1. Capitalist Manifesto. Note that this piece is a little rough around the edges. It needs more
headings, and the footnotes need work. So I may replace the posted version between now
and Monday. I will let you know if and when I do so.
2. Robertson v. Central Jersey Bank. As you will see, this is a case about a trust.
I have added two new cases (and will amend the syllabus to reflect this addition).
3. Davis v. Merrill Lynch.
4. IBM v. Jander.
Please consider the questions below for discussion — and please volunteer to answer one
or more.
With regard to Question 11, I would like EVERYONE to submit by email no later than 9AM
Monday (before class) an answer the following question: What is the amount of price
inflation for purposes of a claim under Rule 10b-5?
9. As I noted at the end of the last class, the Second Circuit seems to have ruled that it is
enough that some (small) part of investor loss is attributable to misrepresentation -- even if
most of the loss comes from the effect of (say) an event (such as the SEC crackdown in
Goldman Sachs). Do you agree? Is there some point at which the loss from
misrepresentation is too small relative to other sources of loss for a fraud claim to be
sustained? Is this what SCOTUS would call a good dose of common sense? Or is it enough
that a plaintiff can point to some element of clearly actionable loss – that cannot be
explained as coming from another source – in order to sustain a claim for the entire loss
suffered even though we know it comes from other sources. (Note that I have called
this consequential damages although I am not sure everyone would agree that that is what
the phrase means.) Is there any burden on the plaintiff to show that the residual loss comes
from fooling the market or is it enough that the residual loss cannot be explained by other
means?
- Is there a dollar amount that might be attributable to the misrepresentation?
- MSJ details:
- PF cannot get any type of discoveries until a motion a dismiss has been heard by
the court. So the plaintiff has to be able to allege that there’s a cause of action. Thus, you
have to be able to say this is how I’m going to prove the claim, because the CEO knew he
was speaking falsely and when the truth came out it caused the market to come down. So
you have to say exactly what you’re going to be prove before you’re allowed to say
anything. 95 Act says you have to have e reasonable basis for thinking you can prove it.
Usually you will have some type of whistleblower ready to fire up as a witness.
10. The Fifth Circuit in Ludlow ruled that it was impossible to know whether a member of the
pre-explosion class would have bought BP anyway (albeit at a lower price) or would have
declined to buy BP at all knowing that it was not following best practices with regard to its
drilling operations. The implication would seem to be that the former subclass is entitled
only to compensation for price inflation while the latter subclass is entitled to its entire loss.
Is this consistent with the fraud on the market (FOTM) theory which seems to preclude
consideration of why individual investors invest (reliance or transaction causation). Note that
the named (representative) plaintiff in Ludlow could avoid the problem by limiting the claim
to exclude consequential damages.
- 5th circuit here said some people might have bought BP anyways, we can’t trust the
plaintiffs to tell us who they are. No one is gonna volunteer to be the investor who would
have bought anyway. Everyone is probably gonna choose the class of wouldn’t have bought
had they known BP’s negligence.
-Fraud on the market theory was invented/adopted by the supreme court in the Basic case
in 1988, as a way of permitting class actions, and clearly that’s true. The theory applies even
in the context of an individual action. You don’t have to prove reliance as an individual when
you raise the fraud on the market theory, even if you didn’t lose a ton of money. All you
gotta prove is the fact that you bought the stock.
-We’re thinking here that when a class action is filed, the idea is that everybody that bought
stock during the fraud period – one reason is that the damages for all the investors would
be greater with a class action so the D is forced to pay. The second reason is that lawyers
will be getting paid out of the settlement money, so they always go after the huge class
actions.
11. Please consider the following hypothetical from the OOPs piece (as summarized in Slide
18):
Acme Blasting Cap Corporation (ABC) generates earnings from operations of $1,000,000 per
year. It has zero long-term debt and $2M in cash in excess of the ordinary needs of the
business. The company has 1,000,000 shares outstanding and a market capitalization of
$12M. Thus, the market assigns the company a 10% capitalization (discount) rate. In other
words, the stock trades for $12 per share with EPS of $1.00 (ignoring any return from excess
cash).
A major customer cancels a big contract, and ABC management expects returns to fall to
$800,000 for the year unless a new customer can be found in the meantime, which
management thinks is a fifty-fifty possibility. If the cancellation is disclosed immediately,
stock price should fall to $11 per share other things equal. But ABC management does not
disclose the bad news. Instead, the CEO in a regular conference call with investors and
analysts reassures the market that the company expects to report earnings of $1.00 per
share for the current year.
Six months later the company reports earnings of $0.80 per share – having found no new
customer. The market processes this earnings surprise quickly, and stock price falls $8 per
share.
-
-
We can take the formula value = return/RRR (required rate of return) + cash and break it
up, assuming it goes from $12 to $8 a share. We also figured that return went down
from 1m, which we can look at as 10$ a share, to 8$.a share or 800k.
o Return – we know that $2 loss comes from the drop of 1m to 800k or 1m/.1 to
800k/.1
 When the loss comes from this originally, where we know the returns
have been misrepresented, three possibilities arise:
 First, the prospect of returns decreased because of ordinary
business risk (CEO says “we cant bind our customers to our
business and they can always choose other suppliers, etc.”)
o This could help the case if the CEO had told the market
before that contracts could be lost very easily etc. This
would make the RRR higher and is probably not
recoverable.
 Second, maybe the management misbehaved in its business with
the customer and that caused the contract to be cancelled, and
the management still didn’t disclose that this contract had been
cancelled, then this would probably be a derivative action.
 Third, the misrepresentation itself.
o RRR (.10) – an increase in the RRR because now the management is considered
riskier. This would also be derivative.
 If there’s no lie involved from the management, then presumable you
got no claim with respected to the RRR.
o Cash – we can assume that the other 2$ loss could come from the fact that the
reduction in expected return decreased cash at the end of the year OR legal
expenses OR insurance premiums, or all the expenses and losses combined. If
it’s cash then it’s a derivative.
Bargaining happens in the shadows of the law – it means that in reality, if there is a
claim for the 2m dollars lost, then it will be negotiated and settled on the sidelines.
If the courts say that those individual purchasers have a claim for 4$ a share, that’s
where bargaining is going to start. They will say if this goes to trial we will claim 4m in
damages, D will pass a SMJ, etc. If the plaintiffs actually make it through the MSJ, then it
will become a class action.
ABC has been sued both directly under Rule 10b-5 by investors who bought ABC stock during the
six-month fraud period and derivatively under state law based on harms suffered by the company
as a result of the CEO's actions in speaking to the market. You represent ABC as their lawyer. The
BOD has asked you to summarize the claims in these actions, to assess the prospects of success on
the merits, and to map out a legal strategy. How do you respond to the first question? Who can sue
whom for what? What are the prospects of success on each? What strategy do you recommend?
12. In Robertson, what is the difference between the rule applied by the district court and the rule
applied by the Third Circuit? Is failure to diversify itself a claim or is it evidence of a BFD?
- District court applied recklessness and the third circuit said no it’s more of a matter of due
diligence.
- This case is a classic trust case where this woman (Robertson) had a trust set up and her
grandparents put a bunch of money in there, she was supposed to get half when she turned 25.
Bank is managing the trust and it turns out when the trust got set up, most of what is in the trust
was a stock that was in the bank’s stock itself. There was a provision in the trust stating that the
trustee cannot be liable simply because the trustee retains the investments that the grantor had
had the trust in when the assets were transferred.
- Question became whether the trustee breached their fiduciary duty by keeping the stocks
invested for the trustor in the bank’s stock.
The bank failed to diversify the investments, it did bad, etc. Also the sale of certain shares
were not paid to the grantor. They overturned the district court’s decision stating that the infringing
on the due diligence is the real issue.
In order to survive a motion to dismiss, you have to credibly plead siander. It’s basically
proving that someone tried to fool you into thinking that the stock will stay high on purpose
implicitly. What the supreme court lately has been clearly suggesting is that recklessness could be
enough to show sciander. Recently not so much as the statement purposefully intending to fool
you, rather one that is made without an adequate basis.
13. The Davis court affirmed jury instructions permitting the plaintiff to recover both excess
commissions and gains in portfolio value that would have obtained but for churning of the account.
Does this imply that the courts would permit an award for failure to diversify even in the absence of
a showing of churning?
Different kind of securities fraud, what Booth calls one-on-one securities fraud. Most of cases so far
has been open market cases, covering some type of bad news, news comes out, price falls, people
who bought during the fraud period want to recover, and they sue.
Typically, the company itself hasn’t sold any stock during the fraud period. One of the reasons we
get sec class action is because of the disconnect between the scienter and the person who
misspoke.
Broker, think real estate, is only involved in making sure the transaction is done properly and
they’re compensated through commission from the seller, they don’t own any part of the
underlying property you’re buying.
Dealer, think car dealership, is involved in the transaction and owns the underlying asset you’re
buying.
A broker-dealer, in terms of stocks, they can be involved in both. They can take commission based
on transactions flowing through their system, or they can be a dealer by buying stock at a certain
bid price and selling it at certain ask price for a profit daily – they usually close out at the end of the
day with 0 stocks.
In the Davis case, she invested money and they were handled on a dealer basis rather than a broker
basis. She invested 144k into stocks. The broker who handled her account basically drove her to pay
commissions of about 43k in 31 months. The person in charge of buying and selling on her behalf,
engaged in 2.1m in sales of her stock, turning her account over 5.4 times a year.
The standard model of compensation for the brokerage is you get a certain percentage of all the
commissions you bring in, in this case, he was getting 9% of all the commissions on the trades.
In addition, most of the trades the broker made were unauthorized by the customer.
The jury was convinced to find that the broker owes a fiduciary duty to the customer and was
trading the account for his own benefit and in bad faith of making the account make more money.
One question is does the broker have a duty to the customer? Under south Dakota law, brokers in
the securities business are fiduciaries for their customer, so they have to disclose to the client that
they are making these trades because of their motivation for their own personal compensation.
Under South Dakota law you don’t need to show that there is a fiduciary duty. Other states you
have to show that the customer treats the broker as if they are their agent rather than allowing
them to do whatever they want.
14. What was the theory of liability asserted by the Jander plaintiffs? What is the rule according to
SCOTUS as established in the Dudenhoeffer case?