Number 665 January 11, 2008 Client Alert Latham & Watkins Litigation Department Virginia Rocket Docket Deemed Proper Venue for Securities Fraud Actions Based Upon Filing of Financial Statements with SEC through EDGAR Going forward, plaintiffs can safely bring an action alleging securities fraud based on the filing of allegedly fraudulent financial statements in the Eastern District of Virginia, knowing that their case will not be dismissed for lack of venue. The US Court of Appeals for the Fourth Circuit recently held that the act of transmitting financial statements to the US Securities and Exchange Commission (SEC) through its computer server in Alexandria, Virginia, is sufficient to make the Eastern District of Virginia an appropriate venue to hear cases alleging securities fraud based upon such filings. 1 The court explained that it is irrelevant whether the person who submitted the financial statements could have reasonably foreseen that the SEC s Electronic Data Gathering, Analysis and Retrieval system (EDGAR) computer server is located in Virginia. In other words, all US and non-us registrants that file financial statements with the SEC through EDGAR may find themselves facing lawsuits in Virginia. This is particularly noteworthy because the Eastern District of Virginia is known as the rocket docket. Cases are subject to expedited discovery and pretrial procedures and frequently get to a jury verdict in less than 10 months. By way of comparison, the average time for a case to reach a verdict in all US District Courts is just under two years. 2 US v. Johnson involved a criminal prosecution of a CEO who was accused of submitting financial statements to the SEC that contained fraudulently inflated revenue figures in violation of 10(b) of the Securities and Exchange Act of 1934 (Exchange Act) and Rule 10b-5. Because the relevant venue statute equally applies to civil actions, and because the SEC requires virtually all US registrants and non-us private issuers to submit their financial statements electronically through the EDGAR computer server, the Johnson decision affects numerous future lawsuits involving allegations of securities fraud. 3 In short, the Department of Justice, the SEC and private plaintiffs can now bring cases alleging securities fraud based on the filing of improper financial statements in the Eastern District of Virginia without risk of dismissal for lack of venue, and take advantage of the expedited proceedings of the rocket docket. Filing of False and Misleading Form 10-Q Via EDGAR Led to Securities Fraud Prosecution in Virginia In January 2005, Charles Johnson was indicted for securities fraud and related offenses in the Eastern District of Virginia. Mr. Johnson was the CEO of PurchasePro.com, Inc. (PurchasePro), a publicly owned company that sold Internet procurement software designed to facilitate business-to- Latham & Watkins operates as a limited liability partnership worldwide with an affiliated limited liability partnership conducting the practice in the United Kingdom and Italy. Under s Code of Professional Responsibility, portions of this communication contain attorney advertising. Prior results do not guarantee a similar outcome. Results depend upon a variety of factors unique to each representation. Please direct all inquiries regarding our conduct under s Disciplinary Rules to Latham & Watkins LLP, 885 Third Avenue,, NY 10022-4834, Phone: +1.212.906.1200. Copyright 2008 Latham & Watkins. All Rights Reserved.
business transactions on the Internet. The indictment charged that in 2001, Mr. Johnson had inflated PurchasePro s reported revenue figures through the use of backdated contracts and false entries in the company s books and records. These revenue figures were included in a quarterly revenue report (Form 10-Q) that was electronically submitted to the SEC through the EDGAR computer server in Alexandria, Virginia. Count 3 of the indictment charged Mr. Johnson with causing the filing of false and fraudulent documents with the SEC in violation of, among other provisions, 10(b) of the Exchange Act and Rule 10b-5. There was no dispute that the transmission of PurchasePro s Form 10-Q to the EDGAR computer server was the only contact between Mr. Johnson and the Eastern District of Virginia. 4 Following the indictment, Mr. Johnson moved to dismiss count 3, asserting that venue in the Eastern District of Virginia was improper under 27 of the Exchange Act. 5 Voicing concern that it was not reasonably foreseeable for Mr. Johnson that he would be subject to prosecution in Virginia based on the happenstance of the location of the EDGAR computer server, the District Court granted the motion and dismissed the allegation that Mr. Johnson had caused the filing of false and fraudulent documents with the SEC. 6 Reviewing the nature of the charged offense and the language of 27 of the Exchange Act, the Court of Appeals disagreed and reversed. Virginia Venue Permitted because Transmission of False Form 10-Q Via EDGAR was Material to Filing Fraudulent Documents with SEC Offense On appeal, Mr. Johnson argued that the lower court was correct and that venue in Virginia was improper under 27 of the Exchange Act because the essence of the alleged offense was the filing of fraudulent documents with the SEC in Washington, D.C., not its EDGAR computer server that happened to be located in Virginia. 7 Mr. Johnson further noted that the same lower court had granted a motion in US v. Ferguson seeking to transfer a case from Virginia to Connecticut because the SEC s decision to locate EDGAR, the electronic filing system and to host the SEC website on a computer server in Alexandria, Virginia will not in and of itself transform the Eastern District of Virginia into the exclusive jurisdiction for criminal securities fraud cases. 8 The Court of Appeals rejected Mr. Johnson s argument because the broad language of 27 of the Exchange Act does not limit venue to the jurisdiction where the essence of an alleged offense occurred. 9 Section 27 of the Exchange Act provides in relevant part: Any criminal proceeding may be brought in the district wherein any act or transaction constituting the violation occurred. Any suit or action to enforce any liability or duty created by this title or rules and regulations thereunder, or to enjoin any violation of such title or rules and regulations may be brought in any such district or in the district wherein the defendant is found 10 The court explained that [a]s a result, the venue-sustaining act need not constitute the core of the alleged violation but merely one that is material to the charged offense. 11 Because it was undisputed that the allegedly fraudulent documents were sent to the Eastern District of Virginia when they were electronically submitted to the EDGAR computer server, the court held that a material act to the charged offense of causing the filing of fraudulent documents with the SEC had occurred in Virginia and that venue was proper under 27 of the Exchange Act. 12 The court expressly noted that its
interpretation of 27 of the Exchange Act would also apply to civil actions. 13 The Court of Appeals also responded to Mr. Johnson s argument that in US v. Ferguson the lower court had transferred a case to Connecticut because the defendant s contact with Virginia was principally based on the transmitting of documents to the SEC through the EDGAR filing system. The court explained that there is an important distinction between deciding whether a case should be transferred to another jurisdiction and whether venue is permissible in the first place: when determining whether to transfer venue to the District of Connecticut, the district court in Ferguson implicitly assumed that venue was permissible in the Eastern District [of Virginia] otherwise, it would not have needed to weigh the relative inconveniences to begin with. 14 Following this decision, defendants accused of securities fraud based on the filing of allegedly fraudulent documents to the SEC will thus no longer be able to get a case dismissed for lack of venue, and will be limited to moving for a transfer to a more convenient forum instead a matter that is largely discretionary. 15 Foreseeability not Required for Establishing Venue in Actions Involving Securities Fraud As a second, independent ground for upholding the judgment of the district court, Mr. Johnson argued that venue in Virginia would be improper because he could not have reasonably foreseen that the PurchasePro s Form 10-Q would be transmitted to Virginia. Mr. Johnson argued that he instead reasonably believed that PurchasePro s financial information would be transmitted to the District of Columbia. In this regard, he pointed out that the SEC s principal office is located in the District of Columbia, that the SEC s address indicated at the top of Form 10-Q is in the District of Columbia, and that a US federal regulation governing the filing of documents with the SEC states that [a]ll papers required to be filed with the Commission pursuant to the [Exchange Act] or the rules and regulations thereunder shall be filed at the principal office in Washington, D.C. 16 The Court of Appeals rejected this argument as well because the plain text of [ 27 of the Exchange Act] does not permit us to hold that such a foreseeability requirement exists. 17 Section 27 of the Exchange Act provides that any criminal proceeding and any suit or action to enforce any liability or duty created by the Exchange Act may be brought in the district wherein any act or transaction constituting the violation occurred. 18 Because venue is similar to a jurisdictional element and thus typically lacks any sort of knowledge or foreseeability prerequisite, the court refused to read a foreseeability requirement into 27 of the Exchange Act. 19 Instead, the court held that the sole act of transmitting allegedly fraudulent financial statements to the EDGAR computer server in Alexandria was sufficient for establishing venue in the Eastern District of Virginia. 20 Following Johnson, Defendants in Securities Fraud Cases Can Still Seek Transfer to Another Forum but Cannot Get Charges Dismissed from the Eastern District of Virginia Based on Improper Venue Because of the broad application of 27 of the Exchange Act to civil and criminal cases alleging securities fraud, and because the SEC requires virtually all US registrants and non- US private issuers to use EDGAR to file financial statements, the Court of Appeals decision in US v. Johnson will impact numerous future cases involving
allegations of securities fraud. Going forward, plaintiffs can safely bring an action alleging securities fraud based on the filing of allegedly fraudulent financial statements in the Eastern District of Virginia, knowing that their case will not be dismissed for lack of venue. Civil and criminal defendants, on the other hand, will be limited to seeking a discretionary transfer to a more convenient forum and can no longer successfully attempt to get such an action or count dismissed because they could not have reasonably foreseen that the electronic transmission of financial statements to the SEC would make them subject to suit in Virginia. 21 It is still unclear how the Eastern District of Virginia will react to its new status as the default venue for securities fraud actions. Because of the inherent discretion in deciding whether to grant a motion seeking a transfer, the court could embrace the opportunity and become a leading venue for securities jurisprudence. Alternatively, the court could determine that simply because it is one permissible venue, it is not normally the most convenient forum and routinely begin to grant motions seeking to transfer the case to a jurisdiction with a greater connection to the litigation. 22 Either way, companies facing securities fraud actions in Virginia will benefit from retaining counsel experienced in practicing in the rocket docket. Endnotes 1 U.S. v. Johnson, 2007 WL 4357393 (4th Cir. Dec. 14, 2007) 2 During the 12 months ending September 30, 2006, the median time interval from filing to disposition of civil cases by means of a trial in the Eastern District of Virginia was 9.8 months. In contrast, the median time interval in the Southern District of was 24 months, in the Southern District of California 25 months and in the District of Columbia 36 months. See Judicial Business of the United States Courts, Table C-5: US District Courts Median Time Intervals From Filing to Disposition of Civil Cases Terminated, By District and Method of Disposition, During the 12-Month Period Ending September 30, 2006, available at http://www.uscourts.gov/ judbus2006/appendices/c5.pdf. 3 See SEC Release 33-7472 (US registrants), available at http://www.sec.gov/rules/final/33-7472.txt, and SEC Release 33-8099 (foreign private issuers), available at http://www.sec. gov/rules/final/33-8099.htm. 4 Johnson, 2007 WL 4357393, at *1. 5 Id. at *2. 6 Id. See also appellant s brief, p. 7 (quoting hearing transcript reflecting the lower court s concern). 7 Id. at *3 8 Id. at *4, citing US v. Ferguson, 432 F. Supp. 2d 559, 569 (E.D. Va. 2006) 9 Id. at *3, citing In re. AES Corp. Sec. Litig., 240 F. Supp. 2d 557, 559 (E.D.Va. 2003). 10 15 U.S.C. 78aa. Any criminal proceeding may be brought in the district wherein any act or transaction constituting the violation occurred. Id. Civil cases may be brought in any such district or in the district wherein the defendant is found. Id. (emphasis added). 11 Johnson, 2007 WL 4357393, at *3, citing In re. AES Corp. Sec. Litig., 240 F. Supp. 2d at 559 (internal quotation marks omitted). 12 Id. 13 Id. at *4. 14 Id. at *5. 15 Under Fed. R. Crim P. 21(b), a defendant seeking a transfer to another venue must demonstrate that prosecution of the case in the district where the count was properly filed would result in a substantial balance of inconvenience to the defendant. Ferguson, 432 F. Supp. 2d at 561 (citations omitted). In considering the inconvenience to the defendant, the court may weigh the: (a) location of the defendant; (b) location of witnesses; (c) location of events likely to be in issue; (d) location of documents and records; (e) disruption of the defendant s business; (f) expense to the parties; (g) location of counsel; (h) relative accessibility of place of trial; (i) docket conditions in each district; and (j) any other specific element which might affect the transfer. See id., citing U.S. v. Heaps, 39 F.3d 479, 483 (4th Cir. 1994). Courts also have discretion in deciding on transfer motions in civil cases. Under 28 U.S.C 1404(a), a district court may transfer any civil action to any other district or division where it might have been brought for the convenience of parties and witnesses and in the interest of
justice. The District Court for the Eastern District of Virginia recently explained that this provision was intended to place discretion in the district court to adjudicate motions for transfer according to an individualized, caseby-case consideration of convenience and fairness. Finkel v. Subaru of America, 2006 US Dist. LEXIS 69064, at *5 (E.D.Va. Sept. 26, 2006) quoting Stewart Org., Inc. v. Ricoh Corp., 487 U.S. 22, 29 (1988). 16 Johnson, 2007 WL 4357393, at *5, citing 17 C.F.R. 240.0-3(a). 17 Id. at *6. Because the Court of Appeals relied on the plain language of 27 of the Exchange Act, it refused to reach the issue whether there is a foreseeability requirement for establishing venue in the context of wire fraud. Id. In this regard, the court noted the split between the Second Circuit where foreseeability is required to establish venue in cases alleging wire fraud and the Third and Ninth Circuits where foreseeability is not required. Compare US v. Svoboda, 347 F.3d 471, 483 (2d. Cir. 2003) with US v. Angotti, 105 F.3d 539, 543 (9th Cir. 1997) and US v. Goldberg, 830 F.2d 459, 465 (3d Cir. 1987). 18 15 U.S.C. 78aa (emphasis added). 19 Johnson, 2007 WL 4357393, at *6, citing US v. Perez, 280 F.3d 318, 330 (3d Cir. 2002) and Fed. R. Crim. P. 18. 20 Id. 21 A number of factors will need to be considered in determining whether a defendant who faces allegations of securities fraud should seek a transfer to another jurisdiction. In making this determination, non-us private issuers should include an evaluation of the willingness of each forum to dismiss claims of non-us purchasers based on the lack of a sufficient connection with the United States and the availability of an alternative recourse for such purchasers to address their alleged injuries, including global settlements abroad. See, e.g., In re Royal Dutch/Shell Transport Securities Litigation (Royal Dutch II), Civ. No. 04-374 (JAP), 2007 US Dist. LEXIS 84434 (D.N.J. Nov. 13, 2007) discussed in Latham Client Alert No. 656, December 6, 2007. 22 See, e.g., Ferguson, 432 F. Supp. 2d at 562 (granting transfer motion because having this matter adjudicated in this district will result in a substantial balance of inconvenience to the defendants. ) (citations omitted).
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