In 2013, the U.S. Supreme Court weighed in on significant securities litigation issues, including the fraud-on-the-market presumption and the SEC’s use of the discovery rule. With numerous important cases pending on topics such as SLUSA, Sarbanes-Oxley and yet another fraud-on-the-market claim, the Court will further define the securities litigation landscape in the year ahead. Meanwhile, the circuit courts — most notably the U.S. Court of Appeals for the Second Circuit — have continued to impact the course of securities claims with rulings on key issues.
U.S. Supreme Court’s Interest in Securities Issues Continues Unabated
The Future of the Fraud-on-the-Market Presumption. In 2013, the Court held in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184 (2013), that plaintiffs alleging fraud on the market need not establish the materiality of a misleading statement at the class certification stage. Justice Ruth Bader Ginsburg, writing for the majority in this 6-3 decision, found that the question of materiality was a common one: “[T]he class is entirely cohesive: It will prevail or fail in unison.” Of potentially greater interest, however, were the concurrence by Justices Samuel Alito and dissenting opinions by Antonin Scalia, Clarence Thomas and Anthony Kennedy, in which they evinced a willingness to revisit — and perhaps discard — the increasingly beleaguered fraud-on-the-market presumption of reliance.
Since the Supreme Court’s 1988 decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), plaintiffs have been permitted to satisfy the element of reliance in securities fraud suits through a presumption of reliance based on the efficient market theory, under which stock prices are believed to incorporate all publicly available information. This has not only made it easier for a plaintiff to bring a securities fraud action, but it also paved the way to class actions because without having to prove actual (or “eyeball”) reliance, this element has become a common rather than individualized factor. However, as economic criticism of the efficient market hypothesis has increased, so have attacks on the fraud-on-the-market presumption of reliance.
All eyes are thus fixed on the Supreme Court as it hears arguments in March of this year on a direct attack on the fraud-on-the-market doctrine for the presumption of reliance in Halliburton Co. v. Erica P. John Fund, Inc., cert. granted (Nov. 15, 2013) (No. 13-317). Petitioner Halliburton, echoing criticism by academics and practitioners alike, claims that the efficient markets hypothesis underlying the fraud-on-the-market doctrine has been “almost universally repudiated” and is in tension with the Court’s “recent, more rigorous approach to class certification.” As Justice Alito stated in his concurring opinion in Amgen, referring to the three-Justice dissent, “[a]s the dissent observes, more recent evidence suggests that the presumption may rest on a faulty economic premise. In light of this development, reconsideration of the Basic Inc. presumption may be appropriate.” Given this notion put forth by four Justices in Amgen, the possibility exists that the Court will completely repudiate fraud on the market. However, the need for a fifth vote may more likely lead to a less drastic result, perhaps a compromise allowing defendants to more easily attack the presumption at the class certification level (see “US Supreme Court Cases to Watch in 2014”).
Scope of the Securities Litigation Uniform Standards Act (SLUSA). Several years after first addressing SLUSA (in a case successfully argued by Skadden), the Court is poised to resolve a divisive circuit court split by interpreting the scope of SLUSA preclusion in three related cases arising from the Allen Stanford Ponzi scheme. SLUSA generally precludes state court securities fraud class actions under state law in which the fraud is “in connection with the sale or purchase” of a security traded on a national exchange or issued by a public company. In Chadbourne & Parke LLP v. Troice, cert. granted (Jan. 18, 2013) (No. 12-79), and its two related appeals, the Court will decide the scope of the “in connection with” element under SLUSA, as well as its application to aiding and abetting claims. In construing the “in connection with” element, several circuit courts have required the alleged misconduct to have “more than a tangential relationship” to a covered securities transaction to find preclusion under SLUSA, while others have deemed an alleged misrepresentation to be “in connection with” a covered transaction if it merely causes the plaintiff to invest in, or coincides with, a securities transaction in a covered security. At issue in Troice were alleged fixed-return CDs issued by a Stanford-controlled bank as part of its Ponzi scheme; the CDs themselves were not covered securities, but they were supposedly backed by investments in covered securities. During oral argument in October 2013, the justices seemed split and focused at length on whether preclusion could exist when there was no actual purchase of a covered security. The Court may end up issuing only a very narrow ruling tailored to Troice’s particular facts, but any such ruling is still likely to shape the future applicability of SLUSA preclusion.
Sarbanes-Oxley and SEC Actions. Several cases before the Court this past term and in the coming year involve the events leading up to filing a securities fraud claim. In Gabelli v. SEC, 133 S. Ct. 1216 (2013), the Court rejected the SEC’s use of the discovery rule to determine the statute of limitations for bringing a securities fraud civil suit. The SEC had argued that the five-year statute of limitations for such suits should start running when the fraud is (or should have been) discovered, not when it occurs. The Court disagreed, holding that the discovery rule is intended to protect defrauded individuals who might be unaware of the fraud for a significant period of time, not government agencies specifically charged with rooting out fraud and armed with powerful weapons to do so. Potential defendants may have breathed a sigh of relief at the finding, which shortens the period during which the SEC can bring a suit, but the decision also may incentivize the agency to bring suits with greater speed, fulfilling SEC Chairman Mary Jo White’s recent promise for “bold and unrelenting enforcement.”
The Court’s upcoming decision in a claim involving whistleblower retaliation protection may similarly augur changes in how securities fraud claims are investigated and brought. Lawson v. FMR LLC, cert. granted (May 20, 2013) (No. 12-3), will address whether Sarbanes-Oxley Section 806 protects the whistleblower employees of privately held companies that contract with public companies. Section 806 does list “contractors and subcontractors” as entities prohibited from retaliating against whistleblowers, but the justices appeared uncomfortable at oral argument with expanding the section beyond public companies, for which the plaintiffs argued. A 2013 decision by the U.S. Court of Appeals for the Tenth Circuit, Lockheed Martin Corp. v. Administrative Review Board, U.S. Dep’t of Labor, 717 F.3d 1121 (10th Cir. 2013), held that whistleblowers are shielded from retaliation even if the reported conduct doesn’t affect shareholders. Thus, if the Court finds that whistleblower protection extends even to the employees of some private companies, these cases together could signal a vast expansion in whistleblower protection — and encourage more whistleblowing.
Court Rejects Review of Class Standing Requirements
One final Supreme Court development over the last year sprang from inaction: The Court denied certiorari in Goldman, Sachs & Co. v. NECA-IBEW Health & Welfare Fund, No. 12-528, cert. denied, 133 S. Ct. 1624 (2013). In NECA, as the case is known, the Second Circuit drew from Supreme Court affirmative action jurisprudence to institute a controversial “same set of concerns” standard for finding that a putative class representative has standing to bring securities claims even for mortgage-backed securities offerings in which it did not purchase any securities. 693 F.3d 145 (2d Cir. 2012). The Second Circuit found that the plaintiff representative had standing to bring such claims provided the claims arose from the same set of concerns — in that case, the allegations focused on the same mortgage originator across securitizations. Many observers predicted the Supreme Court would grant certiorari to resolve NECA’s direct contradiction with the U.S. Court of Appeals for the First Circuit’s decision in Plumbers’ Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., 632 F.3d 762 (1st Cir. 2011), which held that the plaintiff could only bring claims for offerings in which it purchased securities. The Court’s decision to deny review makes it more likely that courts within the Second Circuit, and perhaps elsewhere, will expand the claims which can be brought by a class representative.
Circuit Courts Continue to Play Central Role in Key Securities Disputes
Several key issues were deliberated or decided at the circuit court level last year, including cases relating to the tolling of statutes of repose, the duty to disclose under Item 303(b), the role of confidential witnesses, and liability under the Commodity Exchange Act. As with past years, the Second Circuit continues to be the forum where many of these significant developments are taking place.
Statutes of Repose. In Police & Fire Retirement System of Detroit v. IndyMac MBS, Inc., 721 F.3d 95 (2d Cir. 2013), the Second Circuit addressed the absolute nature of statutes of repose. The court held that the tolling rule set forth in American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974) — that the commencement of a class action tolls the statute of limitations for all potential members of the class — does not apply to the three-year statute of repose in Section 13 of the Securities Act. The three-year bar, the Second Circuit determined, gives defendants the substantive right, which cannot be abridged, to be free from liability after a certain amount of time. As a result, in 2014 we may see more institutions opting out of class actions earlier in the proceedings because the ability to pursue individual claims after the three-year statute of repose expires will be foreclosed as a result of IndyMac.
Corporate Disclosures. In addition, courts weighed in further on the importance of updating corporate disclosures to reflect evolving risks. Courts have adopted a more qualitative approach to examining nondisclosure set forth in Panther Partners Inc. v. Ikanos Communications, Inc., 681 F.3d 114 (2d Cir. 2012), in which the Second Circuit determined that an issuer failed to update “generic cautionary language” to reflect a so-called adverse “known trend or uncertainty,” id. at 121-22, as required by Item 303 of Regulation S-K. In Stratte-McClure v. Morgan Stanley, 2013 WL 297954 (S.D.N.Y. Jan. 18, 2013), for example, the U.S. District Court for the Southern District of New York reversed an earlier decision that the defendants had no duty to disclose subprime assets during the real estate downturn. In doing so, the court determined that the defendants were “aware of factually-based uncertainties” that the plaintiffs needed knowledge of in order to understand the risk’s extent. The First Circuit likewise relied on Panther Partners in Silverstrand Investments v. AMAG Pharmaceuticals, Inc., 707 F.3d 95 (1st Cir.), cert denied, 134 S. Ct. 174 (2013), in stating that Item 303’s disclosure obligations “do not turn on restrictive mechanical quantitative inquiries.” There the court rejected defendants’ statistical analysis of pre- and post-offering severe adverse effects of a drug and, instead, viewed the duty to disclose based on more qualitative factors relating to the importance of the undisclosed information.
Janus, Corporate Scienter and Confidential Witnesses
Though it has been more than two years since the Supreme Court issued its decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), which held that secondary actors cannot be held liable for statements over which they did not have “ultimate authority,” id. at 2302, district courts are still grappling with how to interpret Janus. Lower courts are divided on what level of involvement and control, exactly, is required for a secondary actor to have “ultimate authority” over a misstatement. In Fezzani v. Bear, Stearns & Co., 716 F.3d 18 (2d Cir. 2013), for example, the Second Circuit held that a principal investor in a now-defunct broker-dealer could not be held primarily liable under Section 10(b) under Janus where he had merely facilitated the firm’s misstatements and never directly interacted with its customers. Similarly, in the Southern District of Texas, the district court in In re Anadarko Petroleum Corp. Class Action Litigation., No. 4:12-cv-0900, 2013 WL 3753972 (S.D. Tex. July 15, 2013), found that a defendant could not be held liable for misstatements in regulatory documents made by its partner when (i) the misstatements had been made months before the defendant’s involvement with the partner and (ii) the plaintiff had not alleged that the misstatements were made in the defendant’s name or at its direction.
Courts continue to debate whether and how scienter (or intent) may be inferred from a relationship to “core operations.” Plaintiffs attempt to use the “core operations” doctrine to create a presumption of knowledge on behalf of senior management if the allegations relate to the so-called core operations of the company. However, in the absence of extraordinary facts, courts generally remain unwilling to use “core operations” as a stand-alone basis for inferring scienter and continue to require additional well-pleaded facts. Judge Richard J. Sullivan explained in Shemian v. Research in Motion Ltd., No. 11 Civ. 4068 (RJS), 2013 WL 1285779 (S.D.N.Y. Mar. 29, 2013), that, absent further guidance from the Second Circuit, a relationship to core operations “is not ‘independently sufficient to raise a strong inference of scienter.’” Id. at *18 (citation omitted). This decision is on appeal to the Second Circuit.
Plaintiffs also are on warning on how they use so-called confidential witnesses — putting forth allegations attributed to unnamed former employees. In City of Livonia Employees’ Retirement System v. Boeing Co., 711 F.3d 754 (7th Cir. 2013), the U.S. Court of Appeals for the Seventh Circuit affirmed dismissal of a Section 10(b) complaint against Boeing and remanded the case to determine whether sanctions should be imposed on the plaintiffs’ lawyers for their reliance on confidential witnesses. Discovery had revealed that the plaintiffs’ confidential “witness,” a supposed senior Boeing engineer, had never actually worked for the company, let alone had access to the information attributed to him in the complaint. Judge Richard Posner criticized the plaintiffs’ lawyers for making “confident assurances … about a confidential source … even though none of the lawyers had spoken to the source and their investigator had acknowledged that she couldn’t verify what (according to her) he had told her.” Id. at 762. Likewise, in City of Pontiac General Employees’ Retirement System v. Lockheed Martin Corp., No. 11 Civ. 5026 (JSR), 2013 WL 3389473 (S.D.N.Y. July 9, 2013) (to be published in F. Supp. 2d), Judge Jed S. Rakoff, despite denying the defendant’s motion for summary judgment, issued an opinion after the parties had settled criticizing the plaintiffs’ use of confidential witnesses, five of whom had recanted: “[I]t appeared … that some, though not all, of the [confidential witnesses] had been lured by the investigator into stating as ‘facts’ what were often mere surmises, but then, when their indiscretions were revealed, felt pressured into denying outright statements they had actually made.” Id. at *3.
LIBOR and Foreign Exchange Manipulation Claims
Foreign exchanges and allegations of manipulation of foreign currencies continue to draw the attention of both civil plaintiffs and regulators. Regulators from various jurisdictions have commenced investigations into foreign exchange manipulation, including the U.K.’s Financial Conduct Authority and the U.S. Department of Justice and Commodity Futures Trading Commission. U.S. Attorney General Eric Holder has commented that the manipulation uncovered thus far “may just be the tip of the iceberg.” Recently, plaintiffs have filed antitrust complaints against a variety of financial institutions alleging conspiracy to manipulate benchmark foreign exchange rates by increasing trade volume at the time the benchmark rates are established. Meanwhile, class actions asserting mainly state law claims (breach of contract, breach of fiduciary duty, unjust enrichment) have been filed by bank clients in several jurisdictions, including New York, Massachusetts and California. Judge Lewis A. Kaplan substantially denied a motion to dismiss such a class action in In re Bank of New York Mellon Corp. Forex Transactions Litigation, 921 F. Supp. 2d 56, 94 (S.D.N.Y. 2013). Meanwhile, in a victory for defendants, a financial institution accused of improperly adding a markup to foreign exchange transactions executed by clients succeeded in having such claims dismissed in Louisiana Municipal Police Employees’ Retirement System v. JPMorgan Chase & Co., No. 12 Civ. 6659 (DLC), 2013 WL 3357173 at *17 (S.D.N.Y. July 3, 2013). Judge Denise L. Cote endorsed the defendant’s argument that the plaintiff had no “reasonable expectation” of having the defendant reveal its markup on FOREX transactions in addition to reporting the charged exchange rate. Suits against U.S. dollar LIBOR panel members were consolidated in 2011 before Judge Naomi Buchwald in In re LIBOR-Based Financial Instruments Antitrust Litigation, No. 1:11-MD-2262-NRB (S.D.N.Y. filed Aug. 12, 2011). In March 2013, Judge Buchwald ordered dismissal of antitrust and RICO claims while allowing Commodity Exchange Act claims to stand. In re LIBOR-Based Fin. Instruments Antitrust Litig., 666, 738 935 F. Supp. 2d (S.D.N.Y. 2013). The Southern District of New York dismissed fraud-based LIBOR claims in a separate action for being inadequately particularized under Rule 9(b) in Woori Bank v. RBS Securities, Inc., 910 F. Supp. 2d 697, 702-05 (S.D.N.Y. 2012). In a second round of recently filed complaints, plaintiffs now are trying to cure the pleading infirmities identified by Judge Buchwald in her March 2013 decision. In particular, large investors who had direct contact with the defendant banks are filing individual (rather than class) action complaints that focus primarily on state common law (rather than federal statutory) claims — e.g., breach of contract, breach of the implied covenant of good faith, fraud, tortious interference, unjust enrichment, etc. In the next 12 months, we are likely to learn if this shift in strategy has gained traction.
Mortgage-Backed Securities and Put-Back Litigation in 2014
In 2013, the pace of new credit crisis-related filings decreased, while settlements increased. This decrease can be attributed primarily to the expirations of certain limitation periods on residential mortgage-backed securities sold from 2005 to 2007. Despite the slowdown in new filings, important issues regarding RMBS cases continue to percolate through the courts. Litigation continues for certain statutes that extend the limitations periods for certain government agencies that have taken over certain financial institutions to institute claims, known as extender statutes. For example, in Nat’l Credit Union Administration Board v. Nomura Home Equity Loans, Inc., 727 F.3d 1246, 1257 (10th Cir. 2013)the Tenth Circuit found that “the plain meaning of the text best supports the conclusion that the Extender Statute supplants all other limitations frameworks,” but a petition for certiorari to the Supreme Court is currently pending. See Nat’l Credit Union Amin. Bd. V. Nomura Home Equity Loan Inc., 82 U.S.L.W 3307 (U.S. Nov. 8, 2013) (No. 13-576)
In last year’s Insights, we predicted that in 2013 the New York appellate courts would provide guidance on the state statute of limitations for so-called “put-back claims,” in which holders and insurers of mortgage-backed securities have sought to “put back” loans on the theory that the loans violate contractual representations and warranties made at the time of the offerings. In deciding whether the statute of limitations begins to run on the date the representation was made or the date on which the alleged failure to repurchase occurred, the New York State Appellate Division, First Department, held in the waning weeks of the year that the former is true in ACE Securities v. DB Structured Products, 650980/2012. This is highly significant in that many of the mortgage securitizations at issue for such claims closed more than six years ago; thus, this decision should provide a strong statute of limitations defense against such claims in the future. In addition, the decision applies beyond mortgage-backed securities by confirming that a provision that sets forth the remedies for a breach of a representation or warranty should not be interpreted to expand liability by delaying the start of the accrual of the limitations period beyond the date of the alleged breach of the underlying representation or warranty.
Perhaps one of the more visible actions in put-back litigation was the trial in Assured Guaranty Municipal Corp. v. Flagstar Bank, FSB, 920 F. Supp. 2d 475 (S.D.N.Y. 2013), in which Judge Rakoff held that Flagstar made false representations with respect to loans upon which Assured issued financial guaranty insurance. Assured Guar. Mun. Corp. v. Flagstar Bank, FSB, No. 11 Civ. 2375 (JSR), slip op at 91-94 (S.D.N.Y. Feb. 5, 2013). Despite the fact that the plaintiff’s expert “failed to articulate a clear standard” for when a loan origination file might be deficient on its face, and “was unable to give a clear reason” as to why she deemed certain breaches of representations regarding the loan origination standards to be material, the court found the expert’s “methodology [for determining whether a loan was originated in conformance with guidelines] not only appropriate to the courtroom but corroborated by the Court’s own review.” Id. at 71. In 2014, we anticipate several more battles of the experts in determining the percentage of loans in a mortgage-backed securitization that did not comply with the various origination representations and guidelines and therefore may be subject to being repurchased. This year is likely to bring both additional trials and settlements in the put-back arena.
As evidenced by the cases described here, securities litigation in the wake of the global financial crisis continues to evolve and, despite the decline in credit crisis filings, several important issues remain to be decided by the courts in the coming year. We also anticipate that more traditional stock-drop securities filings — not directly related to the credit crisis — will continue or perhaps even increase, both because the resources of the plaintiffs’ bar will shift away from credit crisis cases and because of anticipated volatility in the equity markets. We also anticipate that the plaintiffs’ bar will continue to seize upon any corporate crisis that causes a decline in stock price to try to assert securities claims. We will be paying close attention to the area of cybersecurity, where a breach of a public company’s data or network infrastructure cannot only cause reputational harm, but also will likely have a significant market impact (see Regulatory/“Cybersecurity: Amid Increasing Attacks and Government Controversy, a Framework to Reduce Risk Emerges”). And finally we note that the primary battlefields will remain at the motion-to-dismiss and class certification levels, although we also anticipate more cases reaching the summary judgment stage.
*This article appeared in the firm's sixth annual edition of Insights on January 16, 2014.