November 2, 2012
Supreme Court Will Consider Requirements for Class Certification in Securities Fraud Class Actions
On Nov. 5, 2012, the U.S. Supreme Court will hear oral argument in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds (No. 11-1085), a case that raises important questions about the “fraud on the market” theory (FOTM) established in Basic Inc. v. Levinson, 485 U.S. 224 (1988), and class certification under Fed. R. Civ. Pro. 23. Currently, there is a split in the Circuits over the necessity of establishing materiality at the class certification stage of a federal securities class action.
The lead plaintiff, Connecticut Retirement Plans and Trust Funds, brought a typical Rule 10b-5 class action alleging material misstatements about the safety, efficacy and marketing of two of Amgen’s products and invoked FOTM in order to show that reliance can be established on a class-wide basis. The district court granted plaintiff’s motion for class certification, and the appellate court affirmed, in an opinion reported at 660 F.3d 1170 (9th Cir. 2011). The defendants did not contest that Amgen stock traded in an efficient market and that the statements at issue were publicly disseminated. They argued, however, that at the class certification stage, plaintiff must also establish the materiality of the statements and defendants must have an opportunity to establish “truth-on-the-market” to rebut FOTM. The Ninth Circuit rejected defendants’ arguments. The court held that in order to invoke FOTM in aid of class certification, the plaintiff need only (1) show that the securities were traded in an efficient market; (2) show that the alleged misrepresentations were public; and (3) plausibly allege that the alleged misrepresentations were material. Similarly, the court rejected defendants’ argument that they must be afforded an opportunity to rebut FOTM at the class certification stage by introducing evidence to establish a “truth-on-the-market” defense.
The questions presented in the petition for certiorari are stated as follows:
1. Whether, in a misrepresentation case under SEC Rule 10b-5, the district court must require proof of materiality before certifying a plaintiff class based on the fraud-on-the-market theory.
2. Whether, in such a case, the district court must allow the defendant to present evidence rebutting the applicability of the fraud-on-the-market theory before certifying a plaintiff class based on that theory.
In asserting that the answer to both questions is “yes,” defendants make a number of arguments. First, materiality, in addition to being an element of a securities fraud claim, is a predicate to FOTM and is therefore necessary to establish reliance on a class-wide basis. Second, because reliance is an essential predicate of FOTM, Fed R. Civ. Pro. 23 requires that it be proved before class certification. Third, if materiality is not determined at the class certification stage, it frequently will not be considered at all, because class certification creates enormous pressure to settle even frivolous claims. To defer judicial inquiry would be unfair to defendants, who should not have to face the pressures of class litigation in order to establish that a class action was not warranted. Finally, defendants refer to modern economic research to demonstrate that proof that a market is generally efficient does not make it appropriate to apply FOTM in every case involving a security in that market.
Connecticut Retirement Plans and Trust Funds assert a number of arguments to the contrary. First, proof of materiality is not required to certify a class under Rule 23, because materiality is a common question not susceptible to different answers for individual class members. Second, FOTM does not require proof of materiality for class certification. Third, requiring proof of materiality for class certification will have adverse effects on courts’ ability to administer securities fraud class actions. Fourth, rebuttal evidence regarding materiality is not appropriate at the class certification stage because it would not demonstrate a lack of predominance under Rule 23(b)(3); Amgen’s “truth-on-the-market” defense is irrelevant at the class certification stage. Finally, plaintiff argues that defendants are making “naked public policy arguments” to alter the rules for certification of federal securities class actions, contrary to Congressional intent expressed in the PSLRA and SLUSA.
The Solicitor General filed an amicus brief in support of the plaintiff and urged the Court to affirm the Ninth Circuit’s opinion. The Solicitor General stated that the United States has a “substantial interest” in the court’s resolution of the questions presented, because “meritorious private securities-fraud actions, including class actions, are an essential supplement to criminal prosecutions and SEC enforcement actions.” The Solicitor General will also participate in the oral argument.
As an indication of the case’s importance, a number of amicus briefs have been filed. Amicus briefs in support of defendants include the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association (SIFMA) and the Washington Legal Foundation. Amicus briefs in support of the plaintiff include CalPERS, AARP, and National Association of Shareholder and Consumer Attorneys. Needless to say, there are amicus briefs filed by law professors on both sides. In the interests of full disclosure, I am a signatory on an amicus brief filed by law professors in support of lead plaintiff Connecticut Retirement Plan.
October 29, 2012
SEC Institutes Stop Order Proceeding Against Caribbean Pacific Marketing
The SEC announced that it instituted proceedings to determine whether to issue an order that would prevent sales of shares in Caribbean Pacific Marketing, Inc., based on allegations that the company's disclosure is misleading. In proceedings instituted against Caribbean Pacific on October 29, 2012, the SEC's Division of Enforcement alleges that Caribbean Pacific's registration statement is materially misleading because it omits any information about William J. Reilly and his position within the company as a de facto executive officer and control person. The Division of Enforcement alleges that Reilly is a disbarred attorney subject to a court order barring him from any penny stock offering, from serving as a corporate office and director, and from violating certain federal securities laws. In addition, Reilly was suspended from appearing or practicing before the Commission as an attorney, with a right to reapply after three years.
The Commission instituted the proceedings against Caribbean Pacific to determine whether the allegations by the Division of Enforcement are true, to give the company an opportunity to respond to the allegations, and to determine whether a stop order should be issued.
On October 23, the U.S. Attorney's Office for the Southern District of Florida filed a criminal complaint against Reilly, alleging securities fraud.
Hurricane Sandy: Everything Shut Down
From the SEC's website:
Hurricane Sandy Information
The EDGAR system is operating normally and filer support teams are available. During this weather emergency, we understand that filers may be unable to submit their filings.
The U.S. equities markets are closed Monday and Tuesday. The SEC will remain in close consultation with the markets as the situation warrants.
SEC offices in DC, New York, Philadelphia, and Boston are closed to the public.
October 28, 2012
Bring Back Fractional Pricing? Everything Old is New Again
Should the SEC bring back fractional pricing of securities so that securities firms can make greater profits at the expense of investors? The SEC is seriously considering a pilot program to explore this, according to Wall St. Journal, SEC Weighs Bringing Back Fractions in Stock Prices
If this sounds strange to you, you're not alone. Decimal pricing of stocks came about eleven years in order to lower investors' costs, and the research shows that it has done so. But some smaller companies complain that investment banks aren't interested in selling their stocks because they won't make enough money. The JOBS Act, which gives us crowdfunding, also required the SEC to study decimal pricing. In July the SEC released its study that concluded:
As discussed above, though there is literature on the types of benefits that lower spreads bring to the market, there is less available information related to how lower spreads may have negatively impacted capital formation, especially with respect to the complex, competitive dynamics and economic incentives of market intermediaries who provide liquidity. More so, as discussed among participants at the Advisory Committee meeting, there are a number of other factors that have influenced the IPO market in addition to decimalization.
( Download Decimalization-072012)
SEC Charges Kohl's Employee with Assisting Financial Fraud at Carter's
On October 24, 2012, the SEC charged Michael Johnson, a divisional merchandise manager at Kohl's, a national department store, with assisting the financial fraud at Carter's, Inc, a manufacturer of children's clothing. Specifically, the SEC alleges that Johnson assisted Joseph Elles, a former Executive Vice President of Sales at Carter's, in concealing his financial fraud from senior Carter's management. That scheme caused Carter's to materially misstate its net income and expenses in several financial reporting periods between 2004 and 2009.
The SEC's complaint, filed in the United States District Court for the Northern District of Georgia, alleges that between 2004 and 2009, Elles fraudulently manipulated the amount of discounts that Carter's granted to Kohl's, Carter's largest wholesale customer in order to induce Kohl's to purchase greater quantities of Carter's clothing for resale. In an effort to conceal the scheme, Elles persuaded Kohl's to defer subtracting the discounts from payments until later periods. Elles also persuaded Johnson, who handled the Carter's account at Kohl's to sign a false confirmation that misrepresented to Carter's accounting personnel the timing and amount of those discounts. By concealing the amount of discounts that had been promised to Kohl's, Elles and Johnson caused Carter's to materially understate it expenses in certain quarters and materially overstate its earnings in those quarters.
After conducting its own internal investigation, Carter's was required to issue restated financial results for the affected periods.
The SEC is seeking permanent injunctive relief and financial penalties against Johnson.
Couture on Criminal Securities Fraud
Criminal Securities Fraud and the Lower Materiality Standard, by Wendy Gerwick Couture, University of Idaho College of Law, was recently posted on SSRN. Here is the abstract:
First, this essay argues that the materiality standard is lower under the relatively new criminal securities fraud provision, § 807 of the Sarbanes-Oxley Act, 18 U.S.C. § 1348, than under the traditional securities fraud provision, § 10(b) of the Securities and Exchange Act of 1934. In particular, in the context of alleged misrepresentations, § 1348 probably imposes a subjective materiality standard rather than an objective standard. In the context of insider trading, § 1348 probably imposes a source-oriented standard rather than an investor-oriented standard. Next, this essay considers the implications of this lower materiality standard in criminal securities fraud prosecutions under § 1348, including the chilling of legitimate market behavior, undue prosecutorial discretion, and disruption of the ordinary relationship between civil and criminal liability. Although these aforementioned concerns are also implicated by the mail and wire fraud statutes, this essay contends that § 1348 imposes a marginal impact. Finally, in light of these implications and this marginal impact, this essay offers guidance to market participants when engaging in behavior that might be within the broader scope of § 1348, to courts when interpreting § 1348, and to Congress when considering the appropriate incentives to encourage voluntary disclosure, securities analysis, and corporate transactions.