The Buck Stops Here

JP Morgan Chase was willing to settle with Enron's investors over its alleged complicity in the energy company's financial scandal, but not with its own investors. That turned out to be a prudent decision when the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of the JP Morgan Chase investors' securities class action last week.

In ECA v. JP Morgan Chase Co., 2009 WL 129911 (2d Cir. Jan. 21, 2009), the court found that the plaintiffs' scienter allegations suffered "from a basic problem concerning plausibility." The plaintiffs argued that JP Morgan "concealed its transactions with Enron in return for excessive fees." The court held, however, that it was "implausible to have both an intent to earn excessive fees for the corporation and also an intent to defraud Plaintiffs by losing vast sums of money [through loans to Enron that JP Morgan could not recover]."

Holding: Dismissal affirmed (on both scienter and materiality grounds).

Addition: The court considered whether Chase was motivated to artificially inflate its stock price via the Enron fraud so that it could use the stock as currency for its acquisition of JP Morgan. Whether this type of motive allegation can contribute to a strong inference of scienter has been an unsettled question. The court found that "a generalized desire to achieve a lucrative acquisition proposal" is common to all companies seeking to make an acquisition and fails "to establish the requisite scienter."

The Principal and the Agent

Global auditing firms are often organized as a professional services organization of member firms, with a different member firm operating in each country. As a result of this structure, courts have often found that the global umbrella entity cannot be liable for the fraudulent activities of a member firm. In the Parmalat securities litigation, however, the court declined to dismiss the claims against Deloitte Touche Tohmatsu ("DTT"). The court found that the plaintiffs had sufficiently alleged a principal-agent relationship between DTT and its Italian member firm that conducted Parmalat audits.

In In re Parmalat Sec. Litig., 2009 WL 179920 (S.D.N.Y. Jan. 27, 2009), the court considered the issue again on summary judgment, with the same result. The court found: (a) the U.S. Supreme Court's decision in Stoneridge did not foreclose vicarious liability for a principal based on the acts of its agent, and (b) there was sufficient evidence that "DTT exercised substantial control over the manner in which the member firms conducted their professional activities," including "in the specific context of the Parmalat engagement." The court also declined to dismiss the control person liability claims against DTT and Deloitte & Touche LLP (Deloitte's U.S.-based member firm).

The WSJ Law Blog has a post on the decision.

Holding: Deloitte defendants' motion for summary judgment denied.

Measuring Damages

The constant percentage method of calculating damages in a securities class action assumes that the fraud caused the stock to be valued at "x" percent more than it was really worth throughout the class period (with "x" percent equaling the percentage decline in the stock price after the fraud was revealed), even if the stock price varied widely during that time.

The New York Law Journal has an interesting column (Jan. 21 - subscrip. req'd) on whether the constant percentage method remains a valid method of calculating damages. The authors argue that the method has been called into question because of the requirement in Dura (the Supreme Court decision on loss causation) that the revelation of the "relevant truth" be the cause of any loss. Only one court, however, has specifically rejected the use of the constant percentage method.

Quote of note: "In excluding the damages and loss causation report of plaintiffs' expert, the [In re Williams Securities Litigation - N.D. Ok.] court found that the constant percentage method was in direct conflict with Dura Pharmaceuticals Inc. v. Broudo, the controlling Supreme Court precedent on loss causation. Securities litigators and their experts should pay heed to Williams. To the extent that this well-reasoned decision starts a trend in the case law, use of the constant percentage method in securities fraud cases may become a thing of the past."

What Does Undue Mean To You?

The PSLRA provides that "all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party." Whether a plaintiff suffers undue prejudice if not provided with documents that have already been produced to a government agency has been the subject of a number of judicial decisions.

Despite an initial split over the issue, in the past few years plaintiffs generally have been unsuccessful in arguing that there is a "government investigation" exception to the discovery stay. As noted in a recent S.D.N.Y. decision, even if it would be easy for the defendant to produce documents that had already been produced to the government, "the mere fact that the discovery stay will prevent Plaintiffs from collecting evidence to assist in potential settlement negotiations or plan their litigation strategy does not constitute undue prejudice." 380544 Canada, Inc. v. Aspen Technology, Inc., 2007 WL 2049738 (S.D.N.Y. July 18, 2007) (finding that there were no "exceptional circumstances," such as the possibility that the plaintiff would be left without a recovery because of the defendant's bankruptcy).

In the absence of appellate court affirmance of the prevailing position, however, there is always the possibility that a district court will decide to turn back the clock. Last week, in Waldman v. Wachovia Corp., 2009 WL 86763 (S.D.N.Y. Jan. 12, 2009), the court considered a request to partially lift the discovery stay in an auction rate securities case to obtain documents produced to the SEC. The court found that because "lead plaintiffs must determine whether to continue with this case despite the settlement reached between the defendants and the SEC," they had sufficiently demonstrated "undue prejudice."

Holding: Motion to partially lift the PSLRA discovery stay granted.

A Second Bite At The Apple

The U.S. Court of Appeals for the Ninth Circuit issued two decisions this week affirming dismissals based on a failure to adequately plead scienter (i.e., fraudulent intent). The decisions - Zucco Partners, LLC v. Digimarc Corp., 2009 WL 57081 (9th Cir. Jan. 12, 2009) and Rubke v. Capitol Bancorp LTD, 2009 WL 69278 (9th Cir. Jan. 13, 2009) - are notable because they appear to tweak the court's approach to evaluating scienter allegations.

The panels found that the U.S. Supreme Court's decision in Tellabs meant that they could no longer dismiss a complaint because the individual scienter allegations were insufficient. Instead, as the Zucco panel held, the court needed to "conduct a dual inquiry: first, we will determine whether any of the plaintiff's allegations, standing alone, are sufficient to create a strong inference of scienter; second, if no individual allegations are sufficient, we will conduct a 'holistic' review of the same allegations to determine whether the insufficient allegations combine to create a strong inference of intentional conduct or deliberate recklessness." The Rubke panel agreed with this two-step approach, finding that it was required to perform a "second holistic analysis to determine whether the complaint contains an inference of scienter that is greater than the sum of its parts."

Whether this dual inquiry, which appears to afford plaintiffs a second bite at the apple, will have any practical effect is difficult to say. Both panels held that scienter was inadequately plead in the respective complaints (even when evaluated holistically), with the Zucco panel noting that "a comprehensive perspective of Zucco's complaint cannot transform a series of inadequate allegations into a viable inference of scienter." To put it another way, can zero plus zero plus zero ever add up to something? Stay tuned.

Deceiving The Accountant

Last month, the U.S. Court of Appeals for the Fourth Circuit issued its first post-Tellabs decision on the pleading of scienter (i.e., fraudulent intent). The court is back this month with another scienter decision, this time in a case against an accounting firm.

In Public Employees' Retirement Assoc. of Col. v. Deloitte & Touche LLP, 2009 WL 19134 (4th Cir. Jan. 5, 2009), the court considered the alleged role of two Deloitte entities in the Royal Ahold fraud. (The corporate defendants settled for $1.1 billion in 2005.) The court found that "to establish a strong inference of scienter," the plaintiffs needed to "demonstrate that the Deloittes were either knowingly complicit in the fraud, or so reckless in their duties as to be oblivious to malfeasance that was readily apparent." The plaintiffs, however, could not "escape the fact that Ahold . . . went to considerable lengths to conceal the frauds from the accountants and it was the defendants that ultimately uncovered the frauds." The "strong inference to be drawn from this fact" is that the Deloitte entities "lacked the requisite scienter."

Holding: Dismissal affirmed.

Quote of note: "It is not an accountant's fault if its client actively conspires with others in order to deprive the accountant of accurate information about the client's finances. It would be wrong and counter to the purposes of the PSLRA to find an accountant liable in such an instance."

Cornerstone And Stanford Release Report On Filings In 2008

Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse have released a report on federal securities class action filings in 2008. The findings include:

(1) There were were 210 filings (through 12/15), a 19% increase over the previous year. As usual, Cornerstone reports a lower number of filings than NERA, presumably due to different counting methodologies.

(2) Almost half of the 2008 litigation activity, or 103 securities class actions, involved firms in the financial services sector. Indeed, nearly a third of all large financial firms were a named defendant in a filing.

(3) For the first time since 2002, companies listed on NYSE or Amex had more securities class action
filings than companies listed on NASDAQ (likely because of the plaintiffs' focus on the financial sector).

(4) Among the resolved class actions filed since 1996, 41 percent were dismissed and 59 percent settled. The majority of cases were resolved after the first ruling on the motion to dismiss but before a ruling on summary judgments, with 71 percent of dismissals and 59 percent of settlements occurring during this stage.

The joint press release announcing the report can be found here.

Quote of note (Professor Grundfest): "The data suggests an intriguing possibility that the pool of major financial services defendants might be getting fished out. Many major financial services firms have already been sued and plaintiffs may be choosing to focus on filing amendments to existing complaints rather than initiating new ones. Litigation activity against the financial sector may decline next year because the supply of new defendants might be drying up, not necessarily because plaintiffs believe there is less fraud."

The D&O Diary has an interesting analysis of the report and predicts another big year for filings in 2009.

Year In Review

Securities Docket will be hosting a "2008 Year in Review - Securities Litigation and Enforcement" webcast on Tuesday, January 6 at 2 p.m. ET. All of the details on the free program, which will include a number of prominent bloggers, can be found here.