securities fraud rule 10b-5 last updated 20 feb 12
TRANSCRIPT
Securities Fraud
Rule 10b-5
Last updated 20 Feb 12
Securities Fraud Action
William Rehnquist:
When we deal with private actions under Rule 10b-5, we deal with a judicial oak which has grown from little more than a legislative acorn.
Blue Chip Stamps v. Manor Drug Stores (US 1975)
Securities Exchange Act of 1934
Section 10 -- Manipulative and Deceptive Devices
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange--
(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered … any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
Securities Fraud Action
Rule 10b-5• Transactional nexus• Plaintiff• Defendant• Elements• Procedure
Transactional nexus• By means of interstate
commerce or mails• “in connection with
purchase or sale”
Securities Fraud Action
Rule 10b-5• Transactional nexus• Plaintiff• Defendant• Elements• Procedure
Plaintiff• Purchaser or seller• Except in SEC action
Securities Fraud Action
Rule 10b-5• Transactional nexus• Plaintiff• Defendant• Elements• Procedure
Defendant• Primary violator (makes
statements on which reliance)
• Includes company statements
• No aiding & abetting (accts / advisors)
Securities Fraud Action
Rule 10b-5• Transactional nexus• Plaintiff• Defendant• Elements• Procedure
Elements• Material misrepresent /
omission• Scienter – not negligence /
knowledge, reckless• Reliance – “fraud on
market” • Causation – must be
proved• Damages – out-of-pocket
Securities Fraud Action
Rule 10b-5• Transactional nexus• Plaintiff• Defendant• Elements• Procedure
Procedure• Statute of limitations (2 yrs
+ 5 yrs)• Special rules for class
actions• Venue (where company
has headquarters)• Worldwide service of
process • Federal discovery rules
Compare to other private actions
Exchange Act Securities Act
Rule 10b-5
§ 18(a) § 9(c) §11 §12(a)(1)§12(a)
(2)
Fraud icw purchase or sale of security
Materially false statement in SEC filing
Specified manipu-lative practice(pools, etc)
False statement in registration statement
Offer or sale of unregistered, non-exempt securities
Offer or sale by means of materially false prospectus
Securities FraudClass Action
“when talk is not cheap”
Stanford Class Action Clearinghouse
Federal Securities Fraud Class Action Litigation
(lawsuits filed)
Pre-Reform Post-Reform
“King of Pain”
“Loathed because he's so mean, feared because he's so powerful, Bill Lerach is the lawyer everyone in Silicon Valley hates.”
Fortune Magazine, Sep. 2000
“"In 10 or 15 years you will be holding another hearing about a debacle in the securities market that will make you remember the S&L mess with fondness."
Bill Lerach, congressional testimony (1995)
Curriculum Vitae• 1946: born in working-class
Pittsburgh• 1970: U Pittsburgh law grad• 1976: joins Milberg Weiss (San
Diego)• 2004: moves to Lerach
Coughlin Stoia Geller Rudman & Robbins (San Diego)
• 2005: $7.2 billion recovery in Enron litigation ($45 over career)
• 2007: pleads guilty to obstruction of justice (later Milberg Weiss)
• 2009: disbarred by California State Bar
• 2010: released from prison / “Circle of Greed” published
Who can be sued …
Press Release:
The company is today announcing its year-end financial results, which continue to look favorable.
* * *• Auditor
– no mention that financials are not audited– no mention of auditor, which had advised that
financials actually “NOT favorable”
• Lawyer– no mention of lawyer who helped draft the
press release– no “noisy withdrawal” by lawyer
Identify corporate “fiction” …
2d and 3d Circuits -• Motive and opportunity• Concrete personal benefit• Insider trading
1st, 5th, 6th, 10th, 11th Circuits• Strong inference of scienter• M&O is external marker• Unusual insider trading
9th Circuit • “Deliberate recklessness”• Intentional misconduct
Tellabs, Inc. v. Makor Issues & Rights, Ltd.(US 2007)
Ruth Bader Ginsburg(civil rights lawyer)
… PSLRA strong inference of state of mind (scienter) means … “a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference.”
… allegations must also be considered “holistically” [isolated insider sales not enough, must have unusual, broad sales]
“omissions and ambiguities [in the plaintiffs’ allegations] count against inferring scienter” [discount confidential witnesses]
… followed by “surprise”
… resulting in “price drop”
TimelineThe lies– 10/21/77: news interview that “no
reason for stock activity and no negotiations”
– 9/25/78: response to NYSE inquiry that “management unaware of development”
– 11/6/78: Quarterly report that “unaware of any developments”
The truth– 12/18/78: announce tender offer
by Combustion
Basic Inc v. Levinson (US 1988)
Efficient Capital Market Hypothesis
“… in open and developed securities market .. Misleading statement defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.”
“… reliance is an element of a Rule 10b-5 cause of action.
“Presumptions typically serve to assist courts in managing circumstances in which direct proof for one reason or another is rendered difficult.”
How can presumption be overcome?
Basic Inc v. Levinson (US 1988)
Justice Harry Blackmun[MN lawyer]
“… I fear that the Court’s decision may have many adverse, unintended effects as it is applied and interpreted in the years to come.”
“… Court assumes buyers and sellers rely on the “integrity of the market price … which most mystifies me.”
Basic Inc v. Levinson (US 1988)
Justice Byron White[former football player]
Big vs small companies
Big companies• Public disclosure• Many analysts• SEC investigation • Large damages
Small companies• Less publicized• Fewer analysts• No SEC interest• Smaller total damages
Identify “scienter” – such as …
Plead “scienter” …
PSLRA [Exchange Act 21D(b)(1)]
In any private action arising under this chapter in which the plaintiff may recover money damages only on proof that the defendant acted with a particular state of mind, the complaint shall, with respect to each act or omission alleged to violate this chapter, state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.
File a complaint
(e.g. Bay Networks, Inc)
Complaint must tell “fraud” story …
… to withstand “motion to dismiss”
If so, start settlement negotiations …
Settlement with “corporation”
Buying shareholders(plaintiffs)
Corporation
Payment
Corporate execs(D&O insurance)
Usually nominalpayments Insider
trading
Settlement with “corporation”
Buying shareholders(plaintiffs)
Holding shareholders(losers!)
Corporation
Payment Subsidy
Corporate execs(D&O insurance)
Usually nominalpayments Insider
trading
Settlement with “corporation”
Buying shareholders(plaintiffs)
Selling shareholders(windfall winners!)
Holding shareholders(losers!)
Corporation
Payment Subsidy
Corporate execs(D&O insurance)
Usually nominalpayments Insider
trading
"Index Funds and Securities Fraud Litigation"
(Booth)SFCA doesn’t make sense• Most investors are diversified • SFCA settlement : holders effectively pay buyers• Because of circularity: stock price declines on SFCA filingConsider index fund • almost always loses more than it gains when SFCA • index funds should oppose SFCA Capturing deterrent effect• w/o SFCA might be more securities fraud• Solution: corporation itself claim – against the individual wrongdoers • subject of a derivative action for the benefit of the corporation – and thus all
of the stockholders • constitute a significant deterrent to fraudProcedure• rules of civil procedure: derivative claim must be resolved before SFCA• No SFCA unless certified no other equally good way to litigate • Caveat: attorney fees are likely to be higher in class actions than in
derivative actions
Sup Ct 10(b) jurisprudence 1970s / 1980s 2000s Gr
Transactional No privity Zandford A
Plaintiff Blue Chip Stamps Lead plaintiff* B
Defendant Central Bank Stoneridge C
Elements
(1) Materiality Basic Bespeaks caution* B
(2) Misrep Va Bankshares Stoneridge B
(3) Scienter Ernst & Ernst Tellabs / reckless* A
(4) Reliance Affiliated Ute / Basic Rebut presumption* A
(5) Causation/$ --- Dura / circularity* C
Procedural
(1) S/L Gilbertson / Huddleston SOX / Reynolds A
(2) Federal/state Santa Fe Dabit C
(3) Arbitration Shearson/Am Express FINRA / D-F* B
* open questions
Mechanics of Class Action Class Counsel Functions
• Get started– identify material corporate misrepresentations– find appropriate shareholders to act as class
representatives– file a complaint in a court of class counsel’s choosing
• Take care of legalities– defend the complaint against motion to dismiss (on legal
grounds)– urge the judge to grant class action status to the litigation – send notice to class members, giving them an option to
withdraw from the lawsuit– undertake discovery of information from the company and
other sources• Close the deal
– enter into settlement negotiations with company officials – champion any settlement before the judge– administer settlement funds – appeal any adverse decisions by the trial court judge
Mechanics of Class Action Class Counsel Functions
• Get started– identify material corporate misrepresentations– find appropriate shareholders to act as class
representatives– file a complaint in a court of class counsel’s choosing
• Take care of legalities– defend the complaint against motion to dismiss (on legal
grounds)– urge the judge to grant class action status to the litigation – send notice to class members, giving them an option to
withdraw from the lawsuit– undertake discovery of information from the company and
other sources• Close the deal
– enter into settlement negotiations with company officials – champion any settlement before the judge– administer settlement funds – appeal any adverse decisions by the trial court judge
Mechanics of Class Action Class Counsel Functions
• Get started– identify material corporate misrepresentations– find appropriate shareholders to act as class
representatives– file a complaint in a court of class counsel’s choosing
• Take care of legalities– defend the complaint against motion to dismiss (on legal
grounds)– urge the judge to grant class action status to the litigation – send notice to class members, giving them an option to
withdraw from the lawsuit– undertake discovery of information from the company and
other sources• Close the deal
– enter into settlement negotiations with company officials – champion any settlement before the judge– administer settlement funds – appeal any adverse decisions by the trial court judge