2011 Year-End Securities Law Compendium · 2011 Year-End Securities Law Compendium . i TABLE OF CONTENTS Page PREFACE

2011 Year-End Securities Law Compendium

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TABLE OF CONTENTS

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PREFACE ..........................................................................................................................................1

I. SUPREME COURT...........................................................................................................2

A. SUMMARY OF DEVELOPMENTS DURING 2011 ............................................2 B. NOTEWORTHY CASES DURING 2011 ..............................................................2

1. Loss Causation .............................................................................................2 2. Pleading Standards for Securities Fraud ......................................................3 3. Materiality ....................................................................................................4 4. Statute of Limitations ...................................................................................4

II. FIRST CIRCUIT ...............................................................................................................6

A. SUMMARY OF DEVELOPMENTS DURING 2011 ............................................6 B. NOTEWORTHY CASES DURING 2011 ..............................................................6

1. Misstatements and Omissions ......................................................................6 2. Scienter ........................................................................................................8 3. Pleading Standards for Securities Fraud ......................................................8 4. Class Certification ........................................................................................9

III. SECOND CIRCUIT.........................................................................................................10

A. SUMMARY OF DEVELOPMENTS DURING 2011 ..........................................10 B. NOTEWORTHY CASES DURING 2011 ............................................................11

1. Loss Causation ...........................................................................................11 2. Statute of Limitations .................................................................................14 3. Misstatements or Omissions ......................................................................16 4. Scienter ......................................................................................................19 5. Morrison / Extraterritorial Application ......................................................23 6. Standing .....................................................................................................23 7. SLUSA .......................................................................................................24 8. Pleading Standards for Securities Fraud ....................................................24 9. Reliance......................................................................................................25 10. Materiality ..................................................................................................27 11. Definition of Underwriter ..........................................................................27 12. Williams Act ..............................................................................................28

IV. THIRD CIRCUIT ............................................................................................................29


1. Class Certification ......................................................................................29 2. Pleading Standards for Securities Fraud ....................................................29

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V. FOURTH CIRCUIT ........................................................................................................31

A. NOTEWORTHY CASES DURING 2011 ............................................................31 1. Loss Causation ...........................................................................................31

VI. FIFTH CIRCUIT .............................................................................................................32

A. NOTEWORTHY CASES DURING 2011 ............................................................32 1. Pleading Standards for Securities Fraud ....................................................32

VII. SIXTH CIRCUIT .............................................................................................................33


1. Scienter ......................................................................................................33 2. Reliance......................................................................................................34

VIII. SEVENTH CIRCUIT ......................................................................................................36


1. Pleading Standards for Securities Fraud ....................................................36 2. Scienter ......................................................................................................38 3. Misstatements and Omissions ....................................................................39 4. SLUSA .......................................................................................................40 5. Reliance......................................................................................................42 6. Expedited Discovery under PSLRA ..........................................................42

IX. EIGHTH CIRCUIT .........................................................................................................43

A. NOTEWORTHY CASES DURING 2011 ............................................................43 1. Scienter ......................................................................................................43

X. NINTH CIRCUIT ............................................................................................................44


1. Pleading Standards for Securities Fraud ....................................................44 2. Loss Causation ...........................................................................................49 3. Misstatements and Omissions ....................................................................50 4. SLUSA .......................................................................................................53 5. Control Person Liability .............................................................................53 6. Scienter ......................................................................................................54 7. Materiality ..................................................................................................56 8. Class Certification ......................................................................................57

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XI. TENTH CIRCUIT ...........................................................................................................59


1. Scienter ......................................................................................................59 2. Misstatements and Omissions ....................................................................60 3. Class Certification ......................................................................................62 4. Morrison / Extraterritorial Reach ...............................................................62 5. SLUSA .......................................................................................................63

XII. ELEVENTH CIRCUIT ...................................................................................................64


1. Scienter ......................................................................................................64 2. Pleading Standards for Securities Fraud ....................................................65 3. Loss Causation ...........................................................................................66 4. Misstatements and Omissions ....................................................................66

XIII. DELAWARE COURTS ..................................................................................................68


1. Fiduciary and Revlon Duties ......................................................................68 2. Fiduciary Duty: State Insider Trading Claim............................................71 3. Books and Records Inspection ...................................................................72 4. Breach of Contract .....................................................................................73 5. Business Judgment Rule / Entire Fairness .................................................74 6. Poison Pill and Other Defensive Measures ................................................75 7. Misstatements and Omissions ....................................................................75 8. Materiality ..................................................................................................75 9. Other ..........................................................................................................76

XIV. SECURITIES AND EXCHANGE COMMISSION ENFORCEMENT CASES ...............................................................................................................................78


1. Pleading Standards for Securities Fraud ....................................................78 2. Scienter ......................................................................................................79 3. Statute of Limitations .................................................................................81 4. Venue .........................................................................................................81 5. Subject-Matter Jurisdiction ........................................................................82 6. Misstatements and Omissions ....................................................................82 7. Insider Trading ...........................................................................................83 8. Other ..........................................................................................................83

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XV. SEC RULES AND GUIDANCE .....................................................................................84

A. SUMMARY OF DEVELOPMENTS DURING 2011 ..........................................84 B. NOTEWORTHY RULES AND GUIDANCE ISSUED BY THE SEC

DURING 2011 .......................................................................................................84 1. SEC Adopts Rules To Establish Whistleblower Program .........................84 2. SEC Approves FINRA’s All-Public Arbitration Panel Rule .....................84 3. SEC Approves Compensation Rules .........................................................85 4. SEC Approves Rule Change for FINRA Arbitration Docs .......................85 5. SEC, CFTC Define Responsibility for Swap Coverage ............................85 6. SEC Approves Facilities To Shine Light on Swap Trading ......................85 7. SEC Inks Sweeping Hedge Fund Adviser Rules .......................................86 8. SEC Advances New Conduct Rules for Swap Markets .............................86 9. SEC Approves New Rules on Large-Trader Reporting .............................86 10. SEC Advances Proposed Volcker Rule .....................................................86 11. SEC Locks In New Private Fund Reporting Rules ....................................87 12. SEC Tightens Standards for Reverse Merger Listings ..............................87

XVI. DEVELOPMENTS WITH THE PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD DURING 2011 ..........................................................................88

A. SUMMARY OF DEVELOPMENTS DURING 2011 ..........................................88 B. NOTABLE RELEASES DURING 2011...............................................................88

1. PCAOB Enters into Cooperative Agreement with the UK Audit Regulator ....................................................................................................88

2. PCAOB Issues Research Note on Chinese Reverse Mergers ....................89 3. PCAOB Enters into First Cooperative Agreement with Swiss

Regulators ..................................................................................................89 4. PCAOB Publishes Staff Audit Practice Alert on Audit Risks in

Certain Emerging Markets .........................................................................89 5. PCAOB Enters into Cooperative Agreements for the Exchange of

Confidential Information with Authorities in Israel and Dubai .................89 6. PCAOB Enters into Cooperative Arrangement with Taiwan ....................90 7. PCAOB Publishes Staff Audit Practice Alert on Assessing and

Responding to Risk in the Current Economic Environment ......................90 C. NOTABLE DISCIPLINARY PROCEEDINGS DURING 2011 ..........................90

1. In the Matter of Price Waterhouse, Bangalore, Lovelock & Lewes, Price Waterhouse & Co., Bangalore, Price Waterhouse, Calcutta, and Price Waterhouse & Co., Calcutta, PCAOB Release No. 105- 2011-002 (Order Instituting Disciplinary Proceedings, Making Findings and Imposing Sanctions) .............................................................90

2. PCAOB Announces Settled Disciplinary Orders Against Former Ernst & Young Partner and Senior Manager For Providing Misleading Documents to PCAOB Inspectors And Altering Working Papers ..........................................................................................91

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3. In the Matter of Bentleys Brisbane Partnership and Robert John Forbes, CA, PCAOB Release No. 105-2011-007 (Order Instituting Disciplinary Proceedings, Making Findings and Imposing Sanctions) ...................................................................................................91

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PREFACE

Latham & Watkins’ Securities Litigation and Professional Liability Practice presents its annual Year-End Securities Law Compendium. The 2011 Compendium highlights noteworthy trends from the past year in the areas of federal securities law, Delaware corporate litigation, and SEC and PCAOB enforcement activity and rule-making. All told, the 2011 Compendium contains:

• Over 100 case summaries from the US Supreme Court and every federal circuit in the US;

• Summaries of more than 25 decisions from the Delaware state courts; and

• Over 30 summaries of SEC enforcement actions and PCAOB disciplinary proceedings, as well as key releases and guidance issued by the SEC and PCAOB.

Latham’s Securities Litigation and Professional Liability lawyers closely monitor developments in these areas throughout the year, circulating concise summaries of all noteworthy decisions and news on a real-time basis. Every year, we compile the most important of these summaries into the Compendium. We present this document as a valuable resource for practitioners and organizations involved or interested in securities litigation and enforcement.

Highlights from the Supreme Court and each circuit, as well as Delaware and the enforcement agencies, are discussed at the outset of each section. The Supreme Court was particularly active in securities litigation in 2011. During the year, the Supreme Court issued three important securities law decisions — Erica P. John Fund, Inc. v. Halliburton Co.; Janus Capital Group Inc. v. First Derivative Traders; and Matrixx Initiatives, Inc. v. Siracusano —all of which are summarized below. The Compendium also tracks trends, circuit-by-circuit, in a variety of substantive areas arising out of shareholder class actions, M&A litigation, enforcement matters and other federal cases. The Compendium provides insight into the cases arising out the financial crisis, as those cases continue to work their way through the federal courts. The regulatory section of the Compendium highlights developments with respect to the SEC’s new whistleblower program, its creation of Dodd-Frank regulations, and tightened standards and releases issued by the SEC and PCAOB with respect to reverse mergers.

If you would like to discuss the Compendium, or learn more about Latham’s Securities Litigation and Professional Liability Practice, please contact one of the editors listed below, any member of the group or your lawyer contact at the firm. For a global roster of our Securities Litigation and Professional Liability Practice, please visit the firm’s website at www.lw.com.

Robert J. Malionek +1.212. 906.1816 [email protected] New York

Kevin M. McDonough +1.212.906.1246 [email protected] New York

Jennifer Greenberg +212.906.1871 [email protected] New York

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I. SUPREME COURT

A. SUMMARY OF DEVELOPMENTS DURING 2011

During 2011, the Supreme Court decided three important securities class action cases: Erica P. John Fund; Inc. v. Halliburton Co., Janus Capital Group Inc. v. First Derivative Traders; and Matrixx Initiatives, Inc. v. Siracusano.

In Halliburton, the Court provided important guidance on class certification issues, holding that plaintiffs are not required to prove loss causation in order to avail themselves of the fraud-on-the-market presumption of reliance. In Janus, the Court held that a person cannot be liable in a private securities action for making a misleading statement or omission unless he or she had “ultimate control over the statement, including its content and whether and how to communicate it.” The Court clarified that “one who prepares or publishes a statement on behalf of another is not its maker.” Lastly, in Matrixx, the Court rejected a bright-line rule of materiality based on statistical significance.

In early 2012, the Court issued a decision in Simmonds v. Credit Suisse Securities (USA) LLC, holding that Section 16’s two-year statute of limitations period is not tolled until the insider discloses his transactions in a Section 16(a) filing, where the plaintiff knew or should have known of the alleged fraud prior to such disclosure.

B. NOTEWORTHY CASES DURING 2011

1. Loss Causation

a. Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011)

Plaintiff investment fund filed suit against defendant oilfield services company on behalf of all investors who purchased defendant’s stock between June 1999 and December 2001. Plaintiff alleged that defendant had deliberately made false statements about the scope of its potential liability in pending asbestos litigation, expected revenue from construction contracts and the benefits of its merger with an energy services company. Investors allegedly suffered losses when defendant made a series of corrective disclosures that caused its stock price to fall. The district court denied defendant’s motion to dismiss in full. The court refused to certify the putative class, however, because plaintiff could not prove a causal connection between the alleged misrepresentations and the economic loss suffered by investors, a requirement known as “loss causation,” and thus was not entitled to the fraud-on-the-market presumption of reliance. The Fifth Circuit affirmed and ruled that for the lawsuit to proceed as a class action, plaintiff would have to prove at the outset that the revelation of the alleged misrepresentations caused the stock price to fall, resulting in investor losses. The Supreme Court granted certiorari to address whether plaintiffs in securities fraud actions must establish loss causation at class certification by a preponderance of admissible evidence without merits discovery.

The Supreme Court rejected the notion that plaintiffs must prove loss causation in order to establish the fraud-on-the-market presumption of reliance and therefore overturned the Fifth Circuit’s ruling. The Court explained that reliance and loss causation are separate elements of a

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securities fraud claim. Reliance means that plaintiff’s decision to purchase shares was based on the misrepresentation. The fraud-on-the-market presumption of reliance posits that, in an efficient market, public statements about publicly traded companies are reflected in share prices, thus giving rise to a presumption that investors rely on public statements when purchasing or selling securities. The element of loss causation, by contrast, requires that the reduced share prices causing plaintiff’s losses resulted from the correction of an alleged misrepresentation. According to the Court, whether a loss occurred for reasons other than the revelation of a misrepresentation is a different issue from whether the investor relied on the misrepresentation in the first place. The Court remanded the case to the Fifth Circuit for further proceedings, including any further arguments against class certification.

2. Pleading Standards for Securities Fraud

a. Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011)

Plaintiff investment fund filed suit against a mutual fund holding company and its subsidiary investment services company. The holding company created a family of mutual funds operated by an independent company wholly owned by mutual fund investors. The investment services company provided advisory and administrative services to the mutual fund company. In a series of prospectuses, the mutual fund company stated that the investment services company would ensure that mutual fund investors did not employ “market-timing” strategies to the injury of other investors. Later, the New York Attorney General accused the mutual fund company and the investment services company of entering into secret agreements to permit market-timing trading. Investors withdrew large amounts of money from the mutual fund company, causing the investment services company to lose significant fees. Because the investment services company accounted for the majority of the mutual fund company’s revenue, the corporation’s stock lost nearly 25 percent of its value.

Plaintiff sued, alleging that the investment services company made false statements in the mutual fund company’s prospectuses. The district court dismissed the complaint for failure to state a claim. The Fourth Circuit reversed, concluding that defendants, “by participating in the writing and dissemination of the prospectuses, made the misleading statements in the documents.” The Supreme Court granted certiorari.

In a 5-4 decision, the Supreme Court overturned the Fourth Circuit ruling. Section 10(b) of the Exchange Act and Rule 10b-5 make it unlawful for persons and entities “to make any untrue statement of a material fact.” The Court held that the investment services company did not “make” the statements in the prospectuses issued by the independent mutual fund company, and thus was not liable under Section 10(b) and Rule 10b-5. The Court explained that “the maker of a statement is the person or entity with ultimate control over the statement, including its content and whether and how to communicate it.” Analogizing to the relationship between a speechwriter and a speaker — in which both credit and blame fall on the speaker — the Court clarified that “one who prepares or publishes a statement on behalf of another is not its maker.” The Court acknowledged that the close relationship between the investment services company and the mutual fund company extended to the drafting of the prospectuses, but nonetheless held

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that the formal separation of the entities meant that the statements were made by the mutual fund company alone.

The dissent objected to the majority’s narrow definition of “make” and concluded that, because of the close relationship between the investment services company and the mutual fund company, the investment services company “made” the misleading statements contained in the mutual fund company prospectuses.

3. Materiality

a. Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309 (2011)

Plaintiff shareholders filed a lawsuit under Section 10(b) of the Exchange Act, alleging that Matrixx, the producer of the cold remedy Zicam, made statements about the company’s future profitability that were rendered misleading by Matrixx’s knowledge of reports and lawsuits claiming that Zicam caused anosmia (the loss of the sense of smell). Matrixx moved to dismiss, arguing that incidents of Zicam-linked anosmia were statistically insignificant, and thus immaterial. Matrixx also argued that plaintiffs failed to allege scienter properly because Matrixx had no knowledge of a statistically significant number of adverse medical reports. The district court dismissed the lawsuit; the Ninth Circuit reversed. On appeal, the Supreme Court affirmed, rejecting Matrixx’s arguments and declining to draw a bright-line rule of materiality based on statistical significance. Instead, the Court concluded that the context of the reports and lawsuits was such that a reasonable investor might find them material, and thus plaintiffs adequately alleged that Matrixx’s statements were materially misleading. Given the nature of the reports of anosmia and the actions that Matrixx took to protect its product in the face of negative reports, the Court held that plaintiffs adequately alleged scienter.

4. Statute of Limitations

a. Credit Suisse Securities (USA) LLC et al. v. Simmonds, 132 S. Ct. 1414 (2012)

Plaintiff filed suit against the underwriters of various IPOs, claiming that they employed mechanisms to inflate the aftermarket price of the issued stock, creating “short-swing” profits, and triggering Section 16(b) of the Exchange Act. Defendants claimed the suit was untimely because Section 16(b)’s two-year statute of limitations had run out. Plaintiff claimed the statute was tolled because the underwriters were subject to, and failed to comply with, Section 16(a)’s reporting requirements. Defendants argued that Section 16(b)’s limitations period is a statute of repose which does not toll. The district court dismissed plaintiff’s complaint on the ground that Section 16(b)’s two-year statute of limitations had expired. The Ninth Circuit reversed, holding that the Section 16(b) limitations period does not establish a period of repose but is “tolled until the insider discloses his transactions in a Section 16(a) filing, regardless of whether the plaintiff knew or should have known of the conduct at issue.”

The Supreme Court was equally divided four to four (with Chief Justice Roberts not participating) on the issue of whether Section 16(b) establishes a period of repose, and thus is not subject to any tolling whatsoever. However, in a unanimous decision, the Court reversed the Ninth Circuit, and held that, even assuming Section 16(b)’s 2-year period is a statute of

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limitations (not a statute of repose), the Ninth Circuit erred in determining that the 2-year period is tolled until a Section 16(a) statement is filed. In support of its holding, the Court looked to the language of Section 16(b), which states that the two-year clock starts from “the date such profit was realized” and found that the Ninth Circuit’s rule should not apply because it conflicts with “long-settled equitable-tolling principles.” In a concealment-of-fraud case, the Court noted, the statute of limitations does not begin to run “until discovery of the fraud where the party injured by the fraud remains in ignorance of it without any fault or want of diligence on his part.” The Court stated that allowing tolling to continue beyond discovery of the fraud, which would be the result of the Ninth Circuit’s holding, is inequitable and inconsistent with the purpose of statutes of limitations — “to protect defendants against stale or unduly delayed claims.” The Court remanded the case for the lower courts to apply the standard rules of equitable tolling.

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II. FIRST CIRCUIT


The First Circuit and the District of Massachusetts issued several notable decisions during 2011. In City of Dearborn Heights Act 345 Police & Fire Retirement System v. Waters Corp., the First Circuit affirmed a lower court’s dismissal of securities fraud on the ground that plaintiffs had not adequately alleged scienter. The court held that a water purification producer and its directors were reasonable in their belief that a change in Japanese water regulations would not materially impact sales, and that defendants’ low volume of stock trades below the stock’s annual high was not evidence of scienter. The District of Massachusetts analyzed the impact of a class action lawsuit on claims brought by investors who had opted out of the class in Special Situations Fund III, L.P. v. American Dental Partners, Inc. Although the court rejected plaintiffs’ argument that their complaint must survive defendant’s motion to dismiss because another district court denied defendant’s motion to dismiss a virtually identical class action complaint, the court nonetheless found that the complaint satisfied the Private Securities Litigation Reform Act’s (PSLRA) particularity requirement despite the complaint’s verbatim repetition of the allegations in the class action complaint. In Hill v. State Street Corp., the District of Massachusetts denied a bank’s motion to dismiss, holding that plaintiffs adequately alleged scienter and materially misleading statements related to foreign exchange transactions and the bank’s holdings of residential mortgage-backed securities. The District of Massachusetts also rejected a summary judgment motion brought by defendant investment analysts in In re Credit Suisse-AOL Sec. Litig. In that case, the court concluded that there were disputed issues of fact as to whether the defendants intentionally omitted negative information from their research reports and whether the plaintiffs suffered losses based on their reliance on those reports.


1. Misstatements and Omissions

a. Hill v. Gozani, 651 F.3d 151 (1st Cir. 2011)

Plaintiff pension fund brought claims under Sections 10(b)(5) and 20(a) in a consolidated class action against a medical device manufacturer and its officers, alleging defendants understated the risk that insurers would not sustain prevalent reimbursement rates for procedures involving a company device. The First Circuit initially affirmed the District Court’s dismissal for failure to state a claim, despite acknowledging the materiality of the company’s reimbursement experts’ warning that current billing practices were fraudulent. The First Circuit ruled that the company adequately disclosed the risk of an uncertain “reimbursement landscape” and that the company was under no obligation to disclose internal disagreement regarding strategy. Following the Supreme Court’s decision in Matrixx Initiatives, Inc. v. Siracusano, which refined the analysis of material misrepresentations, plaintiff appealed. The First Circuit again affirmed the dismissal, finding its earlier decision consistent with Matrixx. The court noted that whereas defendants in Matrixx had blatantly discredited, without basis, material adverse information, defendants in the present action lacked factual support for the adverse internal expert opinions, and thus were under no duty to disclose them.

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b. Hill v. State Street Corp., 2011 WL 3420439 (D. Mass. Aug. 3, 2011)

Plaintiffs, institutional investors and members of an employment benefit plan, filed two consolidated class actions against defendant investment bank and its directors, officers, auditors, and underwriters, alleging that the bank issued misleading statements regarding its positions in residential mortgage-backed securities (RMBS) positions and foreign exchange practices in violation of (i) Sections 11, 12 and 15 of the Securities Act, (ii) Sections 10 and 20 claims under the Exchange Act, and (iii) ERISA. Specifically, the securities plaintiffs alleged that defendants misled investors during a public offering regarding the bank’s foreign exchange profits and failed to disclose that it charged its customers the highest daily foreign exchange rate instead of the rate at which the bank executed its foreign exchange trades. Defendants also allegedly misled investors by repeatedly touting their “high quality” assets during the collapse of the subprime RMBS market. The ERISA plaintiffs alleged that defendants breached fiduciary duties by imprudently offering the defendant bank’s stock as an investment option to benefit plan participants. The district court denied defendants’ motions to dismiss, finding that plaintiffs presented sufficient evidence, including material compiled during an 18-month investigation conducted by the California Attorney General, to support plausible theories of fraud and misleading statements. Moreover, the court held that the misleading statements were material regardless of the size of the foreign exchange markup because the fraud, if disclosed, would cause significant reputational harm to the bank. Regarding the bank’s RMBS exposure, the court could not conclude as a matter of law that the phrase “high quality” referred solely to the credit risk of the bank’s assets, as defendants had argued, and not to indicators such as likelihood of default or future mark-to-market losses, in which contexts the statement would be misleading. Finally, the court rejected defendants’ motions to dismiss ERISA claims, finding plaintiffs sufficiently alleged that the bank’s stock represented an imprudent investment option in the benefits plan.

c. In re Credit Suisse-AOL Sec. Litig., 2011 WL 3813204 (D. Mass. Aug. 26, 2011)

Plaintiff shareholders commenced claims under Sections 10(b) and 20(a) of the Exchange Act against an investment bank, its subsidiary, and four analysts employed by the subsidiary to provide investment research coverage on the merger of two technology companies. Plaintiffs alleged that defendants ignored material information regarding the financial future of the merging companies when formulating investment recommendations in order to obtain increased investment banking business from the merged companies. The district court denied defendants’ motions for summary judgment, finding that plaintiffs presented sufficient evidence to allow a jury to conclude that defendants issued misleading statements regarding the prospects of the merged companies. The court noted that internal emails acknowledged defendants’ misstatements, agreed that material information was omitted, and even conceded that defendants possessed an ulterior motive for failing to disclose the information. Moreover, although defendants were analysts (and not issuers of securities), and numerous analysts had also opined on the financial health of the tech companies, the court found that plaintiffs’ expert testimony presented disputed issues of fact regarding plaintiffs’ reliance on the defendants’ recommendations and the impact of those recommendations on plaintiffs’ losses.

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2. Scienter

a. City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Waters Corp., 632 F.3d 751 (1st Cir. 2011)

Plaintiff pension fund asserted claims under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 against defendant water purification instrument systems producer and its directors, alleging defendants concealed a Japanese regulatory relaxation, which impacted sales. The First Circuit affirmed the lower court’s dismissal and ruled that, regardless of defendants’ knowledge of the regulatory change, defendants reasonably believed the change would have no material effect on global sales. The court further rejected plaintiff’s insider trading scienter argument, finding that (i) plaintiff failed to allege unusual trading activity and (ii) the small volume of trades at a price well below the annual peak did not create inference of scienter.

b. Miss. Public Employees’ Retirement Sys. v. Boston Scientific Corp., 649 F.3d 5 (1st Cir. 2011)

Plaintiff pension fund asserted claims under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 against defendant medical device manufacturer alleging that defendant misled investors about the risk that manufacturer would be required to recall a stent device. The First Circuit affirmed the district court’s decision granting defendant’s motion for summary judgment because, as the district court found, plaintiffs could not point to a material issue of disputed fact regarding defendant’s scienter. In particular, the court found that although defendant knew that it was contemplating a modification of the stent device — to address publicly known complaints regarding stent deployment — plaintiff did not provide sufficient evidence to support an inference that defendant knew that deployment complications threatened the product’s commercial viability, and hence the company’s stock price.


a. Special Situations Fund III, L.P. v. American Dental Partners, Inc., 775 F. Supp. 2d 227, 2011 WL 1226983 (D. Mass. Mar. 31, 2011)

Plaintiff investment partnerships opted out of a class action lawsuit and brought independent claims under Rule 10b-5 and Sections 10(b), 18 and 20(a) of the Exchange Act against defendant dental management service provider, alleging defendant misrepresented the merits of a pending contract dispute with its most significant client. The district court denied defendant’s motion to dismiss in part, finding that defendant knowingly misrepresented that its conduct toward the client had not changed at all over the course of their relationship. As an initial matter, the court rejected plaintiffs’ argument that their complaint must survive defendant’s motion to dismiss because another district court denied defendant’s motion to dismiss a virtually identical class action complaint. The court nonetheless found that the complaint was sufficiently pled to withstand a motion to dismiss. In reaching that conclusion, the court rejected defendant’s argument that the complaint failed to satisfy the PSLRA’s particularity requirements merely because it copied verbatim the class action allegations. Further, the court found that plaintiffs adequately alleged materiality because the service

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provider’s press releases, conference calls, and public filings demonstrated significant investor interest in the merits of the lawsuit. Finally, plaintiffs sufficiently pled loss causation on the basis of inflated stock prices leading up to jury verdicts that awarded over $130 million to the client and revealed the truth about the lawsuit’s merit. The court dismissed plaintiffs’ Section 18 claims as time-barred, finding that the class action complaint, which had alleged only Section 10(b) and 20(a) claims, did not toll plaintiffs’ Section 18 claims.

4. Class Certification

a. In re Evergreen Ultra Short Opportunities Fund Sec. Litig., 2011 WL 3567830, 275 F.R.D. 382 (D. Mass. Aug. 10, 2011)

Plaintiff shareholders brought several class actions alleging violations of Sections 11, 12 and 15 of the Securities Act against defendant mutual fund and its directors, officers, investment advisor and underwriter. Specifically, plaintiffs alleged that defendants invested the fund’s assets in a greater proportion of illiquid securities and riskier-than-represented mortgage-backed securities, and artificially inflated the fund’s net asset value by misstating the value of these illiquid assets. The district court granted class certification, finding that lead plaintiffs possessed standing despite acquiring their shares at least 15 months after the start of the proposed class period because the offering materials at the beginning of the class period were alleged to be part of a “common, fraudulent scheme” that continued when lead plaintiffs acquired shares. The court also rejected defendants’ argument that lead plaintiffs’ claims were atypical of the proposed class because, unlike the remaining class members, lead plaintiffs acquired their shares automatically pursuant to a merger, and thus could not rely on a fraud-on-the-market theory. The court ruled that the Rule 23(a) typicality requirement was satisfied because the fraud-on-the-market theory was relevant to fraud cases brought under the Exchange Act but not to Securities Act claims. Finally, the court found that lead plaintiffs adequately represented the interests of the class, even though the class included members who both benefited from and were harmed by the mis-pricing of the fund’s net asset value.

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III. SECOND CIRCUIT


In 2011, the Second Circuit and the Southern District of New York continued to grapple with shareholder class actions arising out the financial crisis, frequently finding that plaintiffs’ allegations were insufficient to satisfy the heightened pleading requirements of the PSLRA. Courts in the Second Circuit also issued noteworthy decisions concerning opinion statements, materiality and the Supreme Court’s recent Janus decision.

In Amorosa v. AOL Time Warner Inc., the Second Circuit affirmed the district court’s finding that plaintiff failed to establish loss causation where the price of the security in question increased between the time of defendant’s alleged misstatement and the date when the suit was filed. The court also affirmed the district court’s decision to impose sanctions on plaintiff’s counsel for failure to adhere to Rule 11. In City of Pontiac General Employees Retirement System v. MBIA, Inc., the Second Circuit applied the Supreme Court’s decision in Merck & Co. v. Reynolds, 130 S. Ct. 1784 (2010), and reversed the district court’s dismissal of plaintiffs’ Section 10(b) and Rule 10b-5 claims as untimely. The court explained that, under Merck, the statute of limitations does not begin to run until a reasonable investor conducting a timely investigation could have discovered facts constituting a violation. A fact is not “discovered” until a reasonably diligent plaintiff would have enough information about the fact to plead it in a complaint adequately enough to survive a Rule 12(b)(6) motion to dismiss. In In re Lehman Brothers Mortgage-Backed Securities Litigation, the Second Circuit rejected plaintiffs’ attempts to expand the Section 11 definition of underwriter, holding that ratings agencies were not underwriters for Section 11 purposes because they did not directly participate in the purchase or sale of securities.

In Fait v. Regions Financial Corp., the Second Circuit addressed the standard for pleading falsity of opinion statements, and affirmed the district court’s decision to dismiss the complaint because plaintiff failed to allege that defendants did not truly hold the opinions that plaintiffs attacked in their complaint. The Second Circuit also affirmed the district court’s dismissal of the complaint in Wilson v. Merrill Lynch & Co., finding that plaintiffs failed adequately to allege that defendants manipulated the market for auction rate securities (ARS). Finally, in Hutchinson v. CBRE Realty Finance Inc., seeking to reconcile its divergent holdings in ECA & Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., and Litwin v. Blackstone Grp., L.P., the Second Circuit held that materiality depends upon whether the assets at issue comprised more than 5% of a part of the business in total, or more than 5% of a part of the business with particular importance to investors.

The Southern District addressed numerous cases involving mortgage-backed securities (MBS) and ARS. In particular, the court dismissed Section 10(b) and Rule 10b-5 claims relating to MBS and other real estate assets in In re State Street Bank & Trust Co. Fixed Income Funds Investment Litigation (insufficient allegations of loss causation), In re Barclays Bank PLC Securities Litigation (expiration of the statute of limitations), and Footbridge Ltd. Trust v. Countrywide Financial Corp. (expiration of the statute of repose). The court dismissed similar claims relating to ARS in In re Citigroup, Inc. and In re MRU Holdings Securities Litigation, where plaintiffs failed to allege misstatements or omissions with sufficient particularity. In In re

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Optimal U.S. Litigation, the Southern District analyzed the Supreme Court’s decision in Janus Capital Group v. First Derivative Traders and held that a parent company owning a 100% interest in a subsidiary was not liable for its subsidiary’s statements.


1. Loss Causation

a. Amorosa v. AOL Time Warner Inc., No. 09-cv-5270, 2011 WL 310316 (2d Cir. Feb. 2, 2011)

The Second Circuit affirmed the judgment of the Southern District of New York granting defendant auditor’s motion to dismiss and imposing sanctions on plaintiff’s counsel. The court rejected plaintiff’s claim that the district court erred in dismissing his claims under Sections 14 and 10(b) of the Exchange Act for failing to adequately plead loss causation. Because plaintiff’s complaint failed to identify specifically any misstatements or omissions and, in turn, the risk that was thereby concealed, plaintiff failed to establish loss causation on a “materialization of the risk” theory. The Second Circuit agreed with the district court’s finding that plaintiff’s claim under Section 11 of the Securities Act, in addition to being time-barred, failed for lack of loss causation. Defendant’s alleged misstatement could not have resulted in any losses because the price of the securities went up between the time of the misstatement and the date plaintiff filed suit. The court affirmed the district court’s ruling that plaintiff, a mere “holder” of securities, lacked standing to bring a Rule 10b-5 claim. The court further held that plaintiff’s state law claims were preempted by the Securities Litigation Uniform Standards Act (SLUSA), and thus were properly dismissed by the district court. Lastly, the court affirmed the district court’s imposition of sanctions against plaintiff’s counsel pursuant to the PSLRA, which permits the granting of sanctions if the court determines, as it did here, that Rule 11 of the Federal Rules of Civil Procedure was violated.

b. In re Moody’s Corp. Sec. Litig., No. 07-cv-08375, 2011 WL 1237690 (S.D.N.Y. Mar. 31, 2011)

The Southern District of New York denied plaintiffs’ motion for class certification in a securities fraud class action against defendant rating agency for allegedly making material misrepresentations and omissions concerning the conflict of interest in its “issuer-pays” rating business model and its rating methodologies. The court agreed with defendant that two of the proposed lead plaintiffs could not serve as class representatives because they sold their stock prior to the first corrective disclosure. Because their alleged loss was therefore not caused by a materialization of the concealed risk, proposed lead plaintiffs could not demonstrate loss causation. The court found that the third proposed lead plaintiff could adequately represent the class, despite having purchased defendant’s stock after the action was commenced, because the decision to purchase shares after a fraud is revealed does not automatically give rise to a presumption of non-reliance. However, class certification was nevertheless denied because plaintiffs failed to satisfy their burden of showing that questions of reliance common to all members of the class predominated. Defendant successfully rebutted the fraud-on-the- market presumption of reliance set forth in Basic v. Levinson by showing that the alleged misrepresentations did not lead to a distortion in price. The court further held that plaintiffs were

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not entitled to the presumption of reliance on omissions set forth in Affiliated Ute Citizens v. United States because this presumption neither applies to misleading statements that leave investors with overall false impressions, nor to omissions that simply exacerbate the misleading nature of the alleged conduct.

c. In re Security Capital Assurance Ltd Sec. Litig., No. 07-cv-11086, 2011 WL 4444206 (S.D.N.Y. Sept. 23, 2011)

Plaintiff investor brought claims under Sections 10(b) and 20(a) of the Exchange Act, claiming that defendant financial guaranty services corporation reported financial information on the basis of inaccurate FICO scores and that its statements concerning internal risk modeling were based on rating agency data, and thus not independent. The Southern District of New York granted the defendant’s motion to dismiss and denied plaintiff’s request for leave to amend because plaintiff could not adequately plead loss causation. Plaintiff argued that defendant’s disclosure of the worsening stock market and its weakened portfolio was a corrective disclosure that resulted in a decrease in the defendant’s stock price. The court disagreed, holding that the defendant’s disclosures merely represented that the defendant was “grappling with market forces beyond [its] understanding and failing to recognize the enormity of [its] own incompetence,” and was not making the types of corrective disclosures or revelations of concealed information that generally form the basis of loss causation claims. Moreover, none of the alleged disclosures directly related to the use of FICO scores or ratings agency data. Lastly, plaintiff was unable to disaggregate the losses that were allegedly suffered as a result of the misstatements from the losses suffered due to the overall worsening of the economic climate.

d. Fixed Income Funds Inv. Litig., 774 F. Supp. 2d 584 (S.D.N.Y. 2011)

Plaintiff investors brought a putative class action against defendant mutual fund and several of its individual officers, asserting violations of Sections 11, 12(a)(2) and 15 of the Securities Act. Plaintiffs alleged the mutual fund’s offering documents had misrepresented the percentages of mortgage-backed securities held by the fund, overstated the values of the riskier mortgage-backed securities, and had misstated the objectives of the fund to invest in diversified, liquid, and high-quality offerings. The Southern District of New York dismissed the case with prejudice, finding that plaintiffs could not establish loss causation. Plaintiffs, relying on several cases from other jurisdictions, had argued that the misrepresentations disguised a risk that the market value of the mortgage-backed securities would suddenly collapse. Plaintiffs argued that the value of the mutual fund declined when that risk materialized, causing the investors’ losses. However, the court disagreed, based on the valuation structure of mutual funds. Rather than have a price determined by market trading, mutual funds are valued by their “Net Asset Value,” according to a statutory formula derived from the value of the underlying securities. The court found that because the Net Asset Value was calculated in this way, the alleged misrepresentations could not have inflated its value, nor did the revelation of the misstatements cause any loss.

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e. Prime Mover Capital Partners, L.P. v. Elixir Gaming Technologies, Inc., 793 F. Supp. 2d 651 (S.D.N.Y. 2011)

Plaintiff hedge funds brought suit against defendant gaming corporations, an affiliate corporation, and certain of the corporations’ officers under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5, as well as under state law after the share price of the gaming companies fell precipitously in value. Specifically, plaintiffs alleged that defendants intentionally inflated the gaming corporation’s stock by making misrepresentations regarding the corporation’s business and future prospects relating to the placement and profitability of electronic gaming machines in Asia. The district court dismissed all of plaintiffs’ federal securities law claims. Several of the securities fraud claims were dismissed due to lack of transaction causation because plaintiffs who did not acquire any stock during the period in which the stock price was allegedly inflated could not show that the alleged misstatements induced them to purchase the stock. Plaintiffs were also unable to prove loss causation because most of the disclosures that corrected the prior misstatements did not occur until after the stock was at its lowest price. The corrective disclosures, which occurred before the drop in price, were predictions about future profitability, which the court found were covered by the PSLRA safe harbor for forward-looking statements because they were not made with knowledge that the statements were false.

f. Solow v. Citigroup, Inc., No. 10-cv-2927, 2011 WL 5869599 (S.D.N.Y Nov. 2, 2011)

Plaintiff investor claimed that defendant financial corporation had violated Sections 10(b) and 20(a) of the Exchange Act by fraudulently boosting its stock price through issuing falsely positive statements about the capital strength and liquidity of the bank, as well as a proposed acquisition. The Southern District of New York found that plaintiff adequately pled misstatements as well as scienter, but granted defendant’s motion to dismiss for failure to plead loss causation. The court first found that the statements made concerning the strength of defendant’s liquidity were actionable because the defendant failed to disclose the large amount it had borrowed from the Federal Reserve while making positive statements about its liquidity. The statements concerning defendant’s capital strength were not adequately pled because plaintiff could not demonstrate that the capital ratio was below the legal threshold, and thus that the statements were false. Further, no misstatement occurred when the bank stated that the proposed acquisition was not a bid “to save itself” because no facts ever contradicted that statement. Plaintiff adequately pled scienter by showing that defendant was aware that its capital and liquidity were deteriorating while it continued to depict its financial situation positively. The court also noted that statements made after plaintiff’s stock purchase were relevant in determining defendant’s scienter. However, while plaintiff was able to connect some of the statements about the decrease in liquidity with a decline in stock price, he was not able to connect the disclosure of this information with the emergence of any concealed risk. The stock price decreases were instead attributable to a series of events, such as the loss of confidence in the defendant more generally, which were not necessarily related to misstatements or the revelation of a concealed risk. As a result, plaintiff was unable to demonstrate the necessary nexus between the materialization of a concealed risk or corrective disclosure and the losses suffered.

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g. Wilamowsky v. Take-Two Interactive Software, No. 10-cv-7471, 2011 WL 4542754 (S.D.N.Y Sept. 30, 2011)

Plaintiff short seller asserted a Section 10(b) claim against defendant software company, claiming that defendant’s misstatements regarding an options backdating scheme inflated the price of its stock and caused plaintiff to cover his positions at artificially high prices. The Southern District of New York dismissed the complaint on the grounds that plaintiff could not prove loss causation. The court found that the plaintiff’s loss was not attributable to the defendant’s alleged omission, but rather to the fact that plaintiff gambled incorrectly when he decided to cover his position. Moreover, plaintiff was unable to connect his transactions and losses with the period of time during which the inflationary misstatements were made, and instead relied on a theory of “continual inflation,” which the court rejected.


a. City of Pontiac Gen. Emps. Ret. Sys. v. MBIA, Inc., 637 F.3d 169 (2d Cir. 2011)

Plaintiffs, purchasers of shares of defendant bond insurer, brought this securities fraud action under Section 10(b) of the Exchange Act and Rule 10b-5, after defendant amended its financial statements to rebook a seven-year-old transaction as a loan, rather than income. The district court dismissed plaintiffs’ claims as barred by the statute of limitations, finding that press reports on the transaction should have put plaintiffs on inquiry notice six months before the beginning of the class period. Plaintiffs appealed to the Second Circuit, which reversed and remanded for reconsideration in light of Supreme Court’s 2010 decision in Merck & Co. v. Reynolds. The court observed that Merck changed the applicable law on the limitations period, such that the limitations period does not begin to run until a reasonable investor conducting a timely investigation could have discovered facts constituting a violation. A fact is not “discovered” until a reasonably diligent plaintiff would have enough information about the fact to plead it in a complaint adequately enough to survive a 12(b)(6) motion to dismiss. The Second Circuit also questioned the district court’s finding that plaintiffs should have been on inquiry notice six months before the class period began, noting that it is not possible for a securities plaintiff’s claim to accrue until he has purchased or sold a security. The court ordered the district court to reconsider this issue on remand, and determine whether facts exposing the fraud were available before plaintiffs purchased, which may preclude plaintiffs from establishing transactional causation.

b. In re Barclays Bank PLC Sec. Litig., No. 09-1989, 2011 WL 31548 (S.D.N.Y. Jan. 5, 2011)

Plaintiffs, purchasers of securities in four of defendant bank’s offerings from April 2006 to April 2008, alleged that the bank violated Sections 11 and 12(a)(2) of the Securities Act by failing to adequately disclose its exposure to risky real estate investments and take writedowns on those assets as the markets declined. The court held that plaintiffs’ claims as to three of the four offerings were time-barred because plaintiffs were on inquiry notice of those claims more than one year before the filing of the complaint. Additionally, the court held that even if the statute of limitations had not expired, plaintiffs’ claims must be dismissed for failure to

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adequately allege defects in defendants’ disclosures. The court found that defendants’ representations about the value of their credit market exposures were subjective opinions, and plaintiffs failed to allege that defendants did not truly hold such opinions. Additionally, the court noted that defendants are explicitly not required to provide an itemized breakdown of mortgage-related assets, and plaintiffs did not adequately allege how defendants failed to comply with the applicable accounting and SEC requirements.

c. In re Morgan Stanley Mortg. Pass-Through Certificates Litig.,

No. 09 Civ. 2137, 2011 WL 4089580 (S.D.N.Y. Sept. 15, 2011)

Plaintiff investors filed a putative class action against defendant issuer and loan trusts in state court asserting violations of Sections 11, 12(a)(2) and 15 of the Securities Act relating to the marketing and sale of mortgage-backed security pass-through certificates. After the case was removed to federal court, consolidated with a separate action and new plaintiffs were added, defendants moved to dismiss, arguing that plaintiffs’ claims were untimely and that the added plaintiffs’ claims were barred by the statute of repose. The district court granted defendants’ motion to dismiss plaintiffs’ claims, with leave to replead, finding that plaintiffs failed to satisfy the pleading requirements of Section 13 of the Securities Act. However, the court declined to hold that plaintiffs were on inquiry notice of the alleged fraud, finding that neither the ratings downgrades of the mortgage loan trust nor news articles and public reports were sufficient to place plaintiff investors on inquiry notice of a possible claim. The court also applied the tolling doctrine articulated in American Pipe & Construction Co. v. Utah to find that the new plaintiffs’ claims satisfied the three-year statute of repose for actions brought under Sections 11 or 12(a)(1), holding that American Pipe tolling is equitable in nature, and thus applicable to the statute of repose.

The court also held that plaintiffs had standing under Section 12(a)(2), as they sufficiently alleged that defendants promoted and sold the securities to plaintiffs. The court denied defendants’ motion to dismiss for failure to allege a cognizable loss, finding that plaintiffs’ allegation of a diminution in value satisfied that pleading requirement. Finally, the court held that plaintiffs adequately stated viable claims of misrepresentations or omissions regarding two of their three categories of allegations, those regarding the underwriting standards and the appraisal standards. The court dismissed claims arising from plaintiffs’ third category of allegations, those regarding the investment ratings, finding that plaintiffs failed to actually allege that the offering documents conveyed the ratings inaccurately.

d. Footbridge Ltd. Trust v. Countrywide Fin. Corp., 770 F. Supp. 2d 618 (S.D.N.Y. 2011)

Plaintiff hedge funds asserted claims for violations of Sections 11, 12(a)(2) and 15 of the Securities Act against defendants, sellers of mortgage-backed securities (MBS), arising out of their purchases of MBS through two public offerings. The Southern District of New York granted defendants’ motion to dismiss on the grounds that the claims were untimely under the statute of repose. The MBS had been offered pursuant to registration statements filed in February and August 2006, and plaintiffs purchased them as part of the initial offering on four separate dates, the latest of which was October 3, 2006. The court found that the complaint, which had been filed on January 15, 2010, was barred by the three-year statute of repose

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established by Section 13 of the Securities Act. The statute of repose begins to run on Section 11 claims when the security is “bona fide offered to the public” through the filing of the registration statement. For Section 12(a)(2) claims, the statute of repose begins to run when the securities are purchased. In both cases, the court found that plaintiffs’ claims had been extinguished before the complaint was filed. Plaintiffs argued that their claims were tolled by American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974), but the court found that American Pipe did not apply to Section 13, which prohibits claims filed after the statute of repose has run. Plaintiffs argued further that the American Pipe rule was a legal or statutory tolling rule, rather than an equitable rule that cannot apply to a federal statute. However, the court relied on dicta in American Pipe and Young v. United States, 535 U.S. 43 (2002), the text of the Securities Act, and lower court precedent to conclude that the American Pipe rule was an equitable rule that could not toll a federal statute.

3. Misstatements or Omissions

a. Fait v. Regions Financial Corp., 655 F.3d 105 (2d Cir. 2011)

Plaintiff investor brought claims under Sections 11, 12(a)(2) and 15 of the Securities Act, alleging that defendant financial institution failed to account for the weakening housing and mortgage market, and thereby made materially false and misleading statements regarding the value of its goodwill and the amount of loan loss reserves it would maintain. As a result of an acquisition in 2006, defendant reported approximately $6 billion in goodwill. In January 2009, defendant’s stock price declined after defendant reported a $6 billion non-cash charge for impairment of goodwill and doubled its loan loss reserves from the amount held one year earlier. The district court found that defendant’s estimates of goodwill and loan loss reserves were opinions rather than objective facts, and that plaintiff failed to adequately allege that defendant did not in fact hold those opinions at the time they were released. The Second Circuit affirmed the district court’s dismissal of the complaint on the same grounds, agreeing that both calculations of goodwill and loan loss reserves were subjective determinations, and therefore “opinions.” Goodwill, the court noted, is calculated using the “fair value” of the purchased assets, and because the calculation of fair value lacks an objective standard, the determination of goodwill is necessarily subjective. Loan loss reserves are similarly subjective, as they represent the company’s estimates of potential losses.

b. In re Sanofi-Aventis Sec. Litig., 774 F. Supp. 2d 549 (S.D.N.Y. 2011)

Plaintiffs, investors who had purchased securities in defendant pharmaceutical company, filed claims under Sections 10(b) and 20(a) alleging that the company and certain of its executives made misleading statements about a drug submitted for FDA approval. The Southern District of New York denied the company’s motion to dismiss and the court granted dismissal of the claims against all but two of the individual defendants. The court found that plaintiffs adequately alleged that the company’s statements could have misled investors into believing there were no major concerns about the proposed drug because, according to the complaint, the company omitted information regarding concerns by the FDA and the company’s own expert that the drug increased the propensity to suicide. The court noted that defendant company commented regularly on the approval process for proposed drugs and that those statements must

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be both accurate and complete. With regard to scienter, plaintiffs pled facts sufficient to show that defendants acted with recklessness by alleging that both the company and the individual defendants had knowledge or access to the omitted facts.

c. Int’l Fund Mgmt. SA v. Citigroup Inc., 822 F. Supp. 2d 368

(S.D.N.Y. 2011)

Foreign investors brought suit against defendant financial institution and certain of its officers and directors under Sections 11, 12(a)(2) and 15 of the Securities Act and Sections 10(b), 18 and 20(a) of the Exchange Act. Plaintiffs alleged that they suffered losses from financial institution’s misrepresentations concerning its exposure to certain securities, its mortgage lending practices and its solvency. The court granted in part and denied in part defendants’ motion to dismiss for failure to state a claim. The court dismissed several of plaintiffs’ Securities Act claims for failure to allege material misstatements or omissions. For instance, plaintiffs did not establish that defendants had a duty to disclose liquidity problems regarding the auction rate securities or a potential liability to repurchase certain auction-rate securities before defendants actually agreed to the repurchase. The court also dismissed a number of plaintiffs’ claims under Section 10(b) for failure to plead a strong inference of scienter. The court found plaintiffs’ contention that the bank improperly valued its CDO portfolio in April 2008, when the relevant indices had lost nearly all of their value, was insufficient to demonstrate scienter because defendant had explicitly used one of the indices as an input. The court also found that an officer’s undisclosed warnings regarding lapses in mortgage underwriting standards were too vague to constitute particularized allegations of scienter. However, the court sustained claims against an officer who allegedly received and ignored specific information regarding billions of dollars in undisclosed subprime debt obligations, finding these allegations adequate to create an inference of recklessness. Finally, the court refused to dismiss certain Section 20(a) control liability claims finding that plaintiffs’ allegations of primary Section 10(b) violations against certain defendants satisfied the requirement of pleading culpable participation.

d. Plumbers’ & Pipefitters’ Local No. 562 Supplemental Plan & Trust v. J.P. Morgan Acceptance Corp. I, No. 08 CV 1713, 2011 WL 6182121 (E.D.N.Y. Dec. 13, 2011)

Plaintiff pension fund filed a class action complaint against an investment bank and several of its officers for violations of Sections 11, 12(a) and 15 of the Securities Act based on defendant’s issuance of mortgage pass-through certificates whose offering documents allegedly contained false and misleading statements. Plaintiff alleged that defendant abandoned its stated underwriting standards in order to increase loan volume and used appraisal methods to value the property serving as collateral for the underlying mortgages that did not conform to the disclosed standards. Both practices allegedly led to deficient credit enhancement and unjustifiably high credit ratings for the certificates. The district court granted defendants’ motion to dismiss in part. First, the court found that plaintiffs lacked standing to pursue claims arising out of offerings for which the lead plaintiff did not purchase certificates because “a plaintiff’s standing is limited to the specific tranches from which it purchased securities.” The court also dismissed plaintiffs’ claims arising from opinions regarding credit enhancement and certificates ratings, finding that plaintiff failed to sufficiently allege that they were subjectively false when made.

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However, the court found that plaintiffs adequately alleged that defendants made material misstatements regarding (i) defendants’ alleged use of inadequate appraisal standards; and (ii) the originators’ underwriting guidelines by showing that the originators’ possible deviation from the standard guidelines to ensure the borrower’s ability to repay were not stated in the certificates, and thus not legitimately expected by investors.

e. Stratte-McClure v. Morgan Stanley, 784 F. Supp. 2d 373 (S.D.N.Y. 2011)

Plaintiffs, institutional investors in residential mortgage-backed securities, filed a putative class action complaint alleging that defendants, a diversified financial services corporation and several of its officers and former officers, violated Sections 10(b) and 20 of the Exchange Act by making material misstatements and omissions to conceal the corporation’s exposure and losses associated with a series of risky subprime positions. The court granted defendants’ motion to dismiss plaintiffs’ Section 10(b) and Rule 10b-5 claims, finding that the complaint failed to allege with sufficient specificity the falsity of certain disputed statements surrounding its risk controls and subprime exposure. In the court’s view, defendants’ statements about risk controls, which did not guarantee that the corporation would not experience any missteps, were mere puffery. Similarly, the court concluded that defendants’ statements that the corporation was well-positioned to react to changes in the subprime market were puffery, not actionable statements under the securities laws. Although plaintiffs alleged sufficient facts to support an inference that defendants overvalued their subprime position in the face of red flags regarding their valuations and failed to disclose $2.5 billion in subprime losses, the court nonetheless held that the complaint failed to adequately allege loss causation with respect to disputed statements in the corporation’s earnings statement. In particular, the complaint contained only vague allegations linking the alleged misstatements to a decline in the prices of the corporation’s shares. Because plaintiffs failed to show a primary securities violation, the court also dismissed plaintiffs’ Section 20 control person claims.

f. Wilson v. Merrill Lynch & Co., 671 F.3d 120 (2d Cir. 2011)

Plaintiff purchaser of auction rate securities (ARS) filed claims alleging market manipulation in violation of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 against defendant dealer and dealer’s parent company. Plaintiff purchased $125,000 of ARS through an online broker in July 2007. On February 13, 2008, defendant and other major dealers withdrew support for the ARS market, which then collapsed, leaving plaintiff with illiquid securities. Although defendant had made significant disclosures about its participation in ARS auctions, including disclosure of its practice of placing support bids to prevent auctions from failing, plaintiff alleged that the disclosures masked the true extent to which defendant’s support bids were required to support the ARS market. Plaintiff also alleged that beginning in the fall of 2007, defendant believed internally that the ARS market would fail. The Second Circuit affirmed the district court’s dismissal, finding that the complaint’s allegations of market manipulation were inadequate. The court held that defendant’s disclosures at the time of plaintiff’s purchase were adequate to inform the market of its practices and the risks of the ARS market. The court noted that its holding was influenced by the timing of plaintiff’s purchase, and that it was reserving any judgment over the adequacy of a hypothetical complaint in which

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plaintiff had purchased ARS, after defendant was alleged to have believed that the ARS market could fail.

g. In re MRU Holdings Sec. Litig., 769 F. Supp. 2d 500 (S.D.N.Y. 2011)

Plaintiff shareholders brought a class action against defendant corporation, certain of its officers and directors, a multi-purpose banker and the corporation’s independent auditor alleging violations of Sections 10(b) and 20(a) and Rule 10b-5. Plaintiffs argued that the corporation’s financial statements contained material misstatements and omissions regarding the corporation’s use of auction rate securities (ARS). First, the court granted the corporation’s motion to dismiss, finding that the challenged statements were predictions or opinions and not guarantees of financial success. Additionally, the court found no basis for plaintiffs’ claim that defendants did not believe in the predictions contained in their financial disclosures. Second, the court found that plaintiffs failed to adequately plead violations of Rule 10b-5 against defendant multi-purpose banker, which plaintiffs alleged engaged in a scheme to manipulate the ARS market. In particular, the court concluded that defendant multi-purpose banker (i) did not owe a fiduciary duty to plaintiffs, and thus had no liability for alleged nondisclosure; and (ii) could not be liable for market manipulation because it made public disclosures stating that it might support bids to prevent auction failures. Third, the court held that plaintiffs failed to adequately plead scienter with respect to their claims against the officers and directors because plaintiffs did not allege a motive for the officers and directors to commit fraud. Fourth, the court held that plaintiffs failed to plead scienter with respect to their claims against the corporation’s auditor, noting that plaintiffs’ allegations of GAAP violations or accounting irregularities, without corresponding allegations of fraudulent intent, were insufficient.

4. Scienter

a. Brecher v. Citigroup Inc., 797 F. Supp. 2d 354 (S.D.N.Y. 2011)

Plaintiffs, purchasers of securities through defendant bank’s stock purchase program, alleged that the bank and its compensation committee violated Section 12(a)(2) of the Securities Act, Section 10(b) of the Exchange Act, Rule 10b-5 and various state laws. Specifically, plaintiffs alleged that defendants failed to disclose adequate truthful information about the bank’s exposure to subprime mortgages. Defendants moved to dismiss, and the court granted defendants’ motion in its entirety. First, the court dismissed plaintiffs’ claims relating to defendants’ misstatements about the bank’s overall business outlook because the alleged statements and omissions were legally immaterial. Second, the court found that the alleged misstatements about the bank’s financial results failed Section 12(a)(2)’s notice pleading standard, as well as the heightened pleading standards under Section 10(b), because there was no allegation that the statements were false when made. Third, the court found that plaintiffs’ allegations of misstatements relating to the bank’s subprime mortgage exposure did not state claims under either the Securities Act or the Exchange Act. The Section 12(a)(2) claims were untimely because plaintiffs brought their claims more than one year after they were on notice of possible misstatements following a number of disclosures that year by defendants. The Section 10(b) claims failed because plaintiffs did not adequately plead scienter. The court found that plaintiffs’ theories of motive to commit fraud either were too general or postdated the alleged

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fraud, and claims of defendants’ recklessness, which alleged a failure to react to general facts about the economy, were insufficiently particularized to demonstrate scienter. The court then dismissed plaintiffs’ state law claims, finding that they were precluded by the Securities Litigation Uniform Standards Act and/or lacked the necessary factual support in the complaint.

b. Engstrom v. Elan Corp., No. 11-1232, 2011 WL 4946434 (S.D.N.Y. Oct. 18, 2011)

Plaintiff shareholder brought a putative class action alleging that defendant biotechnology corporation violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 by making false and misleading statements. Defendant, which derived substantially all of its revenue from a collaboration agreement with a pharmaceutical company, entered into an asset and stock sale agreement with a corporate investor. After a declaratory judgment action brought by defendant established that a provision of the sale agreement constituted a material breach of the collaboration agreement, the sale agreement was modified, the corporate investor contributed a substantially smaller investment, and the price of defendant’s securities fell. Plaintiff contended that defendant did not disclose the challenged provision of the sale agreement to the public and that defendant either knew that the provision constituted a breach of the collaboration agreement or that defendant acted in a reckless manner in not investigating whether the provision constituted a breach. The court granted defendant’s motion to dismiss on the grounds that plaintiff failed to plead scienter. First, the court rejected plaintiff’s argument that defendant had motive and opportunity to commit fraud. Plaintiff argued that defendant knowingly agreed to breach the collaboration agreement in order to undermine the position of the other party to that agreement. The court rejected this contention, finding that the alternative inference — the breaching provision was merely part of a good faith effort to secure financing from the investing company — was far more compelling. Second, the court found that seeking the declaratory judgment was consistent with defendant’s good faith effort to harmonize the sale and collaboration agreements and rejected plaintiff’s contention that it gave rise to a strong inference that defendant was reckless in failing to realize the risk of breach.

c. In re Lehman Bros. Equity/Debt Secs. Litig., No. 08 Civ. 5523, 09-md-02017 (S.D.N.Y. July 27, 2011)

Purchasers of securities issued by a global investment bank brought claims against defendants, several of the bank’s former officers and directors, its independent auditor, and the banks who underwrote the bank’s securities offerings, under Sections 10(b), 20(b) and 20A of the Exchange Act, Rule 10b-5, and Sections 11, 12(a) and 15 of the Securities Act. Plaintiffs alleged that defendants made a number of materially false and misleading statements in various offering materials and other public filings regarding the use of and accounting for repurchase transactions that allegedly artificially reduced the bank’s net leverage at the end of reporting periods, risk management policies, liquidity and concentrations of credit risk. The Southern District of New York granted defendants’ motions to dismiss in part. With respect to the central issue in the case, the court found that plaintiffs adequately alleged material misstatements and omissions regarding certain of the bank’s repurchase transactions — despite that the bank accounted for those transactions corrected under SFAS 140 — because, in the court’s view, “technical[] compli[ance] with SFAS 140 does not mean [defendants] . . . complied with GAAP.” The court also concluded that plaintiffs adequately alleged scienter on the part of some

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of the individual defendants by pleading facts suggesting that the individual defendants had knowledge of the bank’s alleged improper use of the repurchase transactions. The court dismissed the claims against the independent auditor defendant regarding the auditor’s statements of GAAS and GAAP compliance, except for plaintiffs’ claim that the auditor’s second quarter 2008 review report was materially misleading because there were sufficient allegations in the complaint to support a claim that the report was subjectively false. With respect to the Securities Act claims, the court dismissed the claims arising out of three offerings as untimely under the three-year statute of repose. The court permitted the Section 11 claims to proceed as to the statements and defendants that it concluded were subject to corresponding claims under the Exchange Act. The court declined to dismiss the remaining Securities Act claims against the individual and underwriter defendants based on the due diligence defense, finding it impossible to determine as a matter of law in this case because plaintiffs were not required to negate all affirmative defenses in their complaint. However, the court dismissed all Securities Act claims against the independent auditor, because the only potentially misleading statement — one of the auditor’s quarterly review reports — was not actionable under the Securities Act. Finally, the court permitted the Section 15 control person claims against the individual officer defendants to go forward because they were supported by primary violations of the Securities Act that were not dismissed.

d. In re Merkin, 817 F. Supp. 2d 346 (S.D.N.Y. 2011)

Plaintiffs, investors in three hedge funds, brought suit against the funds, their general partner, investment advisor, and auditors under Sections 10(b) and 20(a) of the Exchange Act and also asserted various common law claims alleging that the defendants failed to disclose the hedge funds’ investments with Bernard Madoff and the involvement of Madoff in the funds’ investment strategy. The court granted defendants’ motion to dismiss and denied plaintiffs’ leave to replead. The court held that plaintiffs failed to adequately allege both scienter and material misstatements or omissions. The investment with Madoff was made with the understanding that his investments comported with the funds’ investment strategy, and the funds’ offering documents included express language indicating that third-party managers would have custody of the funds’ assets. In addition, the court held that plaintiffs’ allegations of “red flags” surrounding Madoff, by themselves, did not give rise to a strong inference of scienter. Plaintiffs also alleged that the auditors failed to perform their work consistent with GAAS and GAAP and failed to discover Madoff’s fraud. The court rejected the plaintiffs’ argument that red flags surrounding Madoff gave rise to a strong inference of scienter on behalf of the auditors, and noted that allegations of GAAS and GAAP violations, standing alone, are insufficient to state a claim for relief under Section 10(b). The court also held that some of plaintiffs’ state law claims were class action claims alleging material misrepresentations or omissions in connection with a covered security, and thus were precluded by SLUSA. In particular, the court rejected plaintiffs’ argument that the claims were not “in connection with a covered security” because the investors purchased shares in the hedge funds, rather than securities. The fact that the pass-through investment with Madoff coincided with a securities transaction was sufficient.

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e. Inter-Local Pension Fund GCC/IBT v. General Electric Co., No. 10-3477, 2011 WL 4348049 (2d Cir. Sept. 19, 2011)

Investors brought a class action against a multinational corporation and its chief officers alleging that defendants violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 by making misstatements regarding the corporation’s quarterly earnings prospects in order to artificially inflate stock prices. The Second Circuit affirmed the dismissal of plaintiffs’ complaint, holding the complaint did not satisfy the PSLRA’s heightened pleading standard because it did not plead facts giving rise to a strong inference of scienter. The court found that the allegations suggesting that defendants received performance-based compensation and may have felt pressure to generate greater returns for shareholders were legally insufficient to establish motive for scienter purposes. The court also found that plaintiffs’ circumstantial evidence of fraud did not give rise to a strong inference of scienter because the complaint did not allege specific facts suggesting that defendants were privy to reports or data inconsistent with their public statements. Defendants’ awareness of general market risk did not contradict any of their public statements about the company’s financial future. Even if defendants’ statements were taken to refer to risks particular to the company, plaintiffs did not allege that defendants were aware of those risks at the time they made public statements about the company’s financial future. Plaintiffs’ Section 20(a) claim was also dismissed, as the complaint failed to allege a primary violation.

f. New Orleans Emps.’ Ret. Sys. v. Celestica, Inc., No. 10-4702-cv, 2011 WL 6823204 (2d Cir. Dec. 29, 2011)

Pension funds filed a class action claiming violations of Section 10(b) of the Exchange Act against an electronics company and two of its officers, alleging that the defendants knowingly made false statements to the public about the company’s financial situation that misrepresented defendant’s rising unsold inventories. The Second Circuit reversed the district court’s dismissal of the complaint for failure to plead scienter. The Court of Appeals held that circumstantial evidence introduced by plaintiffs was specific enough to satisfy the scienter requirement. First, plaintiffs relied on statements by former employees who had direct knowledge of defendant’s officers’ attendance at frequent meetings at which the inventory management problems were discussed and who prepared spreadsheets detailing the excess of inventory. Second, the complaint explained that as inventory levels are crucial to a company’s financial performance, the officers would have been alerted to data regarding the increase of inventory. Additionally, the court held that plaintiffs had described their confidential witnesses with sufficient particularity to support the probability that individuals in their positions would possess enough information to permit an inference of scienter to be drawn from the confidential witnesses’ assertions. Plaintiffs had defined witnesses’ functions and detailed the authors and frequency of the spreadsheets containing inventory information. Further, the court found that the PSLRA safe harbor was unavailable, because defendants made statements about the present state of their inventories, while recklessly disregarding that the opposite was true. The court also rejected defendants’ argument that any misstatement was immaterial as the inventories at issue were only a small portion of the company’s global assets and annual revenues, finding plaintiffs had sufficiently raised an inference that the inventory accounting was relevant to investors’ decisions at that time.

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5. Morrison / Extraterritorial Application

a. In re UBS Sec. Litig., No. 07-cv-11225, 2011 WL 4059356 (S.D.N.Y. Sept. 13, 2011)

Plaintiffs, American and foreign investors, brought a putative class action against defendant foreign bank under Section 10(b) of the Exchange Act and Rule 10b-5, arising out of plaintiffs’ purchase of defendant’s securities on domestic and foreign exchanges. The court granted defendant’s motion to dismiss all claims by plaintiffs who purchased the securities on foreign exchanges on the grounds that the Supreme Court’s decision in Morrison v. National Australia Bank Ltd. limited the application of Section 10(b) to “securities listed on domestic exchanges [] and domestic transactions in other securities.” Plaintiffs argued that under Morrison, Section 10(b) reaches transactions between foreign plaintiffs and foreign issuers on foreign exchanges if the securities at issue were also cross-listed on a domestic exchange. The court rejected this claim, holding that Morrison signals a clear intent to limit the reach of Section 10(b) to securities that were bought and sold within the United States. Plaintiffs also argued that investors located in the United States who purchased securities from a foreign issuer on a foreign exchange may sue under Section 10(b) because the purchase order was made in the United States. The court rejected this argument as well, holding that the location of the transaction, not the investor, determines whether the transaction is “domestic” for the purposes of Section 10(b).

6. Standing

a. Scottrade, Inc. v. Broco Invs., Inc., 774 F. Supp. 2d 573 (S.D.N.Y. Mar. 30, 2011)

Plaintiff, an online securities broker, brought suit under Sections 9(a), 10(b) and 29(b) of the Exchange Act, Rule 10b-5, and the Computer Fraud and Abuse Act (CFAA) against defendant broker-dealer, an institutional investor holding an account, and the investor’s president. The Southern District of New York dismissed the claims for lack of standing. The claims arose from a series of transactions in which one of the investor’s customers, a non-party, hacked into customer accounts held by plaintiff and conducted trades involving certain illiquid securities, leaving plaintiff’s customers with unwarranted securities and achieving profits of up to 32,000 percent in accounts that the hacker maintained with defendant. Upon discovering the fraud, plaintiff restored its customers to their previous positions, incurring losses of nearly $1.5 million as a result. Plaintiff’s Section 10(b) and 10b-5 claims were based on its allegation that defendant, due to monthly reports it generated, should have known a fraud was occurring but for intentional disregard. However, plaintiff did not purchase or sell securities on its own account; it only provided the “interface and systems” to facilitate the sales of its customers. The court found that plaintiff was not an “actual purchaser or seller” for purposes of the Exchange Act, and therefore lacked standing for its claims. Therefore, it dismissed plaintiff’s Section 10(b) and 10b-5 claims, which it noted “sound[ed] more in theft or conversion than securities law,” and dismissed plaintiff’s Section 9(a) claims on the same grounds. The court dismissed the Section 29(b) claim for rescission on the grounds that no contract had been formed between plaintiff and defendant broker-dealer, and dismissed the CFAA claim because plaintiff did not allege that defendant had hacked into its systems.

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7. SLUSA

a. In re Herald, Primeo and Thema Sec. Litig., No. 09 Civ. 289, 2011 WL 5928952 (S.D.N.Y. Nov. 29, 2011)

Plaintiffs, foreign investors in defendant foreign investment funds who invested with Bernard Madoff, asserted New York state law claims against the funds, their directors and foreign and domestic service providers. Plaintiffs claimed defendants ignored red flags that should have led them to discover Madoff’s fraud. The court dismissed plaintiffs’ New York common law claims against two New York-based banks, finding these claims were precluded under the SLUSA, and preempted under New York’s Martin Act. Plaintiffs argued that SLUSA did not mandate dismissal because Madoff never actually purchased “covered securities” and the claims did not plead any misstatements or omissions by defendants in connection with Madoff’s purported purchase and sale of covered securities. The court disagreed with plaintiffs, finding that plaintiffs’ claims against the banks alleged, involved or rested on Madoff’s announced intention to purchase covered securities for the benefit of the funds in which plaintiffs invested. The court dismissed claims against the remaining defendants on the grounds of forum non conveniens in favor of two foreign jurisdictions, finding that plaintiffs’ choice of forum should be accorded little deference because plaintiffs were not U.S. citizens or residents and because their choice of a U.S. forum suggested forum shopping. The court also found that the foreign jurisdictions were adequate fora for these cases because each defendant had consented to jurisdiction, the countries permit this type of litigation and the public and private interest factors favored litigation in the foreign jurisdictions.


a. City of Omaha v. CBS Corp., No. 08 Civ. 10816, 2011 WL 2119734 (S.D.N.Y. May 24, 2011)

Plaintiff shareholders filed a purported class action alleging violations of Sections 10(b) and 20(a) against defendant broadcasting company and its executives, following an impairment charge to the company’s corporate goodwill that resulted in a $14 billion writedown. Plaintiffs claimed that defendants violated Statement of Financial Accounting Standards Board Statement No. 142 (SFAS 142) by not testing for impairment earlier than it did, alleging that defendants waited to test for impairment in order to benefit the company’s chairman, whose compliance with loan covenants for his private company became imperiled by defendant broadcasting company’s declining share price. The court dismissed plaintiffs’ amended complaint for failure to plead securities fraud with the requisite particularity. Specifically, the court held that: (i) public concern regarding depressed advertising revenue and industry-wide testing practices did not compel defendants to conduct interim impairment tests; (ii) intra-year testing under SFAS 142 is largely discretionary; (iii) statements made by an SEC official suggesting a company was required to test for impairment after a decline in share price were not entitled to deference and did not advocate a bright-line rule in any event; and (iv) nondisclosure by defendant chairman of loan covenants that bind his private company did not rise to a securities fraud claim because plaintiffs failed to sufficiently allege that the covenants provided recourse to the broadcasting company’s assets.

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b. In re Optimal U.S. Litig., No. 10 Civ. 4095, 2011 WL 4908745 (S.D.N.Y. Oct. 14, 2011)

Investors initiated a putative class action against defendant investment management company, its corporate parent and an employee asserting claims under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5, alleging that the company failed to conduct adequate due diligence regarding its investment in an investment securities firm. Plaintiffs also alleged that the defendants made misleading statements regarding this investment in explanatory memoranda — the Bahamian equivalent to prospectuses — issued by a mutual fund of which it owned all voting shares. In light of the Supreme Court’s decision in Janus Capital Group v. First Derivative Traders, defendants renewed their first motion to dismiss the federal securities fraud claims for materially misleading statements and omissions in the explanatory memoranda, and the court granted the motion in part, and denied in part. Specifically, defendants argued that they were not liable for the misleading statements because they did not have “ultimate authority” over the memoranda, as evidenced by the following: (i) the memoranda stated on their face that they were issued by the mutual fund, (ii) the mutual fund and the defendant investment company are legally separate entities and (iii) only one director of the mutual fund was affiliated with the investment company. The district court agreed with defendants, rejecting plaintiffs’ contention that the investment company’s 100% shareholder control of the mutual fund gave it “ultimate authority” over the statements. The court reasoned that (a) the board of directors, not the shareholders, had the authority to issue the statements, making the percentage of shareholder control irrelevant, and that (b) drafting a statement does not amount to issuing it according to Janus. However, the court denied defendants’ motion to dismiss the 20(a) claims, finding that plaintiffs had sufficiently pled defendants’ alleged control of the mutual fund and culpable participation in the fraudulent acts.

9. Reliance

a. Ashland v. Morgan Stanley & Co., Inc., 652 F.3d 333 (2d Cir. 2011)

Plaintiff investors asserted that defendant financial services firm had violated Section 10(b) of the Exchange Act and mislead them when their broker told plaintiffs that auction rate securities (ARS) were safe and liquid investments, and that the defendant firm would step in to prevent the failure of auctions. Defendant moved to dismiss the action, and the district court granted the dismissal on the basis that plaintiffs had not alleged reliance on defendants’ alleged misstatements. The Second Circuit affirmed. Plaintiffs alleged that the statements made by defendant regarding the safety of the ARS were misrepresentations upon which they reasonably relied, and when defendant firm stopped intervening in the auctions, the plaintiffs’ investment became illiquid. The court disagreed, finding that it was not reasonable for the plaintiffs to rely on defendant’s statements that the ARS were a safe, liquid investment. First, the firm had placed an SEC-mandated statement on its website specifically stating that it was not obligated to intervene in an auction in order to prevent it from failing. The court found that this statement was easily accessible to plaintiff investors and directly addressed the issues plaintiffs raised. Moreover, the court found that since plaintiffs were sophisticated investors, they should have recognized the risks of ARS despite their broker’s assertion that they were safe and liquid

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investments. As a result of both of these factors, the court found that it was not reasonable for the plaintiffs to rely on the alleged misstatements.

b. In re Citigroup, Inc., No. 08 Civ. 3095, 2011 WL 744745 (S.D.N.Y. Mar. 1, 2011)

Plaintiff, purchasers of auction rate securities (ARS), brought claims under Sections 10(b) and 20(a) and Rule 10b-5 against defendant broker-dealers and underwriters, alleging that defendants’ intervention in the ARS market created a false sense of stability in the market and induced them into purchasing their securities at unfavorable prices and/or interest rates. The Southern District of New York granted defendants’ motion to dismiss the case in its entirety. Plaintiffs alleged that defendant broker-dealers had intervened in the auctions to keep them from failing when there was insufficient demand, creating the misleading impression of a stable market. The auctions failed when defendants stopped intervening, with the alleged effect that plaintiffs were left holding securities with interest rates lower than they would have received had no intervention occurred. The court found that plaintiffs could not properly allege deceptive conduct by defendants or reasonable reliance on that conduct. Defendants’ ability and incentives to intervene, the fact that interventions occurred “routinely,” and the consequences of an auction failure could all be found in publicly available information, including prospectuses, defendants’ websites, and a 2006 SEC order critical of defendants’ activities. Further, defendants did not have a duty to disclose when or if they were intervening on a more frequent basis. The court then found that plaintiffs failed to plead reasonable reliance on what they believed to be the “integrity” of the ARS market. Because the ARS auctions were not efficient markets, plaintiffs could not rely on the fraud-on-the-market presumption, and did not identify any other basis to believe the market was to have “integrity.” Plaintiffs’ reasonable reliance argument also failed due to the availability of public information.

c. Maverick Fund, L.D.C. v. Comverse Technology, Inc.,

801 F. Supp. 2d 41 (E.D.N.Y. 2011)

Plaintiff hedge funds filed this action against defendant company, as well as certain former officers and members of the company’s compensation and audit committees, alleging violations of Sections 10(b), 18 and 20(a) of the Exchange Act and Rule 10b-5 arising from the grant of backdated stock options. Defendants filed a motion to dismiss, which the court granted in part and denied in part. The complaint alleged that the company began to partially reveal the back-dating scheme in March 2006, but the full extent of the fraud was not revealed until 2007. Defendants argued that plaintiffs could not establish reliance or loss causation, as the volume of plaintiffs’ trades suggested that plaintiffs were engaged in program trading. The court rejected this argument, and found that there was no evidence that plaintiffs’ “in-and-out” trading prevented them from suffering losses when the value of the shares declined. The court rejected defendants’ assertion that plaintiffs were required to plead the specific dates and times of each stock transaction, finding that the complaint contained sufficient information regarding the allegedly fraudulent statements. Even though the company was alleged to have only partially revealed the fraud in March 2006, defendants argued that plaintiffs were not entitled to a truth-on-the-market presumption because they were sophisticated investors who should have known that they could not rely on any subsequent releases from the company. The court rejected this argument, holding that there was no requirement that the plaintiffs seek out any information

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beyond what was publicly available. The court dismissed plaintiffs’ claims based on statements made in 2007, finding that the company’s predictions that they expected to become current in their SEC filings by the end of 2007 were protected by the PSLRA’s safe harbor for forward-looking statements.

10. Materiality

a. Hutchison v. CBRE Realty Finance Inc., 647 F.3d 479 (2d Cir. 2011)

Plaintiff investors filed a putative class action against defendant real estate financing company, its CFO, CEO and Chairman of the Board, alleging violations of Sections 11, 12(a)(2) and 15 of the Securities Act. Defendants moved to dismiss, the district court granted the motion and, on appeal, the Second Circuit unanimously affirmed the dismissal, but on different grounds. Plaintiffs alleged that defendants misled investors in violation of the securities laws, where defendant company issued its initial public offering in 2006, and allegedly knew that $51.5 million of mezzanine loans out of its $1.1 billion total portfolio were likely to default, and did not disclose this risk to investors in its offering documents. The district court granted defendant’s motion to dismiss, holding that the failure to disclose could not be “material” because the $51.5 million in loans were fully collateralized. The Court of Appeals held that collateral was but one of several factors to consider when examining the materiality of disclosure. Instead, the court held that materiality depended upon whether the assets at issue comprised more than 5% of a part of the business in total, or more than 5% of a part of the business with particular importance to investors. In so holding, the court sought to reconcile its divergent holdings in ECA & Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., and Litwin v. Blackstone Grp., L.P. Because plaintiffs failed to allege that the mezzanine loans comprised a part of defendants’ business with particular importance to investors, and because it was below the 5% threshold, the court found the loans were not sufficiently material.

11. Definition of Underwriter

a. In re Lehman Bros. Mortgage-Backed Sec. Litig., 650 F.3d 167 (2d Cir. 2011)

Plaintiffs in three class actions appealed an order dismissing their claims against defendant ratings agencies, who had issued credit ratings on registered mortgage pass-through certificates and tranches thereof. Plaintiff-appellants alleged that defendant-appellees were statutory underwriters as defined by the Securities Act of 1933 and therefore could be held liable for misstatements and omissions made by the issuers of the certificates in violation of Section 11 of the Securities Act and could be held liable as control persons under Section 15. The Second Circuit affirmed the district court’s dismissal, holding that appellees could not be classified as underwriters because neither the text of Section 11, applicable precedent, nor the legislative history could support application of the “underwriter” definition to anyone except persons who directly participated in the actual purchase or sale of the securities. Allegations that the appellees structured or created the securities were not sufficient. In addition, the appellees’ credit ratings were more comparable to opinions of an expert than the activities of an underwriter. The court

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further noted that an expanded definition would directly contradict the limited enumeration of liable parties under Section 11. Finally, appellees cannot be considered underwriters simply by their act of commenting on the offering documents. The court then addressed appellants’ allegations that appellees were control persons under Section 15, holding that providing advice and guidance does not constitute control over “management and policies” of the issuers.

12. Williams Act

a. CSX Corp. v. Children’s Investment Fund Management, LLP, 654 F. 3d 276 (2d Cir. 2011)

Plaintiff-appellant corporation brought suit against several hedge funds, alleging that they failed to make necessary disclosures under Section 13 of the Williams Act when they purchased several “cash-settled total return equity swap” agreements and made preparations for a proxy fight with the management of plaintiff corporation. The district court found for the plaintiff, and granted an injunction forbidding defendants from violating the securities laws, but denied the grant of an injunction preventing the defendants from voting their shares at the 2008 shareholder’s meeting. Both parties appealed. The Second Circuit remanded in part and affirmed in part. First, the court found that the district court had erred in considering the shares owned by banks, rather than by defendant funds, for purposes of triggering the Section 13(d) reporting requirement. The district court found that a violation occurred when a group consisting of several funds became beneficial owners of more than a combined five percent of plaintiff’s stock through the swap agreements, but did not make the necessary disclosures within 10 days. According to the Court of Appeals, only when defendants owned these shares outright was the Section 13(d) requirement triggered. The court also found error in the district court’s ruling when it considered defendant funds’ plans to acquire as potentially triggering the reporting requirements. Therefore, the Second Circuit remanded so that the district court could make a finding as to when the funds combined had outright ownership of more than five percent of plaintiff’s shares. The court then considered the appropriateness of injunctive relief. Stating that injunctions may be granted when there is the possibility of irreparable harm or recurrent violations, the court held that the district court’s grant of an injunction was influenced by its faulty basis for finding Section 13(d) liability. As such, it remanded and instructed the district court, if it did find defendant-appellees liable, to consider other factors, including the fact that defendant-appellees made some disclosures within the proper time frame, and that some of their witnesses may have testified falsely. Finally, it affirmed the district court’s denial of an injunctive “sterilization” of defendant-appellees’ shares that would have prevented it from voting in the 2008 shareholder meeting, based on the Second Circuit’s decision in Treadway Companies, Inc. v. Care Corp. Here, plaintiff’s shareholders found out about the defendants’ acquisitions six months before the shareholder vote, and thus had actual knowledge of what the disclosures would have revealed in sufficient time to take action.

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IV. THIRD CIRCUIT


During 2011, the Third Circuit, the District of Delaware and the District of New Jersey issued noteworthy decisions on class certification and pleading standards for securities claims. In In re DVI, Inc. Sec. Litig., the Third Circuit held that plaintiffs satisfied the class certification predominance requirement based on the “fraud-on-the-market” theory with regard to an auditor defendant, but were unable to establish a presumption of reliance on alleged deceptive conduct by a defendant law firm because they could not demonstrate that the conduct was publicly disclosed and attributable to the firm. In In re Merck & Co., Inc. and Local 731 I.B. of T. Excavators and Pavers Pension Trust Fund v. Swanson, district courts in the District of New Jersey and the District of Delaware, respectively, concluded that plaintiffs met securities claim pleading standards with regard to materiality and scienter. In Swanson, the District of Delaware applied the “total mix” standard for materiality, as discussed in the Supreme Court’s recent Matrixx decision, and found there was a substantial likelihood that a reasonable investor would have wanted to know information the company possessed about the declining profitability of one of its business lines.



a. In re DVI, Inc. Sec. Litig., 639 F.3d 623 (3d Cir. 2011)

Plaintiffs brought class action against accounting firm and law firm, claiming violations of Section 10(b) of the Exchange Act and Rule 10b-5, after which defendants’ public company client filed for bankruptcy. In their motion for class certification, plaintiffs argued that they had satisfied the predominance requirement by properly invoking the fraud-on-the-market presumption of reliance (i.e., the presumption of a link between the misrepresentation and the price plaintiffs paid for their securities). The court affirmed the district court’s finding that such a presumption had been successfully invoked with respect to the auditor defendant. The court further found that the auditor, by failing to present evidence that certain plaintiffs were “in and out” traders — traders who sold their securities before the first alleged corrective disclosure — was unable to rebut the fraud-on-the-market presumption of reliance. The court also rejected the auditor’s argument that loss causation must be proven at the class certification stage. The court affirmed the district court’s finding that plaintiffs had not successfully invoked the presumption of reliance with respect to the law firm defendants because plaintiffs did not demonstrate that the law firm’s deceptive conduct was publicly disclosed and attributable to the law firm itself.


a. In re Merck & Co., Inc., No. 05-1151, 2011 WL 3444199 (D.N.J. Aug. 8, 2011)

Plaintiffs alleged securities fraud under Sections 10(b), 20(a), 20A and Rule 10b-5 of the Exchange Act and Sections 11, 12 and 15 of the Securities Act after defendant pharmaceutical company’s pain reliever was withdrawn from the market, causing defendant company’s stock to

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drop significantly. Defendants moved to dismiss and the court granted the motion to dismiss in part, with respect to many individual defendants, but denied the motion in part with respect to the company and a few of the officer defendants. Plaintiffs alleged that defendants were aware of the elevated risk of heart attack associated with the pain reliever throughout the class period and misled the public regarding what defendant company characterized as the drug’s “exceptional safety profile,” repeatedly denying the link between the drug and increased risk of heart attack. The court found that plaintiffs’ adequately alleged that most of the challenged statements were materially misleading, but deemed plaintiffs’ allegations regarding statements made by defendant CEO after the pain reliever’s withdrawal from the market insufficient because, given the overwhelming evidence to the contrary, no reasonable investor would have relied on said statements. The court found that scienter was sufficiently pled against two officer defendants who were shown to have actual knowledge of the drug’s risks. Because plaintiffs successfully pled scienter against two of the company’s agents, the court found the pleading of scienter sufficient for the company itself. Further, plaintiffs were entitled to a presumption of reliance under Affiliated Ute’s “allegations of fraud based primarily on a failure to disclose” doctrine and the fraud-on-the-market doctrine. Plaintiffs alleged three partial curative disclosures to establish loss causation, but the court determined that only two — a Harvard study indicating the link between the pain reliever and increased risk of heart attack and the pain reliever’s ultimate withdrawal from the market due to its risks — qualified as curative disclosures. The third disclosure post-dated the drug’s withdrawal and allegedly revealed the full extent of the defendants’ fraud. Because the disclosure went towards defendants’ state of mind, it was not curative of the fraud regarding the pain killer’s safety and did not aid in establishing loss causation.

b. Local 731 I.B. of T. Excavators and Pavers Pension Trust Fund v. Swanson, No. 09-799, 2011 WL 2444675 (D. Del. June 14, 2011)

Investors brought a putative class action asserting securities fraud claims under Sections 10(b) and 20(a) of the Exchange Act after defendant executives sold their shares at peak value and the company subsequently filed for bankruptcy. Defendants filed a motion to dismiss, arguing that plaintiff impermissibly relied on confidential sources and failed to properly plead materiality and scienter. The court denied defendants’ motion based in part on the Supreme Court decision Matrixx Initiatives, Inc. v. Siracusano, which endorsed a more liberal reading of materiality and scienter pleading requirements under Section 10(b) and Rule 10b-5. First, the court found that plaintiffs pled with particularity the identity of their confidential sources because the complaint identified the basis of the sources’ knowledge with sufficient specificity and provided supporting documentary evidence. Next, the court held that the complaint adequately pled scienter based on the confidential witness allegations, supporting documents and allegations regarding the unusual scope and timing of defendants’ stock sales. Applying the Matrixx “total mix” test for materiality, the court further held that there was a substantial likelihood that a reasonable investor would have wanted to know information that the company possessed regarding the declining profitability of the yellow pages business. Finally, the court rejected defendants’ argument that the claims should be dismissed under the “safe harbor” provision of the PSLRA because defendants’ statements contained both present and future projections, and the cautionary statements were not tailored to the statements plaintiffs challenged in the lawsuit.

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V. FOURTH CIRCUIT

A. NOTEWORTHY CASES DURING 2011

1. Loss Causation

a. Katyle v. Penn Nat’l Gaming, Inc., No. 09-2272, 2011 WL 857144 (4th Cir. Mar. 14, 2011)

In a case concerning an alleged violation of Section 10(b) of the Exchange Act, following dismissal of the complaint, plaintiff investors appealed the district court’s denial of their request for leave to amend the complaint. The investors alleged that the issuer made a recurring material omission regarding an announced leveraged buyout. Specifically, plaintiffs alleged that defendant knew that the LBO would not close and fraudulently omitted this information from eight press releases issued between March 20 and June 6, 2008. The Fourth Circuit affirmed the district court’s decision denying the investors’ motion as futile because they had failed to plead loss causation adequately, as required by the PSLRA. The court concluded that the investors’ third amended complaint did not demonstrate that (i) the issuer’s alleged fraud was a substantial cause of the decline in stock prices, (ii) the purported series of corrective disclosures revealed new facts to the market (as required when claiming loss causation based upon a fraud-on-the-market theory), (iii) the disclosures related back to the issuer’s alleged omissions, or (iv) the market ever learned of these omissions.

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VI. FIFTH CIRCUIT



a. Hopson v. MetroPCS Commc’ns Inc., No. 3:09-CV-2392-G, 2011 WL 1119727, (N.D. Tex. Mar. 25, 2011)

Plaintiff shareholders brought a federal securities class action under Sections 10(b) and 20(a) of the Exchange Act against defendant wireless communication company and the company’s senior executives. Plaintiffs alleged that defendants’ false and misleading statements regarding the company’s business prospects caused plaintiffs to purchase the company’s stock at artificially inflated prices, thereby suffering losses when the alleged misstatements came to light. The district court granted defendants’ motion to dismiss, holding that plaintiffs failed to properly plead scienter and failed to state a claim. Plaintiffs’ attempt to use the company’s executives’ sale of their stock to demonstrate scienter was unavailing as the sales were made pursuant to 10b5-1 trading plans, which, under Fifth Circuit law, are insufficient to plead scienter. Plaintiffs’ other scienter claims, based on the actions of the company and its executives as a whole, were unavailing, as the Fifth Circuit does not permit “group pleading” in securities fraud cases. The court also found that even if scienter had been properly pleaded, plaintiffs’ claims would still warrant dismissal because the alleged misstatements were either forward-looking statements protected by the PSLRA or immaterial business puffery. Accordingly, the court granted defendants’ motion and dismissed the complaint in full.

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VII. SIXTH CIRCUIT


The Sixth Circuit and district courts in Ohio issued several notable decisions in 2011. In Ashland, Inc. v. Oppenheimer & Co., Inc., the Sixth Circuit affirmed the dismissal of a lawsuit against a defendant broker for securities fraud based on the broker’s statements about the safety of auction rate securities, concluding that the plaintiff failed to adequately allege scienter. The Southern District of Ohio dismissed a putative securities fraud class action against a corporation and its executives in International Brotherhood of Electrical Workers Local 697 Pension Fund v. Limited Brands, Inc., concluding that the company’s revelations of numerous problems that beset the development of a new software system and distribution center were inconsistent with allegations that the company had deliberately concealed the initiatives’ problems. In Hawaii Ironworkers Annuity Trust Fund v. Cole, the Northern District of Ohio held that an institutional investor had adequately alleged a claim against executives of one division of an auto parts supplier for violations of the Exchange Act. The court found the complaint sufficiently pled that executives had played a key role in transmitting the false information that was incorporated into the allegedly misleading financial statements, and investors reasonably understood that such information was issued by the executives of that particular division because the company had highlighted the profits of that business segment.


1. Scienter

a. Ashland, Inc. v. Oppenheimer & Co., Inc., 648 F.3d 461 (6th Cir. 2011)

Plaintiff purchaser of auction rate securities (ARS) asserted claims under Section 10(b) of the Exchange Act and Rule 10b-5, common law fraud and promissory estoppel against defendant broker after the ARS market crashed, leaving plaintiff’s securities illiquid and less valuable. Plaintiff alleged that the broker failed to inform plaintiff of the broker’s knowledge of the ARS market’s impending crash, and instead promoted ARS as safe and liquid assets. The district court granted defendant’s motion to dismiss and the Sixth Circuit affirmed. The Sixth Circuit found that plaintiff failed to allege why or how defendant knew of the impending market crash. The fact that a few underwriters had previously let some auctions fail and that defendant may have known what would happen if underwriters left the ARS market was insufficient to show scienter. Further, the court held that referring to ARS as “safe” and “liquid” did not constitute a promise for the purposes of estoppel, and that defendant had made no promises that the ARS market would remain liquid. Moreover, the promises upon which the plaintiff relied were contradicted by disclaimers in the broker’s offering statements and brochures.

b. Int’l Bhd. of Elec. Workers Local 697 Pension Fund v. Limited Brands, Inc., No. 2:09–cv–1008, 2011 WL 1238308 (S.D. Ohio Mar. 29, 2011)

Plaintiff investors brought securities fraud class action against a corporation, which owned and operated women’s lingerie retail stores, and the corporation’s executives, alleging

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that they made false or misleading statements in violation of Sections 20(a) and 10(b) of the Exchange Act and Rule 10b-5. Defendants moved to dismiss, arguing that plaintiffs failed to adequately allege a strong inference of scienter, materiality and falsity. In particular, defendants’ alleged statements concerned the development of a new software system and the opening of a new distribution center at one of the corporation’s subsidiaries — both of which failed before producing an expected increase in profit margins. Investors claimed that defendants’ failure to disclose the true extent of the problems that beset both initiatives was part of a nefarious scheme to artificially inflate the company’s stock price, especially because the executives’ incentive compensation was tied to a higher stock price. The district court granted defendants’ motion to dismiss. The court relied on the fact that defendants revealed, rather than concealed, the problems with both initiatives. The court reasoned that if defendants were truly trying to deceive investors and inflate the company’s stock price, then they would not have revealed any problems whatsoever. The court further concluded that certain statements at issue, such as earnings projections and statements about “significant growth opportunities” for the company, were either immaterial corporate puffery or forward-looking statements protected by the PSLRA’s safe-harbor provision.

2. Reliance

a. Hawaii Ironworkers Annuity Trust Fund v. Cole, No. 3:10CV371, 2011 WL 1257756 (N.D. Ohio Mar. 31, 2011)

Plaintiff, an institutional investor, brought a class action lawsuit against high-level executives of a company that supplies automotive parts and drive-train systems, alleging that defendants violated the Exchange Act and Rule 10b-5. Defendants filed separate motions to dismiss, contending that plaintiff failed to adequately plead reliance, scienter and loss causation in support of its Rule 10b-5 claims. The court denied the motions to dismiss. In particular, plaintiff alleged that defendants caused the company to issue false financial statements for FY2004 and the first two quarters of FY2005. The institutional investor claimed that defendants overstated earnings for their division of the company during a particularly difficult economic time for the automotive parts manufacturing industry. These overstatements were then transmitted from the division to the company and incorporated into its financial statements. As a result, plaintiff and other investors purchased the company’s securities at an artificially inflated price. When the overstatements were revealed, the company had to restate its earnings, which caused its stock price to plummet and resulted in substantial losses for investors. Based on these allegations, the court held that all three elements claimed to be lacking by defendants were, in fact, sufficient.

With regard to reliance, the court held that although defendants did not directly issue the company’s financial statements, each played a major role in transmitting the false information that was incorporated into the statements at issue. The false information regarding defandants’ division was also highlighted in the company’s reports and caused the upswing in its stock price. As a result, since the company highlighted the profits of the division, it was reasonable for the investing public to understand that such information was conveyed by the executives of that particular division. Therefore, the court found that reliance on that false information was reasonable and actionable. Plaintiff’s allegations of scienter were adequate because the complaint pointed to a series of deliberate acts on the part of defendants, evidencing knowledge

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of their wrongdoing and an understanding of the effect such actions would have. With respect to loss causation, the court held that the steep decline in the company’s stock after the restatement announcement was sufficient to link plaintiff’s loss to defendants’ misstatements.

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VIII. SEVENTH CIRCUIT


In 2011, the Seventh Circuit and the Northern District of Illinois issued several noteworthy decisions concerning the pleading requirements for federal securities law claims. In AnchorBank, FSB v. Hofer, the Seventh Circuit affirmed the district court’s decision denying defendant’s motion to dismiss and held that a plaintiff is required to allege only that defendant’s conduct is at least one plausible cause of plaintiff’s loss, not that all if its loss is necessarily attributable to defendant’s actions.

In City of Livonia Employees’ Retirement System v. Boeing Co., the Northern District of Illinois dismissed plaintiffs’ claims when the confidential source whose purported statements provided the necessary support for plaintiffs’ allegations later disclaimed the information attributed to him in the complaint. In Garden City Employees’ Retirement System v. Anixter International, the Northern District of Illinois dismissed the complaint, holding that plaintiffs failed to plead specific facts suggesting the falsity of defendants’ statements and failed to plead scienter because they did not provide information regarding defendants’ stock sales outside the class period.



a. AnchorBank, FSB v. Hofer, 649 F.3d 610 (7th Cir. 2011)

Plaintiffs bank, investment fund and fund trustee of the fund brought suit under Sections 9(a) and 10(b) of the Exchange Act against a bank employee on the basis that he had colluded with colleagues to improperly manipulate the market for the bank’s stock. After defendant’s motion to dismiss was granted by the district court, the plaintiffs appealed and the Seventh Circuit reversed. Specifically, the complaint alleged that as employees of the bank, defendant and his co-conspirators received interest in the bank’s stock as an employment benefit. Plaintiffs alleged that defendant and his co-conspirators manipulated the price of the bank’s stock by coordinating purchases and sales of bank stock in a way that required the fund trustee to make reactive sales and purchases to maintain the trustee’s requisite cash-to-stock ratio. The Seventh Circuit found that plaintiffs adequately pleaded reliance based on allegations that (i) the fund trustee relied on defendant’s allegedly fraudulent trades in deciding how to maintain the required cash-to-stock ratio; and (ii) unwitting fund participants relied on the artificially depressed and inflated stock prices when they made “comparatively uninformed” decisions to buy and sell stock. The court also held that, notwithstanding plausible alternative causation theories advanced by defendant, plaintiffs adequately pleaded economic loss and loss causation because a plaintiff need not “plead that all of its loss is necessarily attributed to the actions of the defendant,” but rather a plaintiff must plead only that the defendant is “at least one plausible cause of the economic loss.”

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b. Baxi v. Ennis Knupp & Assocs., Inc., Case No. 10-cv-6346, 2011 WL 3898034 (N.D. Ill. Sept. 2, 2011)

Plaintiff, a shareholder-employee of an investment advisory company, brought claims against his employer, as well as an investment consulting firm that acquired the company, alleging that defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 by withholding news of a merger from plaintiff before he left his employment. Defendants moved to dismiss and the district court granted the motion in part, and denied in part. While employed by defendant advisory company, plaintiff signed a stock restriction and purchase agreement that required him to sell his shares back to the company upon leaving its employment. The company later closed the office in which plaintiff worked, and plaintiff sold his shares to the company for $119,600, as required by the agreement. When plaintiff inquired as to why defendant company decided to close the office, the company did not disclose a reason. In fact, the company had been engaging in merger talks with defendant consulting firm. After the acquisition was announced, plaintiff filed suit against both entities, alleging that if he had owned his shares at the time of the merger, he would have been entitled to approximately $1.5 million. In considering whether plaintiff pled a securities fraud claim, the court held that Rule 10b-5 prohibits closely-held corporations from withholding news of a merger from shareholder-employees if the news might affect the shareholders’ decisions regarding whether to leave the employment and sell their shares. The court thus noted that the viability of plaintiff’s securities fraud claim turned on whether he had a choice about whether to keep his shares through the time of the merger. Reasoning that the complaint plead only that plaintiff was (i) terminated in accordance with his employment contract, and (ii) subject to the automatic re-sale requirement in the stock restriction agreement, the court held plaintiff was obligated to sell back his shares within 90 days of being terminated. As a result, whatever information the company withheld from him regarding the planned merger was irrelevant. The court dismissed the securities claim without prejudice.

c. Dixon v. Ladish Co., No. 10-CV-1076, 2011 WL 1219256 (E.D. Wis. Mar. 30, 2011)

Plaintiff, a shareholder of a target company in a proposed merger, brought a lawsuit against both companies involved in the proposed merger as well as individual directors of the target company. Having already granted the acquiring company’s motion to dismiss, the court considered the remaining defendants’ motion to dismiss. Plaintiff alleged violations of Sections 14(a) and 20(a) of the Exchange Act and breaches of fiduciary duties arising out of the proposed merger. The court granted the motion to dismiss because, under the PSLRA, plaintiff failed to plead with particularity. Specifically, the court found that the complaint failed to allege: (i) facts regarding what other statements became misleading or false as a result of certain statements identified by plaintiff; and (ii) what made any such statement misleading or false. The court also granted defendants’ motion to dismiss plaintiff’s fiduciary duty claims, finding that plaintiff failed to surmount the high hurdle presented by the business judgment rule’s presumption of good faith.

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2. Scienter

a. Plumbers & Pipefitters Local Union 719 Pension Fund v. Zimmer Hldgs., No. 08-1041, 2011 WL 338865 (S.D. Ind. Jan. 28, 2011)

Plaintiff investors brought this class action against the company and several of its officers for making false and misleading statements in violation of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. The court denied plaintiffs’ motion for leave to replead, finding that plaintiffs’ proposed amended complaint did not allege a strong inference of scienter with the requisite particularity. Specifically, the court concluded that the investors’ allegations did not give rise to a strong inference that defendants received specific, negative information that was inconsistent with public statements during the class period, nor that defendants knew of material information related to a specific product that they had a duty to disclose.

b. Puskala v. Koss Corporation., No. 10-C-0041, 2011 WL 3204683 (E.D. Wis. July 28, 2011)

Plaintiff investor brought a putative class action under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 against defendant corporation, its former accountant, current accounting officer and its CEO. Between 2004 and 2009, defendant corporation’s principal accounting officer embezzled $30 million from the corporation and used a scheme of accounting fraud to avoid detection. The false accounting entries that he made were used to prepare the corporation’s financial statements, rendering its SEC filings materially false. Plaintiff sought to represent a class of investors who suffered economic losses as a result of purchasing the corporation’s stock in reliance on the materially false information in its SEC filings. The district court granted defendant accountant’s motion, and granted in part and denied in part the remaining defendants’ motion. The court refused to dismiss plaintiff’s 10(b) and Rule 10b-5 claim against the corporation, holding that the company could be held liable for the defendant officer’s wrongdoing under the apparent authority theory of agency liability. The court also refused to dismiss the 20(a) “control person” liability claim against the corporation’s CEO. The court dismissed the 10(b) and Rule 10b-5 claims against the CEO and the former accountant, holding that the complaint failed to plead facts creating an inference of recklessness. As to the CEO, plaintiffs argued that he was aware of facts indicating that the company’s internal controls were unreliable such that no top executive at the corporation could have thought the financial statements were accurate. The court rejected this argument, noting that plaintiffs pled no facts about the actual condition of the internal controls over financial reporting during the time the fraud was ongoing, nor any particular measures that could have been taken to prevent the fraud. In addressing the former accountant, plaintiffs argued that they had sufficiently pleaded scienter by alleging that the accountant recklessly failed to take a sample of cancelled checks to identify the entities that endorsed the checks, and failed to cross-check bank records against internal journal entries. The court found that although these failures may suggest negligence in conducting the audit, plaintiffs failed to provide any explanation of how these failures gave rise to an inference of recklessness.

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a. City of Livonia Emps’ Ret. Sys. v. Boeing Co., No. 09-7143, 2011 WL 824604 (N.D. Ill. Mar. 7, 2011)

Plaintiff shareholders filed a putative class action against defendant corporation, alleging securities fraud. Plaintiffs’ second amended complaint survived dismissal based on new confidential source allegations. When the confidential source was later deposed, however, he disclaimed the information attributed to him in the second amended complaint. On a motion for reconsideration, the court found that plaintiffs “misrepresented” material facts and failed to conduct a reasonably thorough investigation. The court determined that the second amended complaint’s informational basis was “at best unreliable and at worst fraudulent.” Based on the source’s deposition testimony, the court granted reconsideration and dismissed with prejudice, holding that it had erred in concluding the allegations in the second amended complaint were sufficient to satisfy the PSLRA pleading requirements.

b. Garden City Emps’ Ret. Sys. v. Anixter Int’l, No. 09-5641, 2011 WL 1303387 (N.D. Ill. Mar. 31, 2011)

Plaintiff shareholders filed a putative class action alleging securities fraud against an issuer and several of its officers. The shareholders alleged that during the first three quarters of 2008, defendants made false and misleading statements concerning the company’s projected organic revenue growth rate and the effect of the general economic downturn on its financial outlook. The court dismissed the complaint, holding that plaintiffs failed to plead specific facts suggesting the falsity of defendants’ statements. With respect to allegations based on individual defendants’ stock sales, the court held plaintiffs failed to plead scienter because they failed to provide information regarding defendants’ stock sales outside the class period. Without such information, the court had no basis for determining whether the class period sales were suspicious.

c. St. Lucie Cnty. Fire Dist. Firefighters’ Pension Trust Fund v. Motorola, No. 10-427, 2011 WL 814932 (N.D. Ill. Feb. 28, 2011)

Plaintiffs, shareholders of defendant corporation, sued the company and three executives for securities fraud. Plaintiffs alleged defendants made material misstatements or omissions regarding: (i) the company’s progress in improving the performance of its mobile services division; (ii) its expected earnings; and (iii) an undisclosed litigation settlement between the company and a supplier. Defendants moved to dismiss, and the court granted their motion, dismissing the case with prejudice. The court held that the projections for the company’s mobile services division were borne out by the actual financial results, and thus not false. The court also ruled that predictions regarding the company’s expected earnings were accurate, and, even if they were not, they fell within the PSLRA’s safe-harbor provisions. Finally, the court held that plaintiffs failed to show that the settlement had been executed by the time the allegedly false statements were made, and defendants were not required to disclose ongoing settlement negotiations.

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d. Plumbers & Pipefitters Local Union No. 630 Pension-Annuity Trust Fund v. Allscripts-Misys Healthcare Solutions, 707 F. Supp. 2d 774 (N.D. Ill. 2011)

Plaintiff shareholder filed a putative class action alleging securities fraud against developer of healthcare-related software applications, its CEO, and CFO. Specifically, plaintiff alleged 21 false or misleading statements concerning (i) the company’s financial forecasts and (ii) implementation problems associated with the latest version of the company’s leading software application. Defendants filed a motion to dismiss, which the court granted in part. The court dismissed the complaint to the extent plaintiff’s claims were based on immaterial optimistic statements, forward-looking projections insulated by the PSLRA’s safe harbor, and statements not properly alleged to be misleading or made with the requisite scienter. The court, however, denied the motion to dismiss to the extent plaintiff’s claims rested on two allegedly misleading statements supported by confidential witness allegations that the CEO and CFO attended monthly conference calls at which the problems plaguing the new software application were discussed.

e. City of New Orleans Employees’ Retirement System v. PrivateBancorp, Inc., 2011 WL 5374095 (N.D. Ill. Nov. 3, 2011)

Plaintiffs brought a putative class action on behalf of similarly situated purchasers of defendant bank’s stock against the bank, its officers and directors, and underwriters for two of the bank’s public offerings for alleged violations of Section 10(b) of the Exchange Act and Sections 11 and 12 of the Securities Act. Defendants moved to dismiss, and the court granted the motion and denied class certification without prejudice. Plaintiffs’ claims were largely prompted by write-downs on loans the bank took in 2009. Plaintiffs alleged the bank and its officers and directors made misstatements in connection with the loans that were ultimately written-down and failed to take remedial action regarding those loans, including failing to maintain a sufficient allowance for loan losses and failing to write-down the loans earlier, despite having knowledge that such action was necessary. Plaintiffs further alleged the bank’s officers and directors deliberately initiated unsound loans. The district court found plaintiffs had not adequately alleged that any of the defendants acted with scienter in connection with the loans that were ultimately written-down in 2009 because there were no allegations showing that the defendants misrepresented the nature of the loans or knew they needed to be written-down earlier. Moreover, plaintiffs had not pled facts showing that the statements made in connection with the public offerings were false, nor did they show that the defendants doubted their accuracy or adequacy. Finally, the court held plaintiffs’ group pleading was insufficient under the PSLRA because “a defendant can be held liable with respect to a statement only if he is a maker of that statement . . . .” Based on this analysis, the court dismissed all of plaintiffs’ claims with prejudice, and denied class certification without prejudice.

4. SLUSA

a. Brown v. Calamos, 664 F.3d 123 (7th Cir. 2011)

Plaintiff filed a putative class action against company officials of a closed-end investment company, alleging that defendants breached their fiduciary duty to common stockholders in the

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investment fund by redeeming certain preferred stock. The district court dismissed the action, and the Seventh Circuit affirmed. According to the complaint, prior to redeeming the preferred stock, defendants had made public statements suggesting that shareholders would benefit indefinitely from the fact that the preferred stock had no maturity date. However, when the 2008 financial crisis hit, the market for preferred stock failed and, in response to anger from preferred stock owners, the company redeemed their shares at a price above market value. Defendant company then replaced that money with funds it borrowed short-term at higher interest rates, increasing the risk to the fund. Plaintiff alleged that defendant redeemed the preferred stock because its parent wanted to please investment banks and brokerage houses that were facing lawsuits from customers who had purchased the stock, and asserted that this decision constituted a breach of fiduciary duty. The district court held that the suit implicitly alleged a material misrepresentation or omission made to plaintiff in connection with purchase or sale of a covered security and, therefore, SLUSA applied to bar the claim. The Seventh Circuit affirmed this holding. The Seventh Circuit also rejected plaintiff’s attempt to circumvent SLUSA by arguing that the instant action only alleged a breach of fiduciary duty, and reasoned that dismissal with prejudice was appropriate because the fraud allegations might be central to the case, and thus even if plaintiff filed an amended complaint, it was likely fraud would “sneak . . . back into the case” at a later stage.

b. Bourrienne v. Calamos, et al., No. 10-CV-7295, 2011 WL 3421559 (N.D. Ill. Aug. 4, 2011)

Plaintiff filed a class action suit for breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, and unjust enrichment on behalf of a class of common shareholders of a closed-end investment fund in the Circuit Court of Cook County, Illinois. Defendants, company officials of the fund, removed the case to federal court and moved to dismiss, arguing that SLUSA permitted the removal of and precluded plaintiff’s claims. The district court granted defendants’ motion to dismiss the claims. Plaintiff alleged that the investment fund, which had issued common shares and auction market preferred shares (AMPS), publicly touted the benefit of the AMPS to induce the common shareholders to buy-in to the fund, but then redeemed the AMPS following the economic meltdown in 2008, even though the fund was not obligated to do so. Plaintiff alleged that defendants, to the detriment of the common shareholders, entered into settlements with investment banks and brokers to redeem outstanding AMPS and replace them with financing that was less advantageous for the common shareholders, but placated wealthy investors and the fund’s business partners. Plaintiff argued that SLUSA was inapplicable because “nowhere in the complaint [did] plaintiff allege that any statements attributed to any of the defendants were false.” The district court found that a crux of plaintiff’s complaint was that they were sold the fund under the false premise that the AMPS were “perpetual” and did not have to be repaid. The court therefore granted defendants’ motion to dismiss, holding that regardless of how plaintiff characterized his claims, the substance of his argument was that defendants misrepresented their intentions with regard to the AMPS, and that defendants omitted a potential conflict of interest with their investors and owners of the AMPS. As such, the SLUSA precluded plaintiff’s claims.

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5. Reliance

a. Gandhi Revocable Trust v. Sitara Capital Mgmt., No. 09-3141, 2011 WL 814647 (N.D. Ill. Feb. 25, 2011)

Plaintiff investors alleged that defendants managed a limited partnership that caused plaintiffs to lose their investment in that partnership. Plaintiffs brought a claim under Section 10(b) of the Exchange Act, and defendants moved to dismiss, arguing that plaintiffs failed to allege actual reliance and to plead the requisite strong inference of scienter. The court dismissed, holding that plaintiffs failed to plead reliance because they failed to identify (i) who allegedly relied on defendants’ representations and (ii) which statements allegedly caused their reliance. In dicta, the court also rejected plaintiffs’ argument that they adequately pleaded scienter by averring that defendants’ subsequent “reckless” actions caused previously made statements to be inaccurate.

6. Expedited Discovery under PSLRA

a. Dixon v. Ladish Co., No. 10-1076, 2011 WL 719018 (E.D. Wis. Feb. 22, 2011)

Plaintiff, a shareholder of a target company in a proposed merger, brought a lawsuit against both companies involved in the proposed merger as well as individual directors of the target company. Plaintiff alleged violations of Sections 14(a) and 20(a) of the Exchange Act and breaches of fiduciary duties arising from the proposed merger. Plaintiff moved for early, expedited discovery. Applying the PSLRA stay of discovery, the court denied that request due to the pendency of motions to dismiss and the lack of a showing of undue prejudice. The court also granted the acquiring company’s motion to dismiss an aiding-and-abetting claim, holding that plaintiff failed to show the company knowingly participated in a breach of fiduciary duties.

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IX. EIGHTH CIRCUIT


1. Scienter

a. Patel v. MEMC Electronic Materials, Inc., 641 F.3d 1023 (8th Cir. 2011)

Plaintiffs brought suit against a silicon wafer manufacturer and its former CEO for violations of Sections 10(b) and 20(a) of the Exchange Act on the grounds that defendants failed to announce two production failures at its facilities. The district court granted defendants’ motion to dismiss, finding that defendants had no duty to disclose the failures, and plaintiffs did not allege facts giving rise to scienter. Defendants, both before and after the alleged failures to announce the production problems, had habitually informed investors of such incidents immediately after their occurrence, but they had also stated in SEC filings that plant disruptions could have material adverse effects on operating results. The Eighth Circuit affirmed the district court’s dismissal, holding that there was no duty to disclose the incidents under Section 10(b) because a “pattern of disclosure may give rise to a duty to disclose” only in extraordinary circumstances. In this case, the defendants (i) never stated that either facility was operational after the failures and (ii) had warned investors that the manufacturer was vulnerable to disruptions. The court also found that plaintiffs failed to adequately allege scienter because the inference that defendants believed the incidents were immaterial or that they believed that they had no duty to disclose was more probable than the inference that the defendants acted with scienter. The court found plaintiffs’ allegation that defendants knew the problems were material, and that defendants had represented that past problems had been resolved, insufficient in light of the fact that plaintiffs (i) could not allege any benefit to defendants and (ii) defendants had cautioned investors about these risks. The Eighth Circuit also affirmed the dismissal of the 20(a) claim because the underlying 10(b) claim was dismissed.

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X. NINTH CIRCUIT


In 2011, the Ninth Circuit and district courts in California and Arizona handed down noteworthy decisions on a variety of topics. In Connecticut Retirement Plans & Trust Funds v. Amgen Inc., the Ninth Circuit held that plaintiffs need not prove materiality at the class certification stage in order to invoke the fraud-on-the-market presumption of reliance. In New Mexico State Investment Council v. Ernst & Young, the Ninth Circuit reversed the district court’s dismissal of the complaint, finding that plaintiffs’ allegations created an inference of scienter on the part of the defendant with respect to the audited company’s stock options back-dating scheme.

In George v. California Infrastructure and Economic Development Bank, following Ninth Circuit precedent, the Central District of California refused to adopt the fraud-created-the-market presumption of reliance for Section 10(b) claims. In Petrie v. Electronic Game Card Inc., the Central District of California dismissed plaintiffs’ Section 10(b) claims, holding that Tellabs and the PSLRA precluded plaintiffs’ group pleading theory of liability. In Theodore Dean v. China Agritech, Inc., the Central District of California dismissed plaintiffs’ Section 11 claims on loss causation grounds, even though that it is an affirmative defense under the statute. In In re Apollo Group, Inc. Securities Litigation, the District of Arizona found that plaintiffs failed to plead loss causation because they did not adequately link the alleged corrective disclosures to specific fraudulent practices.



a. In re VeriFone Holdings, Inc. Sec. Litig., No. C 07-6140 MHP, 2011 WL 1045120 (N.D. Cal. Mar. 22, 2011)

This consolidated litigation represented nine securities fraud class actions brought on behalf of purchasers of defendant corporation’s stock against the corporation and certain of its officers and directors. The court granted defendants’ motion to dismiss, finding that the allegations in plaintiffs’ third amended complaint did not create a strong inference of scienter. The court rejected a multitude of allegations that each defendant knew that certain inventory adjustments in the company’s financials were false. The court found that plaintiffs’ various allegations that were intended to support an inference of scienter were insufficient “based on both an individual and holistic review” and were at times “entirely speculative.”

b. In re Homestore.com, Inc. Sec. Litig., No. CV 01-11115 RSWL (CWx), 2011 WL 1564025 (C.D. Cal. Apr. 22, 2011)

Investors filed a securities class action lawsuit against a company and a number of its directors and officers. In January 2011, a civil jury trial commenced against the company’s former CEO, alleging violations of Section 10(b) and Section 20(a) of the Exchange Act and Rule 10b-5. The jury returned a special verdict, finding that under Section 10(b): (i) defendant was knowingly or recklessly involved in the preparation of five materially misleading company

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statements; (ii) plaintiffs suffered losses as a result of those statements; and (iii) lead plaintiff relied on the integrity of the market price in purchasing the company’s stock. The jury also found that defendant was subject to control person liability with respect to four materially misleading company statements written by others for purposes of Section 20(a) of the Exchange Act. The CEO filed a renewed motion for judgment as a matter of law, arguing that the evidence presented at trial failed to support the jury’s conclusions with respect to loss causation, lead plaintiff’s reliance on the integrity of the market, and scienter. The CEO also argued that the evidence was insufficient to support the finding that he was subject to control person liability under Section 20(a). The court rejected each of defendant’s claims. First, the court rejected his loss causation argument, holding that plaintiffs’ expert testimony was sufficient to support a finding that two press releases were corrective disclosures that led to a decline in the company’s stock and caused plaintiffs’ losses. Second, the court held that the jury’s finding that lead plaintiff reasonably relied on the integrity of the market when purchasing the company’s stock was supported by the evidence at trial. The court noted the testimony of an employee of lead plaintiff who testified that lead plaintiff relied on the integrity of the company’s market price when purchasing the company’s stock. Next, the court rejected defendant’s argument that the evidence did not support a finding that he acted with the requisite scienter, pointing to testimony that defendant had been informed about suspicious business transactions and their risks at the time the challenged statements were issued. Finally, the court held that evidence regarding defendant’s active involvement in all aspects of the company was sufficient to support the finding of control person liability under Section 20(a).

c. George v. Cal. Infrastructure and Econ. Dev. Bank, No. 2:09-CV-01610-GEB-DAD, 2011 WL 837152 (E.D. Cal. Mar. 9, 2011)

Lead plaintiff filed suit against a company and its law firm alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5. Plaintiff alleged that class members purchased certain Section 501(c)(3) revenue bonds (2007 Bonds) issued by the company based on material misleading statements in the company’s prospectus. Specifically, plaintiff alleged that the statement in the prospectus that “the occurrence of an Act of Bankruptcy by [Borrower on or before] . . . September 7, 2007, would prevent the legal defeasance of [1999] Bonds from the proceeds of [2007] Bonds,” wrongly suggested that, assuming no bankruptcy, the preconditions to the defeasance of the senior 1999 Bonds would be met — and the 1999 Bonds would be paid off — by September 7, 2007. In fact, there was never any pre-bankruptcy defeasance of the 1999 Bonds, which led to the relegation of plaintiff to unsecured creditor status upon the bankruptcy of the borrower, resulting in financial losses to plaintiff. In addition, plaintiff alleged that the law firm had an affirmative duty either to disclose the misstatements and their consequences or to refrain from representing the company in connection with the bond offering. Plaintiff admitted in his complaint that he could establish reliance only if the court adopted the fraud-created-the-market presumption of reliance. Plaintiff contended that an investor could consider the integrity of the market as a reliable indication that the securities offered for purchase are entitled to be in the marketplace, such that a security’s availability on the market is an indication of its apparent genuineness. The court held that the fraud-created-the-market theory was not a viable basis upon which to establish reliance. Specifically, the court held that accepting this theory would essentially eliminate the reliance requirement for a Section 10(b) claim, and noted that the Ninth Circuit had not adopted the fraud-created-the-market theory. Finally, the court held that, even if it did adopt the fraud-created-the-market theory, plaintiff’s

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allegations would still fail because he had not established that the bonds were either economically or legally “unmarketable.” The court therefore dismissed plaintiff’s Section 10(b) claim with prejudice.

d. Richard v. Northwest Pipe Co., No. C9-5724RBL, 2011 WL 3813073 (W.D. Wash. Aug. 26, 2011)

Plaintiff shareholders asserted claims against defendant manufacturer and two former officers under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. In particular, plaintiffs alleged that accounting improprieties caused the manufacturer to overstate its earnings, and stock prices fell after the manufacturer restated its earnings following an internal investigation. Defendants moved to dismiss, and the court denied the motion on three grounds. First, the court held that plaintiffs adequately pled loss causation by alleging a decline in stock price following the announcement of a pending internal investigation regarding certain accounting practices and the announcement that public filings would be delayed. Second, the court held that plaintiffs’ allegations, taken together, adequately pled scienter. The court relied on plaintiffs’ allegations that (i) defendants engaged in fourteen accounting violations; (ii) the manufacturer had to significantly revise three years of income and earnings figures; (iii) the officers, who were experienced CPAs, made statements about the company’s revenue recognition practices that were inconsistent with actual practices; (iv) the officers were motivated by a desire to meet Wall Street expectations because their compensation was tied to the manufacturer’s financial performance; (v) the officers signed Sarbanes-Oxley certifications that falsely stated that the financial results were fairly presented; and (vi) the officers both left their positions at approximately the same time that the investigation and restatement occurred. Finally, the court held that plaintiffs adequately pled Section 20(a) control person liability regarding the officers because plaintiffs alleged that the manufacturer was a primary violator and that both officers participated in its day-to-day affairs and had the power to control financial disclosures.

e. Rentea v. Janes, No. CV 11-07345-RGK (MRWx), 2011 WL 5822255 (C.D. Cal. Nov. 16, 2011)

Plaintiff shareholder filed suit under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 against an officer of a medical device manufacturing company. Plaintiff alleged that defendant made public statements about “good news” regarding FDA approval of a medical device when defendant had, in fact, already received a letter from the FDA warning that it would likely deny approval. Defendant moved to dismiss for failure to state a claim, and the court granted the motion and denied leave to amend. First, the court held that plaintiff failed to plead falsity because he did not identify any specific false statements or the time, place or context of such statements. Second, the court held that plaintiff failed to raise a strong inference of scienter because he offered only vague generalizations rather than detailed facts regarding defendant’s state of mind. Third, the court held that plaintiff did not adequately plead reliance because he failed to establish a material misrepresentation that could give rise to reasonable reliance and because he also failed to specify whether he bought the stock in reliance on the representation or because the stock doubled in price. Finally, the court held that plaintiff failed to adequately allege loss causation because instead of alleging that the loss was due to revelations regarding defendant’s misrepresentation, he alleged that the decrease in stock value was due to the FDA’s

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denial of approval. The court further held that plaintiff could not plead Section 20(a) control person liability because plaintiff failed to establish a predicate violation under Section 10(b).

f. Teamsters Local 617 Pension & Welfare Funds v. Apollo Group, Inc., No. CIV-06-02674-PHX-RCB, 2011 WL 1253250 (D. Ariz. Mar. 31, 2011)

Plaintiff filed an amended complaint alleging securities fraud by defendant company and 11 officers and directors. Plaintiff alleged three separate securities fraud claims: (i) a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 against the company and four of the individual defendants based on backdated stock option grants, false statements denying the occurrence of any backdating, and false statements in the Company’s financial statements; (ii) a claim under Section 20A of the Exchange Act against one of the individual defendants; and (iii) a claim under Section 20(a) of the Exchange Act against the company and all individual defendants. Specifically, plaintiff claimed that defendants backdated stock option grants on six specific dates based on the alleged fact that the share prices on those dates were the lows for the month and/or for the year. Further, plaintiff claimed that defendants made material misrepresentations and omissions in the company’s earnings announcements, Form 10-Ks, Form 10-Qs, and SOX certifications. Defendants filed motions to dismiss, and the individual defendants also moved to strike allegations that the court previously dismissed or found insufficient as a matter of law. The court found that plaintiff failed to plead the backdating allegations or the falsity element of Section 10(b) liability with requisite particularity because: (i) the amended complaint made broad allegations of falsity and misconduct without providing any particularized facts to support its claims; and (ii) the facts it did allege were either baseless or presented in a misleading fashion. The court therefore dismissed plaintiff’s Section 10(b) claim. Since liability under both Section 20A and Section 20(a) required an independent violation of another provision of the securities laws, the remaining securities fraud claims were dismissed as well. The court granted defendants’ motions to dismiss as to all claims and dismissed plaintiff’s complaint with prejudice.

g. Petrie v. Electronic Game Card Inc., No. 10-00252, 2011 WL 165402 (C.D. Cal. Jan. 12, 2011)

Plaintiff filed a consolidated amended complaint against multiple defendants alleging securities fraud under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. The Central District of California granted in part and denied in part motions to dismiss brought by four defendants, all former or current officers or directors of a small 10-person company. The court dismissed with leave to amend plaintiff’s Section 10(b) and Rule 10b-5 allegations, holding that plaintiff did not adequately link the moving defendants to alleged misrepresentations about the state of the company’s financial health, that the alleged misrepresentations were mere “puffery” and too vague to be actionable, or that the moving defendants were not liable because the alleged misrepresentations predated their affiliation with the company. The Court further held plaintiff’s “group pleading” theory of liability had not survived the passage of the PSLRA and the Supreme Court’s decision in Tellabs. However, with respect to plaintiff’s Section 20(a) control person liability claims against the moving defendants, the court found that the complaint contained viable allegations of a primary violation by two non-moving defendants that could be

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imputed to the company and that, under the more lenient pleading standards of Rule 8(a), plaintiff sufficiently alleged the moving defendants were control persons.

h. Drescher v. Baby It’s You, LLC, No. CV 10-6854 PSG (PLAx), 2011 WL 63615 (C.D. Cal. Jan. 7, 2011)

Plaintiff alleged violations of Sections 5(a), 5(c) and 12(a)(2) of the Securities Act and Section 10(b) of the Exchange Act in connection with his investment in defendants’ theatrical production. Defendants moved to dismiss for failure to state a claim, arguing that plaintiff was not a “purchaser” within the meaning of the statutes since his complaint did not allege an agreement to purchase securities. The court granted defendants’ motion to dismiss, holding that in the absence of an offer and sale agreement, plaintiff was not a “purchaser” within the meaning of the securities statutes. Specifically, the court found plaintiff’s allegation that defendant “provided” an investment to be inadequate to establish the purchase or sale of a security. The court noted that the securities laws at issue did not define “purchase” or “purchaser,” but that the term was to be understood to include both “offer” and “sell,” which were defined by securities laws. Notwithstanding the variety of transactions that might include an offer and sale, the court found the core issue to be whether the transaction transformed plaintiff into the functional equivalent of a purchaser or seller. According to the court, the complaint failed to include any allegation to suggest plaintiff purchased a security from defendants. In so holding, the court distinguished Goodman v. H. Hentz & Co., 265 F. Supp. 440 (N.D. Ill. 1967) because, in that case, plaintiffs alleged that “but for” defendants’ fraud, plaintiffs would have purchased securities. Finding that plaintiff failed adequately to plead that he was a purchaser in the sale of a security, the court dismissed plaintiff’s complaint, holding that plaintiff lacked standing to pursue the securities violations claims.

i. Theodore Dean v. China Agritech, Inc., No. CV 11-01331-RGK (PJWx), 2011 WL 5148598 (C.D. Cal. Oct. 27, 2011)

Plaintiff investors filed a putative class action against a manufacturer, certain of its executives, its auditor and an underwriter, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5, as well as Sections 11 and 15 of the Securities Act. In particular, plaintiffs alleged that defendants misstated the manufacturer’s net revenue and income in a registration statement and prospectus, and that the executives concealed certain related-party transactions. Defendants moved to dismiss, and the court granted the motions in part and denied them in part. As to plaintiffs’ claims under Section 10(b) of the Exchange Act and Rule 10b-5, the court found that plaintiffs adequately pled materiality because plaintiffs alleged drastic discrepancies between the manufacturer’s allegedly accurate filings in China and its fraudulent filings with the SEC relating to factory production levels and revenues. The court also found that plaintiffs adequately pled scienter, because plaintiffs’ allegations created an inference that the differences in the Chinese and SEC filings were too large to be attributable to differing accounting standards. In addition, the court found that plaintiffs properly pled loss causation by alleging that the public release of investor reports describing the alleged fraud led to a drop in the value of the manufacturer’s stock. As to plaintiffs’ control person liability claims under Section 20(a) of the Exchange Act, the court found that it was reasonable to infer that the executives had control over the manufacturer, noting that the control element of a Section 20(a) claim is not subject to the PSLRA’s particularized pleading requirements. However, the court dismissed

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plaintiffs’ claim under Section 11 of the Securities Act, noting that the Ninth Circuit recognizes the affirmative defense of negative causation for Section 11 claims, and that plaintiffs could not establish loss causation based on the face of the complaint. Finally, the court dismissed plaintiffs’ Section 15 claims because plaintiffs failed to adequately plead a primary violation of Section 11, which is a prerequisite for Section 15 liability.

j. In re Century Aluminum Co. Sec. Litig., No. C 09-1001 SI, 2011 U.S. Dist. LEXIS 21406 (N.D. Cal. Mar. 3, 2011)

Plaintiff investors asserted claims under Sections 10(b) and 20(a) of the Exchange Act, Rule 10b-5, and Sections 11 and 15 of the Securities Act against defendant company, members of its board of directors, and two underwriters, alleging that the company made misleading statements in connection with a secondary offering. Specifically, plaintiffs alleged that defendants’ classification of a financial transaction misled investors into thinking that defendant company was cash-rich when it was not. The district court dismissed all claims with prejudice. In dismissing plaintiffs’ Exchange Act claims, the court found that plaintiffs’ general allegations failed to create a strong inference of scienter. In dismissing plaintiffs’ Securities Act claims, the court found that plaintiffs lacked standing because they failed to plead facts establishing that they had purchased stock traceable to the secondary offering at issue.

2. Loss Causation

a. In re Nuveen Funds/City of Alameda Sec. Litig., No. C 08-4575 SI, 2011 U.S. Dist. LEXIS 52135 (N.D. Cal. May 16, 2011)

Plaintiff municipal noteholders asserted claims under Sections 10(b) and 20(a) of the Exchange Act, Rule 10b-5, and California and Illinois securities laws against defendant city and defendant municipal bond underwriter. In 2004, the city issued notes to refinance debt and raise funds to complete the construction of a cable television and internet system. The notes were secured by revenue from the cable system. In 2008, defendant city had to sell the system at a loss. Plaintiffs sued, alleging that defendants knowingly misrepresented the system’s projections when the notes were issued in 2004. The district court granted defendants’ motions for summary judgment on the Rule 10b-5 claims because plaintiffs failed to raise a triable issue of fact as to loss causation. In particular, plaintiffs failed to create a triable dispute that their losses were caused by defendants’ allegedly fraudulent statements from 2004 and not by intervening, non-fraudulent events. The court also granted defendants’ motion to exclude the opinion of plaintiffs’ expert, finding that the expert’s opinion was unreliable because he did not perform any analysis or investigation to support his conclusion that defendants’ alleged fraud was the sole cause of plaintiffs’ losses.

b. In re Cell Therapeutics, Inc. Class Action Litig., No. 2:10-cv-00414-MJP, 2011 WL 444676 (W.D. Wash. Feb. 4, 2011)

Plaintiffs brought a claim under Section 10(b) of the Exchange Act alleging that defendants, a biopharmaceutical company and its officers, falsely stated that they were abiding by a Special Protocol Assessment (SPA) agreement with the Food and Drug Administration, which would have fast-tracked approval of their cancer-fighting drug. Defendants moved to

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dismiss, arguing that plaintiffs failed to plead scienter and loss causation, and that defendants’ alleged misstatements were protected by the PSLRA safe harbor for forward-looking statements. The court denied defendants’ motion. First, the court found sufficient plaintiffs’ scienter allegations, based in part on allegations that a confidential witness told defendants that the SPA had been invalidated by defendants’ unilateral deviation from the agreement, that defendants’ annual statements revealed knowledge that their deviations would violate the SPA, and that the company was under severe financial distress, demonstrating a motive to conceal the truth about the invalidation of the SPA. Second, the court found that plaintiffs’ reliance on two corrective disclosures — one that revealed that the SPA was invalidated, and another that revealed that the invalidation was the result of defendants’ conduct — adequately established loss causation. Each disclosure revealed new information that, at a minimum, contributed to immediate decreases in the stock price. Third, the court found that defendants’ press releases boasting of the fast-tracking of their product through the SPA functioned as statements of present facts as opposed to forward-looking statements, and therefore did not qualify for the safe-harbor provisions of the PSLRA. The court further rejected defendants’ motion to dismiss plaintiffs’ Section 20(a) control person liability claims, because the individual defendants were control persons and the claim was premised on plaintiffs’ Section 10(b) claim, which the court had allowed. They gave separate consideration to defendants’ argument that plaintiffs lacked standing to bring insider trading claims because they did not make “contemporaneous” purchases of company stock. The court rejected the contention that a purchase within two business days of an individual defendant’s sale was not sufficiently “contemporaneous,” but sustained the argument as to the remaining individual defendants because plaintiffs made no allegations of purchases temporally related to those sales. Therefore, defendants’ motion to dismiss was denied except as to the insider trading claim against all but one of the individual defendants.


a. Rich v. Shrader, et al., No. 09-CV-0652-AJB, 2011 WL 4434852 (S.D. Cal. Sept. 22, 2011)

A former senior executive at a consulting firm filed an action against his former employer and several of its officers, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5. Plaintiff alleged that defendants, with an aim to repurchase his shares at a low book value and resell them later for significantly greater value, forced him and other executives into early retirement and fraudulently concealed plans to sell a part of the company to a private equity firm. Defendants moved to dismiss, and the court dismissed the securities fraud claims with prejudice. The court held that plaintiff failed to identify a misstatement or omission of material fact because (i) he did not allege that the sale was reasonably certain to occur at the time the alleged omissions occurred, and (ii) the alleged misstatement occurred several years before the sale, which diminished the inference that it was false when it was made. The court also held that plaintiff failed to raise a strong inference of scienter. While plaintiff had alleged that the company wrongfully terminated several older employees and had a strong desire to sell part of the company, an equally plausible explanation of the facts was that the executives had simply chosen to retire and that the desire to sell the company was a rational business decision.

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b. Ansell v. Laikin, No. CV 10-9292 PA (AGRx), 2011 WL 3274019 (C.D. Cal. Aug. 1, 2011)

Plaintiff investor brought a putative class action against defendant company and its former CEO, alleging violations Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. Defendants moved to dismiss, and the court denied the motion. Plaintiff alleged that the defendants issued a tender offer that did not disclose a stock manipulation scheme in which defendants artificially inflated prices by paying kickbacks to a promoter to execute stock purchases at times that coincided with press releases. Plaintiff also alleged that after the U.S. Attorney’s office filed an indictment against defendants and the SEC commenced enforcement proceedings against defendants and suspended trading of the company’s stock, the stock prices dropped. First, the court found that plaintiff adequately identified a material omission because plaintiff’s complaint incorporated by reference the SEC complaint, which alleged that defendants failed to disclose the stock manipulation scheme in the tender offer. Second, the court found that plaintiff adequately pled loss causation by alleging that the stock price dropped after the market learned of the SEC investigation, thus indicating that the market reacted to defendants’ stock manipulation scheme and that plaintiff suffered a loss due to the market reaction. Finally, the court held that plaintiff adequately pled control person liability under Section 20(a) because plaintiff sufficiently pled a predicate Section 10(b) violation and it was undisputed that the CEO was a control person.

c. Fosbre v. Las Vegas Sands Corp., No. 2:10-CV-00765, 2011 WL 3705023 (D. Nev. Aug. 24, 2011)

Plaintiff investors brought a putative class action against defendant resort development corporation and certain of its officers, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. In particular, plaintiffs alleged that defendants knowingly or recklessly made misrepresentations about the corporation, its plans to develop certain hotel-casinos and its financial condition. Defendants moved to dismiss for failure to state a claim, and the court granted the motion in part and denied it in part. The court held that plaintiffs sufficiently pled material misstatements and omissions by alleging that a comparison of internal company documents and public disclosures indicated that defendants (i) understated the cost of planned development projects; (ii) assured investors that the corporation had adequate liquidity and funding when there were, in fact, financial problems; and (iii) overstated the favorable operating environment and economic conditions in one target city. The court also held that taken together, plaintiffs’ allegations raised a strong inference of scienter by showing a series of public statements on material issues that were inconsistent with what was allegedly known internally. In addition, the court held that plaintiffs adequately pled loss causation by alleging that the corporation’s stock was inflated and that a series of fraud-related disclosures contributed to a severe decline in stock price. Finally, however, the court held that certain alleged statements were protected by the PSLRA’s safe harbor for forward-looking statements, specifically, statements about (i) the timing and cost of certain planned projects, (ii) the availability of future funding, (iii) the expected implementation of a legal regime permitting certain sales, and (iv) the corporation’s hopes regarding future financial performance. These statements were forward-looking statements, were identified as such, and were accompanied by meaningful cautionary statements identifying factors that could cause actual results to differ materially from those in the statement.

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d. Lopes v. Vieira, No. 1:01-cv-01243 OWW SMS, 2011 WL 1883157 (E.D. Cal. May 17, 2011)

Plaintiffs filed suit against a law firm and an accounting firm, alleging violations of Section 10(b) of the Exchange Act, Rule 10b-5 and various state laws. Plaintiffs invested in a company through an offering memorandum drafted by the law firm and based on financial forecasts presented by the accounting firm. Plaintiffs alleged that the law firm falsely stated that the financial projections in the offering memorandum had been reviewed by the company’s accountants, and intentionally omitted from a draft offering memorandum that one of the company’s managers was being criminally investigated. Plaintiffs further alleged that the accounting firm omitted accurate information from its financial projections, and that both defendants based the company’s business plan on false information. The court denied summary judgment except to the extent plaintiffs relied on the company’s business plan, which the law firm did not prepare and for which the accounting firm’s financial projections were not proven to be faulty. The court found genuine disputes as to whether the law firm’s statement that financial projections had been reviewed by the company’s accountants was a material misstatement, whether the law firm intentionally concealed the criminal investigation from the draft offering memorandum, and whether the accounting firm had omitted accurate information from its financial forecasts. The court also found genuine issues as to duty, scienter and loss causation. The court also found that plaintiffs had established reliance because: (i) they alleged fraud and therefore were permitted to rely on the draft offering memorandum; and (ii) it was undisputed that they would not have invested in the company had they known about the criminal investigation. The court also found that whether plaintiffs relied on the accounting firm’s allegedly faulty financial forecasts was a matter of dispute.

e. Henning v. Orient Paper, Inc., No. 10-CV-5887-VBF, 2011 WL 2909322 (C.D. Cal. Jul. 20, 2011)

Plaintiff investors filed suit against defendants, a corporation, certain of its officers and its independent auditor, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. In particular, plaintiffs alleged that the corporation’s 10-Ks (i) failed to disclose related party transactions between the corporation and its main supplier, which was allegedly owned and controlled by the defendant CEO; (ii) falsely claimed the corporation’s financial results were audited when the independent auditor was, in fact, disbarred; (iii) materially misstated expenditures and revenues from the corporation’s largest customers; and (iv) failed to disclose unusual or frequent events that reduced the corporation’s general expenses. Defendants moved to dismiss, and the court denied the motion. The court found that plaintiffs adequately pled fraud with particularity. First, it was undisputed that the auditor was disbarred. Second, the court also found that plaintiffs made allegations giving rise to a strong inference of scienter. Although the corporation’s voluntary decision to commence an independent investigation and the officers’ failure to sell their stock would appear to negate an inference of scienter, plaintiffs’ allegation that the internal investigation was self-serving and that the related party transactions created an indirect benefit to the officers did create a strong inference of scienter. In addition, the court found that plaintiffs adequately pled loss causation by alleging that an independent report bringing to light the defendants’ frauds caused a drop in the company’s stock price. Finally, the court found that plaintiffs adequately pled control person liability under Section

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20(a) because plaintiffs sufficiently pled a predicate Section 10(b) violation and it was undisputed that the corporation’s officers were control persons.

4. SLUSA

a. West Palm Beach Police Pension Fund v. Cardionet, Inc., No. 10-cv-711-L(NLS), 2011 WL 1099815 (S.D. Cal. Mar. 24, 2011)

Plaintiff filed a class action complaint in state court against a company and its lenders, alleging violations of Sections 11, 12 and 15 of the Securities Act. Plaintiff alleged that it and other similarly situated individuals purchased common stock of the company that could be traced to the company’s initial and secondary stock offerings, and that the registration statements and prospectuses for those offerings contained false and misleading statements. Defendants removed the case to federal court. Plaintiff moved to remand the case, arguing that Section 77(v)(a) of SLUSA prohibited the removal of federal securities actions from state to federal court. The court granted plaintiff’s motion to remand. Section 77v(a) of SLUSA prohibits the removal of complaints alleging violations of the Securities Act that are brought in state court. Section 77p(b) states that class actions based on state claims for covered securities are preempted. Section 77p(c) makes clear that claims that come within Section 77p(b) may be removed. Defendants argued that removal was proper because Section 77v(a) was to be read together with Section 77p(c). The court disagreed because it was clear from the statute that only claims that came within the preclusion provision of Section 77p(b) were removable under Section 77p(c) and plaintiff’s complaint did not allege any state law claims. Plaintiff’s complaint was brought in state court and asserted claims only under the Securities Act and, thus, did not come within the preclusion provision of Section 77p(b), and therefore could not be removed under Section 77p(c). The court therefore concluded that it lacked jurisdiction over the case and granted plaintiff’s motion to remand.

5. Control Person Liability

a. Maine State Ret. Sys. v. Countrywide Fin. Corp., No. 2:10-CV-0302 MRP (MAN), 2011 WL 4389689 (C.D. Cal. May 5, 2011)

Plaintiff investors filed a putative class action against defendants, the issuers of certain mortgage-backed securities and related entities, several of their officers and certain underwriters of the securities, alleging violations of Sections 11, 12 and 15 of the Securities Act. Plaintiffs alleged defendants made materially untrue or misleading statements in the offering documents regarding the origination practices of the originators of the underlying mortgages. Defendants moved to dismiss, and the court granted the motion in part and denied it in part. First, the court dismissed on standing grounds claims relating to the securities (i.e., specific tranches) that plaintiffs did not purchase. The court also dismissed on statute of limitations grounds claims relating to securities that the plaintiffs in an earlier-filed state court putative class action did not themselves purchase and as to which they lacked standing (as a result of which no tolling had been triggered by the earlier filing of those claims). Second, as to the Section 12(a)(2) claims, the court held that certain issuer defendants who were special purpose issuing trusts were not statutory sellers for the purposes of the Section 12(a)(2) because they were not immediate sellers, nor had they solicited purchases to serve their own financial interests. In addition, the court held

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that plaintiffs only had standing to bring a Section 12(a)(2) claim against the seller defendants as to securities purchased in the initial public offering under the prospectus. Third, regarding the Section 15 claims, the court held that plaintiffs adequately alleged control person liability as to certain defendants because plaintiffs had adequately alleged primary violations and that certain defendants had the power to cause the issuers to conceal material facts or controlled the process of issuing certificates. In addition, the court found that the statute of limitations had not run on the claim against defendant CEO because it was tolled by an earlier lawsuit against him concerning essentially the same facts and circumstances. Fourth, the court addressed the defendants’ other arguments about the insufficiency of the complaint. Finally, the court concluded that it was premature to determine whether plaintiffs actually experienced any injury in light of factual questions relating to the liquidity of the market and the sufficiency of the warnings in each offering document.

6. Scienter

a. In re Apollo Group, Inc. Sec. Litig., Nos. CV-10-1735-PHX-JAT, CV-10-2044-PHX-JAT, CV-10-2121-PHX-JAT, 2011 WL 5101787 (D. Ariz. Oct. 27, 2011)

Plaintiff shareholders brought a consolidated class action against defendant education corporation and several of its directors and officers alleging violations of Sections 10(b), 20(a), and 20A of the Exchange Act and Rule 10b-5. Specifically, plaintiffs alleged that defendants made misrepresentations regarding the corporation’s financial condition, business focus, ethics, compensation and recruitment practices, and compliance with Title IV of the Higher Education Act, and that defendant directors and officers engaged in insider trading. Defendants moved to dismiss, and the court granted the motion without leave to amend. As to the claim under Section 10(b) and Rule 10b-5, the court held that plaintiffs failed to establish a strong inference of scienter. The court found that the alleged insider trading by four of the defendant directors and officers did not support a strong inference of scienter because the stock sales at issue were comparatively small and there was no corroborative trading by the other individual defendants. Furthermore, only statements from two out of ten confidential witnesses actually alleged scienter on the part of the defendants, and allegations attributed to those confidential witnesses were not sufficient to establish scienter, because one of the statements was based on hearsay and the other could not, standing alone, establish the required strong inference. In addition, allegations that defendants engaged in GAAP violations by failing to make allowances for receivables when defendants “knew” they would be unable to collect them were conclusory assertions that did not support a strong inference of scienter. The court also held that plaintiffs had not sufficiently pled loss causation because they had not adequately linked the alleged corrective disclosures to specific fraudulent practices. As to the Section 20(a) control person liability claim and the Section 20A insider trading claim, the court found that these claims also failed because plaintiffs failed to allege a primary violation of the Exchange Act.

b. New Mexico State Inv. Council v. Ernst & Young LLP, No. 09-55632 (9th Cir. Apr. 14, 2011)

Plaintiff investors brought a putative class action against defendant auditor, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5. Plaintiffs alleged that

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defendant knew of or recklessly disregarded a company’s fraudulent stock option backdating scheme that artificially inflated the company’s financial statements, and that he issued unqualified opinions attesting to the validity of the company’s financial statements. Defendant moved to dismiss, and the district court granted the motion. The Ninth Circuit reversed, finding that the district court had erred when it found that plaintiffs failed to raise a strong inference of scienter. In particular, plaintiffs had adequately pled scienter by alleging that (i) defendant accepted the oral representations of the company’s officers that a suspicious option grant was properly accounted for instead of demanding documentation; (ii) defendant knew or should have known that the company falsely approved option grants when its compensation committee lacked the necessary quorum to do so; and (iii) defendant’s involvement in corrective reforms to remedy improper option backdating established its knowledge that prior grants were improperly accounted for.

c. In re China Educ. Alliance, Inc. Sec. Litig., No. CV 10-9239, 2011 WL 4978483 (C.D. Cal. Oct. 11, 2011)

Plaintiff investors filed a putative class action alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5 against defendant, a Chinese for-profit education corporation. Specifically, plaintiffs alleged that defendant maintained inaccurate financial records in the United States and fraudulently overstated its revenue and profits. Defendant moved to dismiss, and the court denied the motion. First, the court held that an analyst’s report that featured prominently in the complaint was not an “anonymous” source subject to the heightened pleading standards for anonymous sources under the PSLRA. Despite the fact that the authors were not individually identified on the report, it bore the firm’s name, so it did not implicate the same skepticism as a traditional anonymous source. Next, the court held that it would be improper to take judicial notice of internal reports offered by defendant to show that defendant’s SEC filings were not significantly overstated because plaintiffs questioned the authenticity of the reports. Finally, the court held that plaintiffs’ allegation that defendant’s CEO certified the accuracy of the SEC filings, taken together with other allegations, adequately pleaded scienter. In particular, plaintiffs alleged that (i) defendant filed different revenue figures in China and the United States; (ii) investigators found that defendant’s “state-of-the-art” facility in China was merely an empty building; (iii) Chinese witnesses told investigators that defendant did not actually own the building; (iv) defendant had a rapid turnover of CFOs during the class period; and (v) many of the links on defendant’s website did not work properly despite its online segment purportedly generating millions of dollars each year.

d. United States v. Sumeru, No. 09-50187, 2011 WL 3915506 (9th Cir. Sept. 7, 2011)

Defendants, two bank employees, were convicted at trial of various crimes, including securities fraud and aiding and abetting securities fraud under Sections 17(a)(1) and 24 of the Securities Act, in connection with certain CDs they had sold. Defendants appealed, and the court upheld their convictions, finding that (i) a rational jury could have found that the CDs were investment contracts, and thus “securities” within the meaning of the Securities Act; (ii) investors expected that profits would be produced by defendants’ efforts; (iii) there was vertical commonality sufficient to prove a common enterprise between defendants and certain bank investors; and (iv) Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010) did not

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apply to the case at hand as Morrison arose under Section 10(b) of the Exchange Act, and nonetheless there was ample evidence that defendants made domestic offers of securities. The court also rejected one defendant’s allegation that there was insufficient evidence of scienter, noting evidence that he played a role in the formation and operation of a bank that made material misrepresentations to prospective investors, including representations that the bank was insured by the International Deposit Indemnity Corporation and that the CDs would reap returns of up to 200 percent. There was also evidence that he made material misrepresentations to investors, gave investors conflicting excuses when the bank could no longer make scheduled interest payments, and falsely represented that things were going well after the fraudulent scheme began to unravel.

e. Nguyen v. Radient Pharms. Corp., No. SA CV 11-0406, 2011 WL 5041959 (C.D. Cal. Oct. 20, 2011)

Plaintiff shareholders filed a putative class action against defendant pharmaceutical company and two of its officers, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. Specifically, plaintiffs alleged that defendants falsely represented the future success of the company’s primary product, a cancer test. Defendants moved to dismiss for failure to state a claim, and the court denied the motion. The court held that plaintiffs adequately pled falsity by alleging that defendants issued a press release falsely indicating that the company was conducting a clinical trial of its test with the Mayo Clinic. Although defendants pointed out that the company had entered into a “Collaboration Agreement” with the Mayo Clinic in which the company bought samples from and shared its results with the Mayo Clinic, the court found that the agreement did not necessarily create a significant enough relationship with the Mayo Clinic for it not to be misleadingly characterized as the “Mayo study.” The court then rejected defendants’ truth-on-the market defense, noting that whether the agreement between defendants and the Mayo Clinic was later transmitted to the public with sufficient intensity to counterbalance any prior misleading impression was a question of fact and therefore not appropriate for decision on a motion to dismiss. The court also held that plaintiffs adequately pled scienter because they alleged that defendant company intended the press release to generate investments because it was in dire financial straits and suffering stock price declines. This allegation, coupled with “red flags” related to the defendant company’s financial condition, was sufficient to create a strong inference of scienter.

7. Materiality

a. Reese v. BP Exploration (Alaska) Inc., 643 F.3d 681 (9th Cir. 2011)

Plaintiff investor brought a putative class action against defendants, an oil company and certain of its subsidiaries and officers, for violations of Sections 10(b), 18 and 20(a) of the Exchange Act and Rule 10b-5. In particular, plaintiff alleged that defendants made false and misleading statements about the condition of the company’s pipelines through the public SEC filings of a third party. Defendants moved to dismiss the Section 10(b) claim, and the district court denied the motion. The Ninth Circuit granted defendants’ interlocutory appeal and reversed the district court’s ruling on the grounds that plaintiff failed to allege an actionable misrepresentation. The filings at issue were copies of a trust agreement, pursuant to which

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defendants had created a trust for the purpose of distributing royalty interests derived from the oil production site at issue. In the trust agreement, defendants promised to run the production site according to a prudent operator standard. The trust attached this agreement to its SEC filings. The court found that plaintiffs had not alleged an actionable misrepresentation because the agreement to operate within a prudent operator standard was a forward-looking, contractual promise, and thus a reasonable investor would not view the filing as a certification of the defendants’ ongoing compliance with the prudent operator standard. Moreover, the court held, given the broad nature of the agreement, a reasonable investor would likely view the agreement to be a statement of the trust’s rights, not a particular certification by defendant. The court also noted that even if the periodic filings could be implicit statements of continuing compliance, plaintiff’s claims would still fail because plaintiff failed to allege that defendant had any control over the third party that filed the contracts with the SEC. Finally, the court dismissed plaintiff’s Section 20(a) control person liability claim, as plaintiff failed to allege a predicate actionable misrepresentation.


a. Conn. Retirement Plans & Trust Funds v. Amgen Inc., No. 09-56965, 2011 WL 5341285 (9th Cir. Nov. 8, 2011)

Plaintiff shareholder brought a putative class action against defendant pharmaceutical company and several of its officers. Plaintiff alleged that defendants violated Section 10(b) of the Exchange Act and Rule 10b-5 by misstating or failing to disclose safety information about the company’s product. Plaintiff moved to certify the class in the district court under Federal Rule of Civil Procedure 23(b)(3), and the district court certified the class, finding that common questions predominated all elements of the claim under Section 10(b) and Rule 10b-5. On interlocutory appeal, the Ninth Circuit affirmed. Defendants challenged the district court’s holding that the question of reliance was common to the class because the class could invoke the fraud-on-the-market presumption of reliance. In particular, defendants argued that plaintiffs had failed to prove that the alleged misrepresentations were material, and therefore could not rely on the fraud-on-the-market presumption of reliance. The court rejected this argument, holding that it was not necessary to prove materiality at the class certification stage in order to invoke the fraud-on-the-market presumption of reliance. Rather, the plaintiff needed only to prove that (i) the stock was traded in an efficient market, and (ii) the alleged misstatements were public. The court also held that the district court was correct in refusing to consider defendants’ truth-on-the-market defense to rebut the presumption of reliance because materiality was a merits issue that did not need to be proven at the class certification stage.

b. In re Countrywide Fin. Corp. Sec. Litig., No. CV-07-05295-MRP (MANx), 2009 WL 7322254 (C.D. Cal. Dec. 9, 2009)

Plaintiffs sought class certification in a securities class action against a company, and its officers, auditor and underwriters for allegedly violating Sections 11, 12(a)(2) and 15 of the Securities Act, and Sections 10(b) and 20(a) of the Exchange Act. Defendants filed a comprehensive opposition to the motion for class certification, arguing in part that the market for certain debt securities, which were a subclass of securities purchased by some members of the putative class, was not efficient, and therefore precluded a showing of class-wide reliance. The

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court granted plaintiffs’ motion in part, but restricted the class to exclude persons who purchased certain of the debt securities, which the court found were not traded in an efficient market. The court noted that the putative class represented parties who had purchased different kinds of securities — common stocks, debt securities, and debt-equity hybrid securities. The court also noted that because debt may respond differently to news than equity, determining whether the market for certain debt securities is efficient requires an individualized showing of proof at the class certification stage. Plaintiffs’ expert witness opined that the market for 10 of 23 bonds was efficient, after comparing them against a representative bond he had used in a news reaction event study. However, the court rejected the expert’s analysis as a biased sampling of non-representative data. Specifically, the court reasoned bond markets had become more transparent and yielded more data since In re Enron Securities, Derivative & ERISA Litigation, 529 F. Supp. 2d 644 (S.D. Tex. June 5, 2006) — the only other case to hear expert testimony on the issue. As such, the court explained that using a representative bond as a standard of comparison led to biased results. The court therefore found that plaintiffs had established only that the market for stocks and certain debt securities at issue was efficient, and failed to meet their burden as to the market for other debt securities. Accordingly, the court concluded that Plaintiffs were entitled to a presumption of reliance on a fraud-on-the-market theory as to only certain securities, and granted class certification only in part.

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XI. TENTH CIRCUIT


The Tenth Circuit and the district courts within the Tenth Circuit issued several noteworthy decisions during 2011. In Dronsejko v. Thornton, the Tenth Circuit affirmed the dismissal of Exchange Act claims against an auditor that were filed following the SEC’s questioning of the issuer’s revenue recognition policy and the company’s restatements. The Tenth Circuit found that, at most, the complaint alleged that the auditor had been negligent in its interpretation of the GAAP standard regarding “probable collectability” and therefore failed to assert sufficient allegations of scienter. The District of Colorado denied defendants’ motion to dismiss allegations of securities fraud in Mishkin v. Zynex Inc., finding that statements by an issuer regarding its business projections were not protected by the PSLRA’s safe harbor for forward-looking statements because the projections were based, in part, on present or historical fact. However, in In re Crocs, Inc. Securities Litigation, the District of Colorado granted defendants’ motion to dismiss Exchange Act claims, finding that plaintiffs had alleged poor management rather than securities fraud.


1. Scienter

a. Dronsejko v. Thornton, 632 F.3d 658 (10th Cir. 2011)

Plaintiff investors asserted claims under Section 10(b) of the Exchange Act and Rule 10b-5 against an e-services company and its independent auditor after the SEC questioned the company’s revenue recognition policy and the company was forced to restate its financial statements. Specifically, plaintiffs alleged that defendants deliberately or recklessly overestimated the collection rate on the company’s license sales from extended payment term arrangements. The company settled shortly after the complaint was filed, and the auditor filed a motion to dismiss, which was granted by the district court. The Tenth Circuit affirmed that decision, finding that the complaint’s allegations were more consistent with an inference that the auditor had made an erroneous or negligent interpretation of the ambiguous GAAP standard for “probable collectability.” The court also rejected plaintiffs’ argument that the auditor’s alleged motive “to please the client and continue receiving auditing fees” was sufficient to support an inference of scienter because this motive is present in every relationship between an auditor and its client. The court further held that plaintiffs had failed to meet the requirements of Rule 60(b)(2), which allows courts to grant relief from a prior judgment in certain circumstances. After the district court granted defendant auditor’s motion to dismiss, the Public Company Accounting Oversight Board (PCAOB) imposed sanctions on two representatives of the auditor due to their role in the company’s audits. Plaintiffs argued that the PCAOB orders and the documents referenced in those orders constituted evidence of defendant’s “knowing or intentional misconduct,” and they brought a motion under Rule 60(b)(2) seeking relief from the district court’s dismissal and leave to amend their complaint to incorporate this new evidence. The Tenth Circuit found that the PCAOB findings might support a suit based on defendant’s failure “to properly conduct an audit,” but not a suit based on its failure “to properly apply a GAAP standard to an audit,” which was the sole basis of plaintiffs’ complaint. The Tenth

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Circuit determined that the district court was correct in finding that the PCAOB findings did not present evidence that would remedy the complaint’s deficiencies. The court further found that plaintiffs had not shown that the evidence contained in the PCAOB findings could not have been discovered with due diligence, as required under Rule 60(b)(2). Therefore, the Tenth Circuit held that the district court had not abused its discretion in denying plaintiffs’ Rule 60(b) motion.


a. Mishkin v. Zynex Inc., No. 09-cv-00780-REB-KLM, 2011 WL 1158715 (D. Colo. Mar. 30, 2011)

Plaintiff investors filed a class action lawsuit against defendant medical company and two of its senior executives for violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. Plaintiffs alleged that in 2008 defendants had intentionally over-billed insurance companies and then based their income statements on the amount billed, even though they knew they would never be able to collect that amount. When defendants issued a press release in 2009 showing a substantial decrease in their 2008 revenues, defendant company’s stock prices declined by about 56%. The court denied defendants’ motion to dismiss, holding that plaintiffs’ allegations of false and misleading statements and scienter were sufficient to state a claim for securities fraud. The court first held that defendants’ 2008 statements about their business projections were not protected by the PSLRA’s safe harbor provision because they contained elements of present or historical fact. The court also held that the complaint created a strong inference of scienter because plaintiffs alleged facts that could reasonably support the conclusion that defendants knew that their statements were false when made. The court credited the allegations of confidential witnesses because the complaint adequately established the confidential witnesses’ knowledge of and exposure to the relevant conduct.

b. In re Crocs, Inc. Sec. Litig., Nos. 07-cv-02351-PAB, 07-cv-02412, 07-cv-02454, 07-cv-02465, 07-cv-2469, 2011 WL 782485 (D. Colo. Feb. 28, 2011)

In a consolidated class action lawsuit, plaintiff investors alleged that: (i) defendant company and its senior officers had violated Sections 10(b) and 20(a) of the Exchange Act by knowingly making material misrepresentations about the company’s present and future outlook while neglecting to disclose problems associated with its growth, including weak data management procedures; (ii) the company’s auditor violated Section 10(b) through improper audits of the company’s 2006 and 2007 year-end financial statements; and (iii) the company, its senior officers and other individuals engaged in insider trading and violated Sections 20A, 20A(c) and/or 20A(b)(3) of the Exchange Act. The court dismissed the claims, noting that plaintiffs had not alleged facts specifically explaining why most statements at issue were misleading; instead, most allegations about the company’s data management and inventory records suggested poor performance but not fraud. Moreover, plaintiffs did not adequately plead scienter, because the complaint offered conclusory explanations as to how individual defendants, the company or its auditor knew the information that they allegedly did not disclose to investors. The court did not credit the allegations of confidential witnesses because the complaint failed to explain the basis for the informants’ knowledge. The court also dismissed several insider trading claims under Section 20A because plaintiffs failed to support their allegations with other valid

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claims under the Exchange Act. The court dismissed the remaining insider-trading claims because plaintiffs had not alleged that defendants disclosed private information to individuals outside the company, as required for liability under Section 20A(c).

c. In re Thornburg Mortg., Inc. Sec. Litig., No. CIV 07-0815

JB/WDS, 2011 WL 2429189 (D.N.M. June 2, 2011)

Plaintiff investors brought a putative class action against an issuer of mortgage-backed securities, certain of its officers and directors and underwriters of the securities, alleging violations Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5, as well as Sections 11, 12(a)(2) and 15 of the Securities Act. Plaintiffs alleged that defendants made false and misleading statements and omissions regarding the quality of the issuer’s mortgage assets. The district court granted in part and denied in part defendants’ motion to dismiss. First, the court dismissed plaintiffs’ Section 11 omission claims because the statute does not have a broad abstain-or-disclose rule. Therefore, Section 11 could not by itself require defendants to disclose material, non-public information. Next, the court found that plaintiffs could not rely on Item 303 of Regulation S-K — even assuming that Item 303 could provide the basis for liability under Section 10(b) or Sections 11 and 12(a)(2) — because plaintiffs did not allege that defendants failed to disclose any known material trends or uncertainties. The court also held that plaintiffs did not adequately plead scienter for several of their claims because they never specified what the particular defendants supposedly knew at the time of the alleged misrepresentations or omissions. As to plaintiffs’ control person liability claims under Section 20(a) of the Exchange Act and Section 15 of the Securities Act, the court reconsidered two claims on which it had previously reserved ruling and denied the defendant CEO and the CFO’s motions to dismiss because plaintiffs adequately alleged they were control persons who made misstatements in official financial reports. The court also denied the former CEO’s motion to dismiss because the plaintiffs alleged facts showing that the former CEO directly supervised the current CEO when he made his allegedly fraudulent statements. However, the court upheld dismissal of plaintiffs’ claims against lower-ranking officers because plaintiffs had not alleged with specificity that these officers controlled the CEO or company when the CEO made the allegedly problematic statements or signed the company’s allegedly fraudulent public disclosures.

d. In re Oppenheimer Rochester Funds Grp. Sec. Litig., Nos. 09-md-02063-JLK-KMT, MDL 2063, 2011 WL 5042066 (D. Colo. Oct. 24, 2011)

Investors in seven different municipal bond funds asserted violations of Sections 11, 12(a)(2) and 15 of the Securities Act and Section 13(a) of the Investment Company Act against various defendant municipal bond fund distributors, managers and trustees. Plaintiffs alleged that defendants made materially misleading representations or omissions in fund offering statements regarding (i) the investment objectives of the funds; (ii) exposure levels and risks related to investment in “inverse floaters”; (iii) the liquidity of the funds’ investments; and (iv) the value of fund assets. The court granted defendants’ motion to dismiss plaintiffs’ Investment Company Act claims, but denied defendants’ motions to dismiss the Securities Act claims. First, the court dismissed the Section 13(a) claims, finding that Congress had not intended to imply a private right of action under Section 13(a). Regarding plaintiffs’ Securities Act claims, the court found that plaintiffs adequately alleged that defendants’ statements that they pursued an

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investment strategy consistent with the preservation of capital were material because these statements described an essential feature of the funds that reasonable investors would consider important. In addition, such statements would have been materially misleading given the foreseeable risks of the alleged strategy actually pursued. With respect to defendants’ statements regarding “inverse floaters,” the court held that defendants had a legal duty to disclose the leverage ratios associated with the “inverse floaters,” because once a defendant makes disclosures regarding a particular type of holding’s relative risk, its duty to do so in a manner not directly misleading is inherent to the Securities Act. The court further found that plaintiffs raised a plausible inference that defendants’ statements regarding illiquid assets were materially misleading by alleging that defendants stated they would monitor illiquid assets on an ongoing basis and sell them to maintain illiquidity at or below 15%, when in fact they did not. The court also denied defendants’ motions to dismiss plaintiffs’ control person liability claims under Section 15, finding sufficient support for an inference that defendant officers and a parent company influenced the registration statements’ content, and that defendant trustees had indirect control over the disclosures that were sent to potential investors.


a. Lane v. Page, 272 F.R.D. 558 (D.N.M. 2011)

Plaintiff shareholders brought a class action complaint against defendants alleging violations of Sections 14(a) and 20(a) of the Exchange Act and SEC Rule 14a-9. Plaintiffs alleged that one defendant company had mailed to its shareholders a proxy statement that included numerous misrepresentations and omissions of material facts, and that this statement was used to obtain shareholder approval of a merger with another defendant company. Lead plaintiff moved for class certification and defendants opposed, claiming that lead plaintiff’s past criminal and civil infractions made him unsuitable to act as class representative. The court granted the motion, finding that the class satisfied the various requirements of Rule 23(a) and 23(b)(3), including that: (i) the 6,100 person class was an appropriate size (numerosity requirement); (ii) the type of harm caused by the proxy statement and the relief sought were sufficiently common to all members of the class (commonality requirement); (iii) plaintiff’s claims were typical of the class as a whole (typicality requirement); (iv) plaintiff’s past criminal and civil infractions had little bearing on his fitness as class representative (adequacy requirement); (v) the numerous common questions to the class predominated over any potential individual issues (predominance requirement); and (vi) class action treatment was superior to numerous individual actions because the harm suffered by most members of the class would not be “sufficiently large to warrant individual legislation” (superiority requirement).

4. Morrison / Extraterritorial Reach

a. Cascade Fund, LLP v. Absolute Capital Mgmt. Holdings, Ltd., No. 08-cv-01381-MSK-CBS, 2011 WL 1211511 (D. Colo. Mar. 31, 2011)

Plaintiff investor asserted class action claims for securities fraud under Section 10(b) of the Exchange Act and Rule 10b-5, alleging, in part, that a defendant investment fund manager, its individual directors and officers, and its successor were liable for the fund manager’s failure

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to disclose material information that made the offering memoranda materially misleading. The court dismissed the claims against defendant and its successor, noting that plaintiff had not complied with the U.S. Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010). Morrison requires plaintiffs to allege facts showing that: (i) the relevant securities were bought or sold within the United States; or (ii) the transactions concerned securities listed on domestic exchanges. However, because the Supreme Court announced its decision after plaintiff had filed its pleadings, the district court allowed plaintiff 30 days to amend the complaint and allege facts that would comply with the ruling.

5. SLUSA

a. Northumberland County. Ret. Sys. v. GMX Res., Inc., No. CIV-11-520-D, 2011 WL 5578963 (W.D. Okla. Nov. 16, 2011)

Investors asserted claims under the Securities Act arising from their purchase of common stock pursuant to three public offerings by the defendant. Plaintiffs filed the action in state court, and defendants removed the action to federal district court. Plaintiffs moved to remand, and the court denied the motion. Plaintiffs argued that Section 77v of the Securities Act prohibits removal of actions asserting only Securities Act claims that have been commenced in state court. Plaintiffs also argued that the claims at issue did not fall under the exception added by SLUSA, which permits removal for “covered class actions,” because the exception applies only to actions based on state law and therefore did not cover the present federal claims. The court found that SLUSA’s legislative history demonstrated that Congress intended for federal court to be “the exclusive venue for most securities class action lawsuits,” and that SLUSA’s removal provision applied to any covered class action that involved allegations of untrue material statements or omissions or the employment of manipulative or deceptive devices. The court noted that plaintiffs’ argument “would require this Court to agree that the purpose of SLUSA was to create the anomalous result of making purely state law securities class action suits removable to federal court . . . but requiring securities class actions brought in state court and asserting purely federal claims to remain in state court, subject to the diverse procedural regimes of the various states.”

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XII. ELEVENTH CIRCUIT


During 2011, courts within the Eleventh Circuit rejected multiple complaints on the grounds that plaintiffs failed to allege a strong inference of scienter on the part of defendants. The Eleventh Circuit affirmed the dismissal of Exchange Act claims against a corporation’s executives in Durgin v. Mon, finding that investors had not alleged a strong inference of scienter in asserting that defendants “must have known,” based on the size of the loan and defendants’ positions at the company, that the true nature of a loan was mischaracterized as non-recourse in public filings. The appellate court affirmed the dismissal of securities fraud allegations in Kadel v. Flood on the basis that the complaint failed to allege that defendant mortgage company had knowingly concealed the risks associated with its subprime mortgage portfolio. And in Patel v. Patel, the Northern District of Georgia deemed insufficient plaintiffs’ allegations that a failed bank’s executives were motivated to commit fraud simply to maintain a dividend stream. However, in Findwhat Investor Group v. Findwhat.com, the Eleventh Circuit overturned the district court’s grant of summary judgment to defendants, holding that defendants could be liable for making statements that prolonged inflated stock prices, even where such prices were already inflated at the time defendants issued the statements.


1. Scienter

a. Durgin v. Mon, No. 09-15595, 2011 WL 573483 (11th Cir. Feb. 18, 2011)

Plaintiff pension fund brought a putative class action suit against a corporation’s executives alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. The pension fund asserted that defendants failed to disclose the nature of a large loan made to a joint venture, and misrepresented that the loan was non-recourse to the corporation, and was secured only by the assets of the joint venture. The complaint alleged that defendants intended to deceive, manipulate or defraud shareholders, or acted with severe recklessness by characterizing the loan as non-recourse. The district court dismissed the complaint and the Eleventh Circuit affirmed, holding that the allegations failed to demonstrate that defendants actually knew or were reckless in not knowing that the classification or description of the loan was misleading. Plaintiff’s contention — that defendants “must have known” of the allegedly misleading nature of their statements because of defendants’ positions with the corporation and the size of the loan — was insufficient to support a strong inference of scienter. Accordingly, the court found that an inference of severe recklessness was not as compelling as an inference that, at worst, defendants acted with negligence.

b. Kadel v. Flood, No. 10-12220, 2011 WL 2015379 (11th Cir. May 24, 2011)

Plaintiff investors brought a putative class action against defendants, including a mortgage company, alleging securities fraud and control person liability under Sections 10(b) and 20(a) of the Exchange Act. The investors argued that defendants concealed numerous

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purchases of subprime mortgage securities, and that such purchases contributed to the mortgage company’s demise when the housing and subprime mortgage markets crashed. The district court granted defendants’ motion to dismiss for failure to state a claim. The Eleventh Circuit affirmed, holding that plaintiffs failed to adequately allege scienter because the facts alleged in the complaint did not give rise to a strong inference that defendants actually knew that their statements were fraudulent or reckless. Instead, the allegations gave rise to an inference that the company failed to predict the eventual collapse of the housing and subprime mortgage markets, and therefore was ill-equipped to handle the consequences when the eventual crisis did occur. The court also noted that the numerous warnings and cautionary statements included in the company’s public disclosures “significantly undermine[d]” any inference that defendants intended to mislead the company’s shareholders. Because plaintiffs failed to allege a primary violation, the control person liability claim also failed.

c. Patel v. Patel, No. 1:09-CV-3684-CAP, 2011 WL 198418 (N.D. Ga. Jan. 14, 2011)

Plaintiff investors brought suit against defendants, directors and officers of a holding company and its wholly owned subsidiary bank, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. When the FDIC decided to close the bank, plaintiffs’ stock in the holding company was rendered worthless. Plaintiffs’ assertions that defendants acted as directors and officers, attended meetings, and had access to documents and reports, without more, failed to adequately allege scienter. Allegations that defendants were motivated to commit fraud to maintain a dividend stream, and that certain loans to relatives of defendants exhibited risky lending practices, were also insufficient to support a strong inference of scienter. The Rule 10b-5 claim also failed on the issue of loss causation because plaintiffs did not adequately plead facts separating the allegedly misleading statements and omissions from the financial upheaval affecting banks industry-wide. Because plaintiffs failed to make out a primary Rule 10b-5 claim, the Section 20(a) controlling person liability claim also failed as a matter of law.


a. City of Pontiac Gen. Employees Ret. Sys. v. Schweitzer-Mauduit Int’l, Inc., 2011 WL 3799588 (N.D. Ga. Aug. 26, 2011)

Plaintiff investors brought a putative class action against defendant corporation and two of its officers and directors, alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. Defendants moved to dismiss for failure to state a claim, and the court granted the motion. Plaintiffs had asserted that defendants engaged in a fraudulent scheme to artificially inflate the corporation’s stock price by misleading the market about (i) the corporation’s relationship with one of its largest customers; (ii) the strength of the corporation’s intellectual property protections; and (iii) pressures the company was facing from competitors. The court found that plaintiffs failed to sufficiently plead a false statement or omission of material fact because plaintiffs failed to specify each statement and to explain the reasons why such statement was false or misleading. Moreover, because plaintiffs failed to allege specific facts showing that defendants had knowledge of, or were severely reckless with regard to, the falsity of their statements at the time they were made, the allegations did not give rise to the strong inference of scienter required by the PSLRA. As to the Section 20(a) control person liability claims, the court

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found that because the complaint failed to allege primary liability, there could be no secondary liability.

3. Loss Causation

a. Findwhat Investor Group v. Findwhat.com, 658 F.3d 1282 (11th Cir. 2011)

Plaintiff investors brought a putative class action against defendants, an online, “pay-per-click” advertising company and three of its officers, alleging that the company made false statements that artificially inflated its stock prices. The allegedly false statements were made in the company’s March 2005 10-K filing, in which defendants stated that: (i) they had dropped two major advertising distribution partners; and (ii) they did not rely on spyware or other fraudulent means of generating advertising revenue beginning in the fourth quarter of 2004. Plaintiffs alleged that defendants had not removed these advertising distribution partners and had allowed these partners to use spyware and other non-human advertising traffic as a fraudulent means of generating revenue. The district court held that plaintiffs had failed to adequately allege causation because the statements at issue were “confirmatory” statements relating to misrepresentations made before the start of the class period, rather than new and original false statements. On appeal, the Eleventh Circuit vacated the district court’s grant of summary judgment, and held that the company could be held liable for making false statements which prolonged the inflation of its stock price, even if the price was already artificially high before the statements were made. The panel refused to draw any legal distinction between fraudulent statements that initially caused the stock price inflation and subsequent statements that perpetuated that inflation. Thus, confirmatory information that wrongfully prolongs a period of inflation, even without increasing the level of inflation, may be actionable under the securities laws.


a. In re BankAtlantic Bancorp, Inc., No. 07-61542-CIV, 2011 WL 1585605 (S.D. Fla. Apr. 25, 2011)

Plaintiff investors brought a putative class action against defendants, a bank and its current and former directors and officers. Plaintiffs contended that defendants misrepresented and concealed the true quality and value of certain assets in the bank’s land loan portfolio, in violation of Sections 10(b) and 20(a) of the Exchange Act, causing plaintiffs to suffer a loss. Following a trial, the jury found that defendants made actionable misrepresentations and awarded damages to plaintiffs. Defendants moved for judgment as a matter of law. The court held that the statement at issue — a comment by a member of the bank’s Major Loan Committee voicing concern about one category of land loans, but generally stating that the bank did not have any concerns about the rest of the land loan portfolio — was actionable under Rule 10b-5. The statement was made around the same time that the bank expressed concerns about the land loan portfolio as a whole; thus, a jury could have found that the statement was an actionable concealment of the risk of substantial losses that existed at that time for all the land loans, and not just the specific category referenced in the statement. Plaintiffs failed to produce sufficient evidence, however, as to either loss causation or damages because the expert witness that

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testified on those topics failed to disaggregate the non-fraud effects of earlier disclosed negative information. Thus, the court entered a final judgment as a matter of law in favor of defendants.

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XIII. DELAWARE COURTS


The Delaware Court of Chancery issued several noteworthy decisions in 2011. In In re Del Monte Foods Co. Shareholder Litigation, the court enjoined a shareholder vote and enforcement of deal protection provisions for a merger that was alleged to be tainted by a financial advisor’s misconduct. In Air Products & Chemicals, Inc. v. Airgas, Inc., the court concluded that continued use of a poison pill against a hostile tender offer was neither preclusive nor coercive, even though the incumbent board had lost one election contest, a full year had passed since the offer was first made public, and the shareholders were fully informed as to the target board’s views on the inadequacy of the offer. In Kahn v. Kohlberg Kravis Roberts & Co., the Delaware Supreme Court reversed and remanded an opinion by the Court of Chancery, and held that state insider trading claims do not require actual harm to the corporation, but rather apply to all improper uses of material, non-public information by fiduciaries. Finally, in In re OPENLANE, Inc., the Court of Chancery concluded that a board considering a merger had satisfied its Revlon duties even without utilizing customary safeguards, such as a fairness opinion.


1. Fiduciary and Revlon Duties

a. In re Alloy, Inc. S’holder Litig., C.A. No. 5626-VCP, 2011 Del. Ch. LEXIS 159 (Del. Ch. Oct. 13, 2011)

Plaintiffs filed suit challenging a merger and alleging breaches of fiduciary duty both as to the substantive aspects of the transaction as well as the disclosure related thereto. The company had received an unsolicited acquisition proposal from a private equity firm, leading to the creation of a Special Committee of the company’s board, which explored other potential buyers and ultimately reached an agreement with a different acquirer for an acquisition of the company. The Special Committee retained independent legal and financial advisors. The financial advisor was retained to advise the company and the Special Committee. Plaintiffs alleged that the Special Committee was dominated and controlled by two directors who unfairly extracted senior management positions in the new privately-held corporation. After the transaction closed, defendants moved to dismiss. The court dismissed all claims, concluding that the Special Committee and the board were disinterested and independent despite the facts that inside directors owned 15% of the company’s stock and the chairman of the Special Committee received a $100,000 payment for his service as chairman.

b. In re Del Monte Foods Co. S’holder Litig., 2011 Del. Ch. LEXIS 30 (Del. Ch. Feb. 14, 2011)

Plaintiff shareholders sought a preliminary injunction of a merger in order to remedy an allegedly flawed sale process. Discovery revealed that a financial advisor had purportedly engineered the merger to obtain fees both from providing sell-side advice, as well as buy-side financing. The Delaware Court of Chancery held that the shareholders had demonstrated a reasonable probability of success on the merits of a breach of fiduciary duty claim against the

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target’s board, which had failed to fulfill its fiduciary duties as a result of its financial advisor’s misconduct. The court granted a limited preliminary injunction against the transaction, preventing it from closing for 20 days, and prohibited the parties to the merger agreement from enforcing the no-solicitation, matching rights and termination fee provisions of that agreement during those 20 days. The injunction was conditioned on plaintiffs posting a bond in the amount of 1% of the enjoined termination fee. Shareholders ultimately approved the proposed merger.

c. In re K-Sea Transp. Partners L.P. Unitholders Litig., C.A. No. 6301-VCP, Mem. Op. (June 10, 2011)

Plaintiff unitholders filed a lawsuit against a limited partnership seeking to enjoin a merger and moved for expedited discovery. The Delaware Court of Chancery denied that motion, holding that plaintiffs had failed to state a colorable claim that a conflicts committee breached its duties by not separately considering whether a particular payment to the general partner was fair and reasonable. The conflicts committee had, in fact, adequately dealt with any conflicts of interest by meeting and exceeding the requirements for special approval as outlined under the limited partnership agreement when approving the merger. The court held that plaintiffs had asserted a colorable claim that the grant of phantom units to the conflicts committee members compromised their independence (since such units would vest sooner if a merger occurred), and thereby negated the conflicts committee’s special approval of the merger that was intended to resolve any conflicts of interest. However, the court recognized that this claim was weak, given that the phantom units would align the conflicts committee members’ interests more closely with those of common unitholders. The court held that plaintiffs had failed to state colorable disclosure claims because the limited partnership had disclosed everything it was required to disclose about the merger under the limited partnership agreement. The court also found that plaintiffs failed to demonstrate irreparable harm, because they did not show that money damages were insufficient.

d. In re Ness Techs., Inc. S’holder Litig., C.A. No. 6569-VCN, Del. Ch. LEXIS 107 (Del. Ch. Aug. 3, 2011)

Plaintiff shareholders sought a preliminary injunction of a merger and moved to expedite proceedings. Plaintiffs alleged that the target company’s board had breached its fiduciary duties and that: (i) the merger was a result of an unfair process; (ii) the agreement contained unreasonable deal protections; and (iii) the disclosures associated with the deal were inadequate. The court in large part denied the motion to expedite, concluding that plaintiffs had failed to state a colorable claim regarding the process undertaken by the target company’s board, the deal protections included in the merger agreement, and the disclosures surrounding the work done by the target company’s investment bankers and the background of the merger. However, the court granted the motion to expedite with respect to discovery on plaintiffs’ claims that target company’s financial advisors may have been conflicted based upon unidentified work done for the acquirer.

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e. In re OPENLANE, Inc., C.A. No. 6849-VCN, 2011 WL 4599662 (Del. Ch. Sept. 30, 2011)

Plaintiff shareholder sought to preliminarily enjoin a merger, claiming that the target company’s board breached its fiduciary duties when, among other things, the board failed to undertake an adequate merger review process and agreed to improper deal protection devices. The company did not hold an auction, make a broad solicitation of potential acquirers, or seek a fairness opinion prior to executing the merger agreement. Furthermore, the merger agreement contained a stringent no-solicitation clause and did not contain a “fiduciary out.” The court denied plaintiff’s motion for preliminary injunction, although it expressed reservations about the board’s decision-making process. The court held that the process was adequate because the board had an impeccable knowledge of the company’s business: all of the directors were invested in the company, two directors were founders, four others had served on the board for a long period of time, and together they owned 60% of the company’s voting power. The court further ruled that the defensive measures used were likely permissible and that the no-solicitation clause was a reasonable and short-lived defensive measure. In dicta, the court stated that a merger agreement’s failure to contain a “fiduciary out” would not necessarily justify a preliminary injunction, especially if no better offer had emerged.

f. In re Orchid Cellmark Inc. S’holder Litig., 2011 Del. Ch. LEXIS 75 (Del. Ch. May 12, 2011)

Plaintiff shareholders sought a preliminary injunction of a cash tender offer on the grounds that it was the result of a flawed process where the target’s board had failed to maximize shareholder value by not conducting a sufficient market check. The Delaware Court of Chancery rejected plaintiffs’ argument that the board violated its Revlon duties. Six potential bidders were solicited and there was no indication that one was favored over the others. Although the CEO had opposed the merger, there was no evidence that the board had breached its fiduciary duties — they merely disagreed with the CEO’s optimism toward the target company remaining as a stand-alone entity. The court also rejected plaintiffs’ argument that the board violated its Revlon duties by not pursuing a private equity firm’s interest in the target company’s UK operations. The court found that there was no reason to second guess the board’s decision not to pursue this alternative transaction, given that the board had discussed whether splitting up the target could result in a better outcome for the shareholders and the potential risks, including the availability of financing. The court denied the request for a preliminary injunction.

g. In re Smurfit-Stone Container Corp. S’holder Litig., 2011 Del. Ch. LEXIS 79 (Del. Ch. May 20, 2011)

Plaintiff shareholders sought a preliminary injunction of a merger on the grounds that the target’s board breached its fiduciary duties of care and loyalty by failing to maximize shareholder value. The proposed merger provided that the target’s shareholders would receive approximately 50% of the merger consideration in cash and the other 50% in the buyer’s stock. The Delaware Court of Chancery concluded that such merger consideration triggered the heightened Revlon standard. Although noting that the Delaware Supreme Court had not yet addressed this issue, the court was persuaded by In re Lukens Inc. Shareholders Litig., 757 A.2d 720 (Del. Ch. 1999), which assumed that Revlon applied to a transaction involving merger

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consideration of about 60% cash and 40% stock. The court also found that plaintiffs had not shown a reasonable probability of success on their claim that the board breached its fiduciary duties by approving the merger, given that the board had enough reliable evidence to reasonably conclude that a market check was not worth the risks of jeopardizing the merger and that dealing exclusively with one buyer would maximize shareholder value. The court therefore denied the request for a preliminary injunction.

h. Johnston v. Pedersen, 28 A.3d 1079 (Del. Ch. 2011)

Plaintiff shareholders filed an action alleging that the company’s board had violated its duty of loyalty by approving a preferred stock class vote provision. The incumbent board had ensured that certain loyal stockholders held the majority of a specially issued class of preferred stock. This preferred stock contained a class vote provision that gave those stockholders effective control of any company vote, and thus the ability to block the removal of the incumbent board. The court recognized that the incumbent board acted in good faith by believing “stability” would be in the company’s best interest, but held that defendant directors breached their duty of loyalty by issuing the new class of preferred stock. In reaching this decision, the court applied an enhanced scrutiny test, noting that, when reviewing board action affecting stockholders’ right to vote that involves an election of directors or touches on matters of corporate control, the defendant fiduciaries bear the burden of persuading the court that: (i) their motivations were proper and not selfish; (ii) they did not preclude stockholders from exercising their right to vote or coerce them into voting a particular way; and (iii) their actions were compellingly (not merely reasonably) justified to achieve a legitimate objective. The court found that the desire to avoid being removed as directors was not “compelling justification.”

2. Fiduciary Duty: State Insider Trading Claim

a. Kahn v. Kohlberg Kravis Roberts & Co., 23 A.3d 831 (Del. 2011)

Shareholders filed a derivative lawsuit against defendant corporation alleging, inter alia, that the corporation’s majority shareholder and its designee directors had breached their fiduciary duties to the corporation by trading on material, non-public information — a cause of action known as a Brophy claim. The corporation’s Special Litigation Committee (the SLC) investigated the shareholders’ claims, concluded that they were meritless, and filed a motion to dismiss. The Court of Chancery granted the SLC’s motion to dismiss, explaining that the shareholders were unable to show that the trading caused actual harm to the corporation, which it held was an element of a Brophy claim. The Delaware Supreme Court reversed, explaining that Brophy claims do not require actual harm to the corporation, but rather apply to all improper uses of material, non-public information by fiduciaries. The Supreme Court emphasized that it would be inequitable to allow a fiduciary to profit from the use of confidential corporate information under any circumstances.

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3. Books and Records Inspection

a. Central Laborers Pension Fund v. News Corporation, No. 6287-VCN, 2011 WL 6224538 (Del. Ch. Nov. 30, 2011)

Shareholder, who had previously filed a derivative complaint, sought inspection of the corporation’s books and records to investigate potential breaches of fiduciary duty and determine whether a demand on the board was necessary before commencing a derivative suit. Distinguishing the Delaware Supreme Court’s ruling in King v. VeriFone Holdings, Inc., 12 A.3d 1140 (Del. 2011), the Court of Chancery held that a shareholder with a currently pending derivative suit, when the complaint in that suit has not been dismissed, does not have a proper purpose for simultaneously pursuing an inspection of books and records relating to the same matters as the derivative suit.

b. DFG Wine Co., LLC v. Eight Estates Wine Holdings, LLC, C.A. No. 6110-VCN, 2011 WL 4056371 (Del. Ch. Aug. 31, 2011)

Plaintiff, a limited partner of defendant, demanded access to the books and records of defendant and defendant’s subsidiary to determine: (i) the value of its investments in defendant; and (ii) determine whether it should sit on defendant’s board of managers. Defendant responded that plaintiff was not entitled to inspect its subsidiary’s records under 6 Del. Ch. § 18-305. The court partially granted plaintiff’s request, ruling that plaintiff had a right to inspect: (i) the defendant’s and subsidiary’s state tax returns; (ii) copies of the subsidiary’s financial statements; (iii) employee agreements with the subsidiary’s key employees; (iv) the subsidiary’s general ledger; (v) the subsidiary’s inventory and non-inventory assets; and (vi) the subsidiary’s commodities contracts. The court reasoned that such access was part of the “true and f[u]ll information regarding the status of the business” and was necessary to allow plaintiff to value its holdings in the defendant, given that the subsidiary was defendant’s sole asset and defendant had no value outside of that of its subsidiary. However, the court did not require the defendant to provide information regarding the subsidiary’s contracts and future ability to repay its creditors because plaintiff had, in a prior action, alleged that defendant was insolvent and sought permission to inform defendant’s creditors of its views, and that defendant’s managers had a good faith belief that divulging to plaintiff those materials would not be in the best interests of the company. The court also rejected plaintiff’s request to view payments and benefits provided to managers of the defendant and subsidiary because plaintiff had not articulated how such information was needed to value plaintiff’s investment.

c. King v. VeriFone Holdings, Inc., 12 A.3d 1140 (Del. 2011)

Appellant shareholder who had filed a derivative complaint sought inspection of the corporation’s books and records in support of pleading demand futility. The Delaware Supreme Court reversed the Delaware Court of Chancery’s ruling dismissing the case and concluded that the shareholder had a “proper purpose” for inspecting the requested books and records, notwithstanding that the shareholder had previously filed a derivative suit relating to those same issues.

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d. Sanders v. Ohmite Holding, LLC, 2011 Del. Ch. LEXIS 35 (Del. Ch. Feb. 21, 2011)

Plaintiff, who loaned money to an individual to help purchase membership interests in a limited liability company (LLC) sought inspection of the LLC’s books and records to investigate purported mismanagement. Plaintiff obtained a security interest over the membership interests and the borrower later transferred the membership interests to plaintiff. He thereafter learned that, as a result of a transaction involving the manager of the LLC, his ownership interest was significantly smaller than he had previously been led to believe. He brought suit seeking inspection of the LLC’s books and records. Despite the fact that plaintiff did not own a membership interest in the LLC at the time of the transaction, the Delaware Court of Chancery granted plaintiff’s requested inspection.

e. Louisiana Mun. Police Emps. Ret. Sys. v. Morgan Stanley & Co., 2011 Del. Ch. LEXIS 42 (Del. Ch. Mar. 4, 2011)

Plaintiff pension fund made a demand on the corporation’s board of directors to redress alleged wrongdoing related to auction rate securities. The board, on the advice of the audit committee and its counsel, refused the demand. Plaintiff sought books and records relating to the refusal of the demand. The Delaware Court of Chancery held that plaintiff was entitled to inspect materials related to the refusal, including minutes and notes of board and committee meetings, materials presented to or relied upon by the board or committee thereof, and the engagement letters of the advisors relied upon by the board or committee.

4. Breach of Contract

a. ClubCorp, Inc. v. Pinehurst, LLC, C.A. No. 5120-VCP, 2011 WL 5554944 (Del. Ch. Nov. 15, 2011)

After plaintiff companies filed suit seeking compensation from defendant under an indemnification agreement, plaintiffs merged into new entities. As a result of these mergers, plaintiffs moved for a substitution of parties under Court of Chancery Rule 25(c). Defendant argued that plaintiffs’ mergers constituted an assignment of rights by “operation of law” under the indemnification agreement, and thus the successors could not enforce the rights of the original parties to the contract. A different provision of the agreement, however, stated that each party’s rights extended to its “successors.” Plaintiffs’ motion to substitute was granted in part and denied in part. The court ruled that, because tension existed between the relatively clear language of two sections of the indemnification agreement, the agreement was fairly susceptible to different interpretations. The court did not substitute the parties, but joined the successor entities to the action, and ruled that it would attempt to resolve the ambiguity by considering extrinsic evidence of the parties’ intended meaning.

b. GRT, Inc. v. Marathon GTF Technology, Ltd., C.A. No. 5571-CS, 2011 WL 2682898 (Del. Ch. July 11, 2011)

Plaintiff investor filed a lawsuit against defendant facilities operator alleging that the operator had failed to fulfill its contractually obligated design representations. Plaintiff and defendant had formed a joint venture under which the operator was contractually responsible for

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designing and building an experimental facility. The contract’s survival clause expressly provided that any contractual design representations, along with the sole, contractually provided remedy for breach of those representations, would terminate one year after closing. Plaintiff filed the suit 11 months after the expiration of the survival period, and defendant moved to dismiss the breach of contract claim on the ground that this claim was time-barred. The Delaware Court of Chancery agreed with defendant, holding that Delaware law permits parties to contractually shorten, but not extend, the default three-year statute of limitations on a breach of contract claim. Because the contract in question unambiguously established a one-year limitation period after closing for filing claims alleging a breach of the design representations and the alleged breach of the design representations claim was filed after the one-year survival period, the court concluded that the claim was time-barred and must be dismissed.

5. Business Judgment Rule / Entire Fairness

a. In re John Q. Hammons Hotels S’holder Litig., 2011 Del. Ch. LEXIS 1 (Del. Ch. Jan. 14, 2011)

Plaintiff common stock shareholders filed suit against a controlling shareholder and merger acquisition vehicle, alleging that the controlling shareholder, aided and abetted by the acquisition vehicle, had breached its fiduciary duties by approving a merger that gave plaintiffs inadequate consideration for their shares, while giving the controlling shareholder private benefits. The Delaware Court of Chancery held that the transaction was entirely fair, based on a review of the valuation methodologies used by the parties. The use of an independent special committee to negotiate the transaction shifted the burden of proof to plaintiffs to prove that the transaction was not entirely fair. The court held that this burden was not met — consideration received by the minority shareholders was fair, and the special committee negotiated at arm’s length with bidders over a nine-month period. Moreover, there was no evidence that the controlling shareholder coerced the minority or engaged in self-dealing. Thus, the court entered judgment in favor of defendants.

b. Reis v. Hazelett Strip-Casting Corp., 2011 Del. Ch. LEXIS 11 (Del. Ch. Jan. 21, 2011)

Plaintiff estate co-executor, acting on behalf of the estate beneficiaries, brought suit alleging that the price received for the shares in a reverse stock split was unfair. Specifically, an individual, owner of a minority interest in a family business, bequeathed his shares to 169 non-family individuals. After the executors refused to sell the estate shares to the controlling shareholder, a reverse stock split was approved and the estate was paid. The Delaware Court of Chancery held that entire fairness applied to the reverse stock split because it was an end-stage transaction and a majority of the board was beholden to the controlling shareholder who supported the reverse stock split. The reverse stock split was found to be not entirely fair because no procedural protections were implemented, no one bargained for the minority, and controlling shareholder threatened the minority shareholders. The court awarded plaintiffs damages of fair value plus pre- and post-judgment interest.

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6. Poison Pill and Other Defensive Measures

a. Air Prods. & Chems., Inc. v. Airgas, Inc., 16 A.3d 48 (Del. Ch. 2011)

Plaintiffs tender offeror and corporate shareholders alleged that a corporation and its board breached their fiduciary duties by keeping a poison pill in place when faced with a structurally non-coercive, all-cash, fully financed tender offer. The proposal was directed to the shareholders of the corporation. The Delaware Court of Chancery refused to order redemption of the poison pill, noting it was “reasonable in relation to the threat posed” by an inadequate offer, and entered judgment for defendants. The poison pill was not coercive because it is “not trying to cram down a management sponsored alternative, but rather, simply wants to maintain the status quo and manage the company for the long term.” The court also held that the combination of a rights plan and a staggered board were within the range of reasonable responses proportionate to the threat of a hostile takeover, and were not preclusive.


a. In re Atheros Commc’ns., Inc. S’holder Litig., 2011 Del. Ch. LEXIS 36 (Del. Ch. Mar. 4, 2011)

Plaintiff shareholders brought a class action against a target’s board of directors seeking to preliminarily enjoin a merger, alleging that the proxy disclosures were inadequate. The Delaware Court of Chancery held that the proxy statement failed to adequately disclose the contingent portion of a bankers’ fee, where such fee was 98% contingent. The court also found that the CEO’s future compensation was inadequately disclosed; the CEO had strong reason to believe he would be employed by the buyer after the deal closed, but instead disclosed that he had not discussed the terms of his future employment with the buyer yet. Noting that the shareholders would be irreparably harmed if these disclosures were not corrected, the court preliminarily enjoined the corporation and the board from conducting a shareholder vote on the merger. The injunction was conditioned on plaintiffs posting a bond of $25,000.

8. Materiality

a. Kahn v. Chell, 6511-VCL (Del. Ch. June 7, 2011)

In a purported class action lawsuit, plaintiff shareholder of the target company alleged that the consideration and disclosures in connection with a pending transaction were grossly inadequate. Specifically, plaintiff alleged that the information statement failed to disclose: (i) management’s projections on which the financial advisors relied in rendering their fairness opinions; (ii) the value of pending derivative claims; (iii) the relationship between the independent directors’ financial advisor and the controlling shareholder; and (iv) prior work performed by the financial advisors for the acquirer. Defendants moved to proceed in one jurisdiction and dismiss or stay, in light of related litigation in another court. The court denied defendants’ motion and declined to schedule a pre-closing preliminary injunction hearing. The court reasoned that any rulings it would make on the disclosure issues would merely reiterate existing law, reasserting, inter alia, that bankers’ fees for work previously performed for

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sponsoring firms is material information that is required to be disclosed. Because the transaction had already been approved by the controlling shareholder, the real issue was whether material disclosure violations deprived shareholders of their ability to make a valid appraisal election. These potential violations, the court explained, could be dealt with in a class-wide quasi-appraisal proceeding, post-closing. Therefore, injunctive relief was unnecessary. Finally, because the instant lawsuit would not be expedited, there was no potential for collision with the related action.

9. Other

a. In re Clarient, Inc. S’holders Litig., Consol. C.A. No. 5932-CS, Settlement Hearing Transcript (Aug. 2, 2011)

Parties reached a settlement in connection with class actions filed in both the Delaware Court of Chancery and California Superior Court challenging a merger. Before executing the memorandum of understanding documenting the proposed settlement, the California plaintiffs obtained an agreement regarding their fees and expenses in connection with the California action. The parties did not address the Delaware plaintiffs’ fees and expenses until after they had agreed on all language in a formal stipulation of settlement and confirmed that both sides were prepared to proceed with the settlement regardless of the outcome of the fee negotiations. Although Chancellor Strine ultimately approved the settlement, after reducing the fee award for both the California and Delaware plaintiffs, the chancellor observed that litigants in representative actions should defer fee discussions until after they agree upon the substantive terms of a settlement. Chancellor Strine also stated that he will not consider a proposed settlement of representative actions that contemplates fee applications in multiple jurisdictions out of concern that: (i) misaligned incentives would affect the litigation; and (ii) it would be burdensome for two different courts to assess different fee applications involving the same claims.

b. In re Allion Healthcare Inc. S’holder Litig., 2011 Del. Ch. LEXIS 48 (Del. Ch. Mar. 29, 2011)

Plaintiffs’ attorneys in Delaware and New York were involved in an attorneys’ fee dispute. The Delaware Court of Chancery decided that the New York plaintiffs’ attorneys were entitled to 50% of the disclosure fee award because they had independently negotiated with defendants for improved disclosures, even though such disclosures were incomplete. The court ruled that the New York plaintiffs’ attorneys were not entitled to any amount of the increased share price fee award because “out-of-state counsel is only entitled to a share of attorneys’ fees in a settlement of a Delaware action if their efforts elsewhere conferred a benefit realized as part of the Delaware settlement,” and plaintiffs’ counsel did not “substantiate their contribution to the result achieved.”

c. In re Sauer-Danfoss S’holder Litig., 2011 Del. Ch. LEXIS 64 (Del. Ch. Apr. 29, 2011)

Plaintiff shareholders filed a lawsuit alleging inadequate price and breach of fiduciary duty after the controlling shareholder announced it intended to launch a tender offer for the

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minority shares. After receiving letters from the SEC and a plaintiff, the corporation made a supplemental disclosure. Plaintiffs then amended the complaint to include disclosure allegations, and the corporation made supplemental disclosures to moot these claims. After the tender offer failed and all claims were dismissed as moot, plaintiffs then applied for attorneys’ fees for conferring a corporate benefit in the form of supplemental disclosures. The Delaware Court of Chancery awarded fees of $75,000 for minimal benefit conferred by correcting a factually inaccurate disclosure of the corporation’s 52-week high stock price. It awarded no fees for the disclosure made before plaintiffs filed a complaint with disclosure claims and determined all other disclosures were immaterial and non-compensable.

d. In re Massey Energy Co. Derivative & Class Action Litig., C.A. No. 5430-VCS (Del. May 31, 2011)

Stockholders filed derivative suits seeking to hold management responsible for failures in oversight after a massive explosion occurred in one of the target company’s mines that opened the company up to substantial potential liability. In 2011, the target company entered into a merger agreement with an acquiror. During merger negotiations, the target’s board did not engage in a valuation of the derivative claims that would pass to the acquiror upon completion of the merger. Plaintiff shareholders sought a preliminary injunction against the merger, arguing that the price was unfair because the acquiror was able to acquire the target without paying fair value for the economic value of the derivative claims. The court denied plaintiffs’ request for a preliminary injunction because the record did not support the inference that the derivative claims were material in comparison to the overall value of the target as an entity. Although the aggregate negative financial effect of the mine explosion on the target was considerable, the value of the derivative claims was different from this figure. The latter figure depends on the extent to which: (i) former fiduciaries of the target can be held responsible for fines and settlements; (ii) plaintiffs could meet the difficult challenge of proving that the fiduciaries acted with a wrongful state of mind and (iii) insurance proceeds were available to satisfy a judgment.

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XIV. SECURITIES AND EXCHANGE COMMISSION ENFORCEMENT CASES


During 2011, the SEC pursued several noteworthy enforcement actions. For example, in Gupta v. SEC, the Southern District of New York denied the SEC’s motion to dismiss defendant’s claim that the SEC’s administrative proceeding against him violated his right to equal protection under law. In SEC v. Johnson, the D.C. Circuit Court of Appeals held that the co-conspirator theory of venue was not consistent with the statutory venue requirements of the Exchange Act. In SEC v. Earthly Mineral Solutions, Inc., the SEC prevailed on its motion for summary judgment in an action against an officer of two companies for his participation in a Ponzi scheme. However, the District of Nevada rejected the SEC’s request for civil fines because the SEC neglected to identify the precise number of investors who were harmed by the scheme. In SEC v. Fuhlendorf, the Western District of Washington denied defendant CFO’s motion for summary judgment, finding that the SEC had provided sufficient detail to establish a factual dispute as to whether defendant certified financial statements that he knew had improperly recognized revenue from various contingent transactions.



a. SEC v. Earthly Mineral Solutions, Inc., No. 2:07-CV-1057 JCM (LRL), 2011 WL 1103349 (D. Nev. Mar. 23, 2011)

The SEC filed suit against an officer of two companies for his participation in an alleged Ponzi scheme. The SEC moved for summary judgment on its claims of violations of Sections 5(a) and (c) of the Securities Act and violations of the broker-dealer registration provisions of Section 15(a) of the Exchange Act. In addition, the SEC requested a permanent injunction prohibiting future violations, disgorgement of defendant’s ill-gotten gains, and civil penalties. The court granted summary judgment in favor of the SEC on its Securities Act claims because: (i) the court’s previous findings established that the claims at issue were securities and that defendant participated in their offer and sale; and (ii) defendant admitted in a joint pretrial order that he did not file a registration statement for these securities, and that he used interstate commerce to make the alleged offers and sales. With respect to the SEC’s Section 15(a) claim, the court found that defendant’s own admissions established the elements of the claim, e.g., that defendant fit the definition of a broker-dealer, was unregistered with the SEC, and did not qualify for the safe-harbor protections because, among other things, he engaged in the offer and sale of securities more than once per year. In addition, the court found that a permanent injunction was proper because future violations were reasonably likely, given that defendant was previously enjoined from engaging in similar conduct, was criminally convicted for the conduct at issue in this case, and had committed multiple serious violations of the securities laws. The court similarly found disgorgement appropriate because the SEC showed a reasonable approximation of profits causally connected to the violation. Finally, the court refused to impose civil monetary penalties because, even though defendant’s conduct was egregious, the SEC failed to provide an exact number of investors who were victims of the violations, thus making it impossible for the court to calculate an appropriate award of civil penalties.

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b. SEC v. PCS Edventures!.com, Inc., No. 1:10-CV-433-BLW,

2011 WL337895 (D. Idaho, Jan. 27, 2011)

The SEC filed suit against defendant company and executive for securities fraud under Sections 10(b) and 13(a) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-13 and 13a-14. Defendants had represented in public filings that the company had entered into a contract entitling it to $7.15 million when, in fact, the payment was contingent and no such contract had been executed at the time of the announcement. Defendants moved to dismiss. Because the extrinsic evidence on which defendants relied was not properly authenticated, the court refused to convert defendants’ motion to dismiss into a motion for summary judgment, and subsequently denied defendants’ motion to dismiss in full. The court held that the SEC met the minimum pleading requirements for its fraud claim by sufficiently alleging (i) the existence of misrepresentations regarding the status of the $7.15 million figure in the company’s Forms 8-K, 8-K/A and 10-KSB, (ii) materiality, through the increased share price and trading activity following the announcement, and (iii) scienter. The court stated that while the Ninth Circuit had not addressed the issue directly, the more rigorous pleading requirements of the PSLRA did not apply to fraud cases filed by the SEC, notwithstanding any heightened ethical requirements for government lawyers. The court further held that the SEC adequately pled a claim for aiding and abetting against the executive defendant by alleging a primary violation on the part of the company, the executive’s knowledge of the primary violation, his role in furthering that violation, and his substantial assistance in the violations. Finally, the SEC sufficiently alleged that the executive defendant knew the public filings were false when he certified them.

2. Scienter

a. SEC v. Shanahan, 646 F.3d 536 (8th Cir. 2011)

The SEC brought a civil action against defendant director of a corporation for participating in grants of backdated in-the-money stock options to corporate officials in contravention the corporation’s stated Stock Option Plan (Plan) requiring stock options to be priced at “the closing price of the Stock on the date that the Stock Option is granted.” The SEC alleged that such acts amounted to securities fraud, led to the issuance of misleading proxy statements, and that defendant aided and abetted such acts in violation of Sections 10(b), 14(a), and 20(e) of the Exchange Act. During trial, the district court granted judgment as a matter of law in favor of the defendant on all actions, and the Eighth Circuit affirmed. The court of appeals held that the defendant did not violate Section 10(b) because the SEC failed to prove scienter or, the materiality of defendant’s statements, assuming such statements were misleading. The court of appeals found dispositive the facts that (i) the option backdating practice was not clearly contrary to the Plan, and (ii) that no one, including the corporation’s accounting department and outside auditors, believed that this practice was a material misstatement. The court of appeals cited the same evidence when it found that plaintiffs failed to show defendant was negligent in backdating the stock options in violation of Securities 17(a) of the Securities Act, which prohibits courses of business “which operate[ ]. . . as a fraud or deceit upon the purchaser.” Additionally, the court of appeals found that scienter is an element of a claim of issuing false or misleading proxy solicitations under Section 14(a) — at least with respect to claims against outside directors and accountants — but that the SEC failed to prove scienter

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because it presented no evidence that defendant did not exercise reasonable care in proxy solicitations. Additionally, the court of appeals found it irrelevant that defendant may not have exercised reasonable care in backdating options because it was a distinct issue unrelated to the proxy statement. The mere fact that defendant signed the statements was held insufficient to show a lack of reasonable care. Finally, since the SEC could not prove any primary violation of securities laws, its claim for aiding and abetting violations under Section 20(e) failed as well.

b. SEC v. Retail Pro, Inc., No. 08cv1620-WQH-RBB, 2011 WL 2532501 (S.D. Cal. June 23, 2011)

The SEC asserted claims against defendant for engaging, and aiding and abetting his company in illegal revenue recognition practices in violation of Section 10(b) of the Exchange Act and Rule 10b-5, and Section 13(a) and Rules 12b-20, 13a-1 and 13a-13, and 13a-14. At the close of the SEC’s case, defendant moved for a direct verdict on each claim, and the jury found defendant liable on each claim. The court rejected defendant’s motion, finding that the SEC presented substantial evidence supporting the verdict, by establishing that the defendant: (i) participated in the execution of licensing agreements providing for contingent payments to the company; (ii) recognized revenue from those contingent payments in violation of GAAP; (iii) knew that the collection of such revenue was improbable based on the client’s financial state; (iv) agreed to offset the amount of revenue improperly recognized through purchases from the client in the next quarter; (v) ignored a company employee’s repeated communications regarding the impropriety of the transaction; and (vi) terminated said employee. The court held that the jury was entitled to disregard defendant’s self-serving testimony in light of this substantial evidence, and defendant’s assertion that he relied on auditors because he withheld material information from the auditors.

c. SEC v. Fuhlendorf, No. C09-1292, 2011 WL 999221 (W.D. Wash. Mar. 17, 2011)

The SEC brought various securities claims alleging that the defendant CFO rendered a company’s financial statements misleading by improperly recognizing revenue from various transactions while they remained contingent. In several transactions, defendant allegedly entered into oral side agreements whereby the company’s products could be returned unless an end-user was found. In other transactions, defendant allegedly accounted for contingent sales before finalizing the deals to eliminate the contingencies present in the original agreements. Defendant moved for summary judgment. The court rejected defendant’s scienter argument, finding that defendant arguably knew about the existing contingency in the transactions. The SEC provided evidence that defendant discussed with buyers their unwillingness to finalize transactions during the quarter the revenue was recognized. Moreover, after allegedly recognizing revenue improperly, defendant participated in finalizing the transactions by giving buyers additional products or buying a comparable amount of the buyers’ products. The court also rejected defendant’s materiality argument, finding that although most of the transactions did not amount to a large portion of the company’s quarterly revenue, qualitative factors made the misstatements material to an average investor. For instance, several of the deals occurred in the same quarter, and in the aggregate exceeded the five percent materiality threshold. Moreover, the other transactions were in excess of $800,000 each, a figure defendant himself stated in a letter to the company’s auditor could be material. Finally, although the company would have missed its

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revenue targets with or without the improper transactions, the court held that a jury could find the degree of the shortfall to be material.


a. SEC v. Microtune, Inc., No. 3:08-CV-1105-B, 2011 WL 540280 (N.D. Tex. Feb. 15, 2011)

The SEC brought a variety of Securities Act and Exchange Act claims against defendant officers, alleging that defendants participated in a fraudulent stock-option backdating scheme. Defendants moved for summary judgment, arguing that the SEC’s claims were barred by the five-year federal statute of limitations. The SEC countered that its claims were tolled due to the fraudulent concealment of the backdating scheme and that the statute of limitations did not apply because the SEC sought equitable relief, not penalties. The court held that the SEC’s claims failed to qualify for tolling because the SEC obtained notice of the backdating during the limitations period and did not diligently pursue the claims after receiving such notice. The court further held that all of the SEC’s proposed remedies, with the exception of disgorgement of profits obtained via the exercise of backdated options, were properly considered penalties and accordingly were barred by the statute of limitations. The court therefore granted defendants’ motion for summary judgment as to all claims other than those seeking disgorgement of profits.

4. Venue

a. SEC v. Johnson, 650 F.3d 710 (D.C. Cir. Sept. 22, 2011)

Plaintiff SEC filed a civil enforcement action against defendant, a software company executive, for aiding and abetting his company’s violation of Section 20 of the Exchange Act. The SEC alleged that defendant drafted documents recording fraudulent transactions with a counterparty. The defendant countered that venue in the District of Columbia was improper because: (i) defendant had acted in Nevada only; and (ii) the SEC had not alleged any act or transaction constituting the violations with which he had been charged had occurred in the District of Columbia. The district court rejected these arguments, reasoning that venue was proper under the “co-conspirator” theory of venue because the company had filed a misleading Form 10-K and Form 10-Q in the District of Columbia. After a jury trial, defendant was found guilty of one count of aiding and abetting the software company’s securities fraud, and the district court imposed a fine and barred defendant from serving as an officer and director. On appeal, the D.C. Circuit reversed the findings of the lower court, holding that the plain language of the special venue provision of the Exchange Act, 15 U.S.C. § 78aa, precludes the use of the co-conspirator theory of venue because at least one of the statutory bases for venue must have occurred in the chosen forum. The court acknowledged that decisions in the Second, Fifth, and Ninth Circuits had applied the co-conspirator theory, but rejected those decisions as based on policy concerns that could not override with the text and structure of the venue provision.

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5. Subject-Matter Jurisdiction

a. Gupta v. SEC, 796 F. Supp. 2d 503 (S.D.N.Y. 2011)

Defendant SEC moved to dismiss the complaint filed in the Southern District of New York by plaintiff, a prominent executive at an investment bank, after the SEC initiated an administrative proceeding against plaintiff on charges of insider trading in violation of Section 17(a) of the Securities Act, and Section 10(b)(5) of the Exchange Act. Plaintiff’s complaint in federal court argued that the SEC inappropriately singled him out, violating his equal protection rights, because the SEC filed similar charges against 27 other similarly-situated individual defendants in the Southern District of New York. Plaintiff also claimed that the SEC inappropriately sought to apply the Dodd-Frank Wall Street Reform and Consumer Protection Act retroactively, as the law was passed after plaintiff’s allegedly illegal activities took place. The SEC moved to dismiss, arguing that the court lacked jurisdiction, that plaintiff’s claims were barred by the defenses of sovereign immunity, failure to exhaust administrative remedies and ripeness, and, finally, that the courts of appeal possess exclusive jurisdiction to review SEC administrative proceedings, under Exchange Act Section 25(a)(1) and Section 703 of the Administrative Procedure Act. In response, the court granted the SEC’s motion in part and denied in part. The court dismissed plaintiff’s retroactivity claim because it was not “wholly collateral” to the SEC administrative proceeding as required by the three-prong test set forth in the Supreme Court’s decision in Free Enterprise Fund v. Public Co. Accounting Oversight Board. However, plaintiff’s equal protection claim survived, because it was “wholly collateral” to the SEC proceeding: plaintiff could be guilty of the conduct complained of, and yet his allegedly unequal treatment would not be addressed by the SEC. Further, plaintiff’s equal protection claim survived because: (i) allowing an SEC action to preclude that claim would foreclose any meaningful judicial review; and (ii) the SEC lacked expertise to address such a claim.


a. SEC v. Morgan Keegan & Co., 806 F. Supp. 2d 1253 (N.D. Ga. 2011)

The SEC initiated an action against defendant investment firm engaged in the underwriting and sale of auction rate securities. The SEC alleged, based on the testimony of four of defendant’s customers, that defendant’s brokers orally misstated the risks of the auction rate securities market to its customers. These statements included those in which brokers told those customers that auction rate securities were: (i) “as good as cash”; (ii) “just like money markets and CDs”; (iii) “completely liquid [except for] a possible 35-day hold”; and (iv) “zero risk.” Defendant moved for summary judgment on all of the SEC’s claims, claiming that any misrepresentations or omissions by its brokers were not material in light of the extensive written disclosures, which adequately described the risks associated with auction rate securities. The district court granted defendant’s motion, reasoning that these oral statements could not, standing alone, alter the total mix of information available to the public because various written disclosures clearly and repeatedly stated that auction rate securities had liquidity risks. Thus, the alleged misrepresentations made by four of the firm’s brokers were insufficient to establish that the firm, as a whole, misrepresented the risks of auction rate securities.

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7. Insider Trading

a. SEC v. Dunn, No. 2:09-CV-2213 JCM (LRL), 2011 WL 2623509 (D. Nev. June 30, 2011)

The SEC alleged that defendant tipper engaged in insider trading by giving defendant tippee confidential information regarding his company’s impending negative announcement in exchange for Broadway theater tickets during a 90-second phone conversation. Three minutes after the conversation, defendant tippee sold all of his options and nearly all his stock in the company, and bought put options to cover any losses from his previous purchases. When the news was released the next day, defendant tippee made a substantial profit. The parties brought cross-motions for summary judgment on the alleged violations of Section 10(b) of the Exchange Act and Rule 10b-5, and Section 17(a) of the Securities Act for insider trading. The court denied both motions, finding that neither party showed definitive evidence as to what was said during the 90-second phone call sufficient to establish scienter, or lack thereof. There also existed triable issues as to whether defendant tippee relied on the insider information in making the trades, given that reports predicting negative news had surfaced a week prior to the conversation. As a separate matter, the Court partially granted plaintiff’s motion in limine, excluding expert testimony related to information that defendant tipper was not alleged to have disclosed to defendant tippee.

8. Other

a. SEC v. Berry, No. C07-04431 RMW (HRL), 2011 U.S. Dist. LEXIS 28301 (N.D. Cal. Mar. 7, 2011)

In an SEC enforcement action against the general counsel of a company alleged to have engaged in stock-options backdating, the general counsel moved to compel the audit committee to produce notes and memoranda from witness interviews and meetings with the government. The committee opposed, arguing the materials were work product. The court granted defendant’s motion with respect to materials the committee had shared with the government, which was adverse to the company. However, the court denied the general counsel’s request for the production of materials the committee had shared with the company’s outside auditors because the auditors were not adverse. The court also held that defendant could not compel the opinion work product because it was not at issue in the litigation, and could not compel the fact work product because it was duplicative of the materials the court had already ordered produced.

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XV. SEC RULES AND GUIDANCE


The SEC issued a raft of new regulations in 2011. The SEC announced its intention to create a whistleblower program to incentivize potential tippers to provide information that the agency can use in enforcement actions and approved a rule that directs national securities exchanges to develop listing standards with respect to compensation committees and advisors. It also advanced the so-called Volcker rule prohibiting certain types of proprietary trading. The SEC also approved regulations that imposed new reporting requirements on hedge funds and other funds and advisors and regulations that established which financial products may be regulated as swaps and provided for a security-based swap execution facility designed to make swap trading more transparent.

B. NOTEWORTHY RULES AND GUIDANCE ISSUED BY THE SEC DURING 2011

1. SEC Adopts Rules To Establish Whistleblower Program

On May 25, 2011, the SEC adopted rules to create a whistleblower program that rewards individuals who provide the agency with high-quality tips that lead to successful enforcement actions. To be considered for an award, the whistleblower must voluntarily provide the SEC with original information that leads to a successful enforcement by the SEC of a federal court or administration act in which the SEC obtains monetary sanctions totaling more than $1 million. The following types of people are ineligible to claim a whistleblower award: (i) people with pre-existing legal or contractual duties to report to the SEC: (ii) attorneys who use information obtained through client engagements; (iii) people who obtain information illegally; (iv) foreign government officials; (v) people who learn the information in connection with the entity’s processes of identifying possible violations of law (such as through company hotlines); (vi) compliance and internal audit personnel and (vii) public accountants working on SEC engagements. However, compliance and internal audit personnel and public accountants will become eligible if (i) the whistleblower believes disclosure may prevent substantial injury, (ii) the whistleblower believes the entity is engaging in conduct that will impede the investigation or (iii) 120 days have elapsed since the whistleblower reported it to his/her supervisors or 120 days have elapsed since the whistleblower received the information under circumstances indicating his/her supervisors were already aware of the information.

Under the new rules, the SEC will pay an award based on amounts collected in related actions brought by certain agencies based upon the same original information that led to a successful SEC action. Also, the rules protect against employment retaliation and make it unlawful for anyone to interfere with a whistleblower’s efforts to communicate with the SEC.

2. SEC Approves FINRA’s All-Public Arbitration Panel Rule

On February 1, 2011, the SEC approved the Financial Industry Regulatory Authority’s (FINRA) proposed rule that allows investors bringing claims against companies in FINRA arbitration to opt for an all-public arbitration panel. The new rule will increase transparency and flexibility in FINRA’s proceedings. The prior arbitration model allowed investors to choose a

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panel of two public arbitrators and one nonpublic/industry-affiliated arbitrator. The amended rule, which applies to all investor cases where the potential arbitrators list has not yet been sent to the parties, provides investors the option of selecting a panel of all public arbitrators with no direct affiliation with FINRA.

3. SEC Approves Compensation Rules

On March 30, 2011, the SEC approved a rule that directs national securities exchanges and national securities associations to adopt listing standards with respect to compensation committees and compensation advisors. This rule stands in line with Section 952 of Dodd Frank, which requires the SEC to adopt disclosure rules concerning compensation consultants and conflicts of interest. Exchanges would be prohibited from listing entities that did not meet compensation committee and advisor requirements.

4. SEC Approves Rule Change for FINRA Arbitration Docs

On April 4, 2011, the SEC granted accelerated approval to FINRA’s proposed rule change that amends the list of documents that securities firms and investors must produce in arbitration before FINRA. The changes will apply to FINRA’s discovery guide. The rule change cuts down the number of lists in the discovery guide from 14 to two. The two general lists include a list of documents for firms and associates, and another for customers. The introduction to the discovery guide states that arbitrators may order production of documents not on either list and can decide that certain documents listed are not required to be produced.

5. SEC, CFTC Define Responsibility for Swap Coverage

On April 27, 2011, the SEC, along with the US Commodity Futures Trading Commission (CFTC), approved a joint set of rules that would better define swaps and would help the two agencies draw better jurisdictional lines. The rules establish which financial products are regulated as swaps under the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rules provide for three categories: swaps, security-based swaps and mixed swaps. Swaps fall under the authority of the CFTC. Security-based swaps also fall under the authority of the CFTC, though the SEC holds some anti-fraud authority over them as well. Mixed swaps are to be governed by both agencies. Insurance, forwards, security forwards and standard commercial financial contracts do not fall within the definitions established by the new rule.

6. SEC Approves Facilities To Shine Light on Swap Trading

On February 2, 2011, the SEC unanimously approved the establishment of security-based swap execution facilities (SEFs) to make swap trading more transparent and fair. Currently, security-based swaps occur in the over-the-counter market. The new rules require the swaps to be traded on SEFs or an existing exchange. Under the new rules, SEFs would have to create an electronic trading platform that allows swap participants to see bids and quotes, similar to stock market order books.

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7. SEC Inks Sweeping Hedge Fund Adviser Rules

On June 22, 2011, the SEC approved stringent new rules for advisers to hedge funds and other large private funds. The new rules impose comprehensive reporting requirements for hedge funds, private equity funds and other fund advisers with more than $150 million under management. Advisers to large hedge funds and private funds will now have to register with the SEC and provide the agency with information about the business operations, auditors and brokers for the funds, as well as disclose conflicts of interest and investment strategies. Venture capital funds are exempted from the sweeping reporting requirements.

8. SEC Advances New Conduct Rules for Swap Markets

On June 29, 2011, the SEC voted to move forward with proposed rules under Title VII of the Dodd-Frank Act to establish business conduct standards for security-based dealers and participants. The proposed rules would require security-based swap dealers and participants to disclose to counterparties material information about their derivatives deals, including: material risks, characteristics, incentives, and potential conflicts of interest involved in security-based swap transactions. Security-based swap dealers and participants would also be required to establish a supervision infrastructure and communicate with counterparties in a “fair and balanced” manner. Additionally, the proposed rule would require security-based swap dealers and participants to designate a chief compliance officer to provide an annual compliance report.

9. SEC Approves New Rules on Large-Trader Reporting

The SEC voted to approve Rule 13h-1 and Form 13H, which establish large-trader reporting requirements to identify market participants that conduct a substantial amount of trading activity and collect information on their trading. The large-trader rule will enhance the Commission’s ability to obtain information about the most active market participants by allowing it to identify the largest participants, collect data on their trading activity, reconstruct market events and bring enforcement actions.

The rule will require large traders to register with the SEC by filing Form 13(h), require large traders to provide broker-dealers the unique identification number assigned to them by the SEC and require large traders to provide additional identifying information to the commission upon request. The rule also addresses broker-dealers, requiring them to maintain and report information on transactions in large-trader accounts. It requires certain broker-dealers to monitor customers’ accounts for trading activity that exceeds the large-trader threshold.

10. SEC Advances Proposed Volcker Rule

The SEC approved a proposed rule that would restrict major banks’ proprietary trading activities. Under the proposed rule, bank holding companies and their subsidiaries would be barred from short-term proprietary trading of any security, derivative or other financial products intended only to benefit the company. The rule also bars banks from owning or sponsoring hedge or private equity funds.

The SEC also approved a rule requiring security-based swaps dealers and major market participants to register with regulators. Under the new rule, dealers in previously unregulated

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security-based swaps would have to file registration forms with the SEC similar to those required by stock brokers. Security-based swap dealers would also have to guarantee that a senior officer was on hand and familiar with a firm’s financial, operational and compliance capabilities. Both rules are subject to a 90-day comment period.

11. SEC Locks In New Private Fund Reporting Rules

The SEC approved rules requiring hedge funds and private equity funds to turn over sensitive financial information to regulators. The final rule will require hedge funds and other private funds deemed to be systemically significant to file quarterly reports, known as Form PF. Those reports will be shared with the Financial Stability Oversight Council. Hedge fund advisers managing at least $1.5 billion will have to turn over their aggregated exposures by asset class, geographical concentration and turnover by asset class within 60 days of the end of each quarter. Advisers will also have to turn over information showing the exposures, leverage, risk profile and liquidity for each individual hedge fund with a net asset value of at least $500 million. Managers of liquidity funds, including registered money market funds, with at least $1 billion in assets will be required to provide the types of assets in each of their funds’ portfolios, some information regarding the fund’s risk profile and compliance policies to regulators within 15 days of the end of each quarter under the rule. Large private equity fund advisers, having at least $2 billion in assets under management, will have 120 days from the end of each quarter to report on the leverage its portfolio companies have accrued, the use of bridge financing and the amount their funds have invested in financial institutions under the rule. Smaller private funds are required to report limited information about their funds’ size and leverage, investor types and concentration, liquidity and fund performance within 120 days of the end of each fiscal year. Smaller fund managers will also be required to report on their fund strategy, counterparty credit risk and use of trading and clearing mechanisms.

12. SEC Tightens Standards for Reverse Merger Listings

On November 9, 2011, the SEC approved rules aimed at tightening listing standards for companies that have listed on the US stock exchanges through reverse mergers. The rules will make it more difficult for companies, particularly those based in foreign jurisdictions, to list on US exchanges using the reverse merger process. The rules are intended to give investors easier access to financial reports issued by reverse-merger listed companies. The rules require companies that file an initial public offering through a reverse merger process to complete a one-year seasoning period. The stocks will have to trade on the US over-the-counter market or on another regulated exchange either in the US or abroad following the reverse merger, and file all required reports with the SEC before they can trade on the New York Stock Exchange, Nasdaq or NYSE Amex. Reverse merger companies will also be required to maintain a minimum share price for 30 of the 60 trading days immediately prior to their listing application with one of the three exchanges, and for the same period prior to an exchange’s acceptance. The rule provides an exemption for companies that have filed at least four annual reports with the SEC since completing the process.

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XVI. DEVELOPMENTS WITH THE PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD DURING 2011


The Public Company Accounting Oversight Board (PCAOB) issued several releases and concluded some notable disciplinary proceedings in 2011. The PCAOB announced, for example, that it has entered into cooperative agreements with audit regulators in the United Kingdom, Switzerland, Norway, the Netherlands, Israel, Taiwan and Dubai. The Sarbanes-Oxley Act had restricted such agreements, but the subsequent passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act made such agreements possible again. The PCAOB also issued a research note concerning Chinese reverse mergers, a noteworthy development given that during the course of the study, PCAOB-registered accounting firms based in the United States audited 74 percent of reported reverse merger companies from the China region.1 In addition, the PCAOB published an alert to increase auditors’ awareness of risks when performing audits of companies with operations in emerging markets, as well as an alert to assist auditors in identifying matters that may affect the risk of material misstatement in financial statements.

During 2011, the PCAOB also brought disciplinary proceedings against several persons and accounting firms. These included an order concerning several firms in India, imposing both equitable and monetary penalties based upon violations involving a billion-dollar overstatement of an issuer’s assets. The PCAOB also settled disciplinary orders against a former Ernst & Young partner and senior manager for their roles in providing misleading documents and information to inspectors and altering working papers. In addition, the PCAOB revoked the registration of, and imposed a civil monetary penalty upon, an Australian public accounting firm.

B. NOTABLE RELEASES DURING 2011

1. PCAOB Enters into Cooperative Agreement with the UK Audit Regulator

On January 10, 2011, the PCAOB entered into a cooperative agreement with the Professional Oversight Board (POB) in the United Kingdom to facilitate cooperation in the oversight of auditors and public accounting firms that practice in the two regulators’ respective jurisdictions. This agreement provides a basis for the resumption of PCAOB inspections of registered accounting firms that are located in the United Kingdom and that audit, or participate in audits, of companies whose securities trade in US markets. The PCAOB previously conducted inspections in the United Kingdom with the POB from 2005 to 2008, but had been blocked from doing so since that time. This is the first cooperative agreement that the PCAOB has concluded since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which amended the Sarbanes-Oxley Act to permit the PCAOB to share confidential information with its non-US counterparts under certain conditions.

1 The phrase “China region” refers to the People’s Republic of China, the Hong Kong Special Administrative

Region, and the Republic of China (a.k.a. Taiwan).

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2. PCAOB Issues Research Note on Chinese Reverse Mergers

On March 15, 2011, the PCAOB issued a Research Note, providing new data on the growth of reverse merger transactions involving companies from the China region. The Research Note was prepared to provide further context to issues discussed in Staff Audit Practice Alert No. 6, issued on July 12, 2010. As detailed in the Research Note, 159 out of the 603 reported reverse-merger transactions between January 2007 to March 31, 2010 involved companies from the China region, representing 26 percent of all reported reverse-merger transactions in that period. PCAOB-registered accounting firms based in the United States audited 74 percent of the Chinese reverse-merger companies, while China region-based registered firms audited 24 percent.

3. PCAOB Enters into First Cooperative Agreement with Swiss Regulators

On April 6, 2011, the PCAOB announced that it had entered into a Statement of Protocol with Swiss regulators, establishing a cooperative framework for supervisory oversight of auditors that practice in each country. The agreement with the Swiss Federal Audit Oversight Authority and Financial Market Supervisory Authority allows the PCAOB to commence joint inspections of accounting firms in Switzerland that audit, or participate in audits, of companies whose securities trade on US markets. In addition, the agreement includes provisions governing the sharing of confidential information, consistent with a recent amendment to the Sarbanes-Oxley Act that permits the PCAOB to share such information with its non-US counterparts in certain circumstances.

4. PCAOB Publishes Staff Audit Practice Alert on Audit Risks in Certain Emerging Markets

On October 3, 2011, the PCAOB published a Staff Audit Practice Alert to increase auditors’ awareness of risks when performing audits of companies with operations in emerging markets. The Alert focuses on the particular risks that auditors may encounter with fraudulent statements in audits of companies operating in emerging markets, auditors’ responsibilities for addressing those risks, and certain other auditor responsibilities under PCAOB auditing standards. Although the conditions, situations, and fraud risks described in this Alert have been observed in audits of companies in certain emerging markets, they might also be present at companies in more developed markets.

5. PCAOB Enters into Cooperative Agreements for the Exchange of Confidential Information with Authorities in Israel and Dubai

On October 31, 2011, the PCAOB announced a cooperative agreement for the exchange of confidential information with the Israel Securities Authority (ISA) to enhance the supervisory oversight of auditors and accounting firms that practice in the two regulators’ respective jurisdictions. Although the ISA has permitted the PCAOB to conduct inspections of PCAOB-registered firms in Israel since 2005, the agreement permits the PCAOB and the ISA to share confidential information about the firms that operate in both jurisdictions. This arrangement was the first of its kind with a regulator from the Middle East. In addition, on December 20, 2011,

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the PCAOB announced that it has entered into a cooperative arrangement with the Dubai Financial Services Authority for the oversight of auditors that practice in the regulators’ respective jurisdictions. This marks the second cooperative arrangement that the PCAOB has concluded in the Middle East.

6. PCAOB Enters into Cooperative Arrangement with Taiwan

On November 18, 2011, the PCAOB announced a cooperative agreement with the Financial Supervisory Commission of Taiwan for the oversight of auditors that practice in both of the regulators’ respective jurisdictions. Under similar agreements, the PCAOB already carries out joint inspections with other regulators in the Asia-Pacific region, including Australia, Korea and Singapore. Additionally, in coordination with regulators in Indonesia, Japan, Malaysia, New Zealand, Philippines, and Thailand, the PCAOB has regularly been conducting inspections of PCAOB-registered firms from those countries.

7. PCAOB Publishes Staff Audit Practice Alert on Assessing and Responding to Risk in the Current Economic Environment

On December 6, 2011, the PCAOB published Staff Audit Practice Alert No. 9: Assessing and Responding to Risk in the Current Economic Environment, which updates Staff Audit Practice Alert No. 3 from December 2008, and identifies matters and risks of material misstatements in light of current global economic conditions and recent enhancements to PCAOB standards. Many of the matters discussed in the earlier Practice Alert No. 3, including fair value measurements, accounting estimates, going concern, and financial statement disclosures, continue to be critical in audits of 2011 financial statements. However, certain of the PCAOB standards referenced in that alert regarding risk assessment and response were superseded in 2010 when the PCAOB adopted eight new risk assessment standards (Auditing Standard Nos. 8-15)

C. NOTABLE DISCIPLINARY PROCEEDINGS DURING 2011

1. In the Matter of Price Waterhouse, Bangalore, Lovelock & Lewes, Price Waterhouse & Co., Bangalore, Price Waterhouse, Calcutta, and Price Waterhouse & Co., Calcutta, PCAOB Release No. 105- 2011-002 (Order Instituting Disciplinary Proceedings, Making Findings and Imposing Sanctions)

In an April 5, 2011 order, the PCAOB: (i) censured the registered public accounting firms Price Waterhouse, Bangalore, Lovelock & Lewes; Price Waterhouse & Co., Bangalore; Price Waterhouse, Calcutta; and Price Waterhouse & Co., Calcutta (collectively, the Indian Firms); (ii) temporarily limited the activities, functions and operations of the Indian Firms, including by prohibiting the Indian Firms from accepting SEC Issuer Referred Engagement Work for new clients for a period of six months; (iii) required the Indian Firms to engage an independent monitor; (iv) required the Indian Firms to adopt and implement certain quality-control policies and actions; (v) required the Indian Firms to provide additional professional education and training to its associated persons; and (vi) imposed a civil money penalty jointly and severally in the amount of $1,500,000 as to Price Waterhouse, Bangalore, and Lovelock &

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Lewes. These penalties were imposed in connection with Price Waterhouse, Bangalore’s and Lovelock & Lewes’s violations of PCAOB rules, quality control and auditing standards in connection with a Board inspection. The matter concerned a billion-dollar overstatement of the assets of an issuer that Price Waterhouse, Bangalore and Lovelock & Lewes failed to identify, in part, because of the flawed audit procedures they used.

2. PCAOB Announces Settled Disciplinary Orders Against Former Ernst & Young Partner and Senior Manager For Providing Misleading Documents to PCAOB Inspectors And Altering Working Papers

On August 1, 2011, the PCAOB announced settled disciplinary orders against a former Ernst & Young partner, Peter C. O’Toole, and senior manager, Darrin G. Estella, for their roles in providing misleading documents and information to PCAOB inspectors and altering working papers. The PCAOB found that shortly before inspection of an Ernst & Young audit, O’Toole and Estella created, backdated, and added a document to the audit working papers that related to the most significant issue in that audit. The PCAOB also found that O’Toole authorized other members of the audit engagement team to alter, add, and backdate other working papers in advance of the PCAOB inspection. These actions were found to violate PCAOB Rule 4006, which requires cooperation with inspections, as well as PCAOB Auditing Standard No. 3, which governs audit documentation. Mr. O’Toole was barred from associating with a PCAOB-registered accounting firm, but he may petition to remove the bar after three years. This is the longest bar that the PCAOB has imposed on a partner of a “Big 4” accounting firm. A $50,000 civil penalty was also imposed against O’Toole. In addition, the PCAOB barred Estella from associating with a PCAOB-registered accounting firm, with the right to petition to remove the bar after two years.

3. In the Matter of Bentleys Brisbane Partnership and Robert John Forbes, CA, PCAOB Release No. 105-2011-007 (Order Instituting Disciplinary Proceedings, Making Findings and Imposing Sanctions)

The PCAOB commenced disciplinary proceedings against respondent Bentleys Brisbane Partnership, an Australian public accounting firm and Robert John Forbes, CA, its office managing partner. In a December 20, 2011 order, the PCAOB found that Bentleys Brisbane failed to adhere to PCAOB’s accounting standards in connection with the audit financial statements filed with the SEC by an issuer client, Alloy Steel International, Inc. Specifically, the PCAOB found that Bentleys Brisbane failed to plan, perform or supervise the audit in accordance with PCAOB auditing standards. Instead, a non-PCAOB-registered affiliate of Bentleys Brisbane performed the audit, after which Bentleys Brisbane performed a limited review of the work papers and expressed an unqualified opinion in its audit report of the financial statements. The PCAOB also found that Forbes substantially contributed to these violations of PCAOB accounting standards. The PCAOB therefore: (i) revoked the registration of Bentleys Brisbane Partnership, headquartered in Brisbane, Australia; (ii) imposed a civil penalty of $10,000 upon Bentleys Brisbane; and (iii) barred Forbes from being an associated person of a registered public accounting firm.