Blawgletter®

10-K OK in SEC Case for Backdate of Stock Options, per Ninth Circuit

We can all agree that granting people stock options that can't lose -- as Apple and lots of other (often high-tech) outfits did Not Long Ago -- at least feels wrong. But who knew that accounting for them in the wrong way could expose you to a suit by the Securities and Exchange Commission?

Blawgletter surely did not know. As far as you know. But surely the chief financial officer of a public company should have known that, right?

Likely.

Yet we want to tell you about something else. We desire to let you know that an Annual Report on Form 10-K, the Ninth Circuit held today, can come into evidence under the business records exception to the hearsay rule to help persuade a jury that, yes, you (as CFO) messed up in how you accounted for those stock options that your firm back-dated. Even though the 10-K came out long after you left. And in spite of the fact that the parts the SEC used against you dealt with the results of a series of judgments about pretty complex stuff (like generally-accepted accounting principles). Securities and Exchange Comm'n v. Jasper, No. 10-17064, slip op. 5159-64 (9th Cir. May 15, 2012).

Short-Swing Profits Case Comes up Short in Supreme Court (Update)

You didn't ask what Blawgletter thinks about the Patient Protection and Affordable Care Act, as its fate dangles in the well of the U.S. Supreme Court courtroom. We'll tell you just the same.

The "individual mandate" part of it (and perhaps the requirement that insurers cover all comers) will vanish in a puff of commerce clause vapor. The rest will limp on. The vote will run 5-4. Before long, one of the five will leave the Court, as will one of the four. And the two new appointees will make up a new majority -- one that would have gone the other way.

Mark our words!

Which brings us to a far easier fight, this one over the question of whether a New Deal-era law bars suits more than two years after the day when the defendant "realized' an unlawful "profit" on the purchase and sale (or sale and purchase) of a security within a six-month period.

We say easier because all the justices who voted cast their ballots the same way -- against the party (the plaintiff) who claimed that she could wait to sue much more than two years after "such profit was realized", in the words of the statute.

The Court, speaking through the keyboard of Justice Antonin Scalia, thought the claim nonsense. A panel of the Ninth Circuit had ruled the opposite, citing a rule a different panel had set up in 1981. The rule said that the clock couldn't start ticking on the two-year period until the defendant filed a report disclosing the purchase and sale (or sale and purchase) that happened within a six-month period (and yielded a "short-swing" profit).

The Court said:

[The statute] itself quite clearly does not extend the period in that manner. The 2-year clock starts from "the date such profit was realized." § 78p(b). Congress could have very easily provided that "no such suit shall be brought within two years after the filing of a statement under subsection (a)(2)(C)." But it did not.

Credit Suisse Securities (USA) LLC v. Simmonds, No. 10-1261, slip op. 4-5 (U.S. Mar. 26, 2012).

So there.

Rapping Rakoff's Knuckles

Have you heard people -- okay, lawyers -- talk about "the Southern District"? As if you MUST know what they mean? Surely not the Southern District of West Virginia -- one of the coolest names in the entire U.S. court system.

No. Not that. This:

S.

D.

N.

Y.

Where Learned Hand sat before Calvin Coolidge put him on the Second Circuit. That one.

A couple of days ago, a panel of the court that Judge Hand adorned in all his 37 years there Reined In one of those whose judgments it checks for error. And the panel, per curiam-wise, said His Honor had Gone Too Far.

The case involved a fight between the Securities and Exchange Commission and Citigroup Global Markets over the latter's sales of -- yikes -- "collateralized debt obligations". Citigroup's hawking of CDOs misled people who bought them, the SEC urged, because Citigroup had to know they'd hugely drop in value once the market woke up to the fact that the collateral -- often real estate mortgages -- had Far Less Value than the buyers had guessed.

The SEC and Citigroup struck a deal that would return to the CDOs buyers $285 million -- an amount that Blawgletter thinks reflects a Small Fraction of what the Victims really Lost. But the court, in the guise of U.S. District Judge Jed Rakoff, said Try Again or Go to Trial.

Citigroup filed an appeal and asked for a stay of the ruling. The Second Circuit panel granted the request. It said:

The district court’s reasoning was that the settlement must be deemed to be either insufficiently onerous or excessively onerous unless the liability of Citigroup had been either proved or disproved at trial or one side or the other had conceded the issue.  This is tantamount to ruling that in such circumstances, a court will not approve a settlement that represents a compromise.  It is commonplace for settlements to include no binding admission of liability.  A settlement is by definition a compromise.  We know of no precedent that supports the proposition that a settlement will not be found to be fair, adequate, reasonable, or in the public interest unless liability has been conceded or proved and is embodied in the judgment. We doubt whether it lies within a court’s proper discretion to reject a settlement on the basis that liability has not been conclusively determined.

Securities and Exchange Comm'n v. Citigroup Global Markets, Inc., No. 11-5227-cv, slip op. 11-12 (2d Cir. Mar. 15, 2012).

Notice of Intent to Manipulate Bars Finding of Manipulation, Second Circuit Holds in ARS Case

Caveat emptor, buyers of auction rate securities! The issuer's giving of notice that it might create the illusion of liquidity in an ARS auction defeats your claim that the issuer "manipulated" the auction market. Wilson v. Merrill Lynch & Co, Inc., No. 10-1528-cv (2d Cir. Nov. 14, 2011).

Amgen Class Gets Ninth Circuit Okie Dokie; Living in a Materiality World

The Ninth Circuit today upheld an order that granted class status to a federal securities fraud case against Amgen. Connecticut Retirement Plans and Trust Funds v. Amgen Inc., No. 09-56965 (9th Cir. Oct. 8, 2011).

The panel gave the back of its hand to Amgen's jutting chin of a point -- that the class couldn't prove the materiality element of a claim under Rule 10b-5. Their honors ruled that simply pleading (a la Twombly) a plausible basis for the materiality of Amgen's false statements and omissions suffices at the class cert. stage. Proof of materiality need not come until later (at summary judgment and trial).

Blawgletter finds the panel's views quite sound. We hope to see more courts approach the question of which elements class plaintiffs must present proof of under Rule 23 with a like clearness.

Federal Courts Have Power to Enjoin Arbitration, Second Circuit Holds

What do you do if you paid a bunch of money to settle a class action but some of the class members who didn't opt out demand that you arbitrate a dispute relating, at least in part, to the subject matter of the claims you settled?

You start by asking the arbitrators to stay their hand, but when they refuse you run to a court -- the Southern District of New York, in this case. What do you ask for? An injunction, of course.

Can you get one? Yes, the Second Circuit ruled a day ago in Ameriprise Financial Services, Inc. v. Beland, No. 10-3399, slip op. at 53-58 (2d Cir. Nov. 3, 2011).

The panel also dealt with questions about the scope of the release in the class settlement papers. It held that the Belands had lost most of their claims because they fell within the class release but that the couple didn't forfeit a "suitability" claim, which (in the panel's view) didn't relate to the "common course of conduct" -- the key words in the release -- at issue in the class case.

Blawgletter notes something the court did not do -- it did not speak to the issue of whether making someone arbitrate a claim she didn't agree to arbitrate causes her "irreparable harm", a key element of a request for an injunction pending trial on the merits. Did Their Honors think the question obvious?

A case that we've handled over the last few months suggests that the answer, while not obvious, does seem fairly clear. As the Delaware Court of Chancery ruled (in our clients' favor):

The parties negotiated and agreed to a broad forum selection clause that anticipated that any litigation arising from the Agreements would occur exclusively in Delaware. If Plaintiffs are forced to prosecute an claims falling within that clause in a different forum, they will be deprivated irreparably of the benefit of that bargain, regardless of whether they later prevail on the merits of that action. This Court has consistently held that the processio of a claim in an unwarranted forum poses a threat of irreparable harm warranting a preliminary injunction. To hold otherwise in the cirumstances of this case would render the broad language of the forum selection clause meaningless and deprive Plaintiffs of the benefit of their bargain.

ASDC Holdings, Inc. v. Richard J. Malouf 2008 All Smiles Grantor Retained Annuity Trust, 2011 WL 4552508, at *8 (Del. Ch. Sept. 14, 2011).

Auction Rate Securities Case Founders on Chump Defense in Second Circuit

You may recall that, back in the go-go days, brokers sold a lot of auction rate securities to people who wanted a bit more interest than money market funds and bank accounts yielded but desired about the same degree of safety and liquidity.

When the auctions froze up in early 2008, the chumps who bought ARS couldn't get their money back. Some of them sued or arbitrated, often under section 10(b) of the Securities and Exchange Act of 1934. Few got some of their money back, and fewer did better. Others wait still.

The Second Circuit yesterday may have sounded a death knell for fraud claims against one big broker, Morgan Stanley. The court held that the ARS buyers couldn't have reasonably relied on false statements about the safety and liquidity of ARS because Morgan Stanley had posted an online notice saying that ARS auctions could fail and that the failure of auctions would hurt liquidity. Ashland Inc. v. Morgan Stanley & Co., Inc., No. 10-1549-cv (2d Cir. July 28, 2011).

Interestingly, a settlement in May 2006 with the Securities Exchange Commission required the notice. The SEC thus furnished the chump defense that allowed Morgan Stanley to dodge liability for the ARS mess.

Mock Trial -- Dare You NOT Do It?

Blawgletter's firm handles much of our work on a contingent fee basis. That means we share risk with our clients -- and earn no fee if we don't help our clients get a good result.

What counts as a good result will vary from case to case. It often involves a money inflow, sometimes not having to pay. In some instances, a particular outcome -- winning a motion to dismiss, to compel arbitration, for class certification, for preliminary injunction, and so on -- defines success.

Why do we mention the risk-sharing? Mainly because our firm has a rule that, before trying any case in which we have a contingent fee on the line, we must MOCK TRY it. That should tell you how much we believe in the usefulness of the mock trial.

But what good, you may ask, does the mock trial do? Do the results predict the real outcome? How could they? Cramming weeks of opening statements and witnesses and argument and PowerPoints and blow-ups and expert opinions and juror notebooks and sidebars and so forth into TWO OR THREE HOURS -- how could that possibly tell you anything worthwhile?

Okay. Listen up. We don't want to have to repeat this.

Mock trying the case forces you -- the lawyer and the client -- to prepare. It makes you think about the other side's strengths -- especially if you compel your lead trial counsel to play the other side's lead (in her or his own style, of course). And it fast-forwards your client to the main event, which he or she may have an unrealistic Hollywood-y image of.

Does the outcome predict actual results? Heck no -- by which we mean in the particulars. Mock juries often differ widely in their damages awards. That goes double for punitive damages. But the direction of their verdict -- you win, or the other side does, big time -- has a fair degree of reliability.

Third, the process reveals the One Fact. The One Fact that the lawyers know Has Importance. But that nobody realizes -- until the mock trial -- the Whole Case Turns On.

So mock try your cases. Spend your own money doing it, if you work on a contingent fee. Clients should insist on jury research. You'll like the results. 

RICO Can't Reach Aiding and Abetting Securities Fraud, Second Circuit Rules

Way back in January 2009, Blawgletter wrote that we doubted a 1995 federal law -- a sub-section of which the Second Circuit called "the RICO Amendment" -- bars claims, under the Racketeer-Influenced and Corrupt Organizations Act, that allege fraud involving credit default swaps and other swap contracts. MLSMK Inv. Co. v. JP Morgan Chase & Co., No. 10-3040-cv, slip op. at 13 (2d Cir. July 7, 2011) (referring to 18 U.S.C. § 1964(c)).

The RICO Amendment, we should note, formed a part of the Private Securities Litigation Reform Act of 1995, which put all sorts of hurdles, trip-wires, and snares -- not to mention booby-traps -- in the paths of securities fraud victims.

We should also note that our notion about the reach of the RICO Amendment stemmed from the fact that the dread Commodity Futures Modernization Act of 2000 changed section 10(b) of the Securities Exchange Act of 1934 so that it now prohibited not only securities fraud but also fraud in the purchase or sale of credit default swaps and the like. See Ciaolo v. Citibank, N.A., New York, 295 F.3d 312, 327 (2d Cir. 2002) ("Sections 302 and 303 of the CMFA define 'swap agreements' and then expressly exclude them from the definition of 'securities,' but amend section 10(b) to reach swap agreements."). The CFMA, you'll recall, traded almost wholesale deregulation of derivatives -- with disastrous results -- for creating a private cause of action for victims of fraud relating to derivatives.

Why do we mention all this stuff? Because the Second Circuit held last week that a person can't get around the RICO Amendment by alleging a claim that no private person (and only the Securities and Exchange Commission) can bring -- aiding and abetting securities fraud. The case related to securities fraud of the heinous kind -- the scheme that Bernard Madoff created and ran for many years. The Second Circuit ruled that 18 U.S.C. § 1964(c), when it nixed RICO claims relying on "conduct that would have been actionable" as securities fraud, meant conduct actionable by anybody, including the SEC, even though the private plaintiff couldn't bring the claim. MLSMK at 26-28.

We persist in our belief that the RICO Amendment doesn't cover what we'll call derivatives fraud under section 10(b). Because, you know, it isn't securities fraud.

You Can't "Make" a False Statement Unless You Have "Ultimate Authority", 5-4 Supreme Court Rules

Say you write a press release. It says your firm just won a beauty contest. It claims you expect the contract to increase the firm's net income by X percent.

But your note to the fourth estate doesn't mention that the deal will raise firm costs by an Awful Lot. So much in fact that you expect to lose money!

Someone then somehow buys shares in your firm, at a price that reflects the false hope, which the press release promotes, of rising profits. And then, when your firm's annual report reveals a big drop in net income and the share price plummets as a result, the buyer sues under Rule 10b-5 and section 10(b) of the Securities Exchange Act of 1934.

Did you "make" the false statement about the profits you never thought the firm would get? No, the 5-4 Supreme Court held yesterday in Janus Capital Group, Inc. v. First Derivative Traders, No. 09-525 (U.S. June 13, 2011). Your firm did, but you didn't -- because you lacked "ultimate authority" over what the press release said.

Justice Clarence Thomas penned the majority opinion, which Chief Justice Roberts and Justices Alito, Kennedy, and Scalia joined; Justice Breyer dissented, as did Justices Ginsburg, Kagan, and Sotomayor.

Editors of the WSJ praised the outcome. A less bright-line standard "could implicate the innocent", they wrote.

Blawgletter notes the pregnant "could". It implies that the tough test the majority chose could exonerate the guilty. It also suggests, ever so slightly, that a truly innocent person doesn't include someone who smuggled the false statements into a public disclosure over whose content someone else had "ultimate authority". And yet that person goes free under the Court's ruling.