The hour-long webinar will start at 2:00 P.M. EDT. To register please click here. To read a recent Securities Litigation Watch blog posting on this subject click here.

As head of research for ISS' Securities Class Action Services, I will moderate the panel. I will be joined by the following distinguished guest speakers:

Among their many publications, Professor Cox and Professor Thomas have co-authored several important articles addressing securities class actions and governance issues including Does the Plaintiff Matter?: An Empirical Analysis of Lead Plaintiffs in Securities Class Actions, 100 Columbia Law Review 101-155(2006), and There Are Plaintiffs and ... There Are Plaintiffs: An Empirical Analysis of Securities Class Action Settlements, 61 Vanderbilt Law Review 355-386 (2008). They also co-authored the often cited essay Leaving Money On the Table: Do Institutional Investors Fail to File Claims in Securities Class Actions?, 80 Washington University Law Quarterly 855-881.

• Pessimism that lead plaintiff status would not yield any appreciable benefits over being an unnamed claimant.
• Belief that significant financial resources and time would need to be devoted to discovery and monitoring outside counsel.
• Distraction of management from its primary responsibilities and that adverse reaction from company management would occur.
• Legal staffing resources--securities class actions require in-depth investigations of the potential merits of cases in which institutions may seek lead plaintiff status. This may be difficult for smaller legal staffs. The issue may be compounded by the short time-frame for filing a lead plaintiff motion (PSLRA requires 60 days from notification of the filing of the case).
•  PSLRA’s ban on attorney’s fees for in-house counsel. The use of outside counsel is not only more costly, but gives up a measure of control the institution has over the litigation.
• Negative publicity--institutions may not want to publicize that their investment experts were duped.
• Potential conflicts of interest.

The Cendant Settlement

Over time, however, perceptions began to change as institutions learned more about the lead plaintiff process and the possibilities it creates. Consequently, institutions, especially pension funds, began to seek lead plaintiff status more often. They started by targeting cases where they had substantial market losses, the defendant issuer was large, the allegations were meritorious, and the defendant firm was important to the institution as a long time investment. See Institutional Activism through Litigation, at 12. Such cases not only provided them opportunities to negotiate larger settlements but also to push for governance reforms to help stimulate long-term growth in the issuer defendant. This shift to increased institutional activism, which appears to have taken place in the late 1990s and early 2000s, was likely heavily influenced by landmark settlements, such as In Re Cendant Corp, 264 F.3d 201 (3^rd Cir. 2001), as well as backlash from highly publicized corporate scandals at companies like Enron and WorldCom in the early 2000’s. See Institutional Activism through Litigation, at 11.

• A stricter definition of director independence and a requirement that board’s audit, nominating, and compensation committees be entirely independent.
• The majority of the board would be independent within two years of final approval of the settlement.
• Annual election of directors.
• Changes to employee stock option re-pricing policies.

• UnitedHealth: Investors lead by CalPERS negotiated a $925 million settlement that included: thecreation of an independent lead director under certain circumstances; a shareowner-nominated director; enhanced independence standards; compensation policy changes; changes to the board structure; revised procedures for shareowner meetings; a stock retention policy; and creation of a nominating advisory committee.
• Take-Two Interactive: Investors led by the New York City funds negotiated a $20.1 million accord that included: a “clawback” provision to recoup equity grants in the event of a restatement; a policy requiring a shareholder vote on “poison pills” of 12 months’ duration or longer; and an advance notice bylaw.
• Sequenom: The Los Angeles City Employees' Retirement System, the lead plaintiff, negotiated a $14 million settlement with these governance provisions:  board composition/independence and compensation reforms;new board conduct standards (certification of independence, attendance, special meetings of the independent directors, agendas, meeting minutes, periodic reports, education programs); committee conduct standards (governance committee review, auditing committee meetings, disclosure committee meetings, and creation of new committees); andrevised employee handbooks and ethics manuals.
• Apple:  As lead plaintiff, the  New York City Employees' Retirement System obtained a $16.5 million accord that included: modification of the compensation committee’s charter (requiring, for example, consideration of “clawback” provisions for every executive grant); a stricter insider trading policy; changes to the company’s equity award practices; the appointment of the trading compliance committee; a new governance guideline to provide that at least one member of the compensation committee will not simultaneously serve on the board’s audit committee; new corporate minutes procedures; and director and officer training program

This article is derived from a longer paper, "Effective Corporate Governance Reform Through Securities Class Actions," by Luke Green. 

1. Ally Financial Inc. f/k/a GMAC, LLC
2. Bank of America Corporation
3. Barclays Bank PLC
4. Citigroup, Inc.
5. Countrywide Financial Corporation
6. Credit Suisse Holdings (USA), Inc.
7. Deutsche Bank AG
8. First Horizon National Corporation
9. General Electric Company
10. Goldman Sachs & Co.
11. HSBC North America Holdings, Inc.
12. JPMorgan Chase & Co.
13. Merrill Lynch & Co. / First Franklin Financial Corp.
14. Morgan Stanley
15. Nomura Holding America Inc.
16. The Royal Bank of Scotland Group PLC
17. Société Générale

The Economic Times reports (here) that, following FHFA's news release, BoA's shares fell more than 8.3 percent, while JPMorgan Chase dropped 4.6 percent and Goldman fell 4.5 percent. Mike May, an analyst from Credit Agricole stated that the actions will cause further delays to the housing recovery by requiring banks to pay for loans they made years ago. Fannie and Freddie are rumored to have cost taxpayers $153 billion since the economic meltdown in 2008. The complex FHFA litigation, which will likely take many years to work through, is estimated to cost an additional $363 billion through 2013.

While the multiple FHFA subprime actions are not class actions or fair fund government actions, they do demonstrate that ripples from the financial crisis are still being felt in the courts and are likely to be felt for quite some time. As explained by Kevin LaCroix of the D&O Diary here, only a small number of subprime securities class action cases have settled from the wave of litigation that started in 2008. However, given a recent spat of settlements against Wachovia ($627 million), Washington Mutual ($208.5 million), Wells Fargo ($125 million) and others there is reason to believe that more cases may be headed toward settlement.  

Background

For a federal securities class action to survive the court must certify the class pursuant to Federal Rule of Civil Procedure 23. This requires that the class must satisfy several elements of the certification test including commonality, adequacy, numerosity, and typicality among others. In the Wal-Mart case the primary focus was on the commonality prong of the test, or the requirement that "there are questions of law or fact common to the class." 

Wal-Mart v. Dukes was an employment discrimination suit brought on behalf of all female Wal-Mart employees. The class of female employees asserted that Wal-Mart's practice of allowing its managers discretion over pay and promotions, and their unwillingness to "cabin" or limit that discretion, was a "policy" that created a disparate impact on all female Wal-Mart employees.

The Wal-Mart decision appears to make the certification challenge more rigorous for plaintiffs by requiring the court to look beyond merely the plaintiffs' allegations to the underlying merits of their claims. In a blog post addressing Wal-Mart's impact on securities class actions Kevin LaCroix of the D&O Diary summed up one possible view of the Court's holding in Wal-Mart:

So, it seems, courts determining whether or not to certify a class should not rely on plaintiff’s mere allegations alone, but must examine the merits in order to determine whether or not the plaintiff has met the certification requirements. The “rigorous analysis” requirement apparently applies whenever a claimant seeks to proceed in the form of a class action, regardless of the nature of the underlying claim – including even when the alleged injury is asserted under the securities laws.

In his blog post Mr. LaCroix goes further and asks the question of whether Wal-Mart really makes certification in a securities class action more difficult in light of the recent Supreme Court decision in Halliburton (discussed at length here). Halliburton held that plaintiffs relying on the fraud-on-the-market theory need not show loss causation (i.e. factual reliance on misstatements or omissions) to obtain class certification. At first blush Halliburton and Wal-Mart seem to be contradictory when applied in the securities context since one seems to require a factual showing on the merits while the other does not. However, as Mr. LaCroix makes clear in his blog, footnote 6 of the opinion appears to resolve this matter. It states the following:

Perhaps the most common example of considering a merits question at the Rule 23 stage arises in class-action suits for securities fraud. Rule 23(b)(3)’s requirement that “questions of law or fact common to class members predominate over any questions affecting only individual members” would often be an insuperable barrier to class certification, since each of the individual investors would have to prove reliance on the alleged misrepresentation. But the problem dissipates if the plaintiffs can establish the applicability of the so-called “fraud on the market” presumption, which says that all traders who purchase stock in an efficient market are presumed to have relied on the accuracy of a company’s public statements. To invoke this presumption, the plaintiffs seeking 23(b)(3) certification must prove that their shares were traded on an efficient market...,an issue they will surely have to prove again at trial in order to make out their case on the merits.

Footnote 6 seems consistent with other language in Halliburton, which suggests that plaintiffs in securities cases may rely on the fraud-on-the-market theory (or the "rebuttable presumption of reliance") when they can show that the alleged misrepresentations were publicly known, that the stock traded in an efficient market, and that the relevant transaction took place after the misrepresentation and before the corrective disclosures were made. In other words, the Wal-Mart decision could be interpreted to hold that the rebuttable presumption of reliance in the securities context presents a unique certification standard that is an exception to the more rigorous fact-intensive certification test outlined in Wal-Mart for determining the commonality question.

AIG's Rigorous Standard Argument

Of course, AIG, in its defense, asserts in its memorandum rebutting the plaintiff's motion for certification  that Wal-Mart was a game changer for securities class actions. AIG argues that the plaintiffs merely "parrot" the language of Rule 23 and do not state factual and legal grounds sufficient to meet the "rigorous" standards set forth in Wal-Mart v. Dukes. The meat of AIG's argument focuses on the size and diversity of the class itself. Quoting heavily from the Wal-Mart decision, AIG argues that the plaintiffs not only pose a list of common questions to the class, but, they must also show that the 'truth or falsity' of their alleged common claims 'will resolve an issue that is central to the validity of each one of the claims in one stroke.' In Wal-Mart the Court reasoned that the size and scope of the class coupled with the fact that manager discretion creates an inconsistent "policy" rendered it virtually impossible for any court to answer the alleged common questions with "one stroke." Similarly, AIG argues in its memorandum that, because the "massive" class period spans two years with "three distinct market periods including different fact, different disclosures, and different securities," it presents questions of law or fact that are note consistent among the class and which cannot be confirmed as true or false with "one stroke."

AIG's argument is, as it states, a "common sense" one that focuses on the general nature of commonality and the attributes of the class. However, given the language in footnote 6 in the Wal-Mart case, AIG may have trouble overcoming the fraud-on-the-market theory that has been so prevalent in the certification of securities class actions. In any case, it will interesting to see how the trial court addresses the argument, if they go that far. A decision in AIG's favor on the ground that the class does not meet the "rigorous" fact-based standard outlined in Wal-Mart would likely create a whirlwind of controversy over the future of securities class actions. This is because, as the Supreme Court noted in the Wal-Mart case, "Rule 23(b)(3)’s requirement that 'questions of law or fact common to class members predominate over any questions affecting only individual members' would often be an insuperable barrier to class certification, since each of the individual investors would have to prove reliance on the alleged misrepresentation."

The consolidated class action complaint, filed by lead plaintiffs Orange County Employees' Retirement System, the Louisiana Sheriffs' Pension and Relief Fund, and the Southeastern Pennsylvania Transportation Authority, accused Wachovia of making misleading disclosures relating to the sale of securities between 2006 and 2008. The statements related to the quality of assets linked to the mortgage portfolio of Golden West Financial, a California home lender it had acquired. Specifically, the claims asserted that the Wachovia offering materials at issue misrepresented and/or omitted to disclose material facts concerning the nature and quality of Wachovia's  "Pick-A-Pay" mortgage loan portfolio, and that Wachovia's publicly disclosed loan loss reserves were in violation of Generally Accepted Accounting Principles ("GAAP").

According to Bloomberg News, Wells Fargo agreed to the settlement in order to avoid the "distraction, risk and expense of ongoing litigation," but admits no liability on the part of Wachovia. If the settlement is ultimately approved by Judge Richard J. Sullivan of the U.S. District Court for the Southern District of New York it would be among the 14th or 15th largest securities class action recoveries. It would also eclipse the Countrywide settlement ($624 million) as the largest credit-crisis related settlement to date. According to MarketWatch it is believed to be the largest settlement ever in a class action case asserting only claims under the Securities Act of 1933. And, it represents one of the handful of largest securities class action recoveries ever obtained where there were no parallel civil or criminal securities fraud actions brought by government authorities.

The hour-long webinar will start at 11 A.M. EDT (4:00 P.M. BST, 5:00 P.M. CEST). As head of research for ISS' Securities Class Action Services, I will moderate the panel. I will be joined by the following distinguished guest speakers:

*Beata Gocyk-Farber, a partner with Bernstein Litowitz Berger & Grossman LLP. Her practice focuses on securities fraud actions, complex commercial litigation, and trial practice. She was a senior member of the litigation and trial teams of some of the most noteworthy securities class actions in history, including the WorldCom and HealthSouth litigation. Gocyk-Farber also is in charge of the firm’s European institutional investor relations and is counsel to many of the firm’s European-based clients.

*Deborah R. Hensler, PH.D., Judge John W. Ford Professor of Dispute Resolution and Associate Dean, Graduate Studies, Stanford Law School. Professor Hensler is the organizer of the Stanford Globalization of Class Actions Exchange, which is spearheading international research on class actions and mass litigation, and the co-editor of the recently published volume, The Globalization of Class Actions. Professor Hensler is an associate research fellow of the Oxford Centre for Socio-Legal Studies, has taught at the University of Melbourne (Australia), and has been awarded a visiting professorship to Tilburg University by the Royal Netherlands Academy of Arts and Sciences.

To register for this webinar, please click here. To read a recent Securities Litigation Watch blog posting on the Morrison decision, please click here.

The success of plaintiffs' counsel in Vivendi was short-lived, however.  Vivendi's ordinary shares traded on the Paris Bourse while its American Depository Receipts (ADRs) were listed and traded on the NYSE. Following the Morrison v. NAB decision (discussed by Securities Litigation Watch here), the question remained whether Morrison's "transactional test" would preclude a portion of the Vivendi class from the forthcoming damages award. On February 22, 2011 Judge Richard Holwell of the U.S. District Court for the Central District of California applied Morrison to exclude purchasers of ordinary shares via the Paris Bourse even though they were registered with the SEC. While both U.S. and non-U.S. purchasers of ADRs on the NYSE remained in the class, the removal of purchasers of ordinary shares was estimated by Vivendi's counsel to have reduced the potential damages by as much as 90%.   

Given the forced exodus of purchasers of ordinary Vivendi shares in the U.S. case, the question becomes if, when, and where investors may pursue their rights against Vivendi in other countries. It appears that at least one investor association (here) has taken the lead in pursuing a collective action against Vivendi in France. However, the proposed action by the 'Les Petits Porteurs De Vivendi" or "Small Holders of Vivendi" underscores the trouble that investors face when pursuing class actions outside of the U.S. or Canada. The request for participation in the Small Holders of Vivendi defense association is simply that, a request for participation. Since no settlement or judgment has been reached, participation in the association does not in itself guarantee a successful outcome at trial or at the negotiation table. And, it comes with an initial fee of 95 Euros.

Only about 15 or so countries provide for what could be called a true collective action remedy that allows for some form of class representation and the possibility of a mass settlement or judgment. Most of these are "opt-in" countries in which the judgements are binding only on those who participate and/or pursue their claims in court. Therefore, many countries, like France, do not offer collective action remedies beyond the loose coordination of claims in mass or group actions. Even so, cases like the one being pursued in France by the Small Holders of Vivendi association do present some interesting cross-border questions.  For example, if a group action is pursued in a French court will that court entertain claims from non-French investors? Will the French court recognize the U.S. judgement as preclusive or allow purchasers of Vivendi ADRs to also pursue claims in France? Similarly, the question still remains whether heightened investor activity abroad, as a result of the Morrison decision, will inspire legislative reform in favor of more U.S.-like class action remedies. It seems that, at least in the Vivendi case, the fallout from Morrison may be having some impact abroad.

Other Notable International Updates:

Australia: In a press release issued by the law firm of Slater, Gordon it was reported that a class action settlement on behalf of more than 7,500 investors who purchased shares in the minerals resources company Oz Minerals in 2008 was settled by the Federal Court. Investors who purchased shares in Oz Minerals between February and December 2008 would share in at least $16 million in compensation, after the deduction of legal and funding costs. Slater & Gordon said the settlement was the first shareholder class action where multiple shareholder actions were issued, demonstrating that multiple actions were no barrier to resolving claims efficiently.

Mexico: According to the Standford Global Class Action Exchange (here), in July 2010 an amendment to the Mexican Constitution was published in Mexico’s Official Gazette of the Federation providing for class actions. Mexico’s federal Congress has a year to issue secondary legislation on how to regulate these collective actions.

Morrison Background

Prior to Morrison the "conduct and effects" test had been the dominant test in the circuit courts for determining whether plaintiffs trading in non-U.S. stocks had an implied right of action under the federal securities laws.  While application of the test often varied from circuit to circuit, at a minimum it allowed eligible U.S. investors who traded in non-U.S. stocks on non-U.S. exchanges to sue for securities fraud under federal law (so called f-squared cases). In many circuits, where significant fraud related conduct occurred in the U.S., the test was also used to apply subject-matter jurisdiction over non-U.S. plaintiffs who traded non-U.S. stocks on non-U.S. exchanges (so called f-cubed cases). Thus, the conduct and effects test allowed for truly multi-national securities class actions in certain circumstances.

The Morrison opinion expressly rejected the conduct and effects test as well as the possibility of f-cubed plaintiff actions. In its place, it created the seemingly more concrete "transactional test" for determining the extraterritorial application of the federal securities laws. The transactional test, the Court held, requires that federal securities fraud laws do not apply to  "transactions in securities listed on domestic exchanges, and domestic transactions in other securities."

At first glance, the transactional test seems to be a clear bar to suit for any securities traded on non-U.S. exchanges. However, despite the Court's stab at clarity, the transactional test did create a good bit of controversy among some experts in the field. Many plaintiff lawyers argued, for example, that the "listed on a domestic exchange" language meant that any securities listed on U.S. exchanges would make them eligible to sue regardless of where the alleged transaction actually occurred. However, this argument has been rejected by a number of lower courts in the Second Circuit. See Sgalambo v. McKenzie (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); In Re Alstrom SA (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).

Similarly, even arguments to allow suit for f-squared plaintiffs (i.e. those who were domiciled in the U.S. but who purchased non-U.S. securities on non-U.S. exchanges) were rejected by courts in the Second Circuit even if the transactions were executed from locations within the U.S. See Plumber's Union v. Swiss Re (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); In Re Societe General (US 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 US.); Porsche Automobile Holding SE (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.).

One year after Morrison there does seem to be at least some certainty within the Second Circuit on the interpretation and application of the Morrison transactional test. Transactions in securities on non-U.S. exchanges will likely not give rise to an implied right of action under the federal securities laws in these courts. In at least one case Morrison has also been extended to cover both '33 and '34 Act claims. See In Re Royal Bank of Scotland Group PLC (Applying Morrison to dismiss both '33 and '34 Act claims by plaintiffs who purchased RBS shares on a non-U.S. exchange). On the other hand, there do seem to be more questions than there are answers regarding the scope of Morrison in more novel cases. For example, it is unclear how courts will address over-the-counter transactions involving derivatives as well as ADR's. As discussed by the Securities Litigation Watch here, OTC derivatives are poised to fall within the actionable reach of Section 10(b) later this summer. Furthermore, ADR's 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). Such Morrison issues are likely to see continued litigation.

Adding to the uncertainty about Morrison, there are a variety of alternatives to Exchange Act claims that have not yet been fully explored including supplemental jurisdiction (i.e. applying the laws of the issuers country) and application of common law claims (discussed more fully by Securities Litigation Watch here). While none of these arguments have been successful to date, there is evidence that they would be legitimately entertained by courts in the Southern District of New York. Probably more telling of the uncertainty, however, is that no appellate opinion has been published either affirming or overruling the lower court rulings that have applied Morrison. This is not surprising considering that we are still only one year from the date Morrison was decided. Nevertheless, the court rulings that have come down to date in the Southern District of New York are not controlling precedent. Similarly, courts in the Ninth Circuit, another prominent circuit in securities class actions, have remained relatively silent on the matter. For example, in one of the few cases addressing Morrison in the Ninth Circuit, the U.S. District Court for the Central District of California ruled in Stack House v. Toyota Motor only that purchasers of Toyota stock on the Tokyo stock exchange could not be considered as lead plaintiff candidates.

Securities Class Action Trends and Predictions

When the Morrison decision was handed down in June 2010 many commentators, including Securities Litigation Watch, expected that the decision would, at a minimum, cause multi-exchange-based class action filings to all but dry up. Similarly, it was predicted by some that the decision would reduce the number of suits againt non-U.S. companies and possibly even boost class action litigation and litigation reform outside of the U.S. However, one year out from Morrison it appears that many of these predictions have not yet fully materialized.  

Due to the number of open questions still lingering about Morrison, it seems that many plaintiff law firms are still fully intent on fighting the good fight over the continued existence of multi-national securities class actions in the U.S. Thus, Morrison and its progeny have not necessarily discouraged plaintiffs and their law firms from pursuing multi-exchange litigation in many cases. For example, as Kevin LaCroix of the D&O Diary explains here, two recently filed credit-crisis related cases against Deutsche Bank (whose common shares trade on the NYSE and Frankfurt stock exchange) and Carlyle Capital Corp. (traded primarily on the Euronext Exchange) both include within their classes plaintiffs who engaged in security transactions on non-U.S. exchanges. Similarly, and surprisingly, securities class action suits against non-U.S. companies have not been reduced but have in fact increased in relationship to overall filings. For example, as Kevin LaCroix of the D&O Diary explains here, about roughly 30% of securities class action lawsuits filed so far during 2011 involve non-U.S. companies compared to 15.9 percent during all of 2010. It is important to note, however, a large part of the 2011 filings involve U.S.-listed Chinese companies, which, if removed, would drop the number of filing against such companies to well below historical averages (discussed more here).

Impact On International Securities Class Actions

Another interesting trend worthy of note is that non-U.S. securities class action filings have not seen much of a jump in the post-Morrison era. If anything there have been fewer such actions and those that have been lodged have been much lower profile. Interestingly, some of the more high profile international actions filed in the last couple of years appear to be spin-off litigation from parallel cases filed in the U.S. For example, commentators have noted that the Royal Dutch settlement in the Netherlands was pursued by Royal Dutch Shell as much as it was by the investors in an effort to get the U.S. courts to dismiss non-U.S. claimants on forum non conveniens grounds. It was, in other words, a clever way for the defendant to mitigate its exposure to higher settlement amounts in the U.S. by settling with non-U.S. claimants in a non-U.S. jurisdiction. Now that such claimants may, arguably, be barred from suit by law in the U.S. some non-U.S. defendants may be less likely to settle in outside of the U.S. where the class action laws may be more favorable to them.

International class action reform has not necessarily seen much of a boost after Morrison either. As discussed by Securities Litigation Watch here, a coalition of international pension funds recently lobbied the SEC to reverse Morrison pursuant to the SEC's request for comment on the "Extraterritorial Private Right of Action" provisions of the Dodd-Frank Act (discussed more here). While a strong reaction by international pension funds demonstrates notable investor interest in securities class actions, the form of that reaction is indicative of the futility of class action reform outside the U.S. As mentioned earlier in this post, many non-U.S. governments filed amicus briefs in favor of National Australia Bank in the Morrison case. Following that decision many such governments and respective ambassadors filed comments urging the SEC to support  Morrison's ban on extraterritorial application of U.S. securities laws. (See comments to the SEC on this issue here). Generally speaking, these non-U.S. governments do not support the extraterritorial assertion of U.S. jurisdiction because they deem it "inconsistent with established principles of international law and contrary to the principle of comity." They urge "respect for the sovereignty of other Nations." See Compliance Week for more details. This is code for the general disdain that many international governments have for the U.S. class action system.

One year after Morrison the world's largest international pension funds, including some U.S. based funds such as CalPERS, feel that it is more productive to lobby the U.S. government (even if it means overturning Supreme Court precedent) than to pursue reform abroad. Does this mean that reform abroad is not going to happen? No. But, the time horizon for such reform may be many years if Morrison stands-up to the test of time. While the Morrison decision is still hanging in the balance at the SEC or otherwise suffers from uncertainty or weakness, reform abroad will likely be stunted as well.

Impact On Filings and Settlements

The fallout from Morrison was also expected to impact settlement amounts, at least in cases involving an appreciable number of non-U.S. transactions. In some very large high-profile cases this seems to be the case. For example, in In Re Vivendi the court narrowed the plaintiff class by excluding those who purchased Vivendi common stock on non-U.S. exchanges. This resulted in an estimated 90% reduction in the expected plaintiff's damages. However, to date, the size of federal securities class action settlements does not seem to be significantly different than previous years. From June 24, 2010 when Morrison was filed to the present date the settlement average has hovered at just under $20 million, which is not out of step with historical averages. Similarly, post-Morrison federal securities class action filings, at roughly 290, are in step with previous years numbers.

Conclusion

One year after the Morrison decision U.S. claims administrators are starting to require exchange of trade data from claimants in order to address the application of Morrison by some courts. These lower court rulings are beginning to draw lines of delineation for application of U.S. securities fraud laws abroad. However, the clarity envisioned by Morrison along with its expected changes to the class action landscape have not yet fully materialized. There are still a number of open legal questions about the scope of the transactional test, especially regarding over-the-counter securities and ADRs. Furthermore, there currently is no controlling legal precedent, other than Morrison itself, to ensure consistency among the circuit courts. As a result of these uncertainties and the strong opposition to Morrison in many circles and other factors, securities class action filing and settlement trends have not yet changed. In some cases, such as suits against non-U.S. issuers, the exact opposite of what was expected has occurred. In any case, if Morrison does stick arund for the long-term some trends could start to change. The SEC could play a key role in that process. Under the Dodd-Frank Act the SEC is required to report the results of its study on the "Extraterritorial Private Right of Action" to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives no later than January 21, 2012. A rejection by the SEC of the transactional test could ultimately determine whether Morrison continues to develop and evolve or whether it becomes a relic of the past.

In the Janus Capital case, investors in a collection of mutual funds sued the Janus Investment Fund and the funds' investment advisor, Janus Capital Management (JCM), alleging that the mutual funds were managed in a way that was not consistent with what was reported in their prospectuses, which resulted in a loss to investors. The U.S. District Court in Maryland dismissed the case holding that neither of the defendants actually made or prepared the prospectuses. But, in May 2007, the Fourth Circuit Court of Appeals reversed the District Court's ruling finding that the investors asserted a viable claim under Section 10(b) because the defendants helped to draft and disseminate prospectuses with misleading statements.

Other News: In other news, The SEC reports (here) that it intends to take a "series of actions" in the comming weeks to clarify the requirements that will apply to over-the-counter security-based swaps as of July 16, 2011 (when Title VII of the Dodd-Frank Act becomes effective). As reported by Securities Litigation Watch here, Title VII's inclusion of security-based swaps within the definition of "security" for purposes of the securities fraud laws could place many parties at risk of being sued in a securities class action. This is in addition to the many new reporting and procedural obligations imposed by Title VII regarding parties dealing in security-based swaps. In its announcement the SEC states that it is planning to provide the public with "temporary relief" from the Dodd-Frank provisions. Stay tuned for updates as the SEC continues to define its policy regarding security-based swap developments.

In order to certify a class under Federal Rule of Civil Procedure 23 a court must decide a number of issues. In particular, FRCP 23(b)(3) requires a court to ascertain whether "the questions of law or fact common to class members predominate over any questions affecting only individual members..." In a securities fraud case, this consideration often turns on the issue of whether the plaintiffs relied on material misstatements or omissions by a corporate defendant in making purchases or sales in the securities at issue. Naturally, showing factual reliance on particular statements by an issuer for each individual class member in a class action would be antithetical to the purpose of a class action (i.e. to litigate common issues among the class). Also, it would be difficult for many investors to do so when markets are complex and "impersonal." Therefore, class members in securities class actions have traditionally relied upon the "fraud on the market" theory to create a presumption of reliance. The theory simply states that the market is efficient and takes into account all available public information in arriving at stock prices. Thus, investors are presumed to act on all available market information by purchasing or selling on the price of a stock alone.

The Fifth Circuit in Halliburton, however, took the rebuttable presumption of reliance one step further by requiring that loss causation must be proved as well to invoke the presumption of reliance necessary for class certification. Loss causation is an element of securities fraud that requires the plaintiff to show the causal connection between the material misrepresentation and the plaintiff's economic loss. In other words, the plaintiff must show that the corrective disclosures of the issuer defendant actually caused the stock price to fall and resulted in a loss. As one might imagine this is often difficult to show.

In a unanimous decision, the Supreme Court rejected the Fifth Circuit's approach and remanded the case back to the appeals court for a new ruling. In holding that loss causation is not required to invoke the rebuttable presumption of reliance at the certification stage, the Court distinguished "transaction causation" from "loss causation." The court found that "transaction causation" focuses primarily on the circumstances surrounding the investor's decision to engage in a transaction based on the stock's price fluctuations, which is directly relevant to the question of reliance. Loss causation, by contrast, "requires a plaintiff to show that a misrepresentation that affected the integrity of the market price also caused a subsequent economic loss." This requirement, the justices held, was not a prerequisite to invoking the rebuttable presumption of reliance and, therefore, is not required for a court to certify a class.

The Court's decision to reject the loss causation requirement is significant to securities class actions for very practical reasons. Most securities class actions settle once the court denies the defendant's initial motion to dismiss. This is due in large part to the stay on discovery. The PLSRA requires a stay on discovery once the defendant files its motion to dismiss. This prevents the plaintiffs from running up the defendant's litigation costs through discovery and forcing settlement before the court has a chance to determine the merits of the plaintiffs' claims. If the court denies the defendant's motion to dismiss the case moves to trial and the stay on discovery is lifted. Thus, because defendant's want to avoid the costs of litigating a case through trial, most cases are either dismissed or settled at the motion to dismiss stage.

In most cases, the denial of a defendant's motion to dismiss is typically a good indicator that the court will also certify the class. Thus, defendant's are further incentivized to settle when the motion to dismiss is denied. However, a requirement of loss causation at the certification stage could change this trend. If the court rules on the motion to dismiss before deciding whether to certify the class, defendant issuers may be incentivized to continue with the litigation even if a motion to dismiss is denied. Similarly, courts may be more reluctant to deny a motion to dismiss if they know that the plaintiffs will be unlikely to meet the burden of proving loss causation at the certification stage.

Proving loss causation as a prerequisite to class certification would almost certainly deal a serious blow to investors seeking to recover losses through securities class actions. In effect it would require the plaintiffs to prove most of their case on the merits at the certification stage. This would make class certification much more difficult to obtain, and therefore, would likely result in a much higher number of failed suits. This was demonstrative in the Fifth Circuit where, according to EPJ Fund special counsel Neil Rothstein of Kahn Swick & Foti, it has been almost impossible to get a securities class certified after Halliburton was decided.

Prior to the Supreme Court's decision in Halliburton other courts in the Second and Seventh Circuits had repeatedly seen cases where defendant's asserted loss causation arguments against class certification. After the Halliburton decision those arguments should be become a thing of the past. However, while the Supreme Court did unequivocally rule that showing loss causation is not required for class certification, its ruling was narrowed to that particular point. While it did provide some dicta on what is required for class certification in a securities class action, it did not establish a bright line test. Since the justices remanded the case back to the Fifth Circuit with little direction beyond the loss causation element, the Halliburton case may still not make it past the certification stage based on other elements that the plaintiffs will need to show. In any case, the Supreme Court's ruling bodes well for shareholders as the status quo in courts across the nation should continue unabated.  

International:

• 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.

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."