” meaning that the misrepresented or omitted facts actually caused losses for investors. This can occur, for example, when the company makes a “corrective disclosure” that reveals new or previously concealed information concerning the true state of the company’s affairs, which then causes the price of its stock to drop.

Since then, there has been a great deal of discussion as to how to apply the Dura rule, especially in cases where there has not been a single, or obvious, corrective disclosure. Recently, the Ninth Circuit has been asked to provide  some much-needed clarity in this area.

In August, in Smilovits v. First Solar Inc., a federal district court in Arizona certified for immediate interlocutory appeal the issue of the correct standard to apply for pleading loss causation in cases where the company does not explicitly “correct” any previous disclosures – i.e. admit that they were false or misleading. In such cases, two conflicting standards have emerged in the Ninth Circuit post-Dura, which the district court concluded would yield contradictory results in the case before it. First Solar involves allegations that the defendants withheld information about certain manufacturing defects in their products. Eventually, those defects started to affect the company’s financial condition, and its stock began to decline, falling from nearly $300 per share to less than $50 per share. Plaintiff identified six stock price declines following announcements of disappointing financial results. Although plaintiff claimed that the poor results were actually caused by these undisclosed manufacturing defects, the company did not admit it.

Applying the test articulated in Nuveen Mun. High Income Opportunity Fund v. City of Alameda, plaintiff contended that loss causation is satisfied “by showing that the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff’s economic loss.” On the other hand, defendants urged the court to adopt a much narrower view, which would require not only that the misrepresented or omitted facts caused the loss, but that the company admitted that its previous statements were wrong.

In support of this argument, defendants relied on another line of Ninth Circuit case law beginning with Metzler Investment GMBH v. Corinthian Colleges, Inc. The Metzler line of cases requires a showing that “the market learn[ed] of a defendant’s fraudulent act or practice, the market react[ed] to the fraudulent act or practice, and plaintiff suffer[ed] a loss as a result of the market’s reaction.” According to defendants, since First Solar’s poor earnings announcements were not accompanied by any revelation of a prior fraud, plaintiff could not demonstrate the requisite “causal connection” between defendants’ alleged misrepresentation or omission and plaintiff’s loss.

The district court ultimately determined that Nuveen stated the better rule, holding that the requirements of proximate cause are satisfied so long as the misrepresented fact led to the plaintiff’s loss. Thus, it does not matter whether the company reveals that it has committed a fraud. As the district court explained: “If the plaintiff can prove that the drop in revenue was caused by the misrepresented fact and that the drop in his or her stock value was due to the disappointing revenues, the plaintiff should be able to recover. A causal connection between the ‘very fact’ misrepresented and the plaintiff’s loss has been established.”

An affirmance in First Solar by the Ninth Circuit potentially would have far-reaching implications, because it would prevent companies from averting liability simply by refusing to admit that misstatements had been made. It might also put an end to the ongoing dispute over whether the announcement of governmental investigation, followed by a drop in a company’s stock price, satisfies the loss causation test under Dura. The Ninth Circuit has adopted the reasoning in Loos v. Immersion, which like Metzler, holds that disclosure of an investigation is insufficient to establish loss causation, because “[t]he announcement of an investigation does not ‘reveal’ fraudulent practices to the market,” but only the possibility that a fraud may have occurred. Loos requires something “more” – presumably, some revelation or actual accusation of fraud. However, as the First Solar court recognized, application of Nuveen in cases like Loos yields a completely different outcome, so long as plaintiffs establish that the ‘very fact’ misrepresented, e.g., the undisclosed fraudulent conduct prompting the investigation, caused the stock to decline in value.

The First Solar approach also makes eminent sense as a policy matter. Requiring revelation of fraud before losses are actionable rewards defendants who issue bare bones disclosures or time the announcement of poor financial results to coincide with other events, even though they may have knowledge of the real causes of the company’s difficulties. When and if an actual fraud is revealed, there may be no subsequent price decline, as the market has already incorporated and accounted for the previously-disclosed bad news, and therefore, there is no actionable corrective disclosure. Thus, defendants who succeed at concealing fraud are most likely to be insulated from liability. That is the exact opposite result sought to be achieved by the federal securities laws. We will have to wait to see if the Ninth Circuit agrees.

Leakage Theory is No Longer Just a Theory

ATTORNEY: MICHAEL J. WERNKE
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2015

It all started ten years ago with a question posed by  Justice Stevens during oral arguments in Dura Pharm., Inc. v. Broudo: “What if the information leaks out and there’s no specific one disclosure that does it all and the stock gradually declines over a period of six months?” Until last month, this question remained in the “what if” category of securities fraud jurisprudence. We now have an answer. In Dura, the Supreme Court held that a plaintiff in a securities fraud action must plead the element of loss causation, i.e. that the company’s stock price declined once the truth was revealed through a corrective disclosure. At trial, the plaintiff must ultimately prove that the decline in stock price was a result of the fraud – not market, industry or company-specific nonfraud factors. Since Dura, courts have universally held that loss causation can be established even if the truth is revealed through multiple “partial” corrective disclosures that drove the stock price down.

Courts have also acknowledged that, in theory, a company’s stock price could decline as a result of the truth “leaking” into the market without any actual disclosures of the fraud. For example, the stock price may move because insiders traded on the inside fraud related information prior to a disclosure, or because investors gradually lost confidence in the company’s previous misrepresentations even though the truth was not yet officially disclosed. However, in practice, courts have until now required plaintiffs to connect any decline in stock price to an identifiable “corrective” disclosure. 

The Seventh Circuit’s June 21, 2015 decision in Glickenhaus & Co. v. Household International, Inc. has lifted that restriction, creating the possibility that investors may recover losses resulting from the gradual decline in a company’s stock price that is not directly connected to any corrective disclosure, but which can be attributed indirectly to the unraveling of the underlying fraud. 

In Household, the defendants appealed to the Seventh Circuit a jury verdict finding them liable for securities fraud on the basis that the causation/damages model adopted by the jury failed to establish loss causation. The plaintiffs had presented two models to the jury. The first, a “Specific Disclosure Model,” identified fourteen partial corrective disclosures that revealed the truth to the market and calculated the price declines that followed within the next day, removing price movements attributable to market and industry factors. This model determined that disclosure of the fraud led directly to investor losses of $7.97 per share. The second analysis, the “Leakage Model,” attributed to the fraud all the price declines during the year-long period of partial disclosures, except for declines caused by market or industry factors. Using this model, plaintiffs calculated that losses per share were $23.94. The jury adopted the Leakage Model and damages were ultimately determined to be $2.46 billion.

In their appeal, the defendants argued that the Leakage Model was flawed because it included price declines that did not immediately follow any of the partial disclosures of the fraud. While the Leakage Model eliminated market and industry factors, it did not identify and eliminate the effect of company-specific, nonfraud news on the stock price, which may have contributed to the decline in stock price during the periods between the fourteen partial corrective disclosures. Instead, plaintiff’s expert testified in general terms that he considered the issue but was unable to conclude that non-fraud news would have altered the analysis. The question before the court was whether that was enough or whether the model itself must fully account
for the possibility that company-specific, nonfraud factors affected the stock price.

The court refused to answer simply “yes” or “no,” as doing so would create an unfair advantage for plaintiffs or defendants. Accepting the defendants’ position would likely doom the leakage theory because it may be “very difficult, if not impossible,” for any statistical model to separate damage caused by “leakage” from damage caused by release of company-specific news unrelated to the fraud. On the other hand, if it’s enough for an expert to offer a conclusory opinion that no company-specific, nonfraud related information affected the stock price, then plaintiffs may be able to easily evade their burden of proving that the loss for which they seek recovery was a result only of the alleged fraud.

The court chose a middle ground, creating burden-shifting process to be used at trial. It held that if the plaintiffs’ expert testifies in a nonconclusory fashion that no company-specific, nonfraud related information contributed to the decline in stock price, then the burden shifts to the defendants to identify some significant, company-specific, nonfraud related information
that could have affected the stock price. If the defendants can, then the burden shifts back to the plaintiffs to account for that specific information or provide a model that doesn’t suffer from the same problem. Significantly, the court stated that one solution for the plaintiffs would be to simply exclude from the model’s calculation any stock price movements directly related to the company-specific nonfraud information identified by the defendants. 

While the defendants won the battle – the case was remanded to the trial court – investors may have won the war. Plaintiffs’ recoveries in a securities fraud action are no longer limited to stock price declines immediately following specific disclosures of the fraud. Moreover, the
Seventh Circuit provided a clear roadmap for the creation and use of a leakage model that can withstand judicial scrutiny (at least in the Seventh Circuit). 

Notably, this decision came only a year after the Supreme Court’s decision in Halliburton II, which dialed back the more rigid views of market efficiency which had previously been employed by many of the lower courts, and installed a similar burden-shifting process for that analysis. The Seventh Circuit’s decision could be viewed as a road marker in a forming trend of courts taking a more practical view of how securities markets function and investors’ burdens in proving their losses from frauds.

Ninth Circuit Refuses to Follow Second Circuit's Insider Trading Decision

ATTORNEY: LEIGH HANDELMAN SMOLLAR
POMERANTZ MONITOR JULY/AUGUST 2015

In a controversial decision written by Manhattan U.S. District Judge Rakoff, sitting by designation, the 9th Circuit recently upheld an insider trading conviction and, in the process, refused to follow the standard established by the Second Circuit in its Newman opinion decided in 2014. That case made it more difficult to convict recipients of inside information (“tippees”) by requiring the govern-ment to show that the tippee was not only aware that the information came from a corporate insider, but also that he or she knew that the insider (the “tipper”) had received a tangible benefit in exchange for leaking the information, a benefit that was “objective, consequential and rep-resents at least a potential gain of a pecuniary or similarly valuable nature.” Newman rejects the theory that leaking to enhance a personal, family or business relationship satisfies the personal benefit requirement. Several guilty pleas obtained from tippees were overturned based on the decision.

The Newman case involved tippees who were several layers removed from the tipper’s original disclosure of inside information. When inside information is passed around an investment firm, for example, it may be difficult to prove that someone way down the information food chain was aware of the original source of the leak and that the tipper had received a personal benefit.

In U.S. v. Salman, decided July 6, 2015, the 9th Circuit has refused to follow Newman. In that case Salman’s brother- in-law leaked inside information to his own brother, who in turn, shared that information with Salman. The evidence at trial showed that Salman knew that his brother-in-law was the original source of the inside information.

But the evidence also showed that Salman did not know about any tangible economic benefit received by his brother-in-law in exchange for leaking the information.

But the 9th Circuit disagreed with the Second Circuit in Newman and affirmed the conviction anyway. The court held that the “personal benefit” requirement did not require that the tipper receive a financial quid pro quo. Instead, it held that it was enough that Salman “could readily have inferred [his brother-in-law’s] intent to benefit [his brother].” In declining to follow Newman, the court noted that if the standard required that the tipper received something more than the chance to benefit a close family member, a tipper could provide material non- public information to family members to trade on as long as the tipper “asked for no tangible compensation in return.”

Are Airlines Conspiring to Keep Prices High?

ATTORNEY: JAYNE A. GOLDSTEIN
POMERANTZ MONITOR JULY/AUGUST 2015

Since 1978, when Congress enacted the Airline Deregulation Act (“ADA”), the domestic airline industry has been deregulated. The Act did away with govern-mental control over fares, routes and market entry of new airlines, leaving market forces to dictate these aspects of the industry, and causing the airlines to compete over fares, routes and seats.

Times have changed. Since 2005, with the merger of US Airways and America West, the airline industry has been significantly consolidated. The Delta and Northwest merger followed in 2008, the United and Continental merger in 2010, and the Southwest and AirTran merger in 2011. Most recently, American and US Airways merged in 2013, creating the biggest airline in the world. Today, American, United, Southwest and Delta account for over 80% of the domestic airline market. So much concentration of market power makes it easier for the few remaining behemoth competitors to rig the market.

On June 11, 2015, the New York Times published the article, “‘Discipline’ for Airlines, Pain for Fliers,” in which it revealed that airlines had discussed maintaining “discipline” at a recent industry conference at the International Air Transport Association (“IATA”) held in Miami earlier that month. “Discipline” in this context is a euphemism for limiting flights and seats, raising prices and increasing profit margins. At the meeting, Delta Airline’s president, Ed Bastian, stated that Delta was “continuing with the discipline that the market place is expecting.” Also at this meeting, American Airlines’ chief, Dough Parker, stated that the airlines had learned their lessons from past price wars: “I think everybody in the industry understands that,” he told Reuters. In May 2015, Defendant Southwest’s chief executive, Gary C. Kelly, had considered breaking ranks and announced that Southwest would expand capacity in 2015-2016 by as much as 8 percent. However, after coming under fire at the IATA conference in June 2015, Mr. Kelly changed his position, stating, “We have taken steps this week to begin pulling down our second half 2015 to manage our 2015 capacity growth, year-over- year, to approximately 7 percent.”

The “discipline” is paying off; it is projected that airline industry profits will more than double in 2015, to a record nearly $30 billion. When airlines (or other companies) collude to restrict capacity in their routes and seats, they are subject to violating the antitrust laws. When companies are not competing in the marketplace, consumers foot the bill with high prices.

Several senators called for a federal investigation of U.S. airline prices, which have not come down, despite the fact that the price of jet fuel has fallen dramatically. In mid-June, Senator Richard Blumenthal (D-Conn.) asked the Department of Justice to investigate possible collusion and anti-competitive behavior by U.S. airline companies following the meeting of top executives at the IATA annual conference. It appears that the Department of Justice heard the senators’ requests, and is now investigating whether American, United, Southwest and Delta colluded to restrain capacity and drive up fares, an antitrust violation. On July 1, 2015, the airlines confirmed that the DOJ had requested information from them about capacity and other matters.

In the wake of alleged collusion among the airlines, numerous lawsuits have been filed. On July 10, 2015, Pomerantz instituted an antitrust class action on behalf of direct purchasers of airline tickets against American, United, Southwest and Delta. The case is pending in the Northern District of Illinois.

Our Walter Case Survives Motion To Dismiss

ATTORNEY: MURIELLE STEVENS WALSH
POMERANTZ MONITOR JULY/AUGUST 2015

Judge Ungaro of the U.S. District Court for the Southern District of Florida has recently denied the motion to dismiss our complaint against Walter Investment Management and several of its officers.

The case alleges that the defendants misrepresented that the company had sound internal controls and was in compliance with federal regulations regarding mortgage servicing, when in fact one of the company’s primary subsidiaries, Green Tree Servicing, had engaged in rampant violations of federal consumer laws. Walter’s stock price declined when the company revealed that the government was investigating it for these violations. Defendants initially moved to dismiss our original complaint, arguing that the disclosure of the investigation was not enough to establish loss causation, a requirement for a securities fraud claim. The court agreed, because under applicable 11th Circuit standards, the disclosure of a government investigation and possible government action, standing alone, were not enough to establish loss causation. The theory is that an investigation means that there is merely some possibility that violations had occurred, which the court held is not certain enough to amount to a “corrective disclosure” that the company’s statements about legal compliance were wrong. The court did, however, grant us leave to amend the complaint.

Our second amended complaint included the new allegation that the government announced that it had decided to bring an enforcement action against the company to seek injunctive relief and fines. Importantly, analysts factored this development into their price target for Walter stock. We included these facts in our amended complaint; and the judge found that this disclosure was sufficient to establish loss causation – even though the initiation of a lawsuit by itself is not tantamount to a “corrective disclosure” either, because the company still could prevail at trial. But the Court held that the bringing of the government action moved the potential losses much closer to reality.

Ultimately, the company settled the government case, agreeing to injunctive relief and the payment of fines. 

Whether disclosure of an investigation satisfies the “loss causation” requirement is a contentious issue in securities fraud litigation. Typically, it is such disclosures that actually trigger most of the losses; after that point, the market factors into the market price much of the risk of eventual litigation and its consequences.

Omnicare

ATTORNEYS: JESSICA N. DELL AND H. ADAM PRUSSIN
POMERANTZ MONITOR JULY/AUGUST 2015

In March, the Supreme Court, in a case called Omnicare, tackled the issue of when statements of opinion that appear in a registration statement can violate Section 11 of the Securities Act. Section 11 creates a private right of action for investors who purchased shares in an initial public offering when the registration statement contained materially false or misleading information. Unlike theantifraud provisions of the Exchange Act, Section 11 does not require that the investor show that the issuer, or the directors who signed the registration statement, had a culpable state of mind. If the registration statement was wrong, defendants are liable. The company is subject to strict liability; the directors can escape liability only if they can establish an affirmative defense.

In Omnicare the registration statement expressed the belief that the rebates Omnicare was receiving from suppliers were legal. In its decision below, the Sixth Circuit had held that under Section 11 a statement of opinion or belief can violate Section 11 if the opinion or belief turned out to be wrong – even if the issuer and its directors sincerely believed it at the time.

The Supreme Court rejected that view, holding that statements of opinion or belief are not “misstatements of fact” for purposes of Section 11. “Most important, a statement of fact (‘the coffee is hot’) expresses certainty about a thing, whereas a statement of opinion (‘I think the coffee is hot’) does not.” Because statements of opinion do not convey certainty about the subject, the Court rejected the contention that an expression of opinion or belief can be a misstatement of fact simply because it turned out to be wrong. Instead, the Court held that beliefs or opinions can be misstatements of fact only if the issuer did not really believe them at the time. While opinions themselves may be subjective, whether one holds them or not is an objective fact. In Omnicare, defendants clearly believed what they had said, so there was no misstatement of fact.

But the Court’s opinion did not stop there. It also held that a reasonable investor is entitled to assume that the issuer had a basis for the opinion or belief it is conveying. For example, if the issuer says that it believes that certain of its business practices are in compliance with applicable law, as Omnicare did here, it would also have to disclose whether it had formed that belief without consulting a lawyer, or if its lawyers had given contrary advice. Omissions can render those statements misleading if “the investor … identifies particular (and material) facts going to the basis for the issuer’s opinion—facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.”

This issue is going to be the focus of future litigation over Section 11 liability for statements of opinion or belief. What type of foundation can investors reasonably assume a company has for such statements, and what qualifies as a material fact that had to be disclosed because it might undermine that assumed foundation? Time will tell.

Petrobras: The Whole Barrel is Tainted, Not Just Four Rotten Apples

ATTORNEY: JUSTIN NEMATZADEH
POMERANTZ MONITOR JULY/AUGUST 2015

On July 9, 2015, Pomerantz won a significant victory for investors against Petrobras, the Brazilian energy giant, and four of its senior executives, when the district court rejected defendants’ motion to dismiss the action. For years Petrobras has been embroiled in a massive scandal, as prosecutors there have been pursuing the largest corruption investigation in that country’s history.In 2009 Petrobras had a market capitalization of $310 billion; now, since this massive scheme came to light, itis down to $55 billion. As the Monitor previously reported, the scheme involved overcharging Petrobras for goods and services, with the excessive payments being used to bribe a host of Petrobras and government officials.This scheme was allegedly orchestrated by four Petrobras officials, all of whom are defendants in our action.

The heart of the company’s motion was its contention that scienter, or knowledge, of the wrongdoing was limited to four “rogue” officers of the company, and that their knowledge cannot be “imputed,” or attributed, to the company, under the so-called “adverse interest” theory. Normally, a company is deemed to know what its senior executives know; but if those executives are acting for their own personal interests, and contrary to the interests of their company, they are acting outside the scope of their employment and their knowledge is not imputed to the company. Here, defendants argued that the officers’conduct was adverse to the company’s interests because the scheme diverted cash from the company, as a result of the overcharges the company paid, and into the pockets of the four individual defendants and various corrupt politicians and other conspirators. In addition, by artificially inflating asset values on Petrobras’ balance sheet,defendants argued that the individuals harmed the company by causing it to pay excessive prices that were reflected in the carrying value of those assets.

But, as senior Pomerantz partner Jeremy Lieberman explained to the Court at the hearing on the motion to dismiss, knowledge of the scheme was not limited to the four “rotten apples,” but was, in fact, widely disseminated in the company. Most notably, perhaps, he highlighted evidence showing that the Petrobras board was aware of the over billing scheme. Moreover, he argued that the adverse interest exception applies only when the company receives no benefit what-soever from the misconduct. Here,in contrast, the beneficiaries of the scheme were officials of the Brazilian government – which owns 51% of Petrobras’ stock. Moreover, by failing to correct the company’s fraudulent financial statements,the defendants were benefiting Petrobras by avoiding a massive write-down of the company’s assets.

Defendants also argued that the scheme was immaterial because its payments to contractors were inflated by only 3% and that the four conspirators received kickbacks amounting to a small portion of this 3%. As a result, when the scheme was disclosed Petrobras was forced to write off only $2.5 billion of property, plant and equipment on its balance sheet, about 8% of the total assets. In fact, however, our well-founded allegations showed that Petrobras was over billed by about 20%, not 3%, and that the $2.5 billion write-down reflected only a small fraction of the actual impact of the fraudulent scheme.

Delaware Ban on Fee-Shifting ByLaws Signed Into Law

ATTORNEY: SAMUEL J. ADAMS
POMERANTZ MONITOR JULY/AUGUST 2015

In a victory for shareholder rights, Delaware’s Governor recently signed into law a bill that prohibits fee-shifting bylaws for Delaware-incorporated publicly traded corporations. The bill was passed in response to a growing number of Delaware stock corporations that had recently begun adopting fee-shifting provisions that sought to pass defense costs on to unsuccessful shareholder plaintiffs or, in some cases, even plaintiffs that were only partly successful in a lawsuit for breach-es of fiduciary duty or other similar claims. Because shareholder plaintiffs – like plaintiffs in all other kinds of actions – almost never prevail on all counts asserted in a complaint, the specter of crushing financial liability from such bylaws threatened to choke off almost all shareholder litigation, regardless of the merits.

The increasing number of fee-shifting bylaws adopted by Delaware corporations stemmed from the Delaware Supreme Court’s decision last year in ATP Tour v. Deutscher Tennis Bund, which upheld a fee-shifting bylaw enacted by a private company. In that decision, the court held that a private Delaware corporation may adopt a bylaw which shifts all litigation expenses to a member plaintiff who does not obtain “a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.” While the ATP court did not weigh in on whether such a bylaw would be permissible in the context of a public company, some public corporate boards of directors sensed an opening. With dozens of public companies adopting such fee-shifting provisions, action was needed by either the legislature or the judiciary in order to clarify the enforceability of these bylaws.

Earlier this year, prior to Delaware’s enactment of the fee-shifting bylaw prohibition, Pomerantz was on the vanguard of the fight against fee-shifting provisions in a case of first impression in Strougo v. Hollander. In that opinion, the first to address fee-shifting provisions following ATP, the Delaware Court of Chancery found that a fee-shifting bylaw was inapplicable to a share-holder plaintiff and the class where the bylaw was adopted after a plaintiff had been forcibly cashed out through a reverse stock split. While not explicitly ruling on the broader issue of the applicability of fee-shifting bylaws generally to public corporations, Chancellor Bouchard found that the bylaw in that instance did not apply to the shareholder plaintiff both because the bylaw was adopted after the plaintiff had been forcibly cashed out as a shareholder, and also because Delaware law does not authorize bylaws that regulate the rights or powers of a stockholder whose equity interest in a corporation had been eliminated before the bylaw was adopted.

In enacting the bill, the Delaware legislature recognized the chilling effect that fee-shifting bylaws would likely have on the ability of shareholders to voice certain challenges to corporations in court. Because many public companies chose to incorporate in Delaware, the Delaware courts and judiciary have a substantial influence on corporate governance. The synopsis of the bill itself states that the prohibition on fee-shifting provisions was enacted “in order to preserve the efficacy of the enforcement of fiduciary duties in stock corporations.” While many believed that the Delaware courts would have ultimately invalidated fee-shifting bylaws for public companies, the bill obviated the need for the courts to weigh in on the issue. As a consequence, shareholder plaintiffs can seek to hold corporate fiduciaries accountable without the risk of liability to corporate defendants for potentially millions of dollars in attorneys’ fees.

In a compromise, the recently-enacted bill also affirmed the enforceability of forum selection bylaws which seek to dictate the exclusive court in which plaintiffs may file certain types of shareholder litigation, such as those asserting claims for breaches of fiduciary duty. In many cases, shareholder plaintiff can elect to file such litigation in either a public company’s state of incorporation or the state of a corporation’s head- quarters. For Delaware public companies that wish to limit such litigation to a particular venue, the Delaware legislature clarified that such forum selection clauses are enforceable, so long as Delaware is selected as the exclusive forum for such litigation.

Pomerantz Shatters the Glass Ceiling

POMERANTZ MONITOR, MAY/JUNE 2015

 Pomerantz LLP is once again at the vanguard of the legal field. In a recent report, Law 360 has ranked the firm No. 1 in Top Law Firms for Women: Class Action Securities Firms. Pomerantz is proud to boast a 40% rate of female partners, 40% rate of female Of Counsel, and a 50% rate of female associates. These numbers put Pomerantz near the head of women overall in law firms in the United States, and at the forefront of women in class action securities firms in particular. 

Managing Partner Marc I. Gross shared his thoughts on this distinction, stating, “Pomerantz is proud that its efforts to maintain a diversified staff of attorneys and partners has been so successful. We hope other firms will follow.”
Pomerantz is no stranger to cutting edge accomplishments in the legal field, consistently finding new and innovative ways to fight for our clients’ rights; we are proud of this latest recognition of our success. At a time when the gender gap in America’s workforce is a source of national controversy, Pomerantz strongly stands by our hiring practices, which ensure the best attorneys are chosen for the job of representing our clients. 

Partner Murielle Steven Walsh says, “As a young associate at Pomerantz, I was mentored by a women partner. That experience had a positive impact on my development as an attorney.” Ms. Steven Walsh has prosecuted highly successful securities class action and corporate governance cases, and has argued, and won, cases before the Second Court of Appeals. 

Among recent accolades for Pomerantz attorneys, Partner Jayne Goldstein, who heads Pomerantz’s Florida office, was featured in a recent Law 360 article, “The Female Attorneys You Admire”; and Tamar A. Weinrib, Of Counsel, was chosen as a New York Metro Rising Star in 2014. 

Pomerantz looks forward to keep pushing the envelope in this arena and others as we continue the legacy our founder, Abe Pomerantz, began almost 80 years ago.  

Subprime Redux – Will Securitized Subprime Auto Loans Cause the Next Financial Crisis?

ATTORNEY: C. DOV BERGER
POMERANTZ MONITOR, MAY/JUNE 2015

 Much of the blame for the 2008 financial crisis belongs to subprime mortgage lending - making loans to people who had difficulty maintaining the repayment schedule, and then bundling those loans into securities and selling them to investors. Now some observers are concerned that a recent jump in subprime auto loans could also mean disaster for markets.

Right after the financial collapse auto loans almost dried up completely, threatening the auto industry. But since then the subprime auto loan market has sprung back to life, as millions of Americans with tarnished credit easily obtained auto loans. According to the Federal Reserve Bank of New York, the number of auto loans made to borrowers with credit scores below 660 has nearly doubled since 2009 – a much greater increase than in any other loan type. Some sources place the increase at an even greater figure. According to the New York Times, in the five years since the immediate aftermath of the financial crisis, roughly one in four new auto loans last year went to borrowers considered subprime. Figures from two consumer credit tracking firms, Experian and TransUnion, show record amounts of auto loans on the books at the end of 2014. Not only were drivers buying more cars than any year since 2006, but they were spending more on each car they bought. 

The subprime auto loan market has some characteristics in common with the mortgage loan market. Risky sub-prime auto loans are being bundled into complex bonds and then sold by banks to insurance companies, mutual funds and public pension funds, just like subprime mortgage loans were in the late 2000s. Also, many subprime auto lenders are loosening credit standards and focusing on the riskiest borrowers. Recently, there have been a number of claims of abuse or outright fraud, as some lenders are accused of forging data on their customers’ loan applications, or committing borrowers into loans with terms substantially different than what had been negotiated. But most are hesitant to call the rise in subprime auto lending a bubble. 

Luckily, the overall auto loan market is comparatively small -- $900 billion -- compared to $8 trillion of mortgage loans. Subprime currently makes up about 30% of overall car loans. A higher rate of auto loan defaults probably won’t cause a market decline on a scale comparable to the mortgage crisis. Second, according to some economists, borrowers tend to make car payments a higher priority than mortgage payments or credit card bills, since they need their cars to get to work, school and for many other daily necessities.

Still, the rise in subprime auto loans has caught the attention of regulators. This past summer, federal prosecutors began a civil investigation into the packaging and selling of questionable auto loans to investors. The probe is focusing on whether checks and standards were neglected as the subprime auto loan market surged and whether some borrowers’ loan applications had false information about income and employment. In addition, investigators want to know how the loans, which were pooled and assembled into securities, were represented to investors and whether the lenders fully disclosed to investors the credit-worthiness of the borrowers. 

One company that has been targeted during the investigation is the finance subsidiary of General Motors G.M. Financial Company. In August, the company disclosed that it had received a subpoena from the U.S. Department of Justice directing it to produce certain documents related to its origination and securitization of subprime automobile loan contracts since 2007. The United States attorney for the Southern District of New York is also looking into G.M. Financial, as well as other auto finance companies. 

G.M. Financial, has been one of the largest sellers of auto loan backed bonds, selling a total of $65 billion in securities. This year, G.M. Financial sold investors roughly $730 million in bonds made up of auto loans that carried an average annual interest rate of about 13 percent. Standard & Poor’s gave most of the bonds an AAA rating, but given what we know now about the ratings agencies, that rating is highly suspect. 

With total loans expected to cross the $1 trillion mark by the end of this year or early in 2016, this issue won’t disappear anytime soon. So far, the rise in subprime auto lending hasn’t slowed investors’ appetite for auto loan backed bonds, and most analysts don’t expect a rise in borrower defaults to cause a catastrophic market meltdown like the subprime mortgage crisis. On the regulatory front, aside from a settlement by one auto loan finance company over accusations that it increased the cost of auto loans for minority borrowers, there haven’t been any formal charges brought. However, regulators are clearly taking a closer look and should charges be brought in the future, it could dramatically change the way investors feel about buying securities back by subprime auto loans.

Pomerantz Takes a Bite Out of For-Profit College Scheme in Corinthian Colleges

ATTORNEY: STAR M. TYNER
POMERANTZ MONITOR, MAY/JUNE 2015

On April 22, 2015, in Erickson v. Corinthian Colleges, Inc., Pomerantz scored a significant victory for investors against the much-criticized and poorly regulated for-profit college industry, when Chief Judge George King of the Northern District of California denied the defendant’s motion to dismiss the action. 

Corinthian Colleges was historically one of the largest for-profit college systems in the country, and when our firm filed an amended complaint in the case, the company was operating 111 campuses in 25 states. For-profit colleges are big business, making most of their profits from federal student aid programs. However, many for-profit colleges have come under fire in recent years for their deceptive practices (especially for their promises to adult students regarding the potential for gainful employment upon graduation), leading President Obama to implement new federal student loan and job placement guidelines. 

Our amended complaint alleges that Corinthian was misrepresenting its job placement rates, compliance with applicable regulations, and enrollment statistics. Our complaint relied on a host of sources: in addition to testimony from 15 confidential witnesses from all over the company, we also relied on documentary evidence cited in the California Attorney General’s complaint against the company (showing that job placement data was manipulated, errors were rampant, and placements were not verified consistently) and a Congressional report criticizing the for-profit college industry (especially with respect to Corinthian’s practice of constantly “churning” its student body to keep up enrollment rates, by enrolling massive numbers of new students each year to hide the fact that so many previous enrollees had dropped out after a short time). While the Court dismissed the regulatory compliance statements as too vague to be actionable, it upheld the job placement rate and enrollment statistic misrepresentations. 

The Court put all our allegations under a microscope and determined that the specific facts we alleged supported our claims that many of defendants’ public statements were false, and that the senior executive defendants knew it.

In addition, the Court agreed that we sufficiently alleged loss causation because public disclosures of the Attorney General’s lawsuit and the Congressional report raising these allegations led directly to significant drops in the market price for Corinthian’s securities.

This victory is especially noteworthy because Judge King has dismissed two prior lawsuits against Corinthian with similar allegations and because pleading loss causation in the Ninth Circuit has become particularly difficult in the wake of a recent decision by that court in another case.

How a Landmark Securities Case Helped Certify an Antitrust Class

ATTORNEY: MARK GOLDSTEIN
POMERANTZ MONITOR, MAY/JUNE 2015

Pomerantz currently acts as co-lead counsel for a class of third party payors and consumers in the antitrust action involving heartburn medication Nexium. The plaintiffs in this action allege that the branded dug company, AstraZeneca, and several generic drug makers violated antitrust laws by entering into agreements to delay entry of a generic version of Nexium. This type of case is often referred to as a pay-for-delay case where because the manufacturer of the brand name drug typically pays generic drug manufacturers to delay their entry to the market with a generic version of the brand drug. Such agreements have an obvious anti-competitive effect. 

These cases have been a hot topic in the legal community because the Supreme Court recently reviewed these types of cases and established a standard for analysis of such agreements. In June, 2013, the Supreme Court, in FTC v. Actavis, ruled that such pay-to-delay arrangements can run afoul of antitrust laws under a rule of reason analysis. The Court held that if plaintiffs could show that the brand name manufacturer made a large and unjustified payment to the generic drug makers that could be a violation of the antitrust laws. 

In late 2013, the District of Massachusetts granted plaintiffs’ motion for class certification of our Nexium case, finding that the “plaintiffs had adequately shown that (1) “prices [during the class period] for esomeprazole [the chemical name for Nexium] continued [to be] artificially high as a result of the defendants’ reverse payment agreements,” and (2) “that all class members have been exposed to purchasing or paying for [the drug] at a supracompetitive price.” The District Court also concluded that even though some members of the class did not suffer injury as a result of the alleged antitrust violation that was irrelevant because the vast majority of class members had been injured. 

Defendant appealed the District Court’s class certification ruling to the United States First Circuit of Appeals on the sole ground that the class included members who were not injured by the agreements. Defendants specifically gave the example that some individual consumers would continue to purchase branded Nexium for the same price even after generic entry – so called brand loyalists. Defendants relied on the First Circuit’s previous decision in In re New Motor Vehicles Canadian Export Antitrust Litigation, arguing that to obtain class certification Plaintiffs must show that, “each class member was harmed by defendant’s practice.” 

The First Circuit ultimately rejected that argument, concluding that “class certification is permissible even if the class includes a de minimis number of uninjured parties.” On the topic of the requirement that all class members be harmed the court stated, “[t]o the extent that New Motor Vehicles is read to impose such a requirement, it has been overruled by the Supreme Court’s Halliburton decision. But, in fact, New Motor Vehicles imposes no such requirement. 

In Halliburton, the Supreme Court addressed the treatment of potentially uninjured class members. Halliburton was a landmark securities case that reviewed the presumption of reliance in securities cases. Halliburton found that a securities class can presume that the investors relied on defendant’s misrepresentation when deciding to purchase or sell a stock rather than prove direct reliance of defendant’s misrepresentations for each individual class member and defendants can rebut this presumption. The Supreme Court stated, “[w]hile [the rebuttal] has the effect of leaving individualized questions of reliance in the case, there is no reason to think that these questions will overwhelm common ones and render class certification inappropriate under Rule 23(b)(3).” As a result, the First Circuit in In re Nexium, found that because Halliburton “contemplated that a class with uninjured members could be certified if the presence of a de minimis number of uninjured members did not overwhelm the common issues for the class,” the Nexium class can also be certified despite a de minimis number of uninjured members.  

Our Securities Fraud Case Survives Barclays’ Motion to Dismiss

ATTORNEYS: H. ADAM PRUSSIN, EMMA GILMORE
POMERANTZ MONITOR, MAY/JUNE 2015  

Pomerantz largely defeated defendants’ motion to dismiss our complaint against Barclays bank and several of its officers and directors. Our action accuses Barclays of making false and misleading statements about the operations of its “dark pool.” A “dark pool” is an alternative trading system that does not display quotations or subscribers’ orders to anyone other than to employees of the system. Dark pools were first established to avoid large block orders from influencing financial markets and to ensure trading privacy. Trading in dark pools is conducted away from public exchanges and the trades remain anonymous, lowering the risk that the trade will move the market price. About 15% of U.S. equity-trading volume is transacted in dark pools.

Precisely because these trades are conducted “in the dark,” institutional investors trading in these venues rely upon the honesty and integrity of their brokers and the dark pool operators to act in their clients’ best interest.

If given information about impending customer trades, high frequency traders in the dark pools can trade ahead of those customers and then profit at their expense by reselling the shares to complete the order. Studies seem to show that, as of 2009, high frequency trading accounted for 60%-73% of all U.S. equity trading volume. Keeping such traders away from the dark pools could help protect other investors from their front-running and other predatory trading practices.

After a series of scandals, and in particular disclosure of its manipulation of the LIBOR benchmark interest rates, Barclays commissioned an independent investigation of itself. As a result of the findings, it publicly pledged, among other things, to act with transparency and to impose strict controls over trading in its dark pool. These pledges, it turns out, were a sham. Barclays actually embarked instead on a campaign to make itself the largest dark pool in the industry, by hook or by crook.

An investigation by the New York Attorney General revealed that, in order to grow the dark pool, Barclays increased the number of orders that it, acting as broker, executed in the pool. This required that Barclays route more client orders into the dark pool, and ensure that there was sufficient liquidity to fill those orders. To convince the market of the safety of trading in its dark pool, Barclays represented that it would monitor the “toxicity” of the trading behavior in its dark pool and would “hold traders accountable if their trading was aggressive, predatory, or toxic.” Such “toxic” trading activity included high frequency trading, which it pledged to keep out of its dark pool.

But these alleged controls were illusory. One former director explained that Barclays “purports to have a toxicity framework that will protect you when everybody knows internally that [they don’t]”. Another former director described these controls as “a scam.” Our complaint alleged that Barclays representations about establishing a monitoring program to eliminate “toxic” trading from the dark pool were misleading because Barclays did not disclose that it did not eliminate traders who behaved in a predatory manner, did not restrict predatory traders access to the dark pool, did not monitor client orders continuously, and did not monitor some trading activity in the pool at all. In fact, plaintiffs allege, Barclays encouraged predatory traders to enter the dark pool.

The court’s decision is significant because of its emphasis on the importance to investors of corporate integrity. Barclays' motion to dismiss relied heavily on the contention that its misrepresentations about the dark pool were immaterial to investors because revenues from the dark pool were far less than 5% of the company’s total revenues. This figure is a statistical benchmark often used to assess materiality. In fact, revenues from the dark pool division contributed only 0.1% of Barclays total revenues. The court rejected Defendants’ myopic view of materiality and found that the misrepresentations went to the heart of the firm’s integrity and reputation, which had been jeopardized by its past well-publicized transgressions. The court’s decision means that misrepresentations about management’s integrity can be actionable even if the amounts of money involved in these transgressions falls below a presumptive numerical threshold. 

The court also held that Defendant William White, the Head of Barclays’ Equities Electronic Trading, was a sufficiently high-ranking official that his intent to defraud could be imputed to the company itself. The court explained that “there is strong circumstantial evidence of conscious misbehavior or recklessness on [his]part. “Not only was White the source of many of the allegedly false allegations about [the dark pool] but he was the head of Equities Electronic Trading at Barclays, “the driving force behind the Company’s goal to be the number one dark pool,” and he “held himself [out] to the public as intimately knowledgeable about LX’s functions and purported transparency.” 

Product Hopping, Big Pharma and the High Cost of Prescription Drugs

ATTORNEY: ADAM KURTZ
POMERANTZ MONITOR, MARCH/APRIL 2015

The Monitor has been reporting for years on so-called “pay for delay” schemes used by brand name drug manufacturers to stave off generic competition. Such schemes are subject to antitrust challenge as unlawful restraints of trade, and the Firm has been pursuing such cases vigorously.

Now there is a new scheme, called “product hopping.” In the classic version of this anticompetitive scheme, brand name manufacturers come out with a “new” version of their drug and stop production of the previous version altogether, forcing everyone taking that drug to switch to the new version, even if isn’t any better. The newly introduced drug likely has only minor changes from the existing one (e.g., from tablet to capsule; from immediate to extended release) and does not provide any improvement in its therapeutic benefits. But, since there are no generic competitors for the new version, the brand manufacturer can continue to reap monopoly profits for years to come. By the time a generic of the original formula enters the market, there is no longer a demand for the original brand formula, because it has been discontinued. State laws that require generic substitution do not apply because the new brand drug is slightly different that the original. As a result of a successful product hopping scheme, generic competition—which reduces brand drug prices by about 90%—will be eliminated.

The pushback is beginning against product hopping. Notably, a New York Federal District Court recently granted an injunction stopping a brand name pharmaceutical company, Actavis, from discontinuing sales of its popular Alzheimer drug Namenda IR. The court concluded that the move was an unlawful product hopping scheme intended to switch vulnerable Alzheimer’s patients from the existing Namenda formula, which will face generic competition in 2015, to a newer, slightly different formula, which will not have generic competition until 2029. By removing original Namenda from the market, Actavis would have forced Alzheimer’s patients to switch to the new drug, with all its attendant risks, and would eventually force them to pay billions of dollars more for the new brand name treatment.

New York Attorney General Eric T. Schneiderman successfully brought this antitrust case against Namenda’s manufacturer, Forrest Labs, (now owned by Actavis) alleging that the forced switch to a so-called new and improved version was nothing more than illegal attempt to maintain its $1.6 billion Namenda monopoly even after its patent expires. According to Schneiderman, “[a] drug company manipulating vulnerable patients and forcing physicians to alter treatment plans unnecessarily, simply to protect corporate profits, is unethical and illegal.” The federal district court agreed, although this decision is now on an expedited appeal before the United States Court of Appeals. Oral argument on the appeal is scheduled for April 13, 2015.

In the Namenda case, the brand drug company not only introduced a new once-a-day (extended release) capsule, but also announced that it intended to stop selling its original twice-a-day (instant release) tablet, which was soon to face generic competition. There is no therapeutic difference between the two formulations.

As another court defined the issue last year, “although the issue of product-hopping is relatively novel, what is clear from the case law is that simply introducing a new product on the market, whether it is a superior product or not, does not, by itself, constitute exclusionary [antitrust] conduct. The key question is whether the defendant combined the introduction of a new product with some other wrongful conduct, such that the comprehensive effect is likely to stymie competition, prevent consumer choice and reduce the market’s ambit.”

In particular, courts have increasingly found that where the brand drug company not only introduces a new drug version but also removes the original version of the drug from the market, it violates the antitrust laws. In cases involving the drugs Tricor and Doryx, the manufacturers introduced new versions of the drugs; stopped sales of the original versions; and removed unused inventory of the original formula from the market. In addition, in Tricor, the company changed the code for the original drug to ‘obsolete’ on an industry-wide database, which prevented pharmacies from filling Tricor prescriptions with a generic. In both cases, defendants’ exclusionary conduct restricted consumer choice. In the end, Tricor settled for in excess of $250 million, while Doryx is still pending.

More recently, In re Suboxone Antitrust Litig., allegations of another product hopping scheme were found sufficient to state an antitrust cause of action were the brand drug company not only introduced a new film version of the drug but made false safety claims about the original tablet version and threatened to remove the original version from the market. The court found that the “[t]he threatened removal of the tablets from the market in conjunction with the alleged fabricated safety concerns could plausibly coerce patients and doctors to switch from tablet to film.”

Pomerantz’s antitrust attorneys have been at the forefront of challenging anticompetitive conduct by pharmaceutical companies that seeks to block generic drugs, including product hopping schemes, pay-for-delay agreements and overall anticompetitive conspiracies that combine the two.

Is There Hope For Credit Rating Agencies?

ATTORNEY: ANNA KARIN F. MANALAYSAY
POMERANTZ MONITOR, MARCH/APRIL 2015

Anyone compiling a list of culprits in the U.S. subprime residential mortgage debacle of 2007-2008 would have to include the credit rating agencies at or near the top. Meant to provide investors with reliable information on the riskiness of various kinds of debt, the agencies have instead been accused of defrauding investors by giving triple-A ratings to mortgage-related securities so risky they were even considered doomed to fail by the banks that created them.

Why did this happen? Probably because the financial incentives for the ratings agencies have changed dramatically. In the past, credit rating agencies charged a subscription fee to subscribers to cover their rating activity. Then the practice changed, and the company or issuer being rated pays the fee. By switching to this business model, the ratings agencies assumed a crippling conflict of interest; for if they did not deliver high ratings regardless of the circumstances, issuers would shop around for a more compliant ratings agency the next time around.

The best-known credit rating agencies in the United States are Moody’s Investor Services, Standard and Poor’s, and Fitch. S&P issues nearly half of all credit ratings and together with Moody’s and Fitch, the so-called “Big Three” issue ninety-eight percent of the total ratings. On February 3, 2015, S&P agreed to pay $1.375 billion to settle lawsuits brought by the U.S. Department of Justice and 20 attorneys general concerning ratings S&P gave to certain mortgage securities just before the 2008 financial meltdown. So far, this has been the largest settlement involving a credit rating agency.

The press release issued by the Justice Department said the ratings at issue were given to residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) during the period 2004 to 2007. RMBS are created when a bank or other financial institution pools together mortgage loans. CDOs pool together cash flow-generating assets and repackages this asset pool into discrete tranches that can be sold to investors.

The lawsuit filed by the Justice Department in 2013 alleged that S&P had engaged in a scheme to defraud investors by knowingly inflating the credit ratings it gave to RMBS and CDOs which resulted in substantial losses to investors and ultimately contributed to the worst financial crisis since the Great Depression. The Justice Department claimed that S&P’s rating decisions were not independent and objective as they were required to be but, rather, based in part, on its business concerns.

As a part of the settlement, S&P agreed to a statement of facts that contained an admission that its ratings for CDOs were partially made based on the effect they would have on S&P’s business relationship with issuers. It also admitted that, despite knowledge within the S&P organization in 2007 that many loans in RMBS transactions it was rating were delinquent and losses were probable, it continued to issue and confirm positive ratings.

As credit rating agencies were being blamed for feeding a subprime mortgage frenzy, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in July 2010. Among its various provisions, Dodd-Frank outlined a series of broad reforms to the credit rating agencies market. Despite Dodd-Frank, however, some signs of trouble have re-emerged. In January 2015, for example, S&P paid nearly $80 million to settle accusations of the SEC that it orchestrated similar fraud in 2011, years after the financial crisis took place. S&P also agreed to take a one-year “timeout” from rating certain commercial mortgage investments at the heart of the case, an embarrassing blow to the rating agency. The pact is the SEC’s first-ever action against a major ratings firm.

The SEC has since issued new rules aimed to enhance governance, protect against conflicts of interest, and increase transparency. These rules, which went into effect January 1, 2015, require rating agencies such as S&P to: 

• provide records of their internal control policies and rating methodology;

• prohibit their sales teams from participating in the rating process;

• review, and revise if needed, ratings for companies that later hire one of the agency’s employees; and

• file annual reports showing how the agencies monitor ratings, how ratings changed over time and whether evaluated companies eventually defaulted.

If a credit rating agency violates these rules, the SEC will suspend or revoke the agency’s registration — disciplinary action that may be effective in preventing further violations. However, while the regulations do attempt to keep rating activity under strict surveillance, they do not restructure the way rating agencies solicit business or receive payment. Thus, the inherent conflict of interest still exists since the agencies are paid by the same banks and companies they rate.

The SEC has thus far failed to maintain control and ensure rating agencies follow proper rating methodologies — the multiple accusations against S&P attest to these failures — but only the health of the future financial market will tell whether the recent regulations, coupled with the hefty consequences credit rating agencies such as S&P have had to face, will have a long-term stabilizing impact.

Pomerantz Wins Important Motion, Post-Halliburton

ATTORNEY: JOSHUA B. SILVERMAN
POMERANTZ MONITOR, MARCH/APRIL 2015

When the Supreme Court issued its landmark decision in Halliburton v. Erica P. John Fund last summer, it did not give either side a total victory. Critically for investors, the Supreme Court reaffirmed the fraud-on-the-market presumption, which is necessary for class certification in most securities fraud actions. The presumption allows classwide proof of reliance, an element of Exchange Act claims, by demonstrating that the stock traded in an efficient market. In efficient markets, publicly-available information is incorporated into the stock price and traded on by all investors, so plaintiffs need not show that each class member actually heard or read the misrepresentations giving rise to the lawsuit. By reaffirming these principles, the Court ensured the continued viability of securities fraud class actions. However, at the same time, the decision offered defendants the ability to rebut the fraud-on-the-market presumption at the class certification stage by demonstrating that the alleged fraud did not affect the stock price.

Halliburton did not specify precisely how lower courts should determine market efficiency or lack of price impact. As lower courts begin to grapple with these issues, the early results are promising for investors. Thus far, district courts (and in one case, an intermediate court of appeals) have applied rational tests for both market efficiency and price impact, consistent with the principles set forth in Halliburton. 

The most important consequence of Halliburton may be to stabilize the law over what constitutes an efficient  market. In 1988, when the Supreme Court first recognized the fraud-on-the-market presumption, it declined to adopt any particular test for market efficiency. In the years that followed, most courts used the so-called “Cammer test,” which assessed, among other factors, trading volume, analyst coverage, and price movement following release
of important company-specific news. 

However, more recently defendants and their experts have urged courts to stack on top of the Cammer factors a litany of additional requirements lifted from the extreme end of academic debates about market efficiency. A significant minority of courts accepted these arguments, resulting in a patchwork of inconsistent standards. For example, some courts refused to certify cases involving stocks that moved in trends, theorizing that such trending—or serial correlation—was inconsistent with the belief of some academicians that efficient markets must be wholly unpredictable. Other courts looked to related options markets, holding that a lack of parity input and call options demonstrated constraints on arbitrage activity, and therefore showed market inefficiency. A few other courts suggested that impairments to arbitrage could also be found if the stock was difficult or expensive to sell short. 

Halliburton should put an end to these fringe academic tests. In its opinion, the Supreme Court emphasized that for purposes of the fraud-on-the-market presumption, market efficiency refers only to “the fairly modest premise that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.” As one law professor explained, Halliburton demonstrates that “the efficiency question is not meant to be particularly rigorous.” District courts appear to get the message. Since Halliburton, no district court has cited serial correlation, lack of put-call parity, or short-lending costs as a basis for denying class certification in a securities fraud class action. 

Recently, Pomerantz won an important motion addressing the continued relevance of fringe academic market efficiency tests. In the Groupon securities litigation, where Pomerantz serves as lead counsel, defendants had argued that plaintiffs’ class certification expert was unreliable because he failed to conduct put-call parity and short lending fee analyses. After an extensive evidentiary hearing, the court sided with Pomerantz, holding that such tests were unnecessary because they addressed an extreme variation of market efficiency that “was squarely rejected by the Halliburton court.”

District courts have also applied reasonable, consistent tests when assessing the price impact defense recognized in Halliburton. They have thus far uniformly rejected defendants’ attempts to show lack of price impact by demonstrating that some or all of the misrepresentations did not move the stock at the time they were made. Instead, recognizing that misrepresentations are used to artificially maintain as well as boost share prices, courts in the Regions Financial, IntraLinks, and Best Buy litigations have all held that price impact can be found where the share price declines when the truth is revealed, even if the stock did not move at the time the false statements were issued. Best Buy has been appealed, so the Eighth Circuit will soon weigh in on the issue.

Defendants have been equally unsuccessful in attempts to persuade courts to disregard price movement, where it does occur, by claiming it was caused by something other than the alleged fraud. For example, in Catalyst Pharmaceuticals, the court rejected expert testimony that the truth was already known to the market. Such evidence, the court held, did not disprove price impact but instead addressed whether the omitted information was material, an issue reserved for the trier of fact. By strictly enforcing the Supreme Court’s requirement that defendants prove the absence of price impact instead of just proffering different explanations for price moves, lower courts have ensured that the exception to the fraud-on-the-market presumption did not swallow the rule.

Courts will continue to construe Halliburton in the coming months, particularly in the Best Buy appeal and Halliburton itself (where the issue of price impact was remanded to the district court). If they apply the measured reasoning seen in early cases, it will bring much-needed consistency and predictability to the class certification process.

Delaware Court Refuses to Apply Fee-Shifting Bylaw

ATTORNEY: ALLA ZAYENCKIK
POMERANTZ MONITOR, MARCH/APRIL 2015

Pomerantz achieved an important corporate governance victory for stockholders in March when Chancellor Bouchard of the Delaware Court of Chancery refused to apply a fee-shifting bylaw to plaintiff and the class in Strougo v. Hollander. Fee shifting bylaws impose on plaintiff shareholders and their counsel the defendants’ entire litigation costs, unless the action achieves a complete victory, including an award of the entire remedy sought in the action. Such bylaws, if widely adopted, would foreclose virtually all shareholder litigation, regardless of the merits. Last year, in a case called ATP, the Delaware Supreme Court held that such bylaws can be legally enforceable, at least in some circumstances.

In Strougo v. Hollander, a closely-watched test case, Chancellor Bouchard issued the first Delaware opinion to address fee-shifting bylaws since the Supreme Court’s ATP decision last year. The Chancellor found that defendants cannot bind plaintiff and the class to a fee-shifting bylaw adopted after plaintiff had been forcibly cashed out through a reverse stock split.

Accepting the arguments proffered by Pomerantz partner Gustavo F. Bruckner, head of Pomerantz’s corporate governance practice, the Court found the bylaw inapplicable as to plaintiff and the Class under both Delaware contract and corporate law. Chancellor Bouchard explained that the Bylaw does not apply for two related reasons: (i) the Board adopted the bylaw after plaintiff’s interest in the company was eliminated by the reverse stock split; and (ii) Delaware law does not authorize a bylaw that regulates the rights or powers of former stockholders who were no longer stockholders when the bylaw was adopted.

The Chancellor found that “[A] stockholder whose equity interest in the corporation is eliminated in a cash-out transaction is, after the effective time of that transaction, no longer a party to [the] flexible [corporate] contract. Instead, a stockholder whose equity is eliminated is equivalent to a non-party to the corporate contract, meaning that former stockholder is not subject to, or bound by, any bylaw amendments adopted after one’s interest in the corporation has been eliminated.”

The Chancellor also commented on the underlying merits of the case and the effect of fee-shifting bylaws. He wrote “the Bylaw in this case would have the effect of immunizing the Reverse Stock Split from judicial review because, in my view, no rational stockholder—and no rational plaintiff’s lawyer—would risk having to pay the Defendants’ uncapped attorneys’ fees to vindicate the rights of the Company’s minority stockholders, even though the Reverse Stock Split appears to be precisely the type of transaction that should be subject to Delaware’s most exacting standard of review to protect against fiduciary misconduct.”

Prior to the Chancellor’s ruling, on March 6, 2015, the Council of the Corporation Law Section of Delaware State Bar Association issued proposed amendments to the Delaware General Corporation Law that would ban fee-shifting provisions from a company’s bylaws or charter. If enacted, the amendments will become effective on August 1, 2015.

Pomerantz Appointed Lead Counsel in Historic Petrobras Securities Class Action

ATTORNEY: FRANCIS P. MCCONVILLE
POMERANTZ MONITOR, MARCH/APRIL 2015

Pomerantz will take the helm on a consolidated group of securities class actions over revelations of rampant corruption at Petroleo Brasileiro SA (“Petrobras”), according to an order issued March 4, 2015 by New York U.S. District Judge Jed S. Rakoff. We were selected as lead counsel by lead plaintiff Universities Superannuation Scheme Ltd. (“USS”).

USS was chosen over three other candidates for lead plaintiff: the SKAGEN-Danske group, made up of three European asset managers; a group of three State Retirement Systems; and an individual investor.

The class action against Petrobras, brought on behalf of all purchasers of common and preferred American Depositary Shares (“ADSs”) on the New York Stock Exchange, as well as purchasers of certain Petrobras debt, principally alleges that Petrobras and its senior executives engaged in a multi-year, multi-billion dollar money-laundering and bribery scheme, which was, of course, concealed from investors. Senior management has openly admitted its culpability. In testimony released by a Brazilian federal court, the executive in charge of Petrobras’ refining division confessed that Petrobras accepted bribes “from companies to whom Petrobras awarded inflated construction contracts” and “then used the money to bribe politicians through intermediaries to guarantee they would vote in line with the ruling party while enriching themselves.” These illegal acts caused the company to overstate assets on its balance sheet, because the overstated amounts paid on inflated third party contracts were carried as assets on the balance sheet.

As of November 2014, the Brazilian Federal Police had arrested at least 24 suspects in connection with Petrobras’ money laundering and bribery schemes; and Brazil’s president, who was a senior Petrobras executive during the relevant period, has also been engulfed in this scandal. As a result of the fraudulent scheme, Petrobras may be forced to book a $30 billion asset writedown in order to reduce the carrying value of some of its assets. That impairment would equal approximately 42% of the company’s market value.

USS was not the lead plaintiff applicant with the largest losses from the fraud. Indeed, the SKAGEN-Danske group, with purported losses exceeding $222 million, asserted by far the largest losses of all the competing lead plaintiff applicants. However, although the securities laws establish a rebuttable presumption in favor of the appointment as lead plaintiff of the movant with the “largest financial interest” in the litigation, that movant must also “otherwise sastisf[y] the requirements of Rule 23 of the Federal Rules of Civil Procedure” under the Private Securities Law Reform Act (“PSLRA”).

In particular, USS and Pomerantz argued that the SKAGENDanske and State Retirement Systems were artificial groupings put together by counsel trying to win the lead counsel position, and were plagued by numerous deficiencies rendering them inadequate to represent the Class. Although the PSLRA states that a lead plaintiff may be a “group of persons,” to allow an aggregation of unrelated plaintiffs (asset managers and pension funds, in this instance) to serve as lead plaintiffs defeats the purpose of preventing lawyer-driven litigation. In stark contrast, USS, the largest pension fund as measured by assets in London, opted to move for appointment as sole lead plaintiff, in order to allow it full and independent control of its counsel and the prosecution of the litigation. In fact, prior to engaging the Pomerantz firm, USS spent over 50 hours of in-house attorney time determining whether to step forward as lead plaintiff. To assist its decision making process, USS retained outside counsel at its own expense to assist it in deciding whether to enter the action.

Moreover, the record in this case demonstrated that the SKAGEN-Danske Group – with SKAGEN showing a net gain on Petrobras common ADSs – had interests that could be deemed antagonistic to purchasers of Petrobras common ADSs. In this case, the large losers in Petrobras preferred ADSs, such as the SKAGEN-Danske Group, potentially have interests antagonistic to common ADS purchasers because of the unique qualities of each security and the potential threats facing the capital structure of Petrobras. USS, with the single largest losses of PBR common ADSs among the various lead plaintiff movants, thus presented the court with an attractive and safe option for potential lead plaintiff.

At bottom, USS argued that it was the ideal plaintiff envisioned by Congress when it enacted the PSLRA. No other movant had demonstrated the willingness and ability to adequately oversee counsel and vigorously prosecute the claims against Petrobras on behalf of the Class. Critically, USS was the only movant not overwhelmed by various inadequacies and unique defenses. Nor did USS have any ties to potentially relevant political contributions or curious arrangements with counsel, which have heretofore afflicted the alternative lead plaintiff groupings.

Accordingly, the independence and diligence evidenced by USS and Pomerantz during the lead plaintiff process ultimately paid off. As articulated during the briefing process, USS’s conduct represented the “gold standard” for institutional oversight of proposed lead counsel, and represents the model for institutional investors seeking to file future applications for appointment as lead plaintiff in securities class actions.

SEC Reverses Its Own Whole Foods Ruling

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, JANUARY/FEBRUARY 2015

As we have been reporting for years, corporate America has been at war with activist investors who want the right of “proxy access,” which would allow them to propose nominees for director that can appear on the companies’ own proxy statements. Not too long ago, the SEC backpedaled from a proposed rule that would have granted automatic proxy access to investors who had held a certain percentage of the company’s outstanding shares for an extended period of time. This proposal is now in seemingly eternal limbo.

Instead, investors have sought to put the issue of proxy access to a shareholder vote on a company by company basis. For example, Scott M. Stringer, the New York City comptroller and overseer of five city pension funds with $160 billion in assets, recently put forward proposals at 75 companies that would allow shareholders to nominate directors. In response to these and other similar efforts, some companies have tried to pre-empt those requests by proposing, instead, their own watered-down version of similar proposals – typically with much higher threshold requirements the shareholder would have to meet. An SEC rule states that a shareholder proposal can be excluded if it “directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting.”

Whole Foods is a case in point. A Whole Foods investor proposed that investors holding 3 percent of the grocer’s shares for at least three years be allowed to nominate directors at the company. Whole Foods asked for permission to exclude the proposal last fall, saying that it planned to put its own proposal on director elections to a shareholder vote. Under management’s proposal, an investor interested in nominating directors had to own a far larger stake and to have held it for much longer than in the investor’s proposal.

In its original ruling, issued December 1, the SEC staff granted a no action letter to Whole Foods, allowing it to exclude the shareholder proxy access proposal. Shortly afterwards, 18 other companies asked for no action letters permitting them to do the same. This caused a backlash from institutional investors who viewed this tactic as a too-convenient way for companies to avoid putting more aggressive proxy access proposals to a shareholder vote, and who began asking the SEC to revisit its Whole Foods decision.

On January 16, the SEC announced that it had reversed its Whole Foods decision. In a public statement, SEC Commissioner Mary Jo White said that questions had arisen about “the proper scope and application” of the SEC rule on which its staff had relied when making the decision. She also said she had directed the staff to review the rule and report its findings to the full commission. While its review is underway, the SEC said it would make no rulings on requests for no action letters involving shareholder proposals that are similar to those made by management.

Many view this development as handwriting on the wall, predicting that this preemption tactic is going to be prohibited or at least severely curtailed. Still, without a ruling one way or the other just yet, companies will have to decide for themselves whether to include such proposals in their upcoming proxy statements this spring.

Agencies Shifting Many Enforcement Actions to In-House Administrative Courts

ATTORNEY: EMMA GILMORE
POMERANTZ MONITOR, JANUARY/FEBRUARY 2015

The Securities and Exchange Commission and the Commodity Futures Trading Commission have recently signaled that they intend to bring many future enforcement actions in administrative courts rather than federal courts. Kara Brockmeyer, the chief of the Division’s Foreign Corrupt Practices Act Unit, said at a legal conference in Washington held in October that bringing cases as administrative proceedings “is the new normal.”

While both venues have always been available for such actions, the Dodd-Frank Act expanded the powers of administrative courts, allowing them to impose remedies similar to those available in federal court, including the imposition of monetary penalties. The shift has stirred a flurry of public debates on the fairness of the administrative procedures.

Critics argue that the administrative procedure mechanism deprives defendants of constitutional and procedurals advantages, as discovery is limited (essentially precluding depositions, except to preserve evidence); the Federal Rules of Evidence do not apply (even hearsay is admissible); and there is no right to a jury. Those critics also point out that the initial factfinder is an SEC employee, and is therefore presumably biased in the SEC’s favor. They argue that while a defendant can appeal the administrative decision to a federal court of appeals, the court is likely to defer to the administrative agency. Among the fierce critics of such administrative proceedings is Southern District of New York Judge Jed S. Rakoff, who, in a speech last November, argued that “the law in such cases would effectively be made, not by neutral federal courts, but by SEC administrative judges,” saying that administrative proceedings are compromised by “informality” and “arguable unfairness.”

Another federal judge, Lewis A. Kaplan of the Southern District of New York, takes a decidedly different view. He recently held that a defendant’s right to appeal to a federal court at the end of the procedure would suffice to address any injustice or due process violations committed in the administrative proceeding. He concluded that “Congress has provided the SEC with two tracks on which it may litigate certain cases. Which of those paths to choose is a matter of enforcement policy squarely within the SEC’s province,” and the SEC is “especially competent…to determin[e] which…cases are appropriately brought in a district court and which in an administrative proceeding.” (emphasis in original).

In similar vein, the SEC’s Enforcement Division Director Andrew Ceresney defended the agency’s recent shift. “It’s not the case there is no more activity in district court; there is. Having said that, it is certainly the case we’re going to use [administrative] proceedings more often. Why is that? Because Congress gave us the authority under Dodd-Frank to obtain the same remedies in administrative proceedings as we can obtain in district courts,” Ceresney said. He argued at a November 7 conference sponsored by the Practicing Law Institute (“PLI”) that the administrative proceedings process is not only fair to defendants, but also constitutes a more efficient means to reach a resolution. dministrative proceedings are relatively fast, with rulings usually handed down within 300 days of the case being filed, as opposed to years for the typical federal-court case. Ceresney insisted that cases are heard by judges who are seasoned, sophisticated fact finders in the securities field.

At that same PLI conference, CFTC’s Enforcement Division Director Aitan Goelman said a streamlined enforcement proceeding is necessary because his agency is financially constrained and does not have the money to engage in lengthy litigations. The CFTC is mulling a “best-offer” settlement agreement very early in the proceeding in hopes of streamlining the resolution of enforcement disputes.

Another likely reason for the forum shift may be, as the Wall Street Journal recently reported, that the SEC’s win rate in recent years is “considerably higher” in administrative forums than in federal courts. In the 12 months through September 2014, the SEC won all six contested administrative hearings where verdicts were issued, but only 61%—11 out of 18—federal-court trials. Previous years showed the same pattern: the agency won nine of 10 contested administrative proceedings in the 12-month period through September 2013 and seven out of seven in the 12 months through September 2012, according to SEC data. The SEC won 75% and 67%, respectively, of its trials in federal court in those years.

Given the SEC’s success rate in such forum, this shift can prove beneficial to private litigants. Assuming the administrative procedures are fair and do not violate a defendant’s due process rights (and given the administrative law judges’ specialized knowledge of securities laws), appeals courts are likely to affirm the administrative law decisions. SEC-favorable decisions can in turn be employed as highly persuasive authority by private plaintiffs in actions brought against distinct defendants but under analogous fact patterns.