Securities Litigation and The Supreme Court in Review and a Preview of 2011

Transcription

1 The University of Texas School of Law Presented: The University of Texas School of Law 33 rd Annual Conference on Securities Regulation and Business Law February 10-11, 2011 Dallas, Texas Securities Litigation and The Supreme Court 2010 in Review and a Preview of 2011 Nicholas Even Nicholas Even Daniel Gold Leslie Thorne Haynes and Boone, LLP 2323 Victory Avenue, Suite 700 Dallas, Texas nick.even@haynesboone.com

2 TABLE OF CONTENTS I. LOOK BACK AT A. Merck & Co., Inc. v. Reynolds, 130 S. Ct (April 27, 2010)... 1 Background... 1 Supreme Court Decision... 2 Implications of the Merck Decision... 3 B. Morrison v. National Australia Bank, 130 S. Ct (June 24, 2010)... 4 Background... 4 Supreme Court Decision... 4 Implications of the Morrison Decision... 5 II. A LOOK FORWARD TO A. Janus Capital Group Inc. v. First Derivative Traders, No Background... 8 Supreme Court Proceedings to Date... 9 Potential Implications of the Janus Case B. Siracusano v. Matrixx Initiatives, Inc., No Background Supreme Court Proceedings to Date Potential Implications of the Matrixx Case C. Erica P. John Fund, Inc. v. Halliburton, No Background Potential Implications of the Halliburton Case i

3 SECURITIES LITIGATION AND THE SUPREME COURT 2010 in Review and a Preview of 2011 Nicholas Even, Daniel Gold, and Leslie Thorne In 2010, the United States Supreme Court issued several opinions affecting public companies, their officers, directors, and shareholders, as well as counsel who represent these parties in federal securities litigation. While the Roberts Court has been labeled pro-business by some observers, 1 the Court s securities-related decisions in 2010 provided victories for both shareholder plaintiffs and defendants. This article summarizes the key securities law rulings from the Supreme Court in the past year, as well as the significant issues pending before the Justices in 2011, in the Janus Capital, Matrixx and Halliburton cases. I. LOOK BACK AT 2010 A. Merck & Co., Inc. v. Reynolds, 130 S. Ct (April 27, 2010) In its first major securities decision of the prior term, Merck & Co., Inc. v. Reynolds, 130 S. Ct (April 27, 2010), the Court held that the two-year statute of limitations applicable to fraud claims under Section 10(b) of the Exchange Act of 1934 is not triggered until a reasonably diligent plaintiff would have discovered facts giving rise to the violation. The Court specifically noted that such facts include facts indicating scienter, emphasizing that circumstances revealing a statement s falsity are not always sufficient to show scienter. The Merck decision significantly curtails the ability of defendants to assert the statute of limitations as a defense to a securities fraud claim under Section 10(b), and makes it far less likely that courts will dismiss, on statute of limitations grounds, cases filed within five years of the alleged fraud. 2 Background Merck involved a claim by shareholders that the company knowingly misrepresented the safety profile of the painkiller Vioxx. In 2001, Merck released the results of a Vioxx study comparing the drug to naproxen. The study disclosed that those taking Vioxx were four times as likely to suffer a heart attack as those taking naproxen. Although Merck acknowledged the possibility that Vioxx increased the risk of heart attacks, it defended a contrary position known as the naproxen hypothesis : that naproxen had the effect of lowering the risk of heart attacks rather than Vioxx increasing that risk. In September 2001, the FDA issued a strong warning letter stating that Merck had issued misleading statements about Vioxx s safety profile. Nicholas Even is a partner and Daniel Gold is an associate in the White Collar Defense, Antitrust, and Securities Litigation Practice group of Haynes and Boone, LLP. Leslie Thorne is an associate in the Business Litigation and Insurance Coverage sections of the firm. Associates Scott Ewing, John Tancabel, Tracy Smith and Richard Guiltinan assisted in the preparation of this article. 1 Greg Stohr, U.S. Supreme Court Increasingly Favors Business, Study Says, Bloomberg Businessweek (October 26, 2010); Jeffrey Rosen, Supreme Court Inc., New York Times Magazine (March 16, 2008). 2 The statute of limitations for private claims under Section 10(b) requires that cases be filed within 2 years after the discovery of the facts constituting the violation or no later than 5 years after the violation. 28 U.S.C. 1658(b). 1

4 Shareholders filed suit in 2003, over two years after Merck s release of the initial study 3 and the FDA s warning letter. The plaintiffs alleged that Merck had promoted the naproxen hypothesis knowing that it was false and that Merck s statements artificially inflated the price of the company s stock. Merck moved to dismiss on limitations grounds. The shareholder plaintiffs argued that they could not have discovered defendants scienter and therefore the facts giving rise to the cause of action more than two years before filing suit. Relying heavily on news articles interpreting the 2001 Vioxx-naproxen study and the 2001 FDA letter, the district court dismissed the Section 10(b) claim, holding that the limitations period began to run more than two years before the suit was filed. In re Merck & Co., Inc., 483 F. Supp. 2d 407 (D. N.J. 2007). The Third Circuit reversed, finding that the news of the 2001 study and the FDA warning letter were not enough to put a reasonable investor on notice of a fraud claim, particularly in light of the minimal movement in Merck s stock price in reaction to the articles and FDA warning letter. In re Merck & Co., Inc., 543 F.3d 150 (3d Cir. 2008). Supreme Court Decision In a largely unanimous opinion, the Supreme Court affirmed the Third Circuit s ruling that the plaintiffs had not discovered the facts of the violation more than two years before filing suit. The Court held that the limitations period under Section 10(b) begins to run when a plaintiff discovers or should have discovered with reasonable diligence the facts constituting the fraud, including facts showing scienter. As an initial matter, the Court addressed the statutory phrase after the discovery to determine whether actual or constructive discovery begins the limitations clock. A six-justice majority held that discovery of the facts constituting the violation includes both actual discovery and constructive discovery, i.e, facts that a reasonably diligent plaintiff would have discovered. 130 S.Ct. at However, the Court rejected the concept of inquiry notice. Id. at Prior to Merck, some courts had held that the statute of limitations began to run when a plaintiff possessed a quantum of information sufficiently suggestive of wrongdoing that it should conduct further inquiry. 4 The Court held that the concept of inquiry notice could not be reconciled with Section 10(b), which makes discovery the triggering event. Id. at 598. Most significantly, the Court unanimously held that scienter-related facts (i.e., facts showing that an allegedly false or misleading statement was made knowingly or with reckless disregard for its truth) are among the facts constituting the violation that a plaintiff must discover in order for the limitations clock to begin running. 130 S.Ct. at The Court emphasized that facts revealing the falsity of a material statement do not necessarily suggest scienter and, thus, would automatically not be enough to trigger the limitations clock. Id. at 597. As Justice Breyer explained in the opinion of the Court, because a plaintiff must allege facts giving rise to a strong inference of scienter merely to survive a motion to dismiss, a contrary holding would prevent plaintiffs from bringing their claims if the defendant could conceal for two years that it had any intent to deceive. Id. 3 4 Additional studies continued to raise concerns and Merck withdrew Vioxx from the market in See, e.g., Franze v. Equitable Assurance, 296 F.3d 1250, 1254 (11th Cir. 2002). 2

5 Applying these principles in Merck, the entire Court agreed that the plaintiffs did not discover facts showing defendants scienter more than two years before filing suit. The Court found that neither the FDA letter, the products liability suits filed in 2001 questioning Merck s naproxen hypothesis, nor any other pre-november 2001 circumstance were enough for a reasonable investor to discover facts constituting fraudulent intent. 130 S.Ct. at 600. Implications of the Merck Decision The Merck decision will likely reduce the number of securities fraud suits dismissed on limitations grounds. By overruling decisions that had applied an inquiry notice standard, the Court significantly limited the circumstances in which defendants may successfully assert a statute of limitations defense. The Court s further holding that facts suggesting scienter are necessary to start the limitations period will make an attempted dismissal of Section 10(b) claims on statute of limitations grounds even more difficult. Indeed, defendants will likely be uneasy about arguing that an investor could have been aware of facts showing scienter because the absence of scienter is frequently a principal attack against a Section 10(b) claim on motions to dismiss or for summary judgment. The scienter standard for a motion to dismiss (allegations raising a strong inference) and for summary judgment (evidence raising a genuine issue of material fact) may be more rigorous than the level of facts sufficient to show or reveal scienter for purpose of starting the limitations period. Nevertheless, as a practical matter, a vigorous statute of limitations attack claim highlighting available facts showing scienter may undermine a simultaneous attempt to dismiss the claim for lack of scienter. 5 If there is a silver lining in the Merck opinion for potential defendants, it is in the Court s holding that the FDA warning letter and the many articles debating Merck s naproxen hypothesis were not enough for a reasonable investor to discover any fraudulent intent. The FDA warning letter was particularly strong in reprimanding Merck for its incomprehensible statements regarding Vioxx s safety profile, in the face of the FDA s previous objections to Merck s defense of the naproxen thesis as misleading. The Court s unanimous holding that these facts did not reveal scienter seems to set a high standard for what constitutes scienter. Moreover, while shareholder plaintiffs may now have a longer period in which to assert their claims, the Merck decision also reaffirms the difficulty of their burden to allege scienter with sufficient specificity, as illustrated by the Court s confirmation that scienter cannot necessarily be inferred from the mere existence of a materially false statement. Thus, while the Merck decision limits defendants ability to attack a Section 10(b) claim on the basis of the statute of limitations, the Court s view of scienter may enhance defendants already strong ability to challenge a complaint s allegations of scienter at the motion to dismiss stage. While Merck effectively permits shareholder plaintiffs to more freely assert potentially stale Section 10(b) claims, with the five-year statute of repose as the only meaningful time bar, as of the date of this article, it does not appear that Merck has prompted the filing of a significant number of otherwise time-barred suits. 5 Merck is unlikely to have this effect on Section 11 suits under the 1933 Act, where scienter is not an element. 3

6 B. Morrison v. National Australia Bank, 130 S. Ct (June 24, 2010) While Merck was widely viewed as a victory for shareholders, the Supreme Court s ruling in Morrison v. National Australia Bank, 130 S. Ct (June 24, 2010), was a setback for the shareholder plaintiffs bar. In Morrison, the Court considered the extraterritorial application of U.S. securities laws and held that foreign plaintiffs purchasing foreign securities on foreign exchanges cannot bring suit under Section 10(b) (or Rule 10b-5) for securities fraud sounding a death-knell for what had become known as foreign-cubed cases. Rejecting decades of lower-court decisions expanding the extraterritorial reach of the U.S. securities fraud laws, the Supreme Court adopted a transactional test, limiting the applicability of Section 10(b) to transactions in securities either listed on U.S. exchanges or other domestic transactions. Background National Australia Bank Limited was, during the relevant time, the largest bank in Australia. Although National s American Depository Receipts (ADRs), representing the right to receive a specified number of National s shares, are listed on the New York Stock Exchange, its stock is not traded on any domestic exchange. In 1998, National bought HomeSide Lending, Inc., a mortgage servicing company headquartered in Florida. In 2001, National announced that it was writing down the value of HomeSide s assets by approximately $2.2 billion. Three Australian citizens who had purchased National s shares abroad, before the write-downs, sued National and several of its executives in the United States District Court for the Southern District of New York for alleged violations of Sections 10(b) and 20(a) of the Exchange Act, claiming that the defendants had overstated the value of HomeSide s mortgage-servicing rights in National s financial statements. The defendants moved to dismiss for lack of subject matter jurisdiction under Fed. R. Civ. P. 12(b)(1) and for failure to state a claim under Rule 12(b)(6). The district court dismissed, finding no jurisdiction because the alleged domestic acts of defendants were at most a link in a chain of alleged securities fraud that concluded abroad. In re National Australia Bank Sec. Litig., 2006 U.S.Dist. LEXIS (S.D.N.Y. Oct. 25, 2006). Dismissal was affirmed by the Second Circuit. Morrison v. National Australia Bank, Ltd., 547 F.3d 167 (2d Cir. 2008). Supreme Court Decision While affirming dismissal of the Australian plaintiffs claims, the opinion of the Court began by holding that the Second Circuit had incorrectly analyzed the question as a subjectmatter jurisdiction issue under Rule 12(b)(1), whereas to ask what conduct 10(b) prohibits... is a merits question. 130 S.Ct. at The Supreme Court then proceeded to adopt a brightline transactional test for courts to use in determining the scope of Section 10(b). The Court held that Section 10(b) applies only to purchases or sales of securities that occur on a domestic exchange or in the United States. Critical to the Court s ruling was its view that the extraterritorial application of a statute is governed by an examination of the express language of the law in question: an affirmative intent on the part of Congress to give a statute extraterritorial effect will be honored, while silence on the subject will be treated as an intent to withhold extraterritorial application. 4

7 According to the Court, [w]hen a statute gives no clear indication of an extraterritorial application, it has none. Id. at Justice Scalia, writing the opinion of the Court, stated that Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States, and not any other transaction even if alleged fraudulent conduct in connection with the foreign purchase or sale occurred in the United States. 130 S.Ct. at In fashioning this transactional test, the Court rejected decisions going back to 1968 that had interpreted the Exchange Act s silence regarding its extraterritorial reach as an invitation to determine whether Congress would have wanted the statute to apply to the foreign transactions in question. 130 S.Ct. at Courts had developed various tests, most notably the conduct test (how much fraudulent conduct occurred in the United States) and the effects test (the effect of fraudulent conduct on American investors and exchanges). 6 Finding these tests complex in formulation and unpredictable in application, the Court noted [t]here is no more damning indictment of the conduct and effects tests than the Second Circuit s own declaration that the presence or absence of any single factor which was considered significant in other cases... is not necessarily dispositive in future cases. Id. at The focus of the Exchange Act, the Court found, is not upon the place where the deception originated, but upon the purchases and sales of securities in the United States. Id. at Applying these principles, the Court agreed that plaintiffs could not satisfy the transactional test. National s stock did not trade on a United States exchange, nor had plaintiffs purchased the stock in the United States. Accordingly, Section 10(b) did not apply, and the trial court had properly dismissed the plaintiffs claims S.Ct. at Implications of the Morrison Decision Unlike the earlier Merck decision, the effects of Morrison have been immediately felt in numerous lower court cases. Private Causes of Action. With respect to private causes of action, the Court s holding has had a substantial impact on securities cases involving foreign issuers. Most clearly, the transactional test eliminates ambiguity in foreign cubed cases, precluding cases involving foreign purchasers and foreign exchanges. However, while the Morrison Court held that Section 10(b) governs domestic transactions, 130 S. Ct. at 2884, the decision did not provide complete guidance concerning when a purchase or sale is considered to have been made in the United States. Id. at 2886 (emphasis added); see, e.g., Stackhouse v. Toyota Motor Co., 2010 WL 6 See, e.g., SEC v. Berger, 322 F.3d 187, (2d Cir. 2003); Kauther SDN BHD v. Sternberg, 149 F.3d 659, 667 (7th Cir. 1998); Grunenthal GmbH v. Hotz, 712 F.2d 421, (9th Cir. 1983); Continental Grain (Australia) Pty Ltd. v. Pacific Oilseeds, Inc., 592 F.2d 409, 421 (8th Cir. 1979); SEC v. Kasser, 548 F.2d 109, 116 (3rd Cir. 1977). 7 Justice Breyer wrote a brief concurring opinion that concluded that non-u.s. purchases involving non-u.s. investors did not invoke the statute, and that no other issues need be addressed. 130 S.Ct. at Justice Stevens wrote a longer opinion, in which Justice Ginsburg joined, supporting the use of the conduct and effects tests but ultimately concurring in the judgment because the case has Australia written all over it. 130 S.Ct. at

8 , at *1 (C.D. Cal. July 16, 2010) ( The [Morrison] opinion unfortunately does not directly address what is meant by domestic transactions. ). Nevertheless, lower courts have begun to apply Morrison to bar domestic plaintiffs from suing foreign issuers in a variety of contexts. 8 In Stackhouse, the district court was confronted with the scenario of a U.S. citizen purchasing securities on a foreign exchange without leaving the United States, and considered whether such a purchase constituted a domestic transaction. The Stackhouse court acknowledged that [o]ne view of the Supreme Court s holding would be to consider such a case a domestic transaction, id. at *2, but ultimately adopted an alternative view that because the actual transaction takes place on the foreign exchange, the purchaser or seller has figuratively traveled to that foreign exchange... to complete the transaction. Id. The court in Cornwell v. Credit Suisse Grp., 2010 WL (S.D.N.Y. August 20, 2010), came to similar conclusion and granted a motion to dismiss claims brought by domestic plaintiffs who had purchased Credit Suisse securities on the Swiss Stock Exchange. The Cornwell court held that Section 10(b) does not apply to transactions involving... a purchase or sale, wherever it occurs, of securities listed only on a foreign exchange[.] 2010 WL , at *3 (emphasis in original). See also In re Alstom SA Sec. Litig., 2010 WL (S.D.N.Y. Sept. 14, 2010) (dismissing claims of potential class members who purchased Alstom securities on French exchange); Terra Securities ASA Konkursbo v. Citigroup, Inc., 2010 WL , at *4-5 (S.D.N.Y. Aug. 16, 2010) (dismissing claims involving notes listed on European exchanges and total rate of return swap sold in Europe); Sgalambo v. McKenzie, 2010 WL , at *17 (S.D.N.Y. Aug. 6, 2010) (dismissing claims of potential class members who purchased Canadian Superior common stock on the Toronto Stock Exchange). The application of Morrison has recently been expanded by the Southern District of New York to claims asserted under the 1933 Act involving securities purchased abroad. See In re Royal Bank of Scotland Group PLC Securities Litigation, 2011 U.S. Dist. LEXIS 3974 (S.D.N.Y. January 11, 2011). In the decisions issued since Morrison, courts have found that neither the purchaser s U.S. residence nor the domestic execution of a foreign securities purchase is relevant to the transactional test outlined by the Supreme Court. See, e.g., Plumbers Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., 2010 WL , at *9-10 (S.D.N.Y. Oct. 4, 2010) ( A purchaser s citizenship or residency does not affect where a transaction occurs and the country in which an investor happened to be located at the time that it placed its purchase order is immaterial ); In re Société Générale Sec. Litig., 2010 WL , at *6 (S.D.N.Y. Sept. 29, 2010) ( By asking the Court to look to the location of the act of placing a buy order, and to the place of the wrong, Plaintiffs are asking the Court to apply the conduct test specifically rejected in Morrison. ). Shareholder plaintiffs attorneys have attempted a number of creative transformations of foreign securities transactions in order to avoid the application of Morrison, but those efforts have failed thus far. See, e.g., Elliott Associates v. Porsche Automobil Holding SE, WL (S.D.N.Y Dec. 30, 2010) (dismissing securities fraud actions against Porsche on the grounds that 8 Courts have also applied Morrison outside the securities context, holding that other federal statutes do not apply extraterritorially. Norex Petroleum Ltd. v. Access Indus. Inc., 2010 U.S. App. LEXIS (2d Cir. Sept. 28, 2010) (applying Morrison to hold that RICO does not apply extraterritorially in private lawsuits). 6

9 Section 10(b) does not govern swap agreements referencing foreign securities); Absolute Activist Value Master Fund Ltd. v. Homm, 2010 WL , at *2 (S.D.N.Y. Dec. 22, 2010) (dismissing Section 10(b) claims brought by Cayman-based hedge funds which purchased shares of U.S. penny stock companies in private placement transactions, on the grounds that the stocks were not sold on a domestic exchange); Quail Cruises Ship Mgmt. Ltd. v. Agencia de Viagens CVC Tur Limitada, 2010 WL , at *2-3 (S.D. Fla. Aug. 6, 2010) (rejecting that Section 10(b) applied to a foreign corporation s purchase of another foreign company s stock because parties intended to close the transaction in the U.S.); In re Banco Santander Sec. - Optimal Litig., 2010 WL (S.D. Fla. July 30, 2010) (rejecting that Section 10(b) applied to claims by foreign investors in a Bahamian fund, which in turn was to invest with Bernard Madoff s firm, merely because plaintiffs had intended ultimately to hold securities listed on American exchanges). Plaintiffs attorneys in the United States have also begun filing securities lawsuits in foreign countries seeking to recover damages on foreign transactions. Government Enforcement Efforts. Because Morrison addressed the scope of Section 10(b) in its entirety, rather than limiting its analysis to private rights of action under Section 10(b), the opinion could be read to hold that the extraterritorial limitations apply with equal force to SEC enforcement actions. See 130 S. Ct. at 2883 ( [T]here is no affirmative indication in the Exchange Act that 10(b) applies extraterritorially, and we therefore conclude that it does not. ). However, Justice Stevens, in his dissenting opinion, wrote that the Court s decision does not... foreclose the Commission from bringing enforcement actions in additional circumstances, as no issue concerning the Commission s authority is presented in this case. See id. at 2895 n Congress may have sought to address any uncertainty regarding the scope of the SEC s enforcement authority within the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed just days after Morrison was decided. Section 929P(b) of Dodd-Frank provides that the Securities Act of 1933 and the Exchange Act of 1934 are amended to state that the district courts of the United States have jurisdiction of an action or proceeding brought or instituted by the [SEC] with respect to (1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States. Pub. L. No , 929P, 124 Stat (codified as amended at 15 U.S.C. 78aa) (emphasis added). However, Dodd-Frank does not expressly expand the underlying scope of Section 10(b) or any other substantive provision of the federal securities laws. Given the Supreme Court s express holding in Morrison that the key inquiry was not jurisdictional ( The District Court here had jurisdiction under 15 U.S.C. 78aa to adjudicate the question whether 10(b) applies to National s conduct ), but rather what conduct 10(b) prohibits, the purely jurisdictional wording of Dodd-Frank may be insufficient. Purporting to extend the district courts jurisdiction to hear certain cases does not address the underlying scope of the government s enforcement powers. 9 The government s amicus brief in National Australia Bank had urged the Court to adopt a test based on the amount of fraudulent conduct occurring in the U.S. and to affirm dismissal based on plaintiffs failure to show their injury was directly caused by the U.S. component of the alleged fraud. 7

10 Dodd-Frank also requires a study to determine whether private rights of action should be expanded to reach foreign securities transactions. A report on the study is due within eighteen months of the enactment of the Act. Pub. L. No , 929Y. Issues to be considered include whether an extraterritorial private right of action should be available to all potential plaintiffs or some subset, and the implications of an expanded private right of action. Id. Depending upon the results of this study, it could ultimately result in legislation extending the reach of the Section 10(b) private right of action to foreign securities transactions. Depending on the construction of Dodd-Frank s provisions as to SEC enforcement, and the results of the private right of action study, the Morrison decision may ultimately be abrogated in its entirety. II. A LOOK FORWARD TO 2011 Like 2010, this year promises to provide significant developments in the area of securities litigation at the Supreme Court level. With three cases currently pending before the Court (two have already been argued), there will be new pronouncements on the scope of secondary actor liability (Janus Capital), the disclosure obligations of pharmaceutical companies (and perhaps others) with respect to adverse event reports (Matrixx Initiatives), and the relevance of loss causation at the class certification stage (Halliburton) an issue of particular interest for practitioners in the Fifth Circuit, who have since 2007 been operating under a standard in conflict with many other Circuits. A. Janus Capital Group Inc. v. First Derivative Traders, No On December 7, 2010, the Court heard oral arguments in Janus Capital Group, Inc. v. First Derivative Traders, No , in which it will address the standards for potential securities fraud liability of secondary actors and, more specifically, whether alleged victims of false statements in a company s prospectus can sue entities that assisted in the prospectus preparation. The case arises from a Fourth Circuit decision reversing the dismissal of securities fraud claims against Janus Capital Management, LLC ( JCM ), the investment adviser to the Janus family of mutual funds. In re Mut. Funds Inv. Litig., 566 F.3d 111, 115 (4th Cir. 2009). Background At issue in the Janus case is whether JCM can be held primarily liable under Section 10(b) for its assistance in the preparation of allegedly misleading Janus fund prospectuses, even though the statements in the prospectuses were not attributed to JCM. Plaintiff First Derivatives Traders filed suit against JCM, alleging that the company was responsible for misleading statements in prospectuses for several mutual funds. The District Court for the District of Maryland dismissed the claims against JCM, holding that it had neither prepared the prospectuses nor directly made the allegedly misleading statements. In re Mut. Funds Inv. Litig., 487 F. Supp. 2d 618 (D. Md. 2007). The Fourth Circuit reversed, holding that allegations that JCM helped draft and participat[ed] in the writing and dissemination of the prospectuses were sufficient to state a claim that JCM had made the misleading statements in the prospectuses for purposes of Section 10(b) liability. In re Mut. Funds, 566 F.3d at 121 (emphasis added). Given the publicly disclosed responsibilities of JCM as the funds 8

11 investment advisor, the Court of Appeals found that interested investors would infer that JCM played a role in preparing or approving the content of the Janus fund prospectuses even where the prospectus statements were not specifically attributed to JCM. Id. at 127. The Fourth Circuit s ruling created a direct split on this issue with the numerous other Circuits. 10 On June 28, 2010, the Supreme Court granted certiorari 11 to address: (1) whether the Court of Appeals erred in finding that a service provider can be held primarily liable in a private securities fraud action for helping or participating in another company s misstatements; and (2) whether the Court of Appeals erred in finding that a service provider can be held primarily liable in a private securities fraud action for statements that were not directly and contemporaneously attributed to it. Supreme Court Proceedings to Date The JCM petitioner-defendants contend that the Fourth Circuit s decision is flatly inconsistent with Central Bank and Stoneridge: There is no private liability for helping (i.e. aiding) another company. Brief for Petitioners at The JCM entities also argue that [t]he majority of courts of appeals have recognized that direct attribution is a prerequisite to presuming reliance in [fraud-on-the-market] cases against secondary actors. Id. at 12. Plaintiff-respondent First Derivative Traders has argued that JCM did not simply assist the funds in making misstatements, but rather wrote (i.e. created) its policy regarding market timing in the Janus Funds and caused the Funds prospectuses to be issued and disseminated containing that policy. Brief for Respondents at Plaintiff-respondent asserts that, when considered in the context of the uniquely close relationship between a mutual fund and its investment adviser, id. at 21, these allegations suffice[] to plead that JCM made the misrepresentations in the Funds prospectuses regarding its market-timing policy. Id. at 19 (emphasis added). With respect to the question of attribution, First Derivative Traders has argued that [i]mposing a new direct-attribution requirement in 10(b) actions would frustrate Congress s purposes of promoting honest securities markets and investor confidence. Id. at See PIMCO v. Mayer Brown LLP, 603 F , 148 (2d Cir. 2010); AFFCO Investments 2001 v. Proskauer Rose LLP, 625 F.3d 185 (5th Cir. 2010); SEC v. Wolfson, 539 F.3d 1249, 1259 (10th Cir. 2008); In re Charter Communications, Inc., Sec. Litig., 443 F.3d 987 (8th Cir. 2006); Fidel v. Farley, 392 F.3d 220 (6th Cir. 2004); Ziemba v. Cascade Int l Inc., 256 F.3d 1194, 1205 (11th Cir. 2001). The Fourth Circuit s ruling is closely aligned with the Ninth Circuit which has held that Section 10(b) liability may be imposed on a defendant who played a significant role in drafting and editing the misleading statement. In re Software Toolworks, Inc. Sec. Litig., 50 F.3d 615, 626 n.3 (9th Cir. 1994). 11 The United States filed an amicus brief suggesting that the Court not take the case. According to the Solicitor General s brief, the Fourth Circuit s reversal was correct because JCM was alleged to be responsible for day-to-day management of the funds and, as such, was unlike outside service providers such as lawyers and accountants. 12 See Stoneridge Investment Partners v. Scientific-Atlanta, 552 U.S. 148 (2008); Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994). 13 The United States filed an amicus brief arguing that one can make a statement by creating or writing it, even if the statement s creator is not expressly identified. U.S. Amicus Brief at 14. The amicus brief asserts that [r]eading the word make to apply to the acts of someone who creates an untrue statement that is then transmitted to the 9

12 During oral arguments in Janus on December 7, 2010, Justice Scalia conveyed some skepticism that JCM made the statements in the fund prospectuses, noting that [i]f someone writes a speech for me, one can say he drafted the speech, but I make the speech. Justice Sotomayor expressed concern that the position advanced by JCM might encourage companies to construct complex organizational chains to shield parties from disclosure liability: Do you mean to say to me that puppets become a legal defense for someone who intentionally manipulates the market information? 14 Potential Implications of the Janus Case The Court s answer to the questions presented in Janus will likely have implications for accountants, lawyers, advisors and consultants who play a role in preparing a corporation s offering materials and other public statements. At a minimum, Janus will likely resolve the existing Circuit split over whether attribution is required for a secondary actor s liability under Section 10(b). B. Siracusano v. Matrixx Initiatives, Inc., No On January 10, 2011, the Court heard oral arguments in Siracusano v. Matrixx Initiatives, Inc., No , in which it will address whether a plaintiff properly states a Section 10(b) claim based on a pharmaceutical company s failure to disclose adverse reaction reports where the incidents were not alleged to have been statistically significant. The case arises from the Ninth Circuit s decision reversing dismissal of a Section 10(b) complaint, holding that the plaintiffs adequately stated a disclosure fraud claim despite the lack of any assertion with respect to the statistical significance of the undisclosed adverse reports. Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167 (9th Cir. 2009). Background In April 2004, investors brought suit against Matrixx, claiming that the company had failed to disclose information regarding reports that the nasally-administered versions of its overthe-counter cold remedy, Zicam, caused anosmia (a loss of sense of smell). The complaint alleged that the defendants knew of dozens of grievances from doctors and consumers as well as consumer product complaints. The United States District Court for the District of Arizona market by another person or entity is especially appropriate in the context of Rule 10b-5(b) because [b]oth the statute and the rule encompass any person who engages directly or indirectly in the proscribed conduct. Id. at 15. The United States also contends that JCM is a primary, not secondary, actor: Unlike... a lawyer, accountant or bank... an investment adviser s unique and close relationship with a mutual fund makes it essentially a corporate insider. Id. at 17. With respect to attribution, the government s amicus brief argues that [n]othing in this Court s articulations of the fraud-on-the-market presumption suggests that the presumption depends on contemporaneous public knowledge of the identity of a public statement s author. Id. at At the hearing, the Assistant to the Solicitor General, as amicus, advocated broad liability, asserting that if [someone] writes the statement or provides the false information that s used to construct the statement or allows the statement to be attributed to him, the person should be considered a primary violator. The government also took the position that attribution to the actor is not necessary for the actor s liability for a statement. Justice Kagan expressed some unease with the scope of this view, commenting that it is really pretty broad and might apply to a range of factual situations that are not before us. 10

13 dismissed the complaint, concluding that the information alleged to have been withheld was not material because there was no allegation that these incidents showed a statistically significant correlation between the use of Zicam and anosmia. Siracusano v. Matrixx Initiatives, Inc., 2005 WL , at *7 (D. Ariz. Dec. 15, 2005). The Ninth Circuit reversed, holding that district court erred in relying on the statistical significance standard to conclude that Appellants failed adequately to allege materiality. Matrixx, 585 F.3d at The Court held that a trial court cannot determine as a matter of law whether such links [between use of Zicam and the loss of smell] were statistically significant, because statistical significance is a matter of fact. Id. at The Ninth Circuit found that the question of materiality cannot be resolved by bright-line rules but instead requires delicate assessments of the inferences a reasonable shareholder would draw from a given set of facts. Id. at 1178 (citing Basic v. Levinson, 485 U.S. 224 (1988)). Citing to Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007), the Court of Appeals found that the appropriate test is whether the claim is plausible on its face and that the complaint s allegations against the Matrixx defendants were sufficient to nudge plaintiffs claims from conceivable to plausible. Id. at The Ninth Circuit s holding created a split with the First, Second and Third Circuits, which have previously held that adverse reports related to the safety of a product are not material unless such reports provide reliable statistically significant evidence that the drug is unsafe. 15 On June 14, 2010, the Court granted certiorari of the following question: Whether a plaintiff can state a claim under Section 10(b) and Rule 10b-5 based on a pharmaceutical company s nondisclosure of adverse event reports even though the incidents are not alleged to be statistically significant? Supreme Court Proceedings to Date Matrixx contends that a plaintiff alleging that a company failed to disclose adverse event reports should be required to allege facts establishing that the reports represented statistically significant evidence that the company s product was a cause of the reported event. Brief for Petitioners at 13. Without a standard grounded in such statistical significance, Matrixx argues that pharmaceutical companies would necessarily disclose all adverse event reports to avoid potential securities fraud liability. Id. The market would be flood[ed]...with trivial or meaningless information that would only obscure genuinely important information and thereby obscure sound investment decisionmaking. Id. In response, the plaintiff-respondents contend that [s]tatistical significance is not the same as practical importance and assert that practical importance is what matters for materiality. Brief for Respondents at 22. The plaintiff-respondents argue that Basic forecloses a rule that would make any fact, including statistical significance, a categorical prerequisite for materiality.... Id. at 22. They also warn that a statistical significance requirement would be underinclusive and would authorize[] drug companies to conceal information that reasonable investors would consider important. Id. at See N.J. Carpenters Pension & Annuity Funds v. Biogen IDEC Inc., 537 F.3d 35, 50 (1st Cir. 2008); Oran v. Stafford, 226 F.3d 275, 284 (3d Cir. 2000); In re Carter-Wallace, Inc. Sec. Litig., 220 F.3d 36, (2d Cir. 2000). 11

14 During oral arguments in Matrixx on January 10, 2011, several of the Justices raised concerns about the practical effects of implementing a statistical significance standard for materiality. Chief Justice Roberts focused on the stock price impact of adverse drug-related information, rather than its scientific validity: I m an investor in Matrixx; I worry whether my stock price is going to go down. You can have some psychic come out and say Zicam is going to cause a disease with no support whatsoever, but if it causes the stock to go down 20 percent, it seems to me that s material. Justice Breyer noted that there might be information that could be devastating to a drug even though there isn t one person yet who has been hurt. He expressed reluctance to implement a bright-line rule: I can t see how we can say this statistical evidence always works or doesn t work. Justice Kagan offered the following hypothetical and supplied her own conclusion on materiality (as a consumer and investor): There s a pharmaceutical company and it comes out with its first and only product... a new contact lens solution. And it sells this product to... hundreds of thousands of people. And most of them use this product with no adverse effect whatsoever, but there are ten cases where somebody uses this product and they go blind. Three of those ten cases, the person had to borrow a contact lens from a friend, only used it in one eye, they go blind only in that one eye... There is no way that anybody would tell that you these ten cases are statistically significant. 16 Justice Kagan continues: So if I heard that... I d stop using the product; and if I were holding stock in that company, I would sell the stock. Potential Implications of the Matrixx Case The outcome of the Matrixx case is difficult to predict. Given that pharmaceutical companies are also subject to registration by the Food & Drug Administration, one can envision an ironic outcome where companies are compelled to disclose adverse event reports to investors for federal securities purposes, even where not required by the FDA to disclose the same information to actual users of the drug. It is also worth noting that Justice Alito, while serving on the Third Circuit, wrote an opinion finding that incident reports that are not shown to be statistically significant would not alter the total mix of information available to pharmaceutical company investors and are, therefore, immaterial. Oran v. Stafford, 226 F.3d 275, 284 (3d Cir. 2000). At a minimum, the Court s ruling in Matrixx will resolve the now-existing Circuit split on this issue. However, there is also the possibility that the decision will yield more broadlyapplicable standards with respect to materiality in the context of securities fraud claims generally Counsel for Matrixx attempted to point out in response that determining a scientific cause and effect in the field of medicine is more complex than a question of mere frequency or proportion: You may be describing facts that would satisfy the Bradford Hill criteria [widely-used statistical criteria determining the strength of association between a medical condition and its supposed causative agent], for example, where you can draw a reliable inference that the product is the cause. That s the key here. There has to be a reliable basis for inferring causation. 17 The Court s ruling could also have implications for the scienter analysis in securities fraud cases against drug companies (and others), as senior officers and directors may find themselves in the position of deliberating whether to disclose information a myriad of information that is questionably material. If they choose in good faith, but wrongly (in hindsight), they will nevertheless have known about the adverse information and affirmatively chosen to omit it, strengthening plaintiffs scienter allegations in the process. 12

15 C. Erica P. John Fund, Inc. v. Halliburton, No On January 7th, 2011, the Court also granted certiorari in Erica P. John Fund, Inc. v. Halliburton, No , a class action case of particular interest to public companies and securities practitioners in Texas, and elsewhere in the Fifth Circuit. The Court will consider what plaintiffs in a securities fraud case must demonstrate in order to take advantage of the fraud on the market theory at the class certification stage. At present, the Fifth Circuit stands alone in requiring plaintiffs prove loss causation, i.e., that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in the losses. Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330, 334 (5th Cir. 2010). 18 Background The plaintiff in Halliburton alleged that defendants made false statements about three topics and that plaintiff (and a class of shareholders that it sought to represent) bought stock at prices that were artificially inflated by these alleged misrepresentations and suffered losses when the truth was revealed and the stock price declined. At the class certification stage, the district court found that the plaintiff had failed to prove that the stock price declines in question were caused by the revelation of the alleged truth as opposed to other negative information. Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 2008 WL (N.D. Tex. Nov. 4, 2008). Following the rule established in Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F.3d 261, 265 (5th Cir. 2007), the court held that a plaintiff must prove this causal connection between misrepresentation and loss in order to take advantage of the fraud on the market presumption in seeking class certification stage (thereby proving reliance through evidence applicable to all plaintiffs). For the presumption to apply, the court held that plaintiff needed to prove loss causation by a preponderance of the evidence. Plaintiff appealed, arguing that the requirement that it prove loss causation exceeded a plaintiff s burden as set forth in Basic v. Levinson, 485 U.S. 224 (1988). The Fifth Circuit disagreed. Citing Oscar Private Equity Investments, the Halliburton court explained that plaintiffs seeking class certification must establish loss causation in order to trigger the fraudon-the-market presumption. Halliburton, 597 F.3d at 335. The Halliburton court squarely rejected the plaintiffs argument that the Oscar ruling was contrary to Supreme Court and sister circuit precedent. Id. at 334, n. 2 (noting that the Plaintiff may not assail Oscar as wrongly decided, as we are bound by the panel decision ). Plaintiff filed a petition for a writ of certiorari, asking the Supreme Court to reverse the Fifth Circuit s substantial and unprecedented burden on class action plaintiffs. Plaintiff argued that the Fifth Circuit s holding directly conflicts with the law applied in eight other circuits 19 as 18 The Second Circuit decision, In re Salomon Analyst Metromedia Litig., 544 F.3d 474 (2nd Cir. 2008), recognizes the relevance of price impact at the class certification stage, but places the burden on defendants, permitting them to rebut the fraud-on-the-market presumption by showing the absence of loss causation. 19 See, e.g., In re Salomon Analyst Metromedia Litig., 544 F.3d 474 (2nd Cir. 2008); In re PolyMedica Corp. Sec. Litig., 432 F3d 1, 7 (1st Cir. 2005); Binder v. Gillespie, 184 F.3d 1059, 1064 (9th Cir. 1999); In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1419 n.8 (3d Cir. 1997); In re The Mills Corp. Sec. Litig., 257 F.R.D. 101,

16 well as the Supreme Court s holding in Basic, which approved the fraud-on-the-market presumption as a method for establishing reliance in securities class actions. Plaintiff also asserts that the Fifth Circuit s requirement of proof of loss causation prior to class certification is improper because whether a particular statement caused stock price movement is necessarily a common question to all members of the proposed class. Finally, Plaintiff argued that the Fifth Circuit s consideration of the underlying merits of its claim violated Federal Rule of Civil Procedure 23 and the Supreme Court s decision in Eisen v. Carlisle & Jacqueline, 417 U.S. 156 (1974). On January 7th, 2011, the Court granted certiorari of the following two questions: (1) whether the Fifth Circuit correctly held that plaintiffs in securities fraud actions must establish loss causation at class certification by a preponderance of admissible evidence (without merits discovery), and (2) whether the Fifth Circuit improperly considered the merits of the underlying claims at the class certification stage. Briefing has yet to be submitted by the parties. 20 Potential Implications of the Halliburton Case Under Oscar Private Equity, shareholder plaintiffs and their counsel had difficult winning class certification in securities fraud cases filed in the Fifth Circuit. 21 In light of this development, since 2007 the plaintiffs bar has appeared largely to avoid filing new Section 10(b) class actions in the Circuit. With Halliburton, the Supreme Court will determine whether Oscar Private Equity has placed an improper burden on shareholder plaintiffs at certification stage. If the Court finds that it has, and reverses Halliburton, companies located in Texas, Louisiana and Mississippi could face an increase of securities fraud suits as the plaintiffs bar returns to file cases that were previously viewed as too daunting. However, ironically, a defense victory may also lead to an increase in Section 10(b) suits in the Fifth Circuit. If Oscar and Halliburton become the universal rule, then the nationwide playing field is again leveled and class action plaintiffs and their counsel will have no reason to avoid filing in the Fifth Circuit. * * * (E.D. Va. 2009); Ross v. Abercrombie & Fitch Co., 257 F.R.D. 435, 454 (S.D. Ohio 2009); In re Nature s Sunshine Prods. Inc. Sec. Litig., 251 F.R.D. 656, 665 (D. Utah 2008); In re Netbank, Inc. Sec. Litig., 259 F.R.D. 656, 676 n. 14 (N.D. Ga. 2009). Several months after the Fifth Circuit s decision in Halliburton, the Seventh Circuit held that the stock price impact of an alleged misstatement or omission is a merits issue rather than a prerequisite for class certification. See Schleicher v. Wendt, 618 F.3d 679 (7th Cir. 2010). The Seventh Circuit found that the appropriate time to determine when the stock s price was affected by any fraud is [a]fter a class has been certified, and other elements of the claim have been established. Id. at 687. The Seventh Circuit criticized the Fifth Circuit s go-italone strategy. Id. 20 The Acting Solicitor General recommended that the petition be granted, echoing the plaintiff s position that [n]othing in Basic supports the Fifth Circuit s approach. Brief for the United States as Amicus Curiae at 5, and asserting that the only relevant question at the class-certification stage is whether resolution of the loss-causation issue can be expected to turn on proof that is common to class members generally. Id. at Halliburton, 597 F.3d 330; Fener v. Operating Engineers Const. Industry and Miscellaneous Pension Fund, 579 F.3d 401 (5th Cir. 2009); Barrie v. Intervoice-Brite, Inc., 2009 WL (N.D. Tex. Oct. 26, 2009); In re Seitel, Inc. Sec. Litig., 245 F.R.D. 263 (S.D. Tex. 2007); Ryan v. Flowserve Corp., 245 F.R.D. 560 (N.D. Tex. 2007), vacated-in-part and rev d-in part by Alaska Elec. Pension Fund v. Flowserve Corp., 572 F.3d 221 (5th Cir. 2009). 14