Has The Curtain Finally Fallen On The Galanis Family Of Fraudsters?

ATTORNEYS: H. ADAM PRUSSIN AND JESSICA N. DELL
POMERANTZ MONITOR JULY/AUGUST 2016

This month Jason Galanis and his father John Peter Galanis both entered guilty pleas for their roles in swindling Gerova Financial Group investors. They admitted to manipulating the company’s stock price using a maze of small companies and a straw buyer to conceal their involvement. They agreed to forfeit over $37 million in assets and will both be sentenced in December. Other alleged conspirators include Jason’s two brothers, Jared and Derek Galanis.

If the names sound familiar, it is because the family has bounced from one colorful financial scandal to the next for over thirty years. Five years ago, Pomerantz filed suit for Gerova Investors based on the same violations. That suit was successfully settled. The Galanii currently also face criminal charges alleging that they bilked $60 million from members of the Sioux Nation in South Dakota. In the last two decades, they have reportedly dabbled in gambling, porn, and Kosovo drug rings. It was reported that two months ago, while out on bail and facing criminal charges, Jason Galanis got drunk on an airplane and sent threatening texts to a former friend he thought was cooperating with federal investigators. His bail was consequently revoked.

Although Galanis Senior, the Bernie Madoff of the eighties, served years in prison, investors were never made whole. Throughout that decade, he faced a litany of charges, including stealing hundreds of millions from investors, and millions from the government in false tax deductions. In 1988 he was convicted on 44 felony counts and ultimately sentenced to 27 years in a federal prison. When the sentence was handed down, then U.S. Attorney Rudy Giuliani told the press he hoped it would send a message that: “those like Galanis...who are involved in multimillion-dollar frauds and corruption will realize that no matter how wealthy or how powerful they believe they are, no matter how complex their scheme, they too can be brought to justice.” If the sentence indeed had any deterrent effect, it was short-lived. Perhaps this time, by rounding them all up at once, we can hope again that U.S. District Attorney Bharara has succeeded in shuttering the Galanis family business for good. 

International Portfolio Monitoring And Its Increasing Importance To Pension Funds

ATTORNEY: JENNIFER PAFITI
POMERANTZ MONITOR JULY/AUGUST 2016

The United States sees hundreds of new securities class actions filed each year as well as approximately 100 class action settlements. For many institutional investors, the task of obtaining and tracking all this information is too complex and too expensive to do in-house; nevertheless, it remains essential that pension fund fiduciaries are regularly informed of the extent to which the value of the publicly traded investments they oversee may be diminished by financial misconduct. Increasingly, financial institutions have been turning, for help, to professional portfolio monitoring services.

Increasingly, fiduciaries must now also keep abreast of investor class actions filed abroad. In June 2010, the U.S. Supreme Court decided, in Morrison v. National Australia Bank, that U.S. federal securities law remedies were limited to investors that had purchased relevant securities only on a U.S. stock exchange. In the wake of this decision institutional investors began to realize that they could no longer limit their portfolio monitoring to activity in the U.S. They would need to have their global portfolio monitored by a team equally dedicated to both domestic and international monitoring services.

In the six years since the Morrison decision we have seen more and more litigation activity outside of the U.S.; in particular, (but not limited to) countries with collective redress procedures and securities laws closest to that of the U.S. In the past few years Australia, Canada, the Netherlands, and the United Kingdom have emerged as front runners for pursuing shareholder class actions outside of the U.S. for varying reasons. Here, we examine those merging venues to better understand them.

In Canada and Australia, class action procedures and pro-investor measures have recently combined to allow a steady stream of offering and open-market type claims to yield substantial recoveries.

The number of securities class actions initiated in Australia is growing. An essential feature of the Australian class action system is that there must be seven or more plaintiffs with claims arising out of the same or similar circumstances with substantial common issues of fact or law in question. Compared with many overseas jurisdictions, this is a fairly low threshold and makes Australia a class action friendly jurisdiction.

Australia is officially an “opt-out” jurisdiction (meaning that to be excluded from a class, the class member must formally exclude himself or herself from the class), and employs a “loser pays” system where the losing party may be liable for both their legal costs and that of the prevailing party. This often means that parties will bring in external litigation funders who will take a percentage of the class recovery if successful and hold the fee “risk” if the case is lost. This has effectively resulted in “closed classes” in which only those class members who have agreed to litigation funding are included in the class action and can participate in any recovery. To date, no securities class action filed against a publicly traded company in Australia has proceeded to judgment. Instead, the claims that have concluded have been settled outside the courtroom.

Last year, Canada saw only four new securities class action filings, whereas the U.S. sees roughly 150 new securities class actions filed each year. Most Canadian provinces have adopted an “opt-out” procedure whereby an investor is automatically included in the class unless they affirmatively “opt-out.” Like Australia, Canada has an active third-party litigation funding regime requiring investors to “opt-in” in order to participate in any recovery.

The Netherlands is a unique jurisdiction in that Dutch law enables the formation of settlement foundations (stichting) to bring collective redress for parties wishing to create a binding, European-wide settlement. Resembling the U.S. “opt-out” system, parties have the right to “opt-out” during the defined period set by the court.

An interesting component of the Dutch settlement system is that a significant connection between the conduct complained of and the Dutch jurisdiction is not required. This has led to the suggestion that foreign parties may flock to the Netherlands to seek redress. Notwithstanding this, the Netherlands is yet to be described as a hotspot for international securities class actions.

Unlike the other jurisdictions described above, the U.K. lacks a class action procedure. However, a group litigation mechanism exists whereby individual cases involving the same circumstances against the same defendants are grouped together. Only those claimants who are affirmatively named are included in the litigation and bound by the judgment (similar to “opt-in”). The U.K. adopts an unattractive “loser pays” system. The absence of litigation funders, changes in after-the-event insurance and the “loser pays” system have deterred investors from filing suit there. Nevertheless, the case currently proceeding in the U.K. against the Royal Bank of Scotland (“RBS”), in connection with its 2008 rights issue, is unprecedented in the U.K. and is being closely watched in terms of how the group litigation is being managed and how any loser-pays costs will be distributed. In recent years there has been much demand in the U.K. for a U.S.-style class action procedure to be introduced into legislation. Some argue that, at present, the U.K. government has no interest in changing legislation that would open the floodgates for investors to sue RBS – a bank in which the government has an 83% stake.

Determining whether to become involved in securities litigation outside the U.S. requires examination of near identical issues to be considered when taking affirmative action in the U.S., in addition to consideration of varying jurisdictional statutes of limitations, cost issues, and analysis of what types of losses are compensable.

It is prudent that pension fund fiduciaries are provided with both domestic and international portfolio monitoring services, coupled with comprehensive legal advice so that they can make informed decisions on what action, if any, they take to recover their losses.

Note: Pomerantz provides a no-cost portfolio monitoring service whereby clients receive monthly, personalized reports quantifying losses in new actions relating to the U.S. and worldwide, providing legal advice in respect of those losses and highlighting upcoming claims filing deadlines for settled securities class actions in which the fund is eligible to participate. For more information, please contact the author of this article at: jpafiti@pomlaw.com

Why Bother To Investigate Before Bringing A Derivative Action?

ATTORNEY: GABRIEL HENRIQUEZ
POMERANTZ MONITOR JULY/AUGUST 2016

State law allows shareholders to bring derivative actions, under certain circumstances, seeking recovery on behalf of their corporations. Usually those cases allege that the directors of the corporation have breached their fiduciary duties to the company. Typically the directors, not shareholders, have the responsibility of deciding whether to bring such cases. Shareholders can “demand” that directors bring such a case, but if they do that, and the directors refuse, it is next to impossible for shareholders to pursue their case. But there are exceptions to this “demand” requirement in cases where plaintiffs can show that demand would be “futile.”

ALTHOUGH ONE MIGHT ASSUME THAT IT WOULD ALWAYS BE “FUTILE” TO DEMAND THAT DIRECTORS SUE THEMSELVES, THE LAW DOES NOT START WITH THAT ASSUMPTION. TO THE CONTRARY, DELAWARE COURTS, FOR EXAMPLE, REQUIRE THAT PLAINTIFFS PLEAD SPECIFIC FACTS ESTABLISHING, IN ESSENCE, THAT IT IS LIKELY THAT THE DIRECTORS HAVE DONE SOMETHING WRONG, JUSTIFYING BRINGING AN ACTION AGAINST THEM. “CONCLUSORY,” NON-SPECIFIC ALLEGATIONS ARE NOT ENOUGH. UNLESS SHAREHOLDERS HAVE ACCESS TO INSIDE INFORMATION FROM THE COMPANY, IT IS OFTEN DIFFICULT TO SATISFY THIS STANDARD; AND COURTS HAVE DISMISSED SUCH CASES WITH DEPRESSING REGULARITY.

About 20 years ago, the Delaware Supreme Court started suggesting, in its opinions affirming dismissal of such cases, that the result might have been different if the shareholders had only done a better investigation of the facts before bringing the action. In particular, it pointed to Section 220 of the Delaware Corporation Act, which allows shareholders of Delaware corporations, before bringing a lawsuit, to demand the right to inspect the books and records of the corporation concerning potentially dubious transactions. Such inspections, the court noted, are the “tools at hand” that could in many cases provide the specific facts necessary to establish demand futility and allow a derivative case to go forward. The Delaware Chancery Court has exclusive jurisdiction to grant relief under Section 220.

But this prescription ignores the practicalities of derivative litigation. News of potential corporate wrongdoing typically leads to multiple lawsuits brought by shareholders, sometimes in different states. Because there is no law requiring that investors bring a books and records proceeding before filing a derivative case, some of these cases will be filed without a pre-filing inspection and they will proceed quickly, while shareholders who do file a books and records demand are still waiting for a resolution of that proceeding.

If all the relevant proceedings are brought in the same jurisdiction, such as Delaware, the courts will often stay the quick-filing cases to allow the books and records plaintiffs to catch up. But what happens if the first filed cases are brought out of state, are not stayed, and are dismissed on “demand futility” grounds before the books and records plaintiffs have had a chance to build their case?

Two recent opinions from Delaware’s Court of Chancery are likely to change the ground rules in such situations.

In cases involving Lululemon and Wal-Mart, plaintiffs who had not availed themselves of Section 220 filed “conclusory” complaints outside of Delaware that were dismissed for failure to make demand on the directors to bring an action. At the same time, two different sets of plaintiffs completed their books and records inspections and then filed their respective derivative complaints in Delaware. Because the Section 220 actions took several years to complete, by the time these investors were able to bring their actions, the other, out of state derivative cases had already been dismissed. With the benefit of their inspection of corporate records, the complaints in the Delaware actions were far more specific and detailed than the out of state complaints had been.

Nevertheless, the Chancery Court dismissed the Delaware derivative lawsuits because it found that the courts in the non-Delaware proceedings had already decided that demand on the directors to bring these claims was not excused. As a result, the Delaware plaintiffs gained nothing from their years’-long efforts to investigate the case by using Section 220.

In Lululemon, the company’s founder was accused of insider trading after unloading a bulk of his shares the day after finding out that the company’s CEO intended to resign, but before that information was released to the public. In order to investigate diligently, one of the shareholder plaintiffs, represented by Pomerantz, filed a Section 220 action demanding corporate records from Lululemon in May 2013. Another Section 220 action was brought by another shareholder plaintiff in Delaware in October later that year. On April 2, 2014, the Chancery Court ordered Lululemon to produce documents relating to the sale of shares that occurred just before the public announcement of the CEO’s resignation. In July 2015, the Delaware plaintiffs filed their derivative lawsuit against Lululemon for breaches of fiduciary duties.

The first derivative lawsuits against Lululemon alleging breaches of fiduciary duties were filed in New York federal court after Pomerantz filed its Section 220 action in Delaware. Separate New York suits by two shareholder plaintiffs were filed in August 2013, but an amended complaint consolidating the two was filed January 17, 2014. In response to the New York case, Lululemon filed a motion to dismiss, arguing that the New York plaintiffs failed to adequately allege demand futility. Pomerantz, on behalf of the Delaware plaintiffs, sought to intervene in the New York matter, requesting that the New York court stay the case pending resolution of the Section 220 action in Delaware, or in the alternative, to dismiss one of the breach of fiduciary duty claims without prejudice in order to allow it to move forward in Delaware.

The New York federal court denied Pomerantz’s requests and granted defendant’s motion to dismiss. Shortly thereafter, the Chancery Court in Delaware dismissed the Delaware derivative complaint, finding that the same claims and issues had already been adjudicated in New York.

The Lululemon decision comes on the heels of the Wal-Mart decision, rendered two months before, where diligent plaintiffs in Delaware got the short end of the stick following the dismissal of an analogous but poorly researched case in an Arkansas federal court. In 2012, a widely-publicized bribery scandal led shareholder plaintiffs to file lawsuits against Wal-Mart. In Delaware, the plaintiffs first filed a Section 220 action that took three years to resolve. They did not file their derivative action until July 2015. The Arkansas plaintiffs filed their derivative action without the benefit of making a books and records demand. Much like in Lululemon, Wal-Mart filed a motion to dismiss attacking the Arkansas plaintiffs’ failure to allege demand futility with sufficient facts. The Arkansas federal court agreed with Wal-Mart and dismissed the complaint; shortly thereafter, the Delaware Chancery Court dismissed its derivative complaint on the grounds of issue preclusion.

Key to both decisions was the finding that there is no presumption of inadequacy for fast-filing plaintiffs, and that the level of detail between the competing complaints is irrelevant to the issue preclusion analysis. In other words, diligent plaintiffs who sought books and records before suing are stuck with the results of the quick-filing cases.

At the time, the distinctive circumstances of the Wal-Mart case tempered arguments in favor of de-emphasizing Section 220 actions. Indeed, rarely do Section 220 actions drag on for three years. However, coupled with the Lululemon decision, plaintiffs faced with the prospect of multi-jurisdiction litigation need to analyze the practical benefits of filing an action quickly rather than waiting for a books and records action to conclude—even if the former goes against the advice of the Chancery Court to make use of the “tools at hand.”

The Supreme Court Allows Investors To Pursue State Law Claims In State Court

ATTORNEY: JUSTIN NEMATZADEH
POMERANTZ MONITOR JULY/AUGUST 2016

Federal courts have exclusive jurisdiction over claims alleging violations of the Securities Exchange Act, such as securities fraud. But in some cases the same conduct can violate both the federal securities laws and state laws; and in some of those cases investors may choose, for a variety of tactical reasons, to bring their claims in state court, under state law only. Naturally, defendants look for ways to fight back. In class action cases, Congress passed a law a few years ago that effectively federalizes all state law cases challenging conduct that could have been pleaded as securities laws violations, whether investors pleaded federal claims or not. But that leaves open the question of when and whether claims brought by individual investors can proceed in state court.

In a case involving Merrill Lynch, the United States Supreme Court recently answered that question. It held that a state law case does not have to be brought in federal court just because defendants’ alleged conduct could also be a violation of the Securities Exchange Act.

In that case, former shareholders of Escala Group, Inc. sued Merrill Lynch and several other financial institutions for manipulating the price of Escala stock through “naked short sales” of its stock. In a typical short sale, the seller borrows stock from a broker, sells it to a buyer on the open market, and later purchases the same number of shares to return to the broker. The short seller pockets the potential stock price decline between the time of selling the borrowed shares and buying the replacement shares to pay back the broker’s loan.

But in a naked short sale, the seller has not borrowed the stock that he is selling short. In market manipulation cases, for example, defendants typically flood the market with a large number of sell orders, but it may not be possible to borrow enough shares to cover all these transactions. In those cases, the short seller may not be able to deliver the sold shares to the buyer when the transaction is scheduled to close. Naked short selling can drive down a company’s stock price, injuring investors. SEC regulations aim to curb market manipulation by prohibiting short sellers from intentionally failing to deliver securities.

In the Merrill Lynch case, plaintiffs sued defendants in New Jersey state court for naked short selling under several New Jersey statutes and common law causes of action. Although not alleging violations of the federal securities laws, the complaint catalogued past accusations against defendants for flouting securities regulations, couching the naked short-selling description in terms suggesting that defendants had again violated this regulation.

Defendants attempted to remove the case to federal court, plaintiffs objected, and the ensuing struggle played out all the way to the Supreme Court. There defendants argued that plaintiffs had explicitly or implicitly asserted that defendants had breached an Exchange Act duty, so the suit was “brought to enforce” that duty and gave federal court exclusive jurisdiction. Under this argument, the case would have remained in federal court even if plaintiffs had sought relief only under state law and could have prevailed without proving a breach of an Exchange Act duty. Plaintiffs countered by arguing that a suit is “brought to enforce” the Exchange Act’s duties only if the asserted causes of action were created by the Exchange Act, which was not the case here.

The Supreme Court adopted a middle ground, ultimately siding with plaintiffs and remanding the suit to state court. Adopting a “natural reading” of the exclusive jurisdiction provision, the Court held that it did not apply just because a complaint mentions a duty established by the Exchange Act. The Supreme Court held that exclusive federal jurisdiction applied only when a complaint (i) directly asserted an Exchange Act cause of action or (ii) asserted a state law cause of action that would require the plaintiff to demonstrate that defendants breached an Exchange Act duty. Plaintiffs’ suit would have fallen under the compass of the second prong of this interpretation if the New Jersey statutes made illegal “any violation of the Exchange Act involving naked short selling.”

Noting respect for state courts, the Supreme Court stated that its decisions reflected a “deeply felt and traditional reluctance . . . to expand the jurisdiction of federal courts through a broad reading of jurisdictional statutes.” Deference to state courts was stronger here to limit Section 27 of the Exchange Act’s mandated—rather than permitted— federal jurisdiction, depriving state courts of all ability to adjudicate claims. The Supreme Court stated that Congress likely contemplated that some complaints intermingling state and federal questions would be brought in state court by specifically affirming the capacity of state courts to adjudicate state law securities actions. Moreover, the exclusive jurisdiction provision does nothing to prevent state courts from resolving Exchange Act questions resulting from defenses or counterclaims.

After Merrill Lynch investors can avail themselves of the additional weapon of state court in suing for market manipulation by asserting causes of action under state laws that do not necessitate a showing of a federal-law breach. In doing so, they can even allege defendants’ federal-law violations for similar conduct.

Court Grants Final Approval Of $45 Million Groupon Settlement

POMERANTZ MONITOR JULY/AUGUST 2016

The Honorable Charles R. Norgle of the United States District Court for the Northern District of Illinois has granted final approval of the $45 million class settlement achieved in In re Groupon Securities Litigation, No 12 C 2450 (N.D. Ill.). The Pomerantz Firm was appointed lead counsel in 2012, and has vigorously litigated the case for nearly four years.“We are pleased to have reached this favorable settlement for class members,” Pomerantz partner Joshua Silverman stated.

The Pomerantz Firm reminds all investors who purchased shares in Groupon’s initial public offering, or between November 4, 2011 and March 30, 2012, that the Court has established a claims filing deadline of August 26, 2016.

Claims forms, class notice, and other important documents are available on the settlement website: www.grouponsecuritieslitigation.com

Huge Appraisal Remedy Awarded In Dell Merger Case

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR JULY/AUGUST 2016

In 2013, Michael Dell, the founder and CEO of computer manufacturer Dell, Inc., offered to take the company private at a price of $13.75 per share. Many investors were dissatisfied with the offer, but it was approved by a majority vote of the shareholders.

Many shareholders who voted against the deal elected to pursue an appraisal remedy, which allows dissenters to ask the court to determine the “fair value” of their shares. Appraisal petitions are representative actions brought on behalf of all investors pursuing appraisal, meaning only one dissenting shareholder needs to file a petition and prosecute the appraisal case on behalf of others. An appraisal differs significantly from typical shareholder lawsuits challenging mergers. Most notably, they don’t involve claims of wrongdoing. It is not necessary, for example, to show that the directors who negotiated and approved the transaction were conflicted, were negligent, or in some other way breached their fiduciary duties to investors. In fact, in the Dell case the court determined that no such violation had occurred and that the directors did everything they could to seek competitive bids for the company. Here, no competing bidder could be found who could challenge Michael Dell’s bid.

Nevertheless, dozens of shareholders were convinced that the price Dell paid was not “fair value,” as defined by Delaware law, and sought appraisal of their shares. Several of them were declared ineligible to pursue this remedy because they had failed, for one reason or another, to comply with Delaware’s byzantine rules for pursuing appraisal. In the end, 20 institutional investors were allowed to pursue their claims.

This spring, the Delaware Chancery Court issued a bombshell ruling in the appraisal case, finding that the “fair value” of Dell’s shares was $17.62 each, about 22 percent above the merger price of $13.75. Put another way, the court found that the $22.9 billion paid in the merger undervalued the company by about $6 billion. However, because only 20 investors were deemed qualified to pursue their appraisal remedy, they will get only about $35 million as a result of the decision, leaving almost $6 billion “on the table.”

Embarrassingly, among the disqualified shareholders were clients of T. Rowe Price, a mutual fund manager that had vociferously opposed the merger. Price accidently voted its clients’ shares in favor of the transaction and thereby disqualified them from pursuing an appraisal remedy. As an act of contrition Price reimbursed its clients $194 million – a pretty costly mistake.

The Dell appraisal decision may well add fuel to a recent upsurge in appraisal cases resulting from going private mergers. Increasingly, hedge funds and other aggressive investors have been snatching up shares of companies that are the subject of a takeover or going private proposals, in the expectation that they will file an appraisal case and make a killing in the transaction. From January 2015 to date, appraisal petitions were filed in about 15% of transactions eligible for appraisal. The results in these cases have been pretty good: an article in a trade journal, Securities Law 360, surveyed appraisal cases during the past 6 years, and found that the courts awarded large judgments to investors, above the merger price, much of the time. For example, in the Dole Food deal, it awarded a 20% premium; In the Safeway deal, 26%; Canon, 17.6%; Hesco, 75.5%; Orchard Enterprises, 127.8%; 3M Cogent, 8.5%; Cox Radio, 19.8%; Am. Commercial Lines, 15.6%; Golden Telecom, 19.5%; and Sunbelt Beverage, 148.8%. On top of these large premiums, the courts also awarded hefty interest on these awards. The appraisal statute requires the court to award interest on the award at a relatively high rate.

Sweet.

POMTalk: Defined Benefit Plans Truly Benefit Public Employees

ATTORNEY: JENNIFER PAFITI
POMERANTZ MONITOR MAY/JUNE 2016

As I visit institutional investor clients across America, a frequent topic of discussion is a cost/benefit analysis of defined benefit vs. defined contribution plans. As I will more fully explain below, research and experience have demonstrated that public pension funds and the employees they serve likely do best contributing to a defined benefit plan coupled with a portfolio monitoring service.

Most state, municipal, and county workers are covered by a traditional defined benefit plan.

The financial crisis of 2008 and its aftermath led some public pension funds to consider shifting some or all of their pension systems from a defined benefit to a defined contribution plan. In fact, six states have replaced their traditional defined benefit plan with a mandatory hybrid plan (which requires participation in both a defined benefit and a defined contribution plan): Georgia, Michigan, Rhode Island, Utah, Tennessee, and Virginia.

Prior to the financial crisis, while feeling the glow of the stock market’s stellar performance of the 1990’s, Michigan and Alaska introduced plans requiring all new hires to participate solely in a defined contribution plan. Meanwhile, California, Indiana, and Oregon adopted hybrid plans. Colorado and Ohio have introduced optional defined contribution plans. Enrollment in these plans has been modest, with most workers choosing to continue to maintain the protection against investment risk and the promise of an annuity that defined benefit plans offer. In Alaska, however, despite the fact that nearly three quarters of its public employees are not covered by Social Security, all new hires are required to join a defined contribution plan. The result is that Alaskan state workers and teachers hired since July 2006 do not have any form of defined benefit protection.

According to a 2014 study by Alicia H. Munnell, Jean-Pierre Aubry, and Mark Cafarelli of the Center for Retirement Research of Boston College, what motivated states to introduce a defined contribution plan differed before and after the financial crisis. Before 2008, some saw it as a way to offer employees an opportunity to manage their own money and participate directly in a rapidly rising stock market. In contrast, after the financial crisis, cost and risk factors motivated some states to make the shift.

A 2016 study by Nari Rhee and William B. Fornia of the University of California, Berkeley, modeled how retirement income would fare for teachers on three types of pension: (1) the current defined benefit offering from the $186 billion California State Teachers Retirement System (“CalSTRS”) for hires since 2013; (2) an idealized 409(k) plan (similar to defined contribution); and (3) a cash balance plan with guaranteed 7% interest on contribution. The result, in a nutshell: for the vast majority of California teachers (six out of seven), the CalSTRS defined benefit pension provided greater, more secure retirement income compared to a 401(k)-style plan.

Apart from the rewards of defined benefit plans touted by numerous studies, a significant benefit available to these plans—that is not available to defined contribution plans -- is that their investment portfolios may be monitored by professionals who are expert in identifying and evaluating losses attributable to financial misconduct, and providing advice to institutional investors on how best to maximize their potential recoveries worldwide. The United States sees hundreds of new securities fraud class actions filed each year, as well as approximately 100 class action settlements. Institutional investors that do not engage a portfolio monitoring service run the risk of leaving money on the table by not participating in settlement recoveries or taking affirmative action to recover their losses when appropriate.

Public pension funds that offer a defined benefit plan coupled with a portfolio monitoring service get top marks for ensuring that their employees will enjoy a secure and amply funded retirement. 

POMShorts

POMERANTZ MONITOR MAY/JUNE 2016

CFPB Proposes Rule to Override Arbitration Clauses in Contracts for Financial Transactions.

As the Monitor has reported, the Supreme Court opened the door recently to allowing companies to enforce arbitration clauses in contracts with their customers, which would bar class actions. Because most consumer claims are too small to warrant prosecution on an individual basis, this tactic has the potential to insulate these companies from any avenue of redress.

On May 5, the Consumer Financial Protection Bureau issued a proposed rule that would restore customers’ rights to bring class actions against financial firms. The rule would apply to bank accounts, credit cards and other types of consumer loans. As reported in the Times, the new rules would mean that lenders could not force people to agree to mandatory arbitration clauses that bar class actions when those customers sign up for financial products. The changes would not apply to existing accounts, though consumers would be free to pay off their old loans and open new accounts that are covered. The rule would apply only to the consumer financial companies that the agency regulates. It would not apply to arbitration clauses tucked into contracts for cellphone service, car rentals, nursing homes or employment.

The rules are not subject to Congressional approval.

Labor Department Issues Rule Imposing Fiduciary Duty on Brokers Who Advise Clients Investing in Retirement Products or Accounts.

Acting under authority conferred by ERISA, the Labor Department has finally issued a rule requiring brokers who give retirement advice to clients to enter into contracts with them affirming that they have a duty to recommend transactions only when they are in the client’s best interest. The current rule requires only that the investments they recommend be “suitable” for the clients, leaving room for brokers to recommend investments that generate the biggest fees for themselves, rather than those that are best for their customers.

For years the financial services industry has warned that this rule change would impose an enormous burden on them and on investors as well, whose costs (they say) would increase. But, as Senator Elizabeth Warren pointed out recently in a letter to the SEC, some of the biggest objectors to the new rule have been telling their own shareholders that they have nothing to worry about if the fiduciary rule is adopted. That is like trying to have your cake and eating it too.

Warren sent her letter to the SEC because that agency has so far failed in its obligation to revise these rules for regular, non-retirement brokerage accounts and other advisory relationships, even though the Dodd Frank Act requires the agency to do so.

 Agencies Try To Rein In Executive Compensation.

In April the National Credit Union Administration unveiled its proposal to implement a provision of the Dodd-Frank Act by requiring that incentive compensation that top financial executives receive gets deferred for several years and that  firms put in clawback provisions so they can take back bonuses paid to executives responsible for significant losses or illegal actions.

The Dodd-Frank Act charged the NCUA, the Federal Reserve, the Federal Deposit Insurance Corp., the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the U.S. Securities and Exchange Commission with writing rules or guidance that would restrict bonus and other incentive compensation for financial executives, in a bid to limit the temptation to take on excessive risk. Some of these other agencies, at least, are expected to echo the NCUA’s proposal.

U.S. financial regulators set up three different tiers for implementing rules, with executives at firms with $250 billion in assets facing the toughest restrictions, followed by those at firms with assets between $50 billion and $250 billion. Firms that have between $1 billion and $50 billion will be required to put in place risk-management, record-keeping and other monitoring tools.

 Nastiest Case in Delaware.

The Delaware courts, which handle serious matters of corporate governance, are well known for their decorum and high mindedness. But the Delaware Supreme Court is currently mulling the appeal in one of the nastiest, tackiest cases to hit that state in a long time. Alan Morelli, the former chairman of OptimisCorp., a California based healthcare company, is suing the directors who abruptly terminated him in 2012, after receiving accusations that Morelli had sexual relations with an employee and also sexually harassed her. Three of those directors filed their own action against the executive, claiming that in retaliation for their dismissal of him he launched a legal vendetta against them, using $12 million of company funds. After a six day trial last year, the Chancery Court dismissed Morelli’s claims against the directors, concluding that they were unproven. The vice chancellor added that his decision also reflected a sanction against Morelli for paying or threatening witnesses with criminal prosecution or civil action “based on questionable or baseless claims.” One female therapist who accused Morelli of sexual harassment later withdrew the claim, after receiving a promise of a $550,000 series of payments in exchange for her testimony.

During the argument of the appeal, Supreme Court Justice Strine asked whether Optimis is “one of the weirder companies that exists in the world,” observing that “one of the officers of the company was having a relationship with

Mr. Morelli’s ex-wife,” while Morelli, whose office was in his bedroom, was having relations with the employee who subsequently accused Morelli of harassment.

Eighth Circuit Makes it Too Easy to Rebut Presumption of Reliance

ATTORNEY: MURIELLE J. STEVEN WALSH
POMERANTZ MONITOR MAY/JUNE 2016

In a case called Halliburton II, the Supreme Court reaffirmed the validity of the presumption of reliance under the  fraud on the market theory,” which is critical to securities plaintiffs’ ability to show class-wide reliance on a company’s misstatements. But it also held that a defendant may rebut the presumption of reliance by showing that the alleged misstatements had no “price impact,” i.e. did not affect the price of the stock in question. Under Fed. R. Evid. 301, “the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption,” but the rule does not specify how much evidence must be produced, and Halliburton II did not shed any light on this issue, either. This raises the question: how much evidence is enough to rebut the presumption? Is any showing enough?

In Best Buy, the Eighth Circuit recently handed down the first federal appellate decision to attempt to answer those questions. It is widely accepted that price impact may be proven by evidence showing that either the price increased after an alleged misstatement or that the price decreased after the truth was revealed. In Best Buy, plaintiffs met one but not both of these elements. Specifically, plaintiffs challenged three statements the company made on September 14, 2010. First, it issued an early morning earnings release saying that it was increasing its EPS guidance by ten cents. In response, the stock price opened for trading at a price higher than the previous day’s close. The next two statements were made later that morning in a conference call with analysts, when the CEO and CFO stated that the company’s earnings were “essentially in line with our original expectations for the year” and that it was “on track to deliver and exceed our annual EPS guidance.” The stock price did not increase after the conference call statements. The allegedly corrective disclosure occurred on December 14, 2010, when Best Buy announced a decline in its fiscal third quarter sales and a reduction in its 2011 fiscal year EPS guidance, causing a 15% stock price drop.

In an earlier decision, the district court held that the first misstatement, the early morning earnings release, was not actionable because it was a “forward-looking statement” with appropriate “cautionary language,” and was therefore covered by an Exchange Act “safe harbor” provision. The other two misstatements survived that motion and were the focus of the class certification motion, where defendants claimed that the misstatements did not move the market and that the presumption of class-wide reliance had therefore been rebutted.

In support of its class certification motion, plaintiffs submitted an expert report saying that Best Buy’s stock price had increased in reaction to all three September 14th statements, but did not parse how much of the increase was attributable to each individual statement. Defendants’ expert report said that there was no price impact from the conference call statements because the stock price increased only after the earlier morning press release, and not after the conference call occurred several hours later. In reply, plaintiff’s expert conceded that the conference call statements did not cause an immediate stock price increase, because it essentially just confirmed the representations in the previous early morning release. However, he said that the false statements that came afterwards maintained the artificially inflated price caused by that release.

The district court certified the class, recognizing that price impact (and therefore reliance) can be shown by a price decline in response to a corrective disclosure, and that defendants had failed to make any showing that Best Buy’s stock price did not in fact decrease after the negative news released on December 14th. The district court also found that the alleged misrepresentations could have prolonged the inflation of the price, or slowed the rate of fall, satisfying the “price maintenance” theory of “price impact.”

The Eighth Circuit reversed, pouncing on plaintiffs’ expert’s concession that the conference call statements did not move the stock price, and found that this was “strong evidence” sufficient to negate price impact and therefore class- wide reliance. The majority flatly rejected plaintiffs’ additional contention that the conference call statements caused a gradual increase in the stock price between September and December as “contrary to the efficient market hypothesis.” And the court largely ignored plaintiffs’ additional evidence of price impact, shown by the stock price decline after the corrective disclosure.

This decision is troublesome for several reasons.  Courts have generally found a presumption of reliance exists when shareholders show stock prices fell in response to a corrective disclosure. The Eighth Circuit did not follow that principle, focusing instead only on the front end of the supposed fraud, when misstatements had no obvious impact on the share price. The Eighth Circuit also explicitly rejected the price maintenance theory, which has been heavily relied upon by plaintiffs seeking to prove price impact where misstatements did not move the price of a company’s stock.

A decidedly pro-defendant decision, Best Buy shows that defendants facing securities fraud class actions can significantly narrow or eliminate liability during the class certification phase based on price impact arguments. If followed by other circuits, the decision could have significant negative consequences for securities actions, because false positive statements by a company often have little or no immediate impact on the company’s stock price.

Court Denies Motion to Dismiss Our Staar Surgical Complaint

ATTORNEY: MICHAEL J. WERNKE
POMERANTZ MONITOR MAY/JUNE 2016

Judge Fitzgerald of the Central District of California recently denied defendants’ motion to dismiss our action involving STAAR Surgical Company. The action alleges that the company, its CEO and its vice president of regulatory affairs violated section 10(b) of the Securities Exchange Act as well as section 20(a), the “control person” provision.

STAAR is an FDA regulated company that designs, manufactures and sells implantable lenses to correct vision problems. In March of 2014, the company told investors that it believed that it was in compliance with all applicable FDA regulations despite the fact that an FDA inspection of STAAR’s plant was ongoing at the time and the inspector had repeatedly told management that numerous and significant FDA violations had been found. These violations are particularly important to STAAR and its investors because STAAR had a major new lens that was going before the FDA Advisory Panel in mid-March, and these violations would likely delay its approval. The company did not disclose these reports of violations, and investors did not hear about them until the FDA posted them on its website months later. At that point, STAAR’s stock price plunged 17.5%

 Defendants’ main argument for dismissal was that at the time they made their representations of compliance the violation reports were only preliminary and had not been formalized in written notices. The court rejected that argument, holding that because the FDA inspector had repeatedly identified the violations orally to management, defendants would have known that their statements of compliance would mislead investors. The court also held that the company had a duty to disclose the subsequent Warning Letter from the FDA, which stated that the new lens would not be approved by the FDA until the violations were remedied. The court held that, even though the company did not make any further “compliance” representations when it received the Warning Letter, it nevertheless had a duty to correct its prior statement on that subject.

This opinion is significant because it shows that a statement of compliance can be misleading as a result of the FDA inspector orally identifying violations. Prior cases had dealt with the company having receipt of a written notice of violation or Warning Letter.

Supremes: Statistical Averages Can Provide a Basis for Class-Wide Liability

ATTORNEY: AATIF IQBAL
POMERANTZ MONITOR MAY/JUNE 2016

In Tyson Foods v. Bouaphakeo, the Supreme Court upheld the use of statistical sampling evidence in class actions, at least where such evidence would have been admissible in an individual action. Defendants had argued that such statistical methods improperly treated each individual as if he or she matched a statistical average, thus manufacturing predominance by assuming away the very individualized differences that made class-wide litigation inappropriate in the first place. The Court rejected this premise and focused instead on the relevance of the statistical evidence to the substantive claim at issue. It held that, if a given class member could have used the statistical evidence to obtain a favorable jury verdict in an individual action, then the class could use it the same way. It was up to the jury to decide, in light of all of the evidence presented, whether the statistical average was probative of the situation of each class member.

Particularly under the specific facts of the case, this ruling was a straightforward application of evidentiary common sense. Nevertheless, it was generally seen as a significant victory for the plaintiffs’ bar.

The case involved workers at a pork processing plant who claimed they were not paid overtime for time spent putting on and taking off protective gear, in violation of federal law requiring compensation for such “donning and doffing”  time if it is “integral and indispensable” to their regular work. After the district court certified two classes of employees, the case went to trial and the jury awarded the classes $29 million in damages. On appeal, the defendant argued that the verdict should be thrown out because the classes never should have been certified.

To be certified as a class, the worker-plaintiffs had to prove that they could establish key elements of their claims through generalized, class-wide proof. This was easy for some elements: they all worked in the same plant, had similar job responsibilities, and were subject to essentially the same compensation policies. But the defendant insisted that individualized inquiries into each employee’s total donning and doffing time were necessary because different employees wore different gear and took varying amounts of time to don and doff the gear. It also argued that no class could be certified without proof that every member was injured, which required individualized inquiries into each employee’s time.

Federal law, to some degree anticipating this evidentiary problem, has long required employers to keep accurate records of employee work hours. But despite a 1998 federal court injunction against the very same slaughterhouse requiring it to record employee time donning and doffing protective gear, Tyson Foods had never done so. Instead, it had been compensating workers based on its own approximations of how long those activities should take.

Because there was no good individualized evidence, the worker-plaintiffs used what they called “representative evidence” to show how long workers in each department generally took to don and doff protective gear. Most significantly, they presented a study by an industrial relations expert who drew on a representative sample of 774 videotaped observations of workers and calculated the average time for workers in each department to don and doff their gear.

There are procedural mechanisms to ensure the reliability of this kind of evidence, but the defendant largely ignored them. It did not challenge the expert’s qualifications or statistical methodology. It rejected the workers’ proposal to bifurcate the trial into separate proceedings for liability and damages. While it argued at trial that the expert’s calculations were too high, it did not present a rebuttal expert with different calculations. Instead, in opposing class certification and also at trial, it insisted that it was fundamentally improper to assume that each employee donned and doffed for the same time as the average in the sample. It decried being subjected to a “trial by formula” and barred from raising unspecified “defenses to individualized claims.” And on appeal, it called for a categorical rule barring the use of representative sampling evidence in class actions.

The Supreme Court rebuffed this effort and categorically rejected the idea that class actions required their own special set of evidentiary rules. It emphasized that statistical sampling evidence is routinely used in all kinds of litigation and is often the only practicable means, for plaintiffs and defendants in individual as well as class actions, to collect and present relevant data. Thus, it held that class certification was proper as long as a reasonable jury could have believed that the employees spent roughly equal time donning and doffing. If so, it was for a trial jury to weigh the expert’s average-time calculations against the other evidence presented and to decide whether the statistical average was probative of the time actually worked by each employee.

While the utility of statistical averages in other class actions will vary, the main takeaway is that the issue must be considered in practical terms of how a reasonable jury resolving the underlying substantive claim would view the evidence. In many cases, statistical averages will be the most compelling evidence available and will say a great deal about each member of the class. This was particularly true in Tyson Foods because the defendant had never bothered to keep individualized records (despite being legally mandated to do so), and instead simply paid workers based on its own approximations of how long donning and doffing should take. But in other cases with stronger evidence of meaningful individualized variations, a jury might find statistical averages less useful.

New York Adopts Delaware Standards for Going Private Mergers

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR MAY/JUNE 2016

In a case called the Kenneth Cole Shareholder Litigation, the New York Court of Appeals adopted, as the rule in New York, the MFW decision of the Delaware Supreme Court. There, the Delaware court held that, for claims seeking damages, the business judgement rule can protect the decision of a board of directors to accept a going private merger if certain conditions are met. Ordinarily, such decisions are reviewed under the “entire fairness” test, a very pro-plaintiff standard. The MFW court held that the business judgment rule can apply instead, provided that a series of shareholder protections exist: the merger was approved by both a special committee of independent directors and a majority of the minority shareholders; the special committee was independent and was free to reject the offer and to hire its own advisers; and the vote of the minority was informed and uncoerced. To survive a motion to dismiss, the complaint must allege facts showing that the transaction lacked one or more of these shareholder protections.

Meanwhile, the Delaware Supreme Court has itself recently extended the MFW decision to apply also to director decisions to approve mergers with unrelated entities. In such cases, where the complaint seeks damages, the entire fairness rule is inapplicable, but the courts have typically applied an intermediate standard of review, called enhanced scrutiny.” In a case called KKR, the court has now held that if the MFW conditions are met, the business judgment rule protects such decisions in post-closing actions as well. It added that under those circumstances, a showing of “gross negligence” by the directors is not sufficient to rebut the protection of the rule; “waste” has to be shown, which is an almost insurmountable burden.

Our Control Person Claims Upheld In Magnachip

ATTORNEY: MICHAEL J. WERNKE
POMERANTZ MONITOR MARCH/APRIL 2016

In this case, defendant Magnachip had been forced to restate its earnings drastically after its revenue recognition policies had been found wanting. We settled our claims against all the other defendants in the litigation, except for Avenue Capital Management, which was, at one point, Magnachip’s majority shareholder. We had sued ACM under the “controlling person” provisions of the securities laws.

The district court has now substantially denied ACM’s motion to dismiss our claims against it.

The Court rejected ACM’s argument that it did not control MagnaChip because it was a minority shareholder for much of the Class Period. The Court held as adequate to allege control that ACM was a majority shareholder when the alleged fraud began; its appointees continued to serve on the Board of Directors even after its holdings declined; it continued to have significant influence over MagnaChip’s affairs; and ACM used its control to cash out its investment in MagnaChip at enormous profits.

Loss Causation and Disclosures of Investigations

ATTORNEY: J. ALEXANDER HOOD II
POMERANTZ MONITOR MARCH/APRIL 2016

In many instances, the first indication of securities fraud is an announcement that a company is under investigation by some government authority—for example, the SEC, the Department of Justice, a U.S. Attorney’s office, or a state attorney general, to name a few. Frequently these announcements are immediately followed by significant stock drops, as the market reacts to the fact of the investigation, even before the investigation’s findings are disclosed. Because the market has already reacted to the bad news, it sometimes fails to react to subsequent news of the investigation’s findings or to disclosure of false statements by the company that the government was investigating. This non-reaction often reflects the fact that investors assumed the worst when the investigation was first announced, and thus do not react a second time to what is, in some sense, the same news, when the fraud at issue is subsequently confirmed.

For plaintiffs in securities fraud lawsuits, however, the market’s failure to react to news confirming the fraud can be a problem. To survive a defendant’s motion to dismiss, the complaint must show that the investor’s economic loss was caused by the revelation of the defendant’s fraud. Thus, when a company’s stock price plummets in reaction to news of an investigation and then barely moves when the fraud is subsequently confirmed, the company may argue that the only loss was caused by the announcement of an investigation, which the company would characterize as an intervening event, and that no losses were directly traceable to disclosure of news of the fraud itself.

Addressing these issues in Jacksonville Pension Fund v. CVB Financial Corporation, the Ninth Circuit Court of Appeals presented a sensible, context-specific view ofloss causation, holding that the announcement of an SEC investigation related to an alleged misrepresentation, coupled with a subsequent revelation of the inaccuracy of that representation, can serve as a corrective disclosure for the purposes of loss causation—in other words, that under such circumstances, the losses caused by the announcement of the investigation are recoverable, even if the stock fails to react to the subsequent confirmation of the fraud.

In 2008, CVB Financial Corporation was informed by the Garrett Group, a commercial real estate company that was CVB’s largest borrower, that Garrett would be unable to make payments on its loans from CVB. After the loans were restructured, Garrett again informed CVB in 2010 that it could not make the required payments and was contemplating bankruptcy. Nonetheless, in 2009 and 2010 SEC filings, CVB represented that  there was no basis for “serious doubt” about Garrett’s ability to repay its borrowings.

In 2010, the SEC served a subpoena on CVB, seeking information about the company’s loan underwriting methodology and allowance for credit losses. The day after CVB announced receipt of the SEC subpoena, the company’s stock dropped 22%, from $10.30 to $8.0 0per share, a loss of $245 million in market capitalization.

Analysts noted the probable relationship between the subpoena and CVB’s loans to Garrett. A month later, CVB announced that Garrett was unable to pay its loans as scheduled, wrote down $34 million in loans to Garrett, and placed the remaining $48 million in its non-performing category. On this news, however, the market barely reacted, and CVB’s stock price did not significantly fall.

As lead plaintiff in a consolidated action on behalf of CVB investors, Jacksonville Police & Fire Pension Fund filed a complaint in U.S. District Court for the Central District of California, alleging securities fraud by CVB and certain of its officers. However, the district court granted CVB’s motion to dismiss, holding that Jacksonville had failed to plausibly allege that the statements caused a loss to shareholders, given the market’s failure to react to CVB’s announcement that Garrett would be unable to pay its loans as scheduled.

On appeal, the Ninth Circuit reversed the district court’s decision on the loss causation issue. It agreed with the district court that the only significant fall in CVB’s share price occurred after the announcement of the SEC subpoena, and not after the disclosure that Garrett had failed to repay its loan. It noted that “the announcement of an investigation, standing alone and without any subsequent disclosure of actual wrongdoing, does not reveal to the market the pertinent truth of anything, and therefore does not qualify as a corrective disclosure.” However, the court held that in the case against CVB, the announcement of the SEC investigation did not stand alone; rather, the announcement was followed a month later by the company’s announcement that it was charging off millions in its Garrett loans. The market did not react to the subsequent news about the Garrett loans because the announcement of the SEC investigation foreshadowed the ultimate result. Commenting on the practical effects of its ruling, the Ninth Circuit observed that “any other rule would allow a defendant to escape liability by first announcing a government investigation and then waiting until the market reacted before revealing that prior representations under investigation were false.”

In short, the CVB Financial Corporation decision is a welcome and sensible development that removes a significant potential pleading obstacle to securities class actions in the Ninth Circuit.

Supremes: Rejected Offer Of Judgment Does Not Moot Claims Of Class Representative

ATTORNEY: LOUIS C. LUDWIG
POMERANTZ MONITOR MARCH/APRIL 2016

As we noted briefly in the last issue of the Monitor, in Campbell-Ewald Company v. Gomez, the Supreme Court ruled that a plaintiff’s claim cannot be mooted solely by an unaccepted settlement offer, including an offer of judgment pursuant to Federal Rule of Civil Procedure 68. Defendants had hoped that by offering the class representative – but not the class members – all the relief he or she had requested in the complaint, they could get rid of that representative and the class action as well.

The court’s ruling was widely seen on both sides of the bar as a victory for plaintiffs and their counsel. That reaction, however, was likely premature. Gomez leaves open the possibility that defendants could still “pick off” plaintiffs by actually paying or tendering them the amounts allegedly owed. Simply put, the “pick off” risk that bedeviled class action plaintiffs before Gomez remains at least theoretically intact in its wake.

Generally, Rule 68 allows a defendant to make an offer of judgment for a specified amount, including costs accrued   to date. If the plaintiff rejects the offer and the result obtained in the action is less than the amount of the rejected offer, the plaintiff must reimburse all of defendants’ costs incurred after the offer was made.

Turning down such an offer of judgment necessarily engenders risk, particularly for plaintiffs who choose to lead class actions, which, for various reasons, tend to incur higher costs on the path to trial. Even worse, defense lawyers have sharpened Rule 68 into a unique weapon known as the “pick-off” strategy,” which aims to quickly end potential class actions without ever getting to the merits of the claims.

The pick-off strategy typically plays out as follows: the named plaintiff in a class action is served with an offer of judgment for all the relief he or she personally seeks, separate from the class. Not wanting to sell out the class he or she represents, the named plaintiff rejects the Rule 68 offer in order to continue litigating for a favorable classwide outcome. Next, the defendant seeks the dismissal of the case on the basis that the offer provided the plaintiff with everything asked for in the complaint, leaving no “case or controversy” remaining to litigate. If that happens, the case cannot proceed on a class basis unless a new named plaintiff is willing to step forward. Even assuming that a new named plaintiff can readily be found, the successor is just as susceptible to the pick-off strategy as his or her predecessor.

Prior to Gomez, several federal appellate courts limited the pick-off strategy by making the effectiveness of a Rule 68 offer contingent on, variously, whether plaintiffs had been provided an opportunity to first file a motion for class certification or whether the offer actually preceded the filing of and/or ruling on a motion for class certification.

Gomez involved allegations of an unsolicited text message that violated the Telephone Consumer Protection Act (the “TCPA”). As a general matter, the TCPA places a $1,500 ceiling on statutory damages for a single violation. While Gomez was styled as a class action, the plaintiff, Gomez, had not filed a motion for class certification at the time defendant Campbell-Ewald (the advertising agency that sent the text message) served him with an offer of judgment for just over $1,500, plus reasonable costs. Gomez declined the offer by failing to accept it within the time provided. Subsequently, Campbell-Ewald prevailed on a motion for summary judgment on the ground that the offer of judgment mooted plaintiff’s individual claim.

The Court of Appeals for the Ninth Circuit reversed, holding, in part, that an unaccepted Rule 68 offer does not moot a plaintiff’s individual or class claims. As circuit precedent differed widely on these issues, certiorari was granted. The Supreme Court affirmed the Ninth Circuit, with the majority adopting Justice Elena Kagan’s dissent in Genesis HealthCare Corp. v. Symczyk, which reasoned that an “unaccepted settlement offer — like any unaccepted contract offer — is a legal nullity, with no operative effect.” The court concluded that the rejection could only mean that the settlement offer was no longer operative, and the parties “retained the same stake in the litigation they had at the outset.”

Nonetheless, the Gomez court’s focus on the offer-and acceptance dance of Contracts 101 led it to reserve, “for a case in which it is not hypothetical[,]” the question of whether defendants can continue to moot claims by making an actual payment of full relief. Justice Ruth Bader Ginsberg, writing for the majority, explained that a claim might be mooted under Rule 68 when a defendant “deposits the full amount of the plaintiff’s individual claim in an account payable to the plaintiff, and the court then enters judgment for the plaintiff in that amount.” Perhaps even more ominously, Chief Justice John Roberts described the majority’s “offers only”- circumscribed decision as “good news.”

With the recent passing of Justice Antonin Scalia and resultant 4-4 split on the Court, the possibility remains that defendants will try the tactic of full tenders of relief to named plaintiffs in class actions, and that the issue will likely find its way back to the High Court.

The securities plaintiff’s bar has not borne many such pickoff attempts, probably as an unintended consequence of the Private Securities Litigation Act of 1995 (“PSLRA”).

The PSLRA expressly creates an open competition for “lead plaintiff.” Although the investor with the largest losses usually wins that competition, it is only after a profusion of qualified plaintiffs has come forward following a nationwide notification process. Indeed, an entire informational infrastructure has arisen to provide investors with PSLRA-mandated notice of securities class actions. Moreover, unlike consumer class actions, where damages to individual class members may be relatively small, lead plaintiffs chosen in securities class actions typically hold hundreds of thousands or even millions of shares of company common stock, and have millions of dollars in individual damages. Thus, the act of picking off such plaintiffs would not only be extremely costly but would actually be futile owing to no shortage of potential replacements, and if it did work, it would result in thousands of individual shareholder claims being filed, swamping the courts. This would essentially amount to litigating thousands of shareholder claims on an individual basis. At least in the securities context, Gomez, a case about short-circuiting class actions, ironically ends up highlighting their economy, particularly from the vantage of the defendants’ bar. 

Executives Seeking To Avoid Securities Fraud Liability Must Plan Ahead

ATTORNEY: MATTHEW L. TUCCILLO
POMERANTZ MONITOR MARCH/APRIL 2016

A key element of any securities fraud claim is evidence of defendant’s scienter, or intent to defraud. One way to establish scienter is to show that a given defendant engaged in transactions (typically sales) in company securities during the alleged period of fraud. Indeed, a complaint that does not allege such transactions faces heightened scrutiny by the court on a motion to dismiss.

Executives trying to explain such transactions frequently point to the existence of a so-called Rule 10b5-1 stock trading plan, which, for example, could schedule automatic stock transactions at pre-determined intervals or at specific future times. Rule 10b5-1, enacted by the SEC in 2000, expressly states that a person’s transaction in a security is “not ‘on the basis of’ material nonpublic information” if it is demonstrated that “before becoming aware of the information, the person had…[a]dopted a written plan for trading securities.” See 17 C.F.R. 240.10b5 -1(c)(1)(i)(A)(3). Since then, the case law has strongly weighed in favor of executives who had sold company stock, even at the height of an alleged fraud, where the sales were made pursuant to such a trading plan, often ruling that stock trades made pursuant to the plan could not evidence scienter. 

However, one dogfight in which we frequently engage revolves around the circumstances and timing of a Rule 10b5-1 plan’s creation. In our experience, too often, executives chose either to adopt a new Rule 10b5-1 plan or to amend a pre-existing Rule 10b5-1 plan during the period of alleged fraud, frequently causing an increase in sales of company stock at inflated prices before the fraud gets revealed and the stock price corrected by such revelation. The executives later seek to hide behind the existence of such a plan as exonerating evidence of their lack of intent to profit from an alleged fraud, while we typically argue that the timing of its adoption or amendment negates that argument.

An important battleground on this issue has been the Second Circuit, which encompasses the U.S. federal district courts in Connecticut, Vermont, and most significantly, New York. For context, according to a recent report prepared by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse, the Second Circuit alone accounted for 50 of the 189 (26.5%) securities class action lawsuits filed in 2015. Historically, we have relied upon a collection of lower court decisions from within the Second Circuit that discounted reliance by company insiders on Rule 10b5-1 plans adopted or amended during an alleged period of fraud. Included among them is George v. China Auto Sys., Inc., No. 11 Civ. 7533 (KBF), 2012 WL 3205062, at *9 (S.D.N.Y. Aug. 8, 2012), in which Pomerantz secured a ruling that Rule 10b5-1 trading plans entered into during the alleged period of fraud did not dispel the inference of the defendant executive’s scienter. Defendants, not surprisingly, have instead relied upon district court cases supporting the more generalized legal proposition that the existence of a Rule 10b5-1 plan undercuts the scienter inference, attempting to side-step the more nuanced factual issues surrounding the timing and circumstances of a plan’s adoption or amendment.

The Second Circuit Court of Appeals recently weighed in on this important issue, resolving it in favor of our  plaintiff side arguments in Employees’ Ret. Sys. of Gov’t of the Virgin Islands v. Blanford, 794 F.3d 297 (2d Cir. 2015).

Blanford concerned an alleged fraud regarding Green Mountain Coffee Roasters, Inc. and its Keurig brewing system, where investors were told that Green Mountain’s business was booming, with its inventory at “optimum levels” as it strained to meet high demand. In reality, it had been accumulating significant overstock of expiring and unsold product. During the alleged fraud, company insiders, including defendants Blanford (Green Mountain’s President/CEO/Director) and Rathke (its CFO/Secretary/Treasurer), sold company stock for millions of dollars in proceeds. Both Blanford and Rathke entered into new 10b5-1 trading plans just after one alleged misstatement (an earnings call), which permitted them to engage in significant sales shortly thereafter. The fraud was later revealed, causing Green Mountain’s stock price to plummet.

On these facts, the Second Circuit, citing Pomerantz’s decision in George v. China Auto Sys., among other precedent, rejected defendants’ argument that the 10b5-1 plan insulated them from an inference of scienter. Noting that Blanford and Rathke had entered into their 10b5-1 plans after an alleged misstatement (the earnings call) and after the fraudulent scheme began, the Second Circuit held: “When executives enter into a trading plan during the Class Period and the Complaint sufficiently alleges that the purpose of the plan was to take advantage of an inflated stock price, the plan provides no defense to scienter allegations.” Viewing the alleged facts holistically, the court held that defendants’ stock sales – including those made within the 10b5-1 plans – coupled with other alleged conduct (e.g., steps taken to conceal the true facts from investors), supported a strong inference of their scienter. Going forward, Blanford will be an important precedent, both in the Second Circuit and beyond, and we have already cited it to courts overseeing briefing on motions to dismiss our clients’ complaints.

Pomerantz Wins Class Certification In Two Major Cases: Barclays Investors Win Class Certification

ATTORNEY: TAMAR A. WEINRIB
POMERANTZ MONITOR MARCH/APRIL 2016

The same day as the class cert ruling in Petrobras, February 2, 2016, Judge Scheindlin of the federal district court in the Southern District of New York, after a full evidentiary hearing, granted plaintiffs’ motion to certify a class of allegedly defrauded Barclays investors in the Strougo v. Barclays PLC securities litigation, and appointed Pomerantz as counsel for the class.

The case, which involves claims pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, concerns defendants’ concealment of information and misleading statements over a three-year period regarding its management of its “LX” dark pool, a private trading platform where the size and price of the orders are not revealed to other participants. Even though the dark pool was just a tiny part of Barclays’ overall operations, Judge Scheindlin found that defendants’ fraud was highly material to investors because it reflected directly on the integrity of management. The court also found that reliance by class members on defendants’ omissions and misstatements could be presumed on a class-wide basis.

The court held that, under the Supreme Court’s Affiliated Ute doctrine, it was appropriate to presume that investors relied on the alleged material omissions, which involved defendants’ failure to disclose that they were operating their LX dark pool in a manner that did not protect Barclays’ clients’ best interests. Specifically, defendants failed to disclose that Barclays was not adequately protecting LX investors from “toxic” high frequency trading and were disproportionately routing trading orders back to LX. The court held that because LX constitutes a tiny fraction of Barclays’ business, a reasonable investor likely would have found the omitted misconduct far more material than the affirmative misstatements – because it reflected on management’s overall integrity. Indeed, it is for this reason that the court considered the omissions “the heart of this case.”

With respect to defendants’ affirmative misrepresentations, the court held that under the Supreme Court’s Basic “fraud on the market” doctrine, reliance by investors could also be presumed because Barclays’ stock trades in an efficient market. Its stock price would therefore have reflected defendants’ misrepresentations and omissions during the Class Period.

Of particular interest to Section 10(b) class action plaintiffs is the court’s rejection of defendants’ argument that to show market efficiency, plaintiffs must provide so-called “event studies” showing that the market price of the company’s stock price reacted quickly to the disclosure of new material information about the company. As in the Petrobras decision discussed in the previous article, though plaintiffs did in fact proffer an event study, the court held – consistent with a vast body of case law – that no one measure of market efficiency was determinative and that plaintiffs could demonstrate market efficiency through a series of other measures, which plaintiffs also provided here.

In so holding, the court observed that event studies are usually conducted across “a large swath of firms,” but “when the event study is used in a litigation to examine a single firm, the chances of finding statistically significant results decrease dramatically,” thus not providing an accurate assessment of market efficiency. The district court then found, following its extensive analysis, that plaintiffs sufficiently established market efficiency indirectly and thus direct evidence from event studies was unnecessary. Thus, the court went even further than the court in Barclays in downplaying the importance of event studies on class certification motions.

The district court also rejected defendants’ contention that certification should be denied because plaintiffs had supposedly failed to proffer a proper class wide damages model pursuant to the Supreme Court’s decision in Comcast. In rejecting that contention, the court recognized that the “Second Circuit has rejected a broad reading of Comcast” in its Roach v. T.L. Cannon Corp. decision. Indeed, the district court noted the Second Circuit’s finding in Roach that Comcast “did not hold that proponents of class certification must rely upon a classwide damages model to demonstrate predominance...[T]he fact that damages may have to be ascertained on an individual basis is not sufficient to defeat class certification.” The district court held that our expert’s proposal of using an event study and the constant dollar method to calculate damages is consistent with the theory of the case, and one that is typically used in securities class actions. The district court rejected defendants’ contention that plaintiffs should have proffered a model to identify and disaggregate confounding information as irrelevant, given that confounding information would affect all class members the same.

Pomerantz Wins Class Certification In Two Major Cases: Class Certification Granted In Our Petrobras Case

ATTORNEYS: H.ADAM PRUSSIN AND MATTHEW C. MOEHLMAN
POMERANTZ MONITOR MARCH/APRIL 2016

On February 2, 2016, Pomerantz achieved an important victory for investors when Judge Rakoff of the Southern District of New York certified two classes in our litigation against Petróleo Brasileiro S.A. – Petrobras, Brazil’s state run oil giant, concerning its involvement in one of the largest corruption and bribery scandals of the 21st century. One class consists of investors who purchased equity securities of Petrobras in the U.S. between 2010 and 2015. This class asserts fraud claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The other class consists of purchasers of debt securities Petrobras issued in public offerings in May 2013 and March 2014, who are alleging violations of Sections 11 and 12(a)(2) of the Securities Act of 1933. The lead plaintiff in the case is our client, Universities Superannuation Scheme.

The case concerns one of the most notorious securities frauds ever committed – a multi-year, multi-billion-dollar kickback and bid-rigging scheme. The scheme was allegedly orchestrated by former top Petrobras executives from at least 2004 onward, who systematically conspired to steer construction contracts to a cartel composed of 20-30 of Brazil’s largest contracting companies. The executives ensured that the contracts, padded by billions of dollars, were awarded to designated members of the cartel without any authentic competitive process. In return, the cartel kicked back hundreds of millions of dollars to the executives, who pocketed a cut of the bribe money, then gave the rest to their patrons in Brazil’s three ruling political parties. Revelations of this scheme decimated Petrobras’ stock price, devastating a class of investors. So far, five Petrobras executives have been convicted on criminal conspiracy and money-laundering charges, as well as a number of their confederates at the construction companies, and facilitating intermediaries.

As in many securities fraud cases, a central issue in the class certification motion was whether plaintiffs could establish that defendants committed “fraud on the market,” which allows investors to establish the element of reliance on a classwide basis. Failing this test would mean that reliance would have to be shown separately for each class member and that common questions would therefore not “predominate” over individual ones. To establish fraud on the market, plaintiff has to show that the securities in question trade on an efficient market, and that therefore defendants’ frauds affected the market price that each class member paid for purchasing Petrobras securities.

Courts have established a series of criteria for determining market efficiency, referred to as the “Cammer factors,” originally put together in a seminal case of that name. Most of these factors are indirect measures of market efficiency, including such things as the company’s market capitalization, the volume of trading in its securities, the typical bid-asked spread, the number of market makers in its shares and the number of analysts covering the company. The market for Petrobras securities easily passed all of these tests.

However, using an argument being pressed by defendants in most securities actions, the Petrobras defendants claimed that the most important Cammer factor is the “direct evidence” test, measured by how the market price of the company’s securities actually reacted to disclosure of unexpected news. This test, typically measured by socalled “event studies,” can be more difficult for investors to satisfy, because price movements in the real world can be affected by a host of market-moving information that can obscure the effects of the actual disclosure of the fraud. Defendants argued that this single factor trumps all the other Cammer factors and that it was not satisfied here because the market did not always react perfectly and instantaneously to unexpected disclosures. The district court held that plaintiff’s event studies were sufficient, and, more importantly, that perfect efficiency was not required:           

In assessing market efficiency, courts should not let the perfect become the enemy of the good. In this case, where the indirect Cammer factors lay a strong foundation for a finding of efficiency, a statistically significant showing that statistically significant price returns are more likely to occur on event dates is sufficient as direct evidence of market efficiency and thereby to invoke Basic’s presumption of reliance at the class certification stage. 

The court also rejected defendants’ argument that, because several large institutional investors had already “opted out” of the class, electing to pursue their own actions, investors were motivated to pursue their own actions and a class action was therefore unnecessary. To the contrary, the court determined that to deny class certification would plunge the courts into a morass of individual lawsuits and would do more harm than good.

Pomerantz News, At Home and Abroad

POMERANTZ MONITOR, JANUARY/FEBRUARY 2016

As part of its commitment to education, Pomerantz presented a moot court in January 2016 for advanced law students of Bar Ilan University in Israel. Daniel J. Kramer, Partner at Paul, Weiss, acted as counsel for the defense; Jeremy Lieberman as counsel for plaintiffs; and Marc Gross as judge. They argued Polycom, an actual securities fraud class action in which Pomerantz is lead counsel for the plaintiff class. The case alleges that the company was making positive statements about its operation and prospects, while it did not disclose that its CEO had submitted numerous false expense reports, claiming personal expenses as business expenses, and thereby misappropriating hundreds of thousands of dollars from the company.

 Meanwhile, on the home front, Pomerantz is proud to announce that Brenda Szydlo has joined the firm as Of Counsel in our New York office. Brenda has more than twenty-five years of experience in complex civil litigation in federal and state court on behalf of plaintiffs and defendants, with a particular focus on securities and financial fraud litigation, litigation against pharmaceutical corporations, accountants’ liability, and commercial litigation.

 Brenda is a 1988 graduate of St. John’s University School of Law, where she was a St. Thomas More Scholar and member of the Law Review. She received a B.A. in economics from Binghamton University in 1985.

SCOTUS Shorts

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR JANUARY/FEBRUARY 2016

The Supreme Court has just issued two very significant rulings. In the first one, it granted certiorari to review U.S. v. Salman, a criminal insider trading prosecution. The case turns on the question of what sort of personal benefit, if any, a “tippee” has to give to his “tipper” in exchange for the inside information before the tippee can be liable for trading on it. This issue received national attention a few months ago when the Second Circuit gave its answer to this question in U.S. v. Newman; but the Supremes denied cert in that case.

In Salman, defendant Salman received the inside information from a close friend who, in turn, had heard it from his brother. The question is whether the personal relationship between the two brothers in itself satisfies the “personal benefit” requirement for insider trading, or whether the government also has to show that the tippee brother gave an additional, tangible benefit to his brother in exchange for the information. In its decision, the 9th Circuit held that no additional tangible benefit, beyond the personal relationship, was required. In Newman, the Second Circuit previously held otherwise. Curiously, the 9th Circuit’s opinion was written by Judge Rakoff, a District Court judge sitting by designation. Judge Rakoff sits in the Southern District of New York, which is part of the Second Circuit. Through this quirk of fate, Judge Rakoff got another circuit court to disagree, publicly, with the Second Circuit’s Newman decision, which is binding on him when he sits as a district judge in New York.

In the Supreme Court’s second ruling, Campbell Ewold, it struck a blow against a tactic increasingly used by defendants in class actions: trying to “moot” the claims of the class representative by offering to pay all of his claimed damages. If the representative’s claim is mooted (i.e., satisfied), his individual claim would be dismissed, and the class would have no representative. If the class could not find another representative, the whole class action would be dismissed. If this could work, the class action device could be eviscerated.

Fortunately, the Supremes said no, finding that a rejected offer of settlement does not wipe out the representative’s claim; but, unfortunately, they left open the question of whether this tactic could work if, instead of just offering to pay the claimed damages, the defendant actually pays the money into an account for the benefit of the plaintiff, such as an escrow account or the clerk’s office. To resolve that question, we may need “Campbell Ewold 2.”