Module VIII – Stock Trading
Chapter 24
Securities Fraud Class Action
•
•
•
•
Bar
exam
Corporate
practice
•
statutory basis
comparison to fiduciary derivative suit
structure and recent use
Elements
•
•
•
•
Law
profession
Citizen of
world
Securities fraud class actions
•
Materiality: Basic v. Levinson
Scienter: PSLRA / Tellabs
Reliance: Basic v. Levinson
Causation: which price event?
Analysis
•
•
Lawyers as entrepreneurs?
Cross-subsidization - solutions?
SFCA background …
Source: § 10(b)
Use of SFCA
Securities Exchange Act of 1934
Section 10 -- Manipulative and
Deceptive Devices
It shall be unlawful for any person,
directly or indirectly, by the use of any
means or instrumentality of interstate
commerce or of the mails, or of any
facility of any national securities
exchange-(b) To use or employ, in
connection with the purchase or
sale of any security registered on a
national securities exchange or
any security not so registered …
any manipulative or deceptive
device or contrivance in
contravention of such rules and
regulations as the Commission
may prescribe as necessary or
appropriate in the public interest or
for the protection of investors.
Use of SFCA …
“King of Pain”
“Loathed because he's so mean,
feared because he's so
powerful, Bill Lerach is the
lawyer everyone in Silicon Valley
hates.”
Fortune Magazine, Sep. 2000
Formerly,
• Milberg Weiss Bershad Hynes & Lerach
• Lerach Coughlin Stoia Geller Rudman&Robbins
Currently
• Coughlin Stoia Geller Rudman & Robbins
Securities Fraud Class Actions (“classic”)
250
200
188
150
100
50
0
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
Stanford Class Action Clearinghouse
Structure of SFCA
(elements)
Securities Fraud Action
When we deal with private actions
under Rule 10b-5, we deal with
a judicial oak which has grown
from little more than a
legislative acorn.
Blue Chip Stamps v. Manor Drug Stores
(US 1975)
William Rehnquist
• Parties
– Plaintiff
– Defendant
• Elements
1. Material omission or
misrepresentation of fact
2. Scienter (intentional)
3. Reliance
4. Causation
• Transactional nexus
– “in connection with”
– Securities trading
• Jurisdictional nexus
– Federal court
– Statute of limitation
10b-5 action
Materiality …
1.
•
•
•
•
FACTS
What was transaction?
Who are plaintiffs? Kind of suit?
Allegations? Remedy sought?
Who are the defendants?
2. ISSUES
• Defendant arguments?
• Plaintiff responses?
3. HOLDING
• Alternatives: “agreement in
principle"? "price and structure"?
• "probability-magnitude" test? How do
stock markets determine value of info?
4. ANALYSIS
• Why case-by-case definition of
materiality?
• Why not bright-line test?
• Advantages and disadvantages?
5. CONCLUSION
• After this case, how should corporation
disclose merger negotiations?
• After this case, can corporate executives
strategically misinform stock markets?
Basic Inc. v. Levinson
(US 1988)
Shareholders
(stock market)
Three
“white”
lies
Basic Inc
Combustion
Engineering
merger negotiations
Scienter …
• Parties
– Plaintiff
– Defendant
• Elements
1. Material omission or
misrepresentation of fact
2. Scienter (intentional)
3. Relianc
4. Causation
• Transactional nexus
– “in connection with”
– Securities trading
• Jurisdictional nexus
– Federal court
– Statute of limitation
10b-5 action
Plead “scienter” …
PSLRA [’34 Act § 21D(b)(1)]
In any private action arising
under this chapter in which
the plaintiff may recover
money damages only on
proof that the defendant
acted with a particular state
of mind, the complaint shall,
with respect to each act or
omission alleged to violate
this chapter, state with
particularity facts giving rise
to a strong inference that the
defendant acted with the
required state of mind.
Required “state of mind”?
Compare to Rule 9(b)
How get pre-filing “facts”?
1.
•
•
•
FACTS
What were misstatements?
Material – why?
Who are plaintiffs? Kind of suit?
Tellabs v. Makor Issues & Rights
(US 2008)
2. ISSUES
• Defendant arguments?
• Plaintiff arguments?
3. HOLDING
• Congress intended to “strengthen
pleading standard”
• Must be “cogent and compelling” /
compare inferences: plaintiff wins tie
4. ANALYSIS
• Why should plaintiff win tie? Wasn’t
PSLRA anti-plaintiff?
• Why not same burden as at trial –
preponderance of inferences?
5. CONCLUSION
• After this case, what “facts” will survive
motion to dismiss?
• After this case, are internal reports of
company difficulties enough?
Shareholders
(stock market)
Misstatements
about product /
“channel stuffing”
Tellabs
(Notebaert)
… PSLRA strong inference of state of
mind (scienter) means … “a
reasonable person would deem the
inference of scienter cogent and at
least as compelling as any opposing
inference.”
… allegations must also be considered
“holistically” [isolated insider sales
not enough, must have unusual,
broad sales]
Ruth Bader Ginsburg
(civil rights lawyer)
… omissions and ambiguities [in the
plaintiffs’ allegations] count against
inferring scienter” [discount
confidential witnesses]
Reliance and causation …
1. FACTS
• Who are plaintiffs? Kind of suit?
• Were individual suits be viable?
Basic Inc. v. Levinson
(US 1988)
2. ISSUES
• Reliance in fraud action?
3. HOLDING
• Presumption necessary for class actions to
proceed
• Market performs valuation process: absorbs
publicly-available information into price
• Rebuttable presumption – unless market
knew or did not react OR individual plaintiffs
would have traded anyway
4. ANALYSIS
• Is ECMH part of law?
• Do investors really trust market price – see
White dissent?
• Shouldn’t Congress make policy decisions?
Shareholders
(stock market)
Three
“white”
lies
Basic Inc
5. CONCLUSION
• SFCA have life – compare to Delaware?
• Presumption rebutted in small companies
with few analysts?
Combustion
Engineering
merger negotiations
“… in open and developed securities
market .. Misleading statement defraud
purchasers of stock even if the
purchasers do not directly rely on the
misstatements.”
“… reliance is an element of a Rule
10b-5 cause of action.
“Presumptions typically serve to assist
courts in managing circumstances in
which direct proof for one reason or
another is rendered difficult.”
Justice Harry Blackmun
[MN lawyer]
How can presumption
be overcome?
“… I fear that the Court’s decision
may have many adverse,
unintended effects as it is applied
and interpreted in the years to
come.”
“… Court assumes buyers and
sellers rely on the “integrity of the
market price … which most
mystifies me.”
Justice Byron White
[former football player]
Class action counsel
(business model)
Investigate corporate disclosures …
… identify corporate “fiction” …
… followed by “surprise” …
… resulting in price drop …
… identify “scienter” …
… file complaint …
(e.g. Bay Networks, Inc)
… which must tell “fraud story” …
… to avoid “motion to dismiss”
Who pays?
Average settlement: $80 MM
Average attorney fees: 20%
2006 data
2004 data
2003 data
Atty fees
overview
Cross -subsidization …
Settlement
Selling shareholders
(windfall winners!)
Buying shareholders
(plaintiffs)
Holding shareholders
(losers!)
Payment
Insiders
(insider trading gains)
Corporate execs
(D&O insurance)
Corporation
The end
Class Counsel – Business Model
• Get started
– identify material corporate misrepresentations
– find appropriate shareholders to act as class representatives
– file a complaint in a court of class counsel’s choosing
• Take care of legalities
– defend the complaint against motion to dismiss (on legal
grounds)
– urge the judge to grant class action status to the litigation
– send notice to class members, giving them an option to
withdraw from the lawsuit
– undertake discovery of information from the company and
other sources
• Close the deal
–
–
–
–
enter into settlement negotiations with company officials
champion any settlement before the judge
administer settlement funds
appeal any adverse decisions by the trial court judge
Stanford Class Action Clearinghouse