April 29, 2011
SEC Brings Fraud Charges Against Magnum d'Or Resources and Former CEO
The SEC filed a civil action in the United States District Court for the Southern District of Florida against Magnum d'Or Resources, Inc. and its former chief executive officer and president Joseph J. Glusic of Henderson, Nevada, for antifraud and registration violations and against Dwight Flatt of Delray Beach, Florida, David Della Sciucca, Jr. of Fort Lauderdale, Florida, and Shannon Allen of Miami, Florida for registration violations.
According to the SEC's complaint, Magnum issued stock pursuant to false Form S-8 registration statements, and used bogus consultants to funnel more than $7 million in illicit stock proceeds back into the company. The SEC alleges that in facilitating this kickback scheme, Magnum garnered the assistance of Flatt, Sciucca, and Allen who liquidated Magnum S-8 stock, kept a portion of the sales proceeds, and then returned more than $7 million of the remaining sales proceeds to Magnum under the guise of loan agreements. The SEC's complaint also alleges that Magnum made false and misleading statements in its Form S-8 registration statements and in various press releases during the relevant time period.
Glusic and Allen have agreed to settle the charges against them. Glusic has also agreed to pay disgorgement of $1,878 with prejudgment interest of $231, and a $50,000 civil penalty. Allen has agreed to pay disgorgement of $80,742 with prejudgment interest of $6,258 and a $25,000 civil penalty and to surrender for cancellation approximately 1.4 million shares of Magnum common stock.
SEC Halts Alleged Ponzi Scheme by Co-Founder of China Voice Holding Corp.
The SEC obtained a court order freezing the assets of China Voice Holding Corp., which trades in over-the-counter markets and claims to have a portfolio of telecommunications products and services in both the U.S. and China. The SEC alleges that China Voice's co-founder and his two associates are operating an $8.6 million Ponzi scheme and misusing its proceeds, in part, to help fund the company's operations.
According to the SEC, David Ronald Allen, who also was China voice's chief financial officer, and his associates Alex Dowlatshahi and Christopher Mills promised investors in a series of offerings of limited partnerships that they would earn returns of at least 25 percent on their investments. Investors were falsely told that their money would be loaned to companies with a demonstrated track record and large profit margins. Instead, Allen and his cohorts used investor funds to pay back investors in earlier partnerships and funneled investor money to China Voice and a complicated web of other companies that Allen controls. Allen and his associates also siphoned investor money to enrich themselves and family members.
In addition to the Ponzi scheme, the SEC's complaint filed in U.S. District Court for the Northern District of Texas (Dallas Division) charges China Voice, its former chairman and CEO William F. Burbank IV, and Allen, with a series of fraudulent company statements about its financial condition and business prospects. Among other things, the SEC alleges that China Voice greatly overstated the value of certain business relationships and misled investors by failing to disclose significant loans from related parties needed to fund its operations.
April 28, 2011
Shareholders at NYSE Euronext Annual Meeting: Talk to NASDAQ/ICE
The much-anticipated annual meeting of NYSE Euronext was held today, and, as expected, many shareholders wanted to know why the board didn't want to meet with unwelcome suitors NASDAQ/ICE about their bid. According to Chairman Jan-Michel Hessels, the board saw "no reason to meet with them." The shareholders reelected the directors by an estimated 80% approval; before the meeting, some suggested that an approval rate of 70-75% would indicate shareholder dissatisfaction. Shareholders also adopted a provision that would allow shareholders holding 10% of the common shares to call a special meeting.
A special meeting to vote on the Deutsche Boerse merger proposal is scheduled for July 7.
SEC CHARGES FORMER HEDGE FUND PROFESSIONAL WITH INSIDER TRADING
The SEC today charged Jonathan Hollander, a former hedge fund professional, with insider trading in Albertson’s, LLC based on material nonpublic information regarding an impending acquisition of ABS that Hollander received from a friend who was employed by the financial advisor retained by ABS in connection with impending acquisition. The Complaint alleges that Hollander traded ABS securities on the basis of the material nonpublic information and also tipped a family member and another friend (the tippees) who also traded ABS securities. As a result of their trading, Hollander and his tippees generated $95,807 in illegal profits.
The Complaint alleges that on January 12, 2006, Hollander purchased a total of 5,600 shares of ABS stock in his personal brokerage accounts. The Complaint further alleges that around the same time Hollander’s family member purchased 425 ABS call options. The Complaint also alleges that on January 17, 2006, the next business day after visiting with Hollander, Hollander’s friend purchased 25 ABS call options and on January 18, he purchased an additional 15 ABS call options.
On Monday, January 23, 2006, prior to the opening of trading, ABS announced it would be acquired by a consortium of buyers. Following the public announcement, Hollander’s tippees sold their ABS holdings. Hollander’s family member made a profit of $72,815 and his friend made a profit of $5,250. Hollander earned a profit of $17,742 in his own brokerage accounts.
Without admitting or denying the SEC’s allegations, Hollander agreed to settle the charges against him, to pay disgorgement of $95,807 plus prejudgment interest of and a civil penalty of $95,807. Hollander also consented to the entry of a Commission order, based upon the entry of a final judgment, barring him from association with a broker, dealer, investment adviser, municipal securities dealer or transfer agent with the right to reapply after three years.
April 27, 2011
SEC & CFTC Propose More Rules on Swaps
The SEC today voted unanimously to propose rules further defining the terms “swap,” “security-based swap,” and “security-based swap agreement.” It also proposed rules regarding “mixed swaps” and books and records for “security-based swap agreements.” The rules were proposed jointly with the Commodity Futures Trading Commission (CFTC) and stem from the Dodd-Frank Act.
Public comments on the rule proposal should be received within 60 days after it is published in the Federal Register.
SEC Proposes Rules to Remove References to Credit Ratings
The SEC today voted unanimously to propose amendments that would remove references to credit ratings in several rules under the Exchange Act. These proposals represent the next step in a series of actions taken under the Dodd-Frank Act to remove references to credit ratings within agency rules and, where appropriate, replace them with alternative criteria.
Public comments on the rule amendments should be received within 60 days after they are published in the Federal Register.
April 26, 2011
Former Banco Santander Analyst Settles Insider Trading Charges with SEC
The SEC announced on April 25 that former Banco Santander S.A. analyst Juan Jose Fernandez Garcia of Madrid, Spain, has agreed to pay more than $625,000 to settle insider trading charges against him. The SEC accused Garcia in August 2010 of illegally trading in advance of a corporate takeover by a company that Santander advised. The SEC previously filed an emergency court action and obtained an ex parte temporary restraining order and asset freeze over the funds held in Garcia’s brokerage account. The SEC alleged that Garcia just days earlier had traded on the basis of material, nonpublic information about a multi-billion dollar cash tender offer by BHP Billiton Plc to acquire Potash Corp. of Saskatchewan Inc. At the time, Garcia was the head of a research arm at Santander, a Spanish banking group advising BHP on its bid. Garcia purchased 282 call option contracts for Potash stock in the days leading up to the public announcement, and immediately sold all of his options following the announcement for illicit profits of $576,033.
The settlement with Garcia requires the approval of U.S. District Judge Marvin J. Aspen in the Northern District of Illinois.
Still Thinking About Halliburton
I'm still mulling over yesterday's oral argument; Erik Gerding's insightful posts over at The Conglomerate have helped me to work through some issues. Perhaps it's rash, but I'm going to suggest the framework for the Court's opinion, one that I think there is a reasonable chance of getting at least a majority of the Justices to agree to.
First, it will reverse the 5th Circuit and find that loss causation is not an appropriate issue at the class certification stage. There was no support for the 5th Circuit's opinion, not even from the Halliburton attorney. Loss causation is the ultimate merits determination, as Dura makes clear. The plaintiff will have to establish that there was both a misrepresentation that caused an artificially inflated price and a corrective disclosure that removed that artificial inflation. Moreover, under Rule 23(b)(3), loss causation is a common issue.
Second, it will reaffirm Basic and state that in order to obtain the rebuttable presumption of reliance (thus making reliance a common issue), plaintiff must, at the class certification stage, establish an efficient market for the stock. This can be done by plaintiff's showing that the stock prices generally react promptly to material information. Courts have required plaintiffs to do this since Basic, and, as Erik noted, there are any number of ways that this can be done, such as event studies and expert testimony.
What else, if anything, should the Court say about reliance and loss causation, beyond emphasizing that they are separate elements?
As Erik identified, the problem is when can the defendants rebut the presumption of reliance and should the Supreme Court address this? Suppose that, at the class certification stage, plaintiffs introduce evidence that stock prices generally respond to new information, and defendant wants to introduce evidence that the price did not react to the particular corrective disclosure at issue. So, he argues, this proves that the market was inefficient as to this particular type of information! Should the court allow this? Plaintiff's attorney argued that Basic requires rebuttal of reliance (other than general disproving market efficiency) at the merits stage, but Justice Alito, at least, was skeptical of this. If defendants can introduce this evidence at the class certification stage, it would allow the 5th Circuit on remand to reach the loss causation issue via the reliance route. Justice Scalia made this point explicitly.
If defendants have an event study that demonstrates that the price did not react to this particular corrective disclosure, why not allow it at the class certification stage? Wouldn't that save time and expense of going forward with a claim that will ultimately lose on the merits? Erik sets forth the reasons why it may appear that the stock price did not move in response to the corrective disclosure because the defendant can bundle good news and bad news to mask the effect of the corrective disclosure. Unfortunately, the plaintiff's attorney and the government attorney did not make this point as persuasively as Erik does.
So this may be, after all, a Pyrrhic victory for plaintiffs.
April 25, 2011
NASDAQ/ICE Statement to NYSE Euronext Investors
NASDAQ OMX (NDAQ) and IntercontinentalExchange (ICE) today issued a joint statement on their proposal for NYSE Euronext:
NYSE Euronext investors should be highly skeptical that after two years of exploratory merger discussions, including more than six months dedicated to finalizing the transaction, NYSE Euronext has suddenly found a reported €100 million in additional synergies. This increase appears not to be a matter of sharpening a pencil, but an unexplained shift in strategy. The discovery that initial synergies having been understated by one-third comes after receiving a superior proposal from NASDAQ OMX and ICE that achieves greater synergies.
Importantly, if there are additional synergies to be found after the merger economics have been agreed, then it has to come at the expense of NYSE Euronext stockholders because there has been no increase in the price they are being offered. NYSE Euronext should describe these newly-found synergies in detail in order to support the credibility of these revised estimates, particularly in light of commitments to retain two technology platforms and two headquarters. Increasingly it appears that NYSE Euronext is more focused on protecting the transaction than its stockholders.
NASDAQ OMX and ICE have described in detail our proven and focused long-term strategy from which stockholders would benefit and our companies demonstrated outperformance relative to their proposed strategy of creating a financial supermarket. We look forward to having the same opportunity when the NYSE Euronext Board agrees to due diligence.
U.S. Supreme Court Hears Oral Argument in Halliburton
Here are my initial thoughts after reading the transcript of today's oral argument in Erica P. John Fund v. Halliburton Co.:
The most important message: Nobody, not even defendant's counsel, supports the Fifth Circuit's position that requires plaintiffs to prove loss causation at the class certification stage.
The plaintiffs' and government's oral arguments, and their colloquys with the Justices, were rather bland. Petitioner-Plaintiff's argument was relatively straight forward: loss causation is a common issue and not appropriate at the class certification. The Justices asked a number of questions but, with the possible exception of Justices Scalia and Alito, no one seemed inclined to revisit the Basic presumption or reach other policy issues.
The Justices asked the fewest questions of the attorney for the government, who argued as amicus curiae supporting Petitioner. Whether this reflects a deference for the government's position (who agreed with plaintiff) or whether the Justices were simply taking a breather, of course, can't be known.
The transcript became a more interesting read with the defendants' oral argument and the Halliburton attorney's herculean effort to revise the Fifth Circuit's holding so that it is really all about the Basic presumption of reliance. As articulated by Halliburton's attorney, the Fifth Circuit wasn't focusing on loss causation at all, but price impact. Since the Basic presumption is rebuttable, any showing that severs the link between the misrepresentation and stock price defeats the presumption. After being pressed by Justice Kagan, he also allowed that (contrary to the 5th Circuit, which put the initial burden of production on plaintiff) Basic puts the initial burden on the defendant to show absence of price impact; once that is met, the burden is on the plaintiff to show by a preponderance of the evidence that the market price was distorted. This is, he asserts, all part of the Basic reliance presumption and is so much less onerous than establishing loss causation.
Justices Ginsburg and Kagan separately made the observation that it seemed that defendant's argument essentially requires the plaintiffs to prove their case on the merits at the class certification stage. No, not at all, asserted defendant's attorney. Justice Kagan: "in your world the Basic presumption is not worth much."
Justice Scalia dropped a hint of where he might be going. He asked the plaintiff's attorney why not just agree that loss causation is not required at the class certification stage and remand to the Fifth Circuit to adopt the theory that defendants say they've already adopted. That would be a pyrrhic victory for plaintiffs, he observes. Plaintiff's attorney argued that would be a really bad result since loss causation and reliance are two distinct elements, but it's not clear he got that argument across.
My impression, which of course could prove to be totally wrong, is that, consistent with other recent securities opinions, the Justices are not looking to revisit Basic or address larger policy questions. They don't want to adopt the most extreme Circuit position (remember they didn't adopt the 8th Circuit reasoning in Stoneridge that would have eliminated "scheme liability"), but there's no indication that they want to relax the requirements for class certification.
I look forward to reading others' initial reactions.
Morgan Stanley & TD Ameritrade Agree to Repurchase ARS from New Jersey Retail Investors
On April 21 the New Jersey Division of Consumer Affairs, through its Bureau of Securities, announced that it signed final Consent Orders requiring Morgan Stanley and TD Ameritrade to repurchase auction-rate securities (ARS) from New Jersey clients to settle allegations that the firms sold ARS without disclosing known risks of the ARS market.
Under the terms of the settlements, Morgan Stanley, an underwriter of ARS, has agreed to offer the repurchase of $322.7 million in ARS sold to retail investors in New Jersey. Morgan Stanley also will pay $1.56 million in civil penalties to the State, under terms of the Consent Order. As part of its findings, the Bureau determined that Morgan Stanley failed to adequately train all of its brokers and financial advisers about the potential illiquidity of ARS and never disclosed increasing risks of owning or purchasing ARS to its customers even as the firm became aware of increasing strains in the ARS market.
TD Ameritrade, a distributing or “downstream” broker-dealer who sold ARS, has repurchased $16.1 million of the ARS it sold to retail investors in the state. The Bureau found, among other things, that TD Ameritrade’s registered representatives failed to provide customers with adequate and complete disclosures regarding the complexity of the auction process and the risks associated with ARS.
SEC Releases Study on Section 404(b) Required by Dodd-Frank
On April 22 the SEC posted on its website the staff's Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 For Issuers With Public Float Between $75 and $250 Million, as Required by Section 989G(b) of of the Dodd-Frank Act. That section required the SECto conduct a study to determine how the Commission could reduce the burden of complying with Section 404(b) of the Sarbanes-Oxley Act for companies whose market capitalization is between $75 and $250 million, while maintaining investor protections for such companies. Section 989G(b) also provides that the study must consider whether any methods of reducing the compliance burden or a complete exemption for such companies from Section 404(b) compliance would encourage companies to list on exchanges in the United States in their initial public offerings.
This study addresses the auditor attestation requirement with respect to an issuer‘s internal control over financial reporting and does not address management‘s responsibility for reporting on the effectiveness of ICFR pursuant to Section 404(a). The research discussed in this study primarily focuses on findings related to accelerated filers. According to the Executive Summar:
[I]n conducting this study, the SEC Staff‘s research and analysis considered certain existing information about Section 404 compliance beyond the specific areas of the study requirements as provided in the Dodd-Frank Act. This approach was used to develop findings and recommendations regarding Section 404(b) through the analysis of existing research, even though the purpose of the existing research may have been broader than the requirements of the current study.
* * *
The information compiled for the study provided the Staff with an understanding that:
The costs of Section 404(b) have declined since the Commission first implemented the requirements of Section 404, particularly in response to the 2007 reforms;
Investors generally view the auditor‘s attestation on ICFR as beneficial;
Financial reporting is more reliable when the auditor is involved with ICFR assessments; and
There is not conclusive evidence linking the requirements of Section 404(b) to listing decisions of the studied range of issuers.
The Study sets forth two principal recommendations:
1. Maintain existing investor protections of Section 404(b) for accelerated filers, which have been in place since 2004 for domestic issuers and 2007 for foreign private issuers
2. Encourage activities that have potential to further improve both effectiveness and efficiency of Section 404(b) implementation
April 24, 2011
Thinking About Halliburton
Erica P. John Fund v. Halliburton Co. will be argued tomorrow before the U.S. Supreme Court, and my friends at The Conglomerate are engaged in a roundtable discussion of the issues, in which they have graciously invited me to participate. Eric Gerding started off the discussion with an excellent summary of the issues. I'm reposting here my opening comment:
I'm Barbara Black, otherwise known as SecuritiesLawProf, and I'm visiting on Conglomerate for the next day or so to comment on Erica P. John Fund v. Halliburton Co., which will be argued tomorrow in the U.S. Supreme Court. Eric Gerding has written an excellent post to start off the Roundtable discussion, and I want to thank him for inviting me to participate, perhaps to provide a historical perspective. In 1984, I was an untenured faculty member, looking for the “next big thing” in securities law to write about. Fortunately for me, I picked the fraud on the market theory, and my article was quoted by both the majority and dissenting opinions in the Supreme Court’s 1988 opinion in Basic Inc. v. Levinson.
A bit of background might be in order for those who do not regularly think about these issues. Until Basic, the reliance element of a Rule 10b-5 claim, and the implication that this involved individual issues of fact, threatened to doom the use of the class action device in securities fraud actions. After Basic, at least in efficient markets, reliance was a common issue, and a class of investor-plaintiffs could be certified under F.R.C.P. 23(b)(3). At the time of Basic, the FOTM was a nascent theory; the Supreme Court, however, did not see its task as “assessing the general validity of the theory,” but to address a narrower question: “whether it was proper for the courts below to apply a rebuttable presumption of reliance, supported in part by the fraud-on-the-market theory” (emphasis added).
After Basic, critics of the Rule 10b-5 class action sought legislatively to reverse the outcome. Congress, however, in the 1995 PSLRA legislation, made clear its purpose was to reform the securities fraud class action, not to kill it, and it rejected efforts to eliminate the FOTM presumption. After PSLRA, the Court has seen its task as implementing Congressional intent in the area of securities fraud class actions (see Stoneridge). Critics of the federal securities class action won a major victory in the Fifth Circuit with the 2007 Oscar decision, in which the Fifth Circuit announced its requirement that plaintiffs prove loss causation at the class certification stage, as a further check on the efficiency of the markets, because of the powerful impact of the Basic presumption. If the Supreme Court adopts the approach of the Fifth Circuit, maintaining a federal securities fraud class action will become extremely difficult.
As Eric states in his post, a fascinating question (beyond the outcome) is how the Court will arrive at its decision. It would be easy for the Court to decide the case narrowly in favor of the plaintiffs. The Fifth Circuit opinion has not been followed in other Circuits; the Seventh Circuit, in an opinion by Judge Easterbrook, labeled the Fifth Circuit’s approach as a “go-it-alone strategy.” Loss causation, measuring as it does the impact of the misstatement on the stock price, is, unlike reliance, typically a common question and therefore not a relevant consideration at the class certification stage. The government supports the petitioners’ position, and the Supreme Court frequently gives deference to the government’s position (again, see Stoneridge). So this could be a short opinion.
But will the Court be persuaded to go farther? If so, the outcome becomes more difficult to predict. Is the Court inclined to re-examine Basic and FOTM, now that there has been over 20 years of further research and scholarship on the issue? In the years subsequent to Basic, there have been real-life events (e.g., tech bubble) and empirical studies that cast doubt on the efficiency of the markets. However, as noted above, Basic was only partly based upon economic theory. The Court also cited “considerations of fairness, public policy, and probability” to support “the congressional policy embedded in the 1934 Act” that “securities markets are affected by information, and enacted legislation to facilitate an investor’s reliance on the integrity of the markets.” Those policy consideration remain equally compelling today.
I look forward to others’ views and reading the transcript of the oral argument.
Booth on Securities Fraud Litigation
Class Conflict in Securities Fraud Litigation, by Richard A. Booth, Villanova University School of Law, was recently posted on SSRN. Here is the abstract:
Although securities fraud class actions are a well-established legal institution, few (if any) such actions in fact meet the requirements of Rule 23 of the Federal Rules of Civil Procedure for certification as a class action. Among other things, Rule 23 requires the court to find that the representative plaintiff will fairly and adequately protect the interests of the class and that a class action is superior to other means of resolving the dispute.
In the typical securities fraud case, the plaintiff class consists of investors who buy the subject stock at a time when the defendant corporation has negative material information that should be publicly disclosed. When the truth comes out, stock price declines, and those who bought during the fraud period sue the corporation for damages equal to the difference between the price they paid and the price at which the stock finally settles. Only buyers have standing to sue in such circumstances. Mere holders have no claim.
The problem is that most buyers are also holders. Most investors are well diversified. More than two-thirds of all stock is held through mutual funds, pension plans, and other institutional investors, who trade mostly for purposes of portfolio balancing. As a result, most of the buyers in the plaintiff class will also be holders as to more shares than the number of shares bought during the fraud period. Because the defendant corporation pays any settlement – further reducing the value of the corporation and its stock price through what I call feedback damages – most of the plaintiff class will lose more as holders than they gain as buyers. Thus, many members of the plaintiff class would prefer that the action be dismissed. It is therefore impossible for anyone to be an adequate representative of a class composed of both members who support the action and members who oppose the action. Even if a court would permit a plaintiff class to be gerrymandered to include only those buyers who would gain more than they lose, there is no practical way to identify such investors.
In addition, it is likely that in most meritorious securities fraud actions, part of the decrease in stock price will come from expenses associated with defending and settling the securities fraud claim and from harm to the reputation of the defendant company resulting in an increase in its cost of capital. But these claims are derivative rather than direct. Accordingly, it is the corporation – and not individual buyers – who should recover for this portion of the damages. Aside from the fact that such claims are derivative in nature and presumably must be litigated as such, a derivative action is clearly superior to a class action because recovery by the corporation from individual wrongdoers – rather than payment by the corporation to buyers – eliminates feedback damages and thus reduces the size of the aggregate claim. Moreover, a derivative action is much more efficient in that there is a single plaintiff – the corporation – rather than hundreds or thousands of individual buyers.
Finally, policy considerations also militate against certification. Diversified investors are hedged against securities fraud by virtue of being diversified and have no need for a remedy. A diversified investor is just as likely to sell a fraud-affected stock as to buy one. It all comes out in the wash. Thus, the expenses associated with securities fraud class actions are a deadweight loss that serves only to reduce investor return. Because the vast majority of investors are diversified – and because it is irrational for most investors not to diversify – the interests of diversified investors should trump those of any undiversified investors who would favor a class action remedy. Moreover, class actions constitute excessive deterrence, whereas derivative actions provide a response that is proportional to the true harm suffered by investors. Diversified investors are completely protected against any true loss by the prospect of derivative litigation, which also provides an effective deterrent against securities fraud.
In short, when faced with a motion to certify a securities fraud action as a class action, a court should ordinarily treat the action as derivative and proceed accordingly. To be clear, this approach would effectively abolish securities fraud class actions and replace them with derivative actions. But as demonstrated here, investors would be better off as a result.
Griffin & Sun on Investors' Response to Wells Notice
Troublesome Tidings? Investors’ Response to a Wells Notice, by Paul A. Griffin, University of California, Davis - Graduate School of Management, and Yuan Sun, University of California, Berkeley - Haas School of Business, was recently posted on SSRN. Here is the abstract:
Scant evidence has amassed about how a Wells notice might affect stock prices. We find that prices fall significantly in the three days around a first-time Wells disclosure and, for disclosures that involve subsequent timely litigation, stock prices drop more sharply, by more than three percent. For companies that report the receipt date of a Wells notice, we observe no market reaction on that date but, rather, a negative reaction 2-4 days after receipt date, especially for disclosures made in a later 10-Q or 10-K. These results suggest that prior studies of market reaction to SEC or shareholder litigation events may have understated investors’ response. Consistent with investors’ negative response to a Wells notice, we further find a significant shift from insider buying to selling up to four weeks before disclosure, although this tracks best with stock return in the same period. From the standpoint of disclosure policy, our results imply that investors consider a Wells disclosure as a material event.
Steinberg & Kirby on Section 11
The Assault on Section 11 of the Securities Act: A Study in Judicial Activism, by Marc I. Steinberg, Southern Methodist University - Dedman School of Law, and Brent A. Kirby, was recently posted on SSRN. Here is the abstract:
This article focuses on the federal courts' restrictive interpretation of Section 11 of the Securities Act of 1933, the most investor-friendly express remedy that the "New Deal" Congress enacted. This judicial erosion has resulted in a cause of action that extends to fewer investors and is riddled with uncertainty at the pleading stage. The authors posit that recent federal court decisions that have added reliance as an element of Section 11 claims and rejected the use of statistical evidence to prove tracing are inconsistent with Section 11's text and legislative history. The article then explores the inconsistencies associated with pleading Section 11 claims that "sound in fraud" by asserting that these claims should be extended the longer statute of limitations available to such fraud-based claims under the Sarbanes-Oxley Act of 2002. The authors conclude that the federal courts' focus on impeding vexatious litigation has resulted in unduly restrictive judicial interpretations that have altered the very nature of Section 11.
Hanley & Hoberg on Underpricing of IPOs
Litigation Risk, Strategic Disclosure and the Underpricing of Initial Public Offerings, by Kathleen Weiss Hanley, Federal Reserve Board, and Gerard Hoberg, University of Maryland - Department of Finance, was recently posted on SSRN. Here is the abstract:
Using word content analysis on the time-series of IPO prospectuses, we find evidence that issuers trade off underpricing and strategic disclosure as potential hedges against litigation risk. This tradeoff explains a significant fraction of the variation in prospectus revision patterns, IPO underpricing, the partial adjustment phenomenon, and litigation outcomes. We find that strong disclosure is an effective hedge against all lawsuits. Underpricing, however, is an effective hedge only against the incidence of Section 11 lawsuits, those lawsuits which are most damaging to the underwriter. Underwriters who fail to adequately hedge litigation risk experience economically large penalties including loss of market share.
Ferrell & Saha on 10b-5 Damages
Forward-Casting 10b-5 Damages: A Comparison to Other Methods, by Allen Ferrell, Harvard Law School; European Corporate Governance Institute (ECGI), and Atanu Saha, Compass Lexecon, was recently posted on SSRN. Here is the abstract:
We propose in this paper the forward-casting method for estimating 10b-5 damages. We argue that this method compares favorably to two commonly used 10b-5 damage methods: constant dollar back-casting and the allocation method. Most importantly, both constant dollar back-casting and the allocation method, in contrast to forward-casting, fail to incorporate market expectations in estimating the stock price that would have obtained absent the alleged fraud. In the course of our discussion, we demonstrate how each one of these three methods work in practice using facts and data from an actual case. The choice of a damage method, as we document, can make a dramatic difference in estimated damages
Saha & Ferrell on Event Studies
Event Study Analysis: Correctly Measuring the Dollar Impact of an Event, by Atanu Saha, Compass Lexecon, and Allen Ferrell, Harvard Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN. Here is the abstract:
Using the traditional event study approach in the context of securities litigation, the determination of the "materiality" of a firm disclosure hinges on the statistical significance of the abnormal share price change (i.e., return) on the disclosure day. To estimate per share damages, the abnormal return is then transformed to an abnormal dollar impact. It is often assumed that if the abnormal return on a disclosure day is statistically significant, so is the abnormal dollar effect. We demonstrate - first analytically and then through an empirical example - that need not be the case. We derive the proper t-statistic if one wishes to determine the statistical significance of an abnormal dollar effect. This has obvious implications for liability and damages in securities litigation matters.
Edelman & Thomas on Poison Pills
Selectica Resets the Trigger on the Poison Pill: Where Should the Delaware Courts Go Next?, by Paul H. Edelman, Vanderbilt Law School, and Randall S. Thomas, Vanderbilt Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN. Here is the abstract:
Since their invention in 1982, shareholder rights plans have been the subject of intense controversy. Rights plans, or as they are known more pejoratively “poison pills,” enable a target board to “poison” a takeover attempt by making it prohibitively expensive for a bidder to acquire more than a certain percentage of the target company’s stock (until recently 15-20%). Not surprisingly, some commentators view rights plans as an inappropriate means of shifting power from shareholders to the board of directors.
In this Article, we critically examine Delaware law on the use of shareholder rights plans and propose a new approach to assessing these plans. This new approach is particularly important given the Delaware Supreme Court’s recent decision in Versata Enterprises v. Selectica Inc. (5 A.3d 586 (Del. 2010)), which upheld a novel form of the poison pill with a only a 5% trigger level and created substantial confusion for future courts and commentators in the process.
To bring clarity to this area, we provide courts with a new, consistent, and transparent methodology for evaluating whether a rights plan, or for that matter any defensive tactic, is “preclusive” of shareholders’ ability to wage a proxy contest and is therefore invalid under Delaware law. Specifically, we argue that courts should stop using ad hoc techniques for deciding preclusion and should instead adopt a weighted voting model to make this determination. Such a model will allow courts to transparently consider all of the key parameters that affect the outcome of corporate elections, including the type of bidder, the type of contest, and the differences in voting recommendations that result from these variations. We provide such a model and put it to the test. Specifically, we apply a weighted voting model to illustrate the effect lower trigger levels will have on dissidents’ chances of winning proxy contests. We further demonstrate the effect a classified board, an ESOP, or a white-squire defense will have on these contests. In each case, the model provides a level of consistency and transparency that has never existed in this area of the law.