Securities FraudClass Action

Last updated 18 Feb 09

Stanford Class Action Clearinghouse

                                                                                                                    

            

Stanford Class Action Clearinghouse

                                                                                                                    

            

Anatomy of securities fraudclass action …

Securities fraud action

                                                                                                                    

            

Securities fraud action

                                                                                                                    

            

Press Release 10/15/03

Netflix ended the third quarter of 2003 with approximately 1,291,000 total subscribers, up 144,000 or 13% sequentially. During the quarter Netflix acquired 383,000 new trial subscribers, a 38 percent year-over-year increase from the 277,000 new trial subscribers acquired in the third quarter of 2002 …

Securities fraud action

                                                                                                                    

            

Press Release 6/1/04

Netflix has restated its financial information to reflect changes in revenues and earnings for the third and fourth quarters of 2003. This restatement corrects improper information about the number of new subscribers. Management does not, however, believe that these changes detract from a positive outlook for the company …

Law of 10b-5 …

Securities Fraud Action

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)

William Rehnquist

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.

Rule 10b-5

• Nexus– Transactional– Jurisdictional

• Plaintiff• Defendant• Elements

– Material misrepresentation– Scienter (intentional)– Reliance– Causation– Damages

• Procedure

Reliance

Basic Inc v. Levinson (US 1988)

The 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 Lies Exposed– 12/18/78: announce tender offer

by Combustion

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 HarryBlackmun

(general practitioner)

Big vs small

Big companies• Public disclosure• Many analysts• SEC investigation • Large damages

Small companies• Less publicized• Fewer analysts• No SEC interest• Smaller total damages

Scienter

• Rule 9(b) and PSLRA• Circuit courts

–Motive and opportunity–Reasonable and strong inferences (insider trading, save salaries)

–Deliberate recklessness

Scienter

Private Securities Litigation Reform Act

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.

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]

Loss causation

… In any private action arising under this title, the plaintiff shall have the burden of proving that the act or omission of the defendant alleged to violate this title caused the loss for which the plaintiff seeks to recover damages.

PSLRA [Exchange Act 21D(b)(4)]

                                                                                                                    

            

Plaintiffs’ argument:

PL shows loss by showing that price inflated on day of purchase

Loss Causation

                                                                                                                    

            

Defendant’s argument:

PL must show that price drop actually related to prior false statements

Loss Causation

“… .. At the moment the transaction takes place, the plaintiff has suffered no loss.”

“When the purchaser subsequently resells at a lower price … that price may reflect not the earlier misrepresentation but changes in economic circumstances.

Dura Pharmaceuticals v. Broudo (US 2005)

Justice Stephen Breyer

Business model for SFCA plaintiffs’ lawyers …

Class Counsel – Business Model• 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

                                                                                                                    

            

The end