Securities Fraud Class Action Last updated 18 Feb 09

Stanford Class Action Clearinghouse

Stanford Class Action Clearinghouse

Anatomy of securities fraud class 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 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 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 Harry Blackmun (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

1 st, 5 th, 6 th, 10 th, 11 th Circuits Strong inference of scienter M&O is external marker Unusual insider trading

9 th 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