Food for Thought

Food for Thought:  To be updated periodically with quotes, excerpts, and tidbits!


An article on U-5 Defamation:  http://www.sfmslaw.com/Securities-Regulation-Corporate-Governance/U-5-Defamation.shtml

“The Supreme Court in an Interdependent World”

(The Wall Street Journal, 9.15.15; A7)

The Supreme Court Goes Global:

“Legal problems – human rights violations, threats to national security, computer hacking, environmental degradation, corporate fraud, copy-right infringement – surface beyond our borders and may become potential threats to us at home...the frequent presence of foreign-related issues in the court's cases has little or nothing to do with the current political debate about whether American courts, including the Supreme Court, should refer in their opinions to decisions of foreign courts. Judicial reference to foreign law and practices do not reflect the ideologies of justices – rather they reflect a world in which cross-boundary travel, marriage, commerce, crime, security needs and environmental impacts have become prevalent.”

- Supreme Court Justice Stephen Breyer

Change is the law of life. And those who look only to the past or present are certain to miss the future.

- John F. Kennedy

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A Texas attorney was sentenced to 35 months in prison and the surrender of his law license for misleading investors with artificially inflated stock prices of a sham company advertised to be on the verge of launch.

Martin Cantu and his partner Jason Wynn allegedly engaged in a $3 million conspiracy, netting about $550,000 and $2.5 million, respectively. Cantu still faces an $800,000 penalty from the U.S. Securities and Exchange Commission. [i]

Cantu pled guilty to conspiracy, but was also found guilty of securities fraud for his role in the unregistered stock offering of a web-based company that was never in a position to fulfill its promises to investors. After selling 10 million shares for one penny each, Cantu received 300,000 shares at no cost, just prior to a publicity campaign that included advertising in the USA Today newspaper.[ii]

Three million mailers were also distributed touting the company’s imminent launch, with promises of near limitless returns on the investment. In addition to the increased demand resulting from this publicity, the co-conspirators utilized brokerage accounts to buy shares and create the illusion of demand, while maintaining an inflated higher share price.[iii]

After accepting a plea deal, Wynn was sentenced to five years of probation and $425,000 in restitution. This does not include the $11 million SEC penalty he faces.[iv] Generally speaking, attorneys should never get personally involved with unregistered offerings.

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[i] Orzeck, K. (2015, December 15) Texas Atty Gets 3 Yrs. For Duping Investors in $3M Web Scam [electronic format]. Retrieved from http://www.law360.com/articles/738329

[ii] Ibid.

[iii] Ibid.

[iv] Ibid.

U.S. Supreme Court Debates Coverage of the Securities Litigation Uniform Standards Act

The U.S. Supreme Court recently debated whether investors in a consolidated class action suit were precluded by the Securities Litigation Uniform Standards Act (“SLUSA”) from bringing state law causes of action against law firms and other third party entities for their alleged roles in the $7 billion R. Allen Stanford Ponzi scheme. SLUSA bars plaintiffs from bringing state law claims based on misrepresentations made “in connection with the purchase or sale of a covered security.” 

The Ponzi scheme at the center of the allegations involved over 21,000 investors who bought certificates of deposit from R. Allen Stanford’s bank in Antigua. Stanford promised a risk-free investment with above-market rates of return and said the CDs were backed by portfolios of liquid securities.  However, there were no securities and the money went to fund a string of failed businesses, bribe regulators, and support Stanford’s lavish lifestyle. R. Allen Stanford was convicted and sentenced to 110 years in prison in March of 2012.  The receiver, who was court appointed in 2009 to recover money from Stanford’s failed companies to return to investors, recently began mailing checks ranging from $2.81 to $110,000 to hundreds of investors.  That amounts to approximately $55 million of the $6 billion lost from the scheme – less than a penny on the dollar.

The complaints filed by investors alleged that various third party entities made misrepresentations concerning the safety of the investments and that Stanford’s attorneys conspired with and aided and abetted Stanford in violating the securities laws by lying to the SEC and assisting Stanford to evade regulatory oversight.

The District Court examined whether a covered security was applicable in the case because although the CD was not a covered security, the marketable securities purportedly backing the CD’s were a covered security.  During this analysis, the District Court used the Eleventh Circuit’s approach, which asks “whether a group of plaintiffs premise their claim on either ‘fraud that induced [the plaintiffs] to invest with [the defendants] … or a fraudulent scheme that coincided and depended upon the purchase or sale of securities.’” The District Court determined that the belief that the CD’s were backed by marketable securities induced the investors to purchase the CD’s.  Therefore, the District Court dismissed the investors’ claims.

On appeal, the Fifth Circuit reversed the decision, rejecting the test applied in the Eleventh Circuit and adopted the Ninth Circuit test: “A misrepresentation is ‘in connection with’ the purchase or sale of a security if there is a relationship in which the fraud and the stock sale coincide or are more than tangentially related.”  The Fifth Circuit relied on public policy considerations that requires interpretation of the “in connection with” element in a manner not to preclude group claims simply because the issuer advertises that it owns covered securities in its portfolio. 

In order to resolve the circuit split on the interpretation of SLUSA’s “in connection with” requirement, the Supreme Court granted certiorari. The issues considered by the highest court were the following: (1) whether the Securities Litigation Uniform Standards Act (SLUSA) precludes a state-law class action alleging a scheme of fraud that involves misrepresentations about transactions in SLUSA-covered securities; and (2) whether SLUSA precludes class actions asserting that defendants aided and abetted SLUSA-covered securities fraud when the defendants themselves did not make misrepresentations about the purchase or sale of SLUSA-covered securities.

Plaintiffs hinge part of their argument on the fact certificates of deposits were specifically excluded from Congress’s definition of “covered security” and request the Court uphold the 5^th Circuit’s ruling.  The defendants claimed that the application of federal law should be broad and because Stanford made the promise to back the CD’s with securities, the SLUSA effectively blocks the state causes of action.

During oral arguments, the nine justices gave no clear indication on how they will rule.  However, Justice Scalia’s questions and comments suggested he felt the suits could go forward because he read the statutory language “in connection with the purchase or sale of a covered security.”  Justice Alito, on the other hand, read “in connection with” broadly.  Stay tuned for and update when the court releases its ruling.   

The Supreme Court Reaffirms Total Mix Test for Materiality

The U.S. Supreme Court adopted the position urged by the SEC’s amicus brief, affirming its traditional test of materiality in 10b-5 actions in Matrixx Initiatives, Inc., v. Siracusano on March 22, 2011. The unanimous ruling rejected the petitioner’s contention that there should be a bright-line test for materiality in a securities fraud suit, a position that the Court also previously rejected in Basic Inc. v. Levinson.

The complaint alleges that Matrixx made false statements in 2003 about a cold remedy nasal spray, Zicam. The statements publicized the success of the nasal spray, which made Matrixx increase its earning guidance based on increased Zicam sales. However, the company had information from multiple sources showing that the nasal spray could cause loss of smell.

After several product liability suits had been filed, Matrixx continued to state that Zicam was safe and that none of the clinical trials supported findings that the nasal spray caused loss of smell. After an FDA investigation report was released, Matrixx’s share price dropped.

The District Court dismissed the original complaint holding that a pharmaceutical company is not required to disclose such reports unless they are statistically significant—consistent with precedent in the Second Circuit. However, the Ninth Circuit Court of Appeals reversed concluding that the statistically significant test was contrary to the test for materiality set forth by the Supreme Court in Basic and TSC Industries, Inc v. Northway, Inc.. In TSC and Basic, the Court articulated the “total mix” test, which sets the threshold for materiality as satisfied when there is "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available."

The Supreme Court affirmed the Court of Appeals, holding that “the materiality of adverse event reports cannot be reduced to a bright-line rule. Although in many cases reasonable investors would not consider reports of adverse events to be material information, respondents have alleged facts plausibly suggesting that reasonable investors would have viewed these particular reports as material.” Namely, that Zicam is Matrixx’s key product.

In its reasoning, the Supreme Court again rejected adopting a bright-line approach. Arguments in favor of a bright-line rule are based on the idea that statistical significance is the only indication of causation. However, the Court stated that lack of statistically significant data does not mean that medical experts have no reliable basis for inferring a causal link between a drug and adverse events. The Court concluded that investors may utilize a similar approach: considering context, not just statistical significance for determining causation. Similarly, the question of materiality is based on a contextual inquiry.

In Matrixx, the Court held that the total mix standard for materiality was met because Matrixx received information and reports that indicated a plausible causal link between Zicam and loss of smell. The court held this is sufficient to meet materiality at the pleading stages.

Second Circuit Reaffirms Refusal to Enforce Arbitration Clause

Arbitration provisions have been the subject of recent lawsuits, especially those found in credit card agreements. In July 2010, the Minnesota Attorney General, Lori Swanson, filed suit against the National Arbitration Forum, alleging, inter alia, that mandatory arbitration provisions in credit card agreements are unconscionable and unenforceable.

Most recently, on Monday, March 8, 2011, the Second Circuit Court of Appeals reaffirmed its earlier decision not to enforce a mandatory arbitration clause in a credit card agreement. The court’s earlier decision in In re Am. Express. Merchs. Litig. in 2009 held that the pre-dispute arbitration clause in American Express’ credit card agreements was not enforceable because it contained a provision requiring card holders to waive their rights to bring a class action suit. The Supreme Court granted certiorari in 2010 and remanded the case back to the Second Circuit.

The Second Circuit’s 2009 decision applied the Supreme Court’s analysis laid out in dicta in Green Tree Financial Corp.-Alabama v. Randolph. In Greentree, the Supreme Court ruled that a mandatory arbitration clause was unenforceable against a party who proves that the costs of arbitration of a federal statutory claim are so high, such that the arbitration costs effectively prohibit that party from vindicating statutory rights. Accordingly, the Second Circuit concluded that individual arbitrations would be cost-prohibitive and preclude cardholders from asserting their statutory rights under federal antitrust laws. Thus, the arbitration clause was unenforceable.

Subsequent to the Second Circuit’s decision, the Supreme Court ruled in Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp. that arbitration clauses, which are silent on the issue of class arbitrations, could not be read by arbitrators as reflecting the parties’ agreement on the issue of class arbitration. Pursuant to this decision, American Express petitioned for certiorari, which was granted.

Upon remand, the Second Circuit again concluded that the pre-dispute arbitration clause was unenforceable, determining that the Stolt-Nielsen decision did not alter its previous analysis because Stolt-Nielsen focused on the ability of arbitrators, not courts, to interpret clauses in mandatory arbitration provisions.

This spring, the Supreme Court is set to make another decision regarding class arbitrations in AT&T v. Concepcion. The issue in AT&T is whether the Federal Arbitration Act preempts states from mandating that class arbitration be available as part of an arbitration agreement.

AARP AND NASAA FILE JOINT U.S. SUPREME COURT AMICUS BRIEF REGARDING §10(b) LIABILITY

Last month the AARP and the Northern American Securities Administrators, Inc. (NASAA) joined forces to file an Amicus Brief in the United States Supreme Court in Janus Capital Group, et al v. First Derivative Traders. At issue was the extent to which a person or entity must be involved in drafting false statements in order to be exposed to potential §10(b) liability. According to the Amici, the mutual fund advisers should fall within the reach of §10(b) liability because the fund's advisers were the primary actors relative to the false statements made within the prospectuses for the mutual fund.

Plaintiff's are mutual fund investors in Janus Funds. Janus Management stands accused of engaging in secret market timing deals to the detriment of the Janus Fund investors. On appeal, Janus Management argues that the Court should apply a “Direct Attribution” standard. AARP and NASAA argue that the application of this restrictive standard would allow the fund advisers to dodge liability and shift it to the Fund's innocent shareholders by simply keeping their name off the prospectus. Seems like a fairly compelling argument.

Perhaps the most interesting angle on the Brief, and the issue on appeal, is NASAA's argument that §10(b) must be afforded an expansive application and interpretation in light of the absence of an alternative state court remedy. But its primary basis for this argument is not the absence of a remedy, but the absence of a procedure – class actions. Indeed, the 1998 Securities Litigation Uniform Standards Act (“SLUSA”) imposed heavy restrictions upon the utilization of class litigation in the state courts. The Amici noted as somewhat of an after-thought the absence of a remedy as well, due to the absence of a state common law fraud-on-the-market cause of action.

The Supreme Court heard oral argument on the matter on December 7^th. A transcript or the oral argument can be retrieved by clicking here. The Amicus Brief can be reviewed by clicking here.