As the U.S. economy continues to recover from recession, it is clear that the judicial and regulatory landscape has changed for the financial community. Likewise, the same is true for the world of securities class actions. Many of the trends that developed in 2010 appear to have continued into 2011. Therefore, the discussion below provides a Q1 2011 updated on the most recent key developments impacting securities class actions.
- Stack House v. Toyota Motor (07/16/10) (C.D. Cal.) (Hon. Dale S. Fischer) - Court appoints a US purchaser of Toyota ADS's on a US exchange as lead plaintiff. Purchasers of Toyota stock on Tokyo stock exchange are not considered for lead plaintiff status because, per Morrison, the "transaction" took place in the foreign country through foreign brokers/sellers even though the ultimate purchaser was physically in the U.S.
- Cornwell v. Credit Suisse Group (07/27/20) (SDNY) (Hon. Victor Marrero) - Per Morrison, US based purchasers of Swiss issued shares traded on Swiss Stock Exchange have no cause of action under Section 10(b). "[R]ead as a whole, the Morrison opinion indicates that the Court considered that under its new test Section 10(b) would not extend to foreign securities trades executed on foreign exchanges even if purchased or sold by American investors, and even if some aspects of the transaction occurred in the United States."
- Sgalambo v. McKenzie (08/06/10) (SDNY) (Hon. Shira A. Scheindlin) - Morrison warrants dismissal where plaintiff purchased Canadian issued shares on Toronto Stock Exchange, despite registration of the non-U.S. issuer on the NYSE and with the SEC.
- Terra Sec v. Citigroup (08/16/10) (SDNY) (Hon. Victor Marrero) - Morrison warrants dismissal where plaintiff had purchased a Norwegian securities firm's fund-linked notes arranged by a US bank for sale to US investors. But, common law fraud and fraudulent misrepresentation claims entertained on the merits by the court.
- In Re Alstrom SA (09/14/10) (SDNY) (Hon. Victor Marrero) Morrison warrants dismissal where plaintiffs purchase non-U.S. issued shares on the Euronext exchange, but where those shares were also available for purchase as ADRs on a U.S. exchange. The fact that the purchases were initiated in the US is not dispositive. Supplemental jurisdiction to apply French law was rejected on grounds of judicial efficiency and existence of available remedies in France. "Though isolated clauses of the [Morrison] opinion may be read as requiring only that a security be "listed" on a domestic exchange for its purchase anywhere in the world to be cognizable under the federal securities laws, those excerpts read in total context compel the opposite result."
- In Re Societe General (09/29/10) (SDNY) (Hon. Richard M. Berman) - U.S. purchasers of non-U.S. issued securities on the Euronext Paris stock exchange have no cause of action under Section 10(b) even though they purchased them while in the U.S. Also, ADRs traded over-the-counter in the U.S. cannot serve as a basis for a Section 10(b) action. "SocGen's ADRs 'were not traded on an official American securities exchange; instead, ADRs were traded in a less formal market with lower exposure to U.S.-resident buyers...'" "Trade in SocGen ADRs is a 'predominately foreign securities transaction.'"
- Plumber's Union v. Swiss Re (10/04/10) (SDNY) (Hon. John G. Koelti) The purchase of securities on a Swiss stock exchange from a location in the U.S. is insufficient to subject the purchase to coverage under Section 10(b). The court mentions in a footnote that the plaintiff did not fully pursue a claim under Swiss law. The court entertains the possibility of state common law claims.
- Porsche Automobile Holding SE (12/30/2010) (SDNY) (Hon. Harold Baer, Jr.) Applying Morrison, dismissed hedge fund claims of fraud in connection with purchase of security swap agreements. The case was dismissed even though the swaps did not trade on any exchanges and all of the steps necessary to transact the swap agreements were allegedly carried out in the U.S.
- In Re Royal Bank of Scotland Group PLC (01/11/11)(SDNY) (Hon. Deborah A. Batts) Applying Morrison to dismiss both '33 and '34 Act claims by plaintiffs who purchased RBS shares on a non-U.S. exchange.
- In Re Vivendi Universal, S.A. (02/17/11)(SDNY)(Hon. Richard J. Holwell) Applying Morrison court narrowed the plaintiff class by excluding those who purchased Vivendi common stock on non-U.S. exchanges.
Generally speaking, lower federal courts have applied Morrison to reject securities fraud claims by investors who traded their securities on non-U.S. exchanges regardless of where the purchaser is domiciled or the type of security involved. ADR's, for example, have been held actionable under Morrison's transactional test with the notable exception of ADR's purchased over-the-counter (which were excluded by Judge Berman in In Re Societe General). Interestingly, as noted by as a recent study conducted by PwC (here), continued litigation is expected regarding the application of Morrison to non-exchange traded securities such as derivatives and over-the-counter ADRs.
Given the bar on non-U.S. traded securities one would expect to see fewer class actions against international issuers. However, as the PwC study found, there was a 35% increase in the number of cases brought against international issuers with nearly half of those cases being brought against Chinese based companies. Other drivers, according to PwC, were M&A cases in the second half of 2010 and cases filed against for-profit educational institutions.
As discussed recently by the D&O Diary here and here, the trend toward actions against Chinese companies has continued in 2011 with at least 11 suits filed already. It is important to note that, while many of these companies have their principal place of business in China, most of them are incorporated in the U.S. and are listed on a U.S. exchange. Even if the companies were not incorporated in the U.S., the fact that they are listed on a U.S. exchange and trade on a U.S. exchange pulls many of their shares within the reach of Morrison's transactional test and exposes them to liability under U.S. federal securities laws. The Court's opinion in Morrison (here) expressly rejects jurisdictional analysis as a basis for hearing "extraterritorial" U.S. securities fraud cases. The transactional test, at least as it has been interpreted by the lower courts thus far, looks at whether the security at issue was traded on a U.S. exchange or not. In sum, a more interesting statistic regarding suits against non-U.S. issuers would be the number of suits filed against non-U.S. issuers that do not trade regularly on a U.S. exchange.
As discussed by Securities Litigation Watch here, the Dodd-Frank Reform Act authorizes the SEC to conduct a study on whether the federal securities fraud laws should allow private parties to bring extraterritorial claims (essentially overruling the Morrison decision). The SEC issued a request for comments in October 2010 (here) and has since had a large number of comments submitted (available here). The Morrison decision has spawned vigorous debate among interested parties, especially investors who are concerned that they will be left unprotected from fraud when trading securities outside of the U.S. Comments submitted by a coalition of non-U.S. pension funds (discussed here) is telling of the impact that the Morrison decision has had and will have on many institutional investors. According to the 10b-5 Daily blog (here), commentators on this issue included current litigants in cases with extraterritoriality issues, forty-two law professors, the U.S. Chamber of Commerce, and the governments of Australia and France. The SEC will report on the results of its study and make recommendations to the Senate Banking Committee and the House Financial Services Committee in January 2012. Given that the House of Representatives is now controlled by Republicans it will be interesting to see how the matter plays out. A decision by Congress to uphold Morrison could have far reaching implications for U.S. securities class actions as well as those abroad (discussed in more detail by Securities Litigation Watch here).
U.S. Supreme Court
Matrixx Initiatives, Inc. v. Siracusano (materiality standard) - In a rare victory for investors, the U.S. Supreme Court ruled here that drug companies don’t have to wait to receive "statistically significant" complaints about their products before they are required to disclose those reports to investors. On March 22, the justices ruled unanimously in favor of investors who had sued Mattrixx Initiatives over its failure to disclose reports that its Zicam cold remedy had caused some users to lose their sense of smell. The Arizona-based company argued that it should not have a disclosure obligation unless the reports were statistically significant.
In an opinion written by Justice Sonia Sotomayor, the court said a company’s duty to disclose hinges instead on whether a reasonable investor would regard the omitted fact as a significant part of the "total mix" of information that affects a decision on whether to buy or sell stock. This ruling should resolve the previous split in the circuit courts on the issue of the need to plead statistical significance in order to establish the materiality of a securities fraud claim.
In Re Apollo Group (loss causation) - On March 7, 2011 the Supreme Court denied certiorari in the Apollo case. The plaintiff's in this case claims that Appollo Group failed to disclose the existence of a government report finding that its wholly-owned subsidiary had violated Department of Education regulations. After a jury trial, the plaintiffs won a $277.5 million verdict. The trial court, however, held that the plaintiffs did not provide any new fraud related material than that already disclosed in the government report that was already known by the public. The plaintiffs appealed to the Ninth Circuit, which held that the jury could have found the reports were "corrective disclosures" in that they provided additional fraud-related information that deflated the stock price. The Ninth Circuit's decision added to the complexity of a Circuit court split on the issue regarding the timing of when the market must react to "correctivedisclosures" in order for the plaintiffs to prove loss causation. According to a memo in the case quoted by the 10b-5 Daily blog (here):
"The five circuits that have addressed the timing of the loss are divided. The Second and Third Circuits have held that a securities-fraud plaintiff must demonstrate that the market immediately reacted to the corrective disclosure. Conversely, the Fifth, Sixth, and Ninth Circuits have held that the price decline may occur weeks or even months after the initial corrective disclosure. By denying certiorari in Apollo Group, the Supreme Court left this split unresolved."
Halliburton (loss causation) - On April 25, the Supreme Court will hear oral arguments in a case, Erica P. John Fund v. Halliburton, that involves the proof that plaintiffs need to present in securities fraud lawsuits to obtain class certification. Specifically, the justices will consider whether investors must prove loss causation before receiving class certification, or is loss causation a question that should be left for trial?
The investors originally filed suit in 2002. They contend that Halliburton officials deliberately misled the public about the company's liability for asbestos claims; its probability of collecting revenue on fixed-price construction contracts; and the benefits of a merger with Dresser Industries. A coalition of 16 public pension funds, a group of law professors, the National Association of Shareholder and Consumer Lawyers, the North American Securities Administrators Association, and the U.S. government have filed amicus briefs in support of the investors. The Securities Industry and Financial Markets Association, another group of law professors, and various industry and insurance groups have filed briefs in support of the company.
The Court's decision could have significant implications for defendants as their ability to end meritless cases early in the litigation will increase if they can address the issue of loss causation as an element of the certification process. The Supreme Court likely will issue its decision by the end of June.
Statistics and Trends
As previously stated, the rash of filings against Chinese based companies in 2010 continued through Q1 2011. Other trends have continued as well, including the increased prevalence of M&A class action suits discussed in detail by the D&O Diary here.
There were also a number of research reports issued in Q1 reviewing securities class action trends for the year 2010. Securities Litigation Watch covered them here (Cornerstone's 2010 settlement study), here (studies by Advisen and Cornerstone on 2010 filings), and here (NERA Economic Consulting 2010 study). The most recent study on 2010 statistics and trends was release by PwC (available here) and discussed at length by the D&O Diary (here).
The PwC study, which covers federal cases, is packed full of both statistical information as well as thought provoking commentary and analysis. It is well worth a read if you are wanting an overview of the current state of securities class actions. Below are some of the key highlights from the study.
- Credit-Crisis Filings - Continued to decline. Notably, securities class action filings still increased from the previous year.
- Number of Filings - After a slow start, federal securities class action filings increased in 2010 by 12 percent from 2009. Overall filings reached the second highest level in the last five years. This was despite a continuing decline in the number of financial-crisis-related filings. PwC attributes this trend to increased filing activity against educational companies, Chinese domiciled companies, an increase in health industry cases, and a continued increase in M&A related cases. While filings against financial services firms still dominated, such filings decreased significantly as did filings against Fortune 500 companies. Filings against firms in the health, technology, and utilities industries experienced notable growth.
- Federal Court of Choice - As other reports on 2010 have indicated, PwC also noted a shift in filings from the Second Circuit to the Ninth Circuit. This reversed a trend of Second Circuit dominance running from 2005 to 2009.
- Settlement Numbers - The number of settlements in 2010 increased slightly from 2009 and eclipsed the average number of settlements since the PSLRA by a good margin. However, the total value of federal settlements decreased by 9 percent to $2.9 billion, compared to $3.2 billion in 2009. The average settlement amount decreased by 11% to $30.1 million. On the other hand, the average settlement for more than $1 million and less than $50 million increased by 21%.
- Top Settlements - The top ten settlements in 2010 amounted to $1.8 billion and represented 64% of the total value of settlements. Six of the top ten settlements were above $100 million.
- Institutional Investors - In 2010, 52% of filings had an institutional investor assigned as lead plaintiff (up from 46% in 2009). Pension funds, as in the past, constituted the majority of the institutional investor lead plaintiffs in 2010, representing 68% of the filings with institutional lead plaintiffs. The number of institutional investor settlements also increased by 5% in 2010 and eight of the top 2010 settlements involved institutional investors as lead plaintiffs.
- SEC and DOJ - Filings by the SEC and DOJ rose only slightly in 2010. But, their overall activities increased significantly. For example, the SEC obtained increased penalties and disgorgements and increased its number of reported enforcement cases as well as the number of investigations it opened and closed. It also completed the restructuring of its enforcement division and continued internal reforms.
- Dodd-Frank Act - Significantly expanded the SEC's authority, reach, and enforcement capabilities, including expanded oversight over market participants not previously subject to registration and regulation. The Act's new whistleblower program could also produce a surge in allegations of securities violations.
It is worth noting that, while the average settlement amount appeared to drop in 2010 according to PwC, many of the credit-crisis related suits have yet to settle (discussed more here). Similarly, PwC speculates that "a number of settlements will be reached in cases where motions are denied in 2011, which may increase the median size of securities class action settlements compared to previous years." Ultimately, however, what can be said with some degree of certainty is that the future of securities class actions will be quite a departure from the past. As PwC observed, the regulatory landscape is "vastly different in 2010 from what it was just one year ago, and companies will have to devote significant resources to understanging and adapting to its new topography."