Securities Law Prof Blog

Supreme Court Grants Cert in Foreign Cubed Action

The U.S. Supreme Court accepted certiorari today in Morrison v. National Australia Bank Ltd., 547 F.3d 167 (2d Cir. 2008), an important case dealing with the extraterritorial effect of federal securities law.  The Second Circuit affirmed the district court's holding that it should not exercise jursidiction over a class action where (1) foreign plaintiffs are suing (2) a foreign issuer in an American court for violations of American securities laws based on securities transactions in (3) foreign countries (so-called foreign cubed action).  The U.S. Solicitor General had filed a petition advising the Court not to grant certiorari.

According to the petitioners, the issues presented are:

I. Whether the antifraud provisions of the United States securities laws extend to transnational frauds where: (a) the foreign-based parent company conducted substantial business in the United States, its American Depository Receipts were traded on the New York Stock Exchange and its financial statements were filed with the Securities Exchange Commission (“SEC”); and (b)the claims arose from a massive accounting fraud perpetrated by American citizens at the parent company's Florida-based subsidiary and were merely reported from overseas in the parent company's financial statements.

II. Whether this Court, which has never addressed the issue of whether subject matter jurisdiction may extend to claims involving transnational securities fraud, should set forth a policy to resolve the three-way conflict among the circuits ( i.e., District of Columbia Circuit versus the Second, Fifth and Seventh Circuits versus the Third, Eighth and Ninth Circuits).

III. Whether the Second Circuit should have adopted the SEC's proposed standard for determining the proper exercise of subject matter jurisdiction in transnational securities fraud cases, as set forth in the SEC's amicus brief submitted at the request of the Second Circuit, and whether the Second Circuit should have adopted the SEC's finding that subject matter jurisdiction exists here due to the “material and substantial conduct in furtherance of” the securities fraud that occurred in the United States.

Fifth Circuit Holds Stanford Receiver Could Not "Clawback" Interest Payments from Innocent Investors

The Fifth Circuit, in Janvey v. Adams (No. 09-10761 Nov. 13, 2009)(Download Opinion_of_Appeals_Court_from_Hearing_Regarding_Claw_Backs), recently held that the receiver for the Stanford interests, appointed to conserve, hold, manage and preserve the value of the receivership estate, had no authority to recover payments of interest from investors who received the payments prior to the receivership.  The receiver wanted to recover the payments as assets of the estate and distribute them pro rata to all victims of the fraud.  The SEC, however, argued that it would be inequitable to allow the receiver to bring "clawback" claims against innocent investors.  The court agreed with the SEC.

The Court examined the lightly-analyzed issue of who may be named as a "relief defendant" in SEC enforcement actions and applied a two-prong test: a relief defendant (1) has received ill-gotten funds, and (2) does not have a legitimate claim to those funds.  While the investors certainly received ill-gotten funds, the receiver failed to establish that the investors lacked a legitimate claim to the proceeds.  It was undisputed that the investors received the payments as interest pursuant to written CD agreements with the Stanford Bank.  Since the investors could not be considered proper relief defendants, the district court lacked authority to freeze their accounts. 

While the Fifth Circuit's opinion does not discuss issues under fraudulent conveyance law, the holding suggests that this court would not consider such theories favorably.

Supreme Court Hears Oral Argument in Excessive Mutual Fund Fees Case

The U.S. Supreme Court heard oral argument Monday in Jones v. Harris Associates, a case that could impact the amount of managerial fees that millions of mutual fund investors pay fund advisers.  The Court must decide what standard governs whether advisors' fees are excessive under the Investment Company Act (ICA) of 1940. Congress amended the ICA in 1970 to create a fiduciary duty for investment advisers “with respect to the receipt of compensation for services.” 15 U.S.C. § 80a-36(b).  The 1970 amendment also granted a private right of action to fund holders to sue for breaches of this fiduciary duty. 

 In Jones, three Oakmark Funds shareholders brought suit against the fund’s adviser for charging double the amount of managerial fees that it charged institutional investors for purportedly similar services.  The district court granted the advisor’s motion for summary judgment, holding that the Second Circuit’s 1982 decision in Gartenberg v. Merrill Lynch Asset Management, 694 F.2d 923, recognized a breach of duty under the ICA only where an adviser charges fees that are “so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s length bargaining.”  While affirming the result, a Seventh Circuit panel led by Chief Judge Easterbook criticized Gartenberg, finding that the decision ignored economic realities.  As long as funds fully disclose managerial fees, market forces should keep mutual fund costs down in the face of industry competition.  527 F.3d 627.  The Seventh Circuit denied rehearing en banc by a 5-5 vote, accompanied by a forceful dissent from Judge Posner assailing the panel decision.  537 F.3d 728.

 The Seventh Circuit decision may not survive review. The Court signaled little enthusiasm for Judge Easterbrook’s analysis at oral argument on Monday, and even the litigants abandoned the panel’s position to revisit different aspects of the Gartenberg test.  Chief Justice Roberts and Justice Scalia, however, touched on free market principles in questions to petitioner’s counsel.  Chief Justice Roberts noted that technological developments now allow investors easy access to information about management fees at the click of a button.   If investors find the fees excessive, they could move money to another fund in “thirty seconds.”  Justice Scalia added that any fund experiencing investor exodus would clearly see the problem and recalibrate its adviser's compensation.   

Most of the questioning revolved around different articulations of the Gartenberg test.  Justice Kennedy inquired whether the ICA’s fiduciary duty language comported with other fiduciary duties, such as those applied to corporate officers and boards of directors.  Petitioner’s counsel argued that Congress used fiduciary in a special sense to ensure the fairness of fees.  Counsel offered a two-pronged fairness test a la Gartenberg.  First, was there full disclosure and good faith negotiating between the mutual fund board (many of whose directors may have been appointed by the advisors) and the investment advisers?  Second, was the fee fair when compared to the same or similar services charged to an outsider in an arms-length transaction (in this case, an institutional investor)?

 Justice Breyer noted that the plain text of the Gartenberg test could be read different ways simply based on one’s tone of voice.  The Court spent a good portion of argument grappling over the proper metric to measure excessive fees.  Breyer posed that a workable standard may lie in petitioner’s argument that courts should evaluate what an adviser charges a mutual fund against its institutional clients. 

It is difficult to predict what direction the Court will take.  Without a clear majority in support of the Seventh Circuit market analysis decision, the Court may reverse the appellate panel and embellish the Gartenberg test to provide additional guidance to lower courts on how best to determine excessive managerial fees. (It should be noted that there is no reported case where fund holders have prevailed under the Gartenberg standard.)

(Aaron Bernay, Corporate Law Fellow and University of Cincinnati Law '10, prepared the above summary analysis of the Nov. 2 oral argument in Jones v. Harris Associates.)

Second Circuit Affirms Insider Trading Verdict Against Inhouse Attorney

On September 21, 2009, the United States Court of Appeals for the Second Circuit affirmed a jury verdict finding Mitchell S. Drucker, an attorney and former associate general counsel at NBTY, Inc. ("NBTY"), a nutritional supplements manufacturer and retailer, and his father, Ronald Drucker, liable for violating the antifraud provisions of the federal securities and affirmed the remedies imposed by the federal district court. The Court of Appeals also affirmed the District Court's order of disgorgement against relief defendant William Minerva ("Minerva").

The Commission had charged that, while Mitchell Drucker was a lawyer at NBTY, and had learned that NBTY was about to announce lower than expected quarterly earnings, he and his father, a former New York City police detective, sold their entire holdings of NBTY stock just before the negative announcement. Collectively, the defendants avoided $197,243 in losses by selling in advance of the announcement.  On December 3, 2007, a federal jury in the United States District Court for the Southern District of New York found Mitchell Drucker and Ronald Drucker violated the antifraud provisions of the federal securities laws by committing insider trading.

Credit Rating Agencies Can Be Liable for Ratings Issued in Private Placement, Court Holds

Judge Scheindlin's opinion in Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Download AbuDhabiCommercialBank(S.D.N.Y. Sept. 2, 2009) is receiving a great deal of press, and deservedly so.  Two institutional investors brought a class action to recover losses stemming from the liquidation of notes issued by a SIV and sued eight defendants, including two rating agencies, Moody's and S&P.  The court recognized that it is "well-established" that the First Amendment protects rating agencies, subject to an "actual malice" exception, from liability arising out of their issuance of ratings and reports because their ratings are considered matters of public concern.  Nevertheless, the court found that the rating agency is not afforded the same protection where its ratings were disseminated only to a select group of investors.  Accordingly, the agencies' First Amendment argument was rejected because the ratings were provided in connection with a private placement to a select group of investors.

The court also rejected the argument that the ratings are nonactionable opinions instead of actionable misrepresentations, since plaintiffs adequately pled that the agencies did not genuinely or reasonably believe that the ratings were accurate and had a basis in fact.

I have a great deal of difficulty understanding how rating agencies can assert the First Amendment to escape liability for ratings that they produce and sell; we might as well say that issuers' statements in prospectuses are protected by the First Amendment.  It's good to see at least a small chink in the armor.  

D.C. Circuit Remands SEC Fixed Indexed Annuity Rule for Further Consideration

The D.C. Circuit continues its practice of being tough on the SEC's compliance with the requirements for federal rulemaking .  Yesterday the Circuit remanded to the agency the SEC's controversial rule 151A that stated that fixed indexed annuities (FIAs) are not annuity contracts within the meaning of the Securities Act (and therefore are treated as securities under the securities laws and not regulated solely by state insurance laws).  American Equity Investment Life Ins. Co. v. SEC (D.C. Cir. 7/21/09)(Download D.C.OpiniononIndexAnnuities).  According to the Court (1) the SEC's interpretation of "annuity contract" is reasonable under Chevron, but (2) the SEC failed to consider properly the effect of the rule on efficiency, competition and capital formation under section 2(b) of the Act.  Therefore, the SEC must either complete an analysis sufficient to satisfy its obligations under section 2(b) or explain why that section does not govern this rulemaking.

On the SEC's interpretation of "annuity contract," the Court found that the statute is ambiguous on the scope of the phrase and that the prior Supreme Court decisions did not set forth a test that determined the treatment of FIAs.  Accordingly, under Chevron, the SEC's interpretation of the statute will be upheld if it is reasonable.  Because FIAs have characteristics that "involve considerations of investment not present in the conventional contract of insurance," a "variability in the potential return that results in a risk to the purchaser," the SEC's interpretation was reasonable.

As to the SEC's inadequate section 2(b) analysis, the Court first rejected the SEC's argument that the agency was not required to conduct a section 2(b) analysis, since the agency purported to conduct just such an analysis.  It then found that the agency's analysis of the effect of the rule on efficiency, competition and capital formation was arbitrary and capricious, because it did not provide a reasoned basis for its conclusion that the rule would increase competition.  The agency could not justify the rule on the ground that it would bring clarity to an uncertain area of law, since this reasoning would support any rule that the SEC adopted in a previously unregulated area.  The SEC must provide an analysis of why this specific rule would promote competition.  The SEC's analysis was also deficient because it did not make any finding on the existing level of competition under state regulation.  Its efficiency and capital formation analyses were similarly deficient because it failed to analyze the efficiency of the current state regulation.

Court Dismisses SEC's insider Trading Case Against Cuban

A Federal District Court in Dallas has dismissed the SEC's insider trading case against Mark Cuban; the agency has 30 days to replead its case.  According to the SEC, Cuban sold shares of Mamma.com while in possession of inside information.  The defense argued that Cuban was not a corporate insider and owed no duty not to trade on the information.  WSJ, Judge Dismisses SEC Insider-Trading Case Against Mark Cuban.

Hedge Fund Found Liable for Short Selling Violations of Reg M

On July 7, 2009, the United States District Judge for the Southern District of New York found after a bench trial that Cary G. Brody and two entities he controlled, New York hedge fund Colonial Fund LLC and its adviser, Colonial Investment Management LLC, were liable for illegal trading relating to eighteen registered public offerings. The court permanently enjoined the defendants from violating Rule 105 of Regulation M under the Securities Exchange Act of 1934. Judge Castel also ordered defendants to pay disgorgement totaling more than $1.4 million in ill-gotten gains, plus prejudgment interest, and required Brody to pay a civil penalty of $450,000.

In general, Rule 105 seeks to prevent manipulative trading by short sellers prior to registered public offerings and to promote offering prices that are based upon open market prices, determined by supply and demand, rather than by artificial forces. At the time of the violations, Rule 105 generally prohibited short sellers, regardless of intent, from using securities purchased in registered public offerings to cover short sales that occurred during the five business days before the pricing of the offerings (the restricted period).

The Commission's complaint, filed in federal court in Manhattan on October 15, 2007, alleged that the defendants violated Rule 105 when they used shares purchased in at least eighteen registered public offerings to cover short sales that they made during the rule's restricted period. The defendants allegedly realized profits in excess of $1.4 million from the illegal trades because Colonial Fund typically sold shares short during the restricted period at prices that were higher than the offering prices and then covered the restricted period short positions with shares purchased at lower prices in the offerings. The complaint also alleged the defendants often structured post-offering trades in an effort to conceal their Rule 105 violations.

In his ruling, Judge Castel found, among other things, that the defendants' Rule 105 violations were complete when Colonial purchased offering stock, that the defendants' post-offering trading could not undo the violations, and that those trades were an effort by the defendants to create the false appearance to third parties and regulators that they had not used shares purchased in public offerings to illegally cover the short positions. Judge Castel further found that defendants acted recklessly with respect to five of the offerings, and knowingly, intentionally, and willfully with respect to the other thirteen offerings. The court imposed a $450,000 civil penalty on Brody, finding that Brody's unlawful actions involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement.

Supreme Court Upholds Power of State Banking Regulators to Enforce State Law

In an important case for state regulators, the Supreme Court held (5-4), in Cuomo v.Clearing House, that the federal Comptroller of the Currency’s regulation under the National Bank Act purporting to pre-empt state law enforcement is not a reasonable interpretation of the NBA.  This case arose out of an investigation initiated in 2005 by the New York Attorney General to determine whether various national banks had violated New York’s fair-lending laws.  The AG sent the banks letters requesting “in lieu of subpoena” that they provide certain nonpublic information about their lending practices. Both the Comptroller or OCC and a banking trade group brought this action to enjoin the information request, claiming that the Comptroller’s regulation prohibits that form of state law enforcement against national banks. The lower courts agreed with the Comptroller and issued an injunction prohibiting the AG from enforcing the state fair-lending laws through demands for records or judicial proceedings.  A majority of the Justices, however, affirmed the injunction as applied to the AG's threatened issuance of executive subpoenas, but vacated it as it prohibits the AG from bringing judicial enforcement actions. 

The relevant provision of the NBA provides: “No national bank shall be subject to any visitorial powers except as authorized by Federal law, vested in the courts . . . , or . . . directed by Congress.” Among other things, the Comptroller’s implementing regulation forbids States to “exercise visitorial powers with respect to national banks, such as conducting examinations, inspecting or requiring the production of books or records,” or (the language at issue here) “prosecuting enforcement actions” “except in limited circumstances authorized by federal law.” 

The majority noted the ambiguity in the NBA’s term “visitorial powers” and recognized that, under Chevron, the Comptroller can give authoritative meaning to the term within the bounds of that uncertainty. However, the majority stated, "the presence of some uncertainty does not expand Chevron deference to cover virtually any interpretation of the NBA."  The Court goes on to find that evidence from the time of NBA's enactment, the Court's precedents, and ordinary principles of construction make clear that the NBA does not prohibit ordinary enforcement of state law.

Moreover, the Court noted that the regulation’s consequences also cast its validity into doubt.  Even the OCC acknowledges that the NBA leaves in place some state substantive laws affecting banks, yet the Comptroller’s rule says that the State may not enforce its valid, non-pre-empted laws against national banks. “To demonstrate the binding quality of a statute but deny the power of enforcement involves a fallacy made apparent by the mere statement of the proposition, for such power is essentially inherent in the very conception of law.” ... In contrast, channeling state attorneys general into judicial law-enforcement proceedings (rather than allowing them to exercise “visitorial” oversight) would preserve a regime of exclusive administrative oversight by the Comptroller while honoring in fact rather than merely in theory Congress’s decision not to pre-empt substantive state law.

SCALIA, J., delivered the opinion of the Court, in which STEVENS, SOUTER, GINSBURG, and BREYER, JJ., joined. THOMAS, J., filed an opinion concurring in part and dissenting in part, in which ROBERTS, C. J., and KENNEDY and ALITO, JJ., joined.

SEC Files Amicus Brief in Mutual Fund Case

The SEC filed an amicus brief in Jones v. Harris Associates in favor of the petitioners.  The case, which will be argued next term before the Supreme Court, addresses the appropriate test for determining the fees investment advisors charge mutual funds and the correct interpretation of section 36(b) of the Investment Company Act.  The Seventh Circuit found in favor of the investment adviser, finding it had not lied to the mutual fund and that "market forces" should determine fees.

Law Professors File Brief in Mutual Fund Fees Supreme Court Case

William A. Birdthistle (Chicago-Kent College of Law) has posted on SSRN the Supreme Court Amicus Merits Brief of Law Professors in Support of Petitioners in Jones v. Harris Associates, No. 08-586, filed with the U.S. Supreme Court.  William is the Counsel of Record and the principal drafter of the brief.  The issue is the appropriate test for determining the reasonableness of the fees investment advisors charge to mutual funds under Section 36(b) of the Investment Company Act of 1940, which imposes a fiduciary duty on advisers with respect to fees. The Seventh Circuit (527 F.3d 627) diluted the fiduciary duty language of the statute and held that the fiduciary "must make full disclosure and play no tricks but is not subject to a cap on compensation" and asserted that "market forces" would sufficiently regulate the fees.  This is certain to be an important case in mutual fund regulation.

SEC v. Bear Stearns & Co.

I am pleased to introduce Professor Jill Gross (Pace) as an occasional guest blogger.  Today Jill analyzes SEC v Bear Stearns & Co. (S.D.N.Y. June 10, 2009), the final installment in the Global Research Analyst Settlement:

Yesterday, in the SEC enforcement action that resulted in the well-known $1.4 billion Global Research Analyst Settlement of 2003, United States District Judge William H. Pauley III of the Southern District of New York issued an opinion addressing the “quandary” of what to do with the “undisbursable,” residual settlement funds.  In the underlying action, the SEC alleged that research analysts employed by numerous investment banks failed to disclose conflicts of interest in their research reports.  The consent judgments originally provided for, among other things, monetary payments by the named investment banks of $460 million for independent investment research, $528.5 million in disgorgement and penalties to the states, $432.75 million in federal disgorgement and penalties, and $85 million for investor education programs. 

However, as the opinion notes, the SEC provided no detailed plan for the distribution of the federal disgorgement monies as restitution to aggrieved investors, instead leaving it to the district court to work out.  Judge Pauley heavily criticized the SEC and the settling investment banks for their lack of specificity and forethought as to the “destiny of the disgorgement and penalties,” which led them to submit a proposed Distribution Plan.  Following the approval of the plan, Judge Pauley appointed a Distribution Fund Administrator, who embarked on five-year effort to identify and locate potential claimants for the monies.  Judge Pauley then details the torturous history of the Fund Administrator’s efforts and difficulties in locating claimants for the $432.75 million.  In the end, $75 million still remained undistributed.

After skewering the SEC for its misstep in agreeing to monetary settlements with no mathematical or formulaic connection to identifiable investor losses, Judge Pauley addresses and rejects various third party requests (including a consortium of investor justice law school clinics) for a cy pres distribution of the residual funds.  Notably, Judge Pauley expressly declines to authorize payment to FINRA because of the “disappointing performance” of FINRA’s Investor Education Foundation in awarding grants for investor education programs, and the SEC’s failure to properly oversee the Foundation.  He asks: “When will the SEC exercise its responsibility to ensure that these substantial sums are expended to educate the investing public?”  With no other entity available as worthy to him, Judge Pauley orders that the residual funds be transferred to the United States Department of Treasury “to be used by the Government for its operations.  Pragmatism, simplicity and the need for finality also counsel this denouement.”  Judge Pauley cynically concludes his lengthy opinion with this observation:

In the final analysis, this Court does not question the SEC’s interest in bringing to an end improper conduct.  Nor does it question the SEC’s interest in recompensing investor victims and deterring future violations.  However, whether the SEC has the institutional resolve and commits adequate resources to reach these goals is an open question. (emphasis added)

 

Judge Sotomayor's Securities Law Opinions

My RA has found eleven Second Circuit opinions authored by Judge Sotomayor dealing with securities issues.  Here is the list of the cases and a very brief description of the issue:

Securities Investor Protection Corp v. BDO Seidman, LLP, 222 F. 3d 63, (2nd Cir. 2000)
Discussed the "fraud on the regulatory process" theory as it pertains to reliance

U.S. v. Falcone, 257 F.3d 226 (2nd Cir. 2001)
Addressed the misappropriation theory in regards to insider trading

In re NYSE Specialists Securities Litigation, 503 F.3d 89 (2nd Cir. 2007)
Considered liability for a national security exchange and relevant immunity

Dabit v. Merrill Lynch, Pierce, Fenner & Smith Inc., 395 F.3d 25, (2nd Cir. 2005)
Biased research/investment claim and the applicability of the Securities Litigation Uniform Standards Act preemption (reversed by Supreme Court)

Press v. Quick & Reilly, Inc., 218 F.3d 63 (2nd Cir. 2000)
Addressed binding nature of SEC determination on broker/dealer conduct

LNC Investments, Inc. v. First Fidelity Bank, N.A. New Jersey, 173 F.3d 454 (2nd Cir. 1999)
Bondholders' action for breach of fiduciary duty against trustees

Official Committee of Unsecured Creditors of Worldcom v. SEC, 467 F.3d 73 (2nd Cir. 2006)
Addressed SEC distribution of bankruptcy settlement funds after fraud action

Gerber v. MTC Electronic Technologies CO., LTD, 329 F.3d 297 (2nd Cir. 2003)
Discussed Settlement and Private Securities Litigation Reform Act applicability

Lerner v. Fleet Bank, N.A., 318 F.3d 113 (2nd Cir. 2003)
RICO case involving a ponzi scheme

LNC Investments, Inc. v. National Westminster Bank, New Jersey, 308 F.3d 169 (2nd Cir. 2002)
Applicability of Trust Indentures Act regarding bankruptcy proceedings

Moore v. PaineWebber, Inc., 306 F.3d 1247 (2nd Cir. 2002)
Class Certification in a life insurance fraud action

Supreme Court Grants Cert in "Inquiry Notice" Statute of Limitations Case

The Supreme Court accepted cert in a securities fraud action from the Third Circuit today, In re Merck & Co. Securities Deriv. & ERISA Litig., 543 F.3d 150 (3d Cir. 2008).  In the action the plaintiffs charge that the drug manufacturer made misstatements about the safety and commercial viability of Vioxx.  The district court had dismissed the complaint, holding that the plaintiffs were put on inquiry notice more than two years before filing the complaint, but the Third Circuit (2-1) reversed.  The question presented is:

 Did Third Circuit err in holding, in accord with Ninth Circuit but in contrast to nine other courts of appeals, that under "inquiry notice" standard applicable to federal securities fraud claims, the statute of limitations does not begin to run until investor receives evidence of scienter without benefit of any investigation?

Eighth Circuit Reviews Standard for Determining Mutual Fund Fees Excessive

The 8th Circuit, in Gallus v. Ameriprise Financial (4/08/09) -- an excessive mutual fund fees case under Investment Company Act section 36(b), reversed the district court's grant of summary judgment for the defendant because it found that the lower court construed too narrowly the extent of the defendants' duties in its analysis of the Gartenberg factors.

We believe that the proper approach to § 36(b) is one that looks to both the adviser’s conduct during negotiation and the end result. ...We conclude that the district court erred in holding that no § 36(b) violation occurred simply because Ameriprise’s fee passed muster under the Gartenberg standard. Although the district court properly applied the Gartenberg factors for the limited purpose of determining whether the fee itself constituted a breach of fiduciary duty, it erred in rejecting a comparison between the fees charged to Ameriprise’s institutional clients and its mutual fund clients. ...
Likewise, the district court should not have engaged in so limited a scope of review. Ameriprise’s conduct must be evaluated independent from the result of the negotiation. The district court concluded that Ameriprise did not breach its fiduciary duty in one way (by setting a fee that was exorbitant relative to that of other advisers), but it should have also considered other possible violations of § 36(b). Specifically, the court should have determined whether Ameriprise purposefully omitted, disguised, or obfuscated information that it presented to the Board about the fee discrepancy between different types of clients. The record indicates that there are material questions of fact on this issue.

Fifth Circuit Issues Opinion on Loss Causation

In Lormand v. US Unwired, Inc. (5th Cir. 4/09/09), the Fifth Circuit considered the issue of loss causation in partially affirming, partially reversing the district court's ruling on a MTD.  Plaintiffs were able to establish loss causation as to alleged misrepresentations about a phone company's subprime program, in part because of facts showing that defendants understood adoption of the program (forced on them by Sprint) would be disastrous to the company.  This strengthened the loss causation link between the misrepresentations and stock price decline.

Fifth Circuit Affirms Rule 10b-5 Judgment Against Market-Timing Broker

In SEC v. Gann (5th Cir. 4/17/09), the Fifth Circuit affirmed a district court's judgment that a broker that facilitated his customers' market-timing activities violated Rule 10b-5, although its affirmance seemed somewhat begrudging.  In a seven-month period, the broker concluded 2500 trades in the mutual funds of 56 companies and received 69 block notices.  On the question of scienter, the court mused:

The SEC is essentially enforcing corporate regulations on behalf of the various mutual funds. Because market timing itself is not illegal, the SEC had to prove an intent to deceive to fit Gann’s behavior within Section 10(b) and Rule 10b-5. This creates a dilemma for the courts, which are asked to determine whether the defendant’s legal acts are made illegal by his compliance or noncompliance with corporate regulations that companies sometimes suspend or ignore, either tacitly or expressly, depending on the circumstances of that particular trade. ... We emphasize again, however, that market timing is not illegal. The SEC’s prosecution of Gann is based on the fund companies’ regulations and Gann’s violation of those regulations.   The SEC’s chief evidence of Gann’s intent to deceive was his use of numerous account and registration numbers that actually represented his (and Fasciano’s) work for HCM. The SEC contended that Gann’s efforts were meant  to circumvent the funds’ regulations for his own gain and that of his customer.  We perceive the evidence in this case to be in equipoise, making critical the question of credibility. The district court found Gann not credible and sided with the SEC. Based on this express finding, the district court adopted the SEC’s version of the facts. Credibility is uniquely “the province of the trier of fact,” and we defer to it.

In re Refco, Inc. Securities Litigation

The federal district court for the Southern District of New York recently dismissed charges against the Meyer Brown law firm in In re Refco, Inc. Securities Litigation, 2009 WL 724378 (S.D.N.Y. Mar. 17, 2009).  As you may recall, one of Meyer Brown's partners, Joseph P. Collins, was indicted for his role in the fraud to cover up the true financial condition of the international brokerage firm.  Plaintiffs argued that the law firm's alleged substantial involvement in the fraud made them liable in damages under Rule 10b-5.  While the court's analysis is a straightforward application of Central Bank and Stoneridge (the judge rejecting the plaintiff's attempt to distinguish Stoneridge because that case involved "remote" participants in the fraud), what is interesting is the judge's footnote 15:

It is perhaps dismaying that participants in a fraudulent scheme who may even have committed criminal acts are not answerable in damages to the victims of the fraud. However, as the Court noted in Stoneridge, the fact that the plaintiff-investors have no claim is the result of a policy choice by Congress. 128 S.Ct. at 769. In 1995, in reaction to the Supreme Court's decision in Central Bank, Congress authorized the SEC-but not private parties-to bring enforcement actions against those who “knowingly provide [ ] substantial assistance to another person” in violation of the federal securities laws. See PSLRA, Pub.L. No. 104-67, § 104, 109 Stat. 737, 757, codified in 15 U.S.C. § 78t(f). This choice may be ripe for legislative re examination. While the impulse to protect professionals and other marginal actors who may too easily be drawn into securities litigation may well be sound, a bright line between principals and accomplices may not be appropriate. There are accomplices and there are accomplices: after all, in the criminal context when the Godfather orders a hit, he is only an accomplice to murder-one who “counsels, commands, induces or procures” but he is nonetheless liable as a principal for the commission of the crime. 18 U.S.C. § 2(a). Likewise, some civil accomplices are deeply and indispensably implicated in wrongful conduct. Perhaps a provision authorizing the SEC not only to bring actions in its own right but also to permit private plaintiffs to proceed against accomplices after some form of agency review would provide the necessary flexibility without involving the courts in standardless and difficult-to-administer line-drawing exercises.
 

Surpreme Court Accepts Cert in 36(B) Excessive Fee Case

The U.S. Supreme Court accepted certiorari today in an important case involving a mutual fund holder's ability to challenge the investment adviser's fees as excessive under section 36(b) of the Investment Company Act.  In Jones v. Harris Associates, 527 F.3d 627 (7th Cir. 2008), a three-judge panel of the 7th Circuit, with Judge Easterbrook writing the opinion, held that investment advisory fees that were comparable to those of similar funds (and not otherwise unlawful under the ICA) were not excessive and specifically disapproved an earlier 2d Circuit opinion, Gartenberg v. Merrill Lynch Asset Management, 694 F.2d 923, as relying too little on markets:  "a fiduciary duty differs from rate regulation."  Judge Posner dissented from a subsequent denial of a petition to rehear the case en banc, 537 F.3d 728.  Professor Bill Birdthistle (Chicago-Kent) filed, on behalf of a group of law professors, an amicus brief urging the Court to accept cert and advises me that he plans to write a merits brief to explore the ramifications of Gartenberg/Harris Associates.

First Circuit Affirms Dismissal of Fraud Charges Against Three Former Employees of Putnam Fiduciary Trust

The SEC recently announced that on February 6, 2009, the United States Court of Appeals for the First Circuit affirmed a federal district court decision dismissing a civil fraud action against three former executives of Putnam Fiduciary Trust Company (PFTC), a Boston-based registered transfer agent. The action, filed in December 2005, alleges that six former PFTC executives engaged in a scheme beginning in January 2001 by which the defendants defrauded a defined contribution plan client and group of Putnam mutual funds of approximately $4 million. On March 6, 2007, the district court issued a ruling dismissing the Commission's case against three of the six defendants: Virginia Papa, a former managing director and director of defined contribution servicing; Sandra Childs, a former managing director who had overall responsibility for PFTC's compliance department; and Kevin Crain, a managing director who had responsibility for PFTC's plan administration unit. Judgments by consent were entered in October 2008 against two of the three remaining defendants. The case against the remaining defendant, Donald McCracken, of Melrose, Massachusetts, a former managing director and head of global operations services for PFTC, is pending.

The Commission's Complaint alleges that through their conduct, all defendants violated Section 17(a) of the Securities Act of 1933 and violated and/or aided and abetted violations of Section 10(b) of the Securities Exchange Act of 1934 and one defendant violated Sections 34(b) and 37 of the Investment Company Act of 1940. The Commission is seeking injunctive relief and civil monetary penalties against the remaining defendant.