News & Developments
Eighth Circuit Affirms Novastar Dismissal
In the first appellate decision borne out of the wave of litigation related to the subprime meltdown and credit crisis, on September 1, 2009, the U.S. Court of Appeals for the Eighth Circuit affirmed the Western District of Missouri’s dismissal of a securities class action brought against Novastar Financial, Inc.
The plaintiffs filed numerous complaints against Novastar—a residential subprime mortgage lender and originator of mortgage-backed securities—following a February 2007 earnings announcement that precipitated a one-day 40 percent drop in the company’s share price. A subsequent consolidated class action complaint alleged a deterioration of Novastar’s underwriting standards and auditing processes, and identified a laundry list of purportedly false or misleading statements issued by Novastar and its officers and directors during the class period.
In June 2008, the district court granted Novastar’s motion to dismiss, rejecting the complaint on both falsity and scienter grounds. The court additionally criticized the plaintiffs for drafting a 100-page complaint that failed to be sufficiently specific, and denied the plaintiffs the opportunity to amend because any such attempt would be “futile.”
In the opinion authored by Circuit Judge Raymond Gruender, the Eighth Circuit conducted a de novoreview and agreed with the district court that the plaintiffs’ complaint did not satisfy the heightened pleading requirements of the Private Securities Litigation Reform Act (PSLRA). The court did not reach the issue of scienter, but held with respect to falsity that, by simply reproducing lengthy excerpts from press releases, Securities and Exchange Commission filings, and conference calls transcripts, the plaintiffs failed to satisfy the PSLRA’s pleading requirements. Judge Gruender noted that “any indication as to what specific statements within these communications are alleged to be false of misleading” was conspicuously absent from the complaint. Slip. op. at 7.
Given that the plaintiffs did not identify which statements were alleged to be false or misleading, the court found it “difficult, if not impossible, to determine whether the complaint adequately specified why each statement was misleading.” Id. at 8. The Eighth Circuit also noted that “[e]ven if we were able to identify specific statements that were alleged to be misleading,” the complaint “does not provide any link between an alleged misleading statement and specific factual allegations demonstrating the reasons why the statement was false and misleading.” Id.
The court affirmed the denial of leave to amend, holding that the plaintiffs failed to submit a proposed amended pleading to the district court and thus did not preserve this right. Id. at 10.
As the first substantive appellate decision concerning a subprime-related securities class action, this decision represents an important development for defendants embroiled in the wave of credit crisis litigation. Certainly, prospective subprime defendants will rely on this decision to make clear that plaintiffs may not rely on the kitchen-sink approach to pleading securities fraud, whereby courts are left to identify what statements are allegedly false or misleading and why. However, given the Eighth Circuit did not reach the often hotly contested issues of scienter and loss causation, this decision’s precedential value may be somewhat limited.
S.D.N.Y. Approves Settlement of 309 Consolidated Securities Class Actions
In re Initial Public Offering Sec. Litig.
No. 1:21-mc-00092 (S.D.N.Y. Oct. 5, 2009)
On October 5, 2009, Judge Shira A. Scheindlin of the U.S. District Court for the Southern District of New York provided the final approval for a consolidated settlement that puts to rest over three hundred separate securities class actions and caps eight years of multi-district litigation. See In re Initial Public Offering Sec. Litig., No. 1:21-mc-00092 (S.D.N.Y. Oct. 5, 2009).
The consolidated action consisted of 309 securities class actions brought against more than 300 issuers, hundreds of individuals associated with these issuers, and 55 underwriters of technology stocks that went public during the so-called Tech Bubble in the late 1990s. The plaintiffs allegedly lost billions of dollars as a result of the defendants’ scheme to defraud the investing public by requiring IPO clients to purchase additional shares in the aftermarket, often at escalating prices, to create artificial demand and drive up stock prices.
Recognizing that “adjudication of these actions would have been a daunting task,” slip op. at 29, Judge Scheindlin held the $586 million settlement was fair, reasonable, and adequate. The defendants were not required to admit any wrongdoing and, as detailed in the settlement agreement, agreed to the settlement to avoid protracted and expensive litigation. The plaintiffs’ attorneys were awarded $217 million in fees and expenses.
Plaintiffs' Allegations of Insider Trading Insufficiently Probative of Scienter in In re Gildan Activewear, Inc. Securities Litigation
On July 1, 2009, Judge Harold Baer Jr. of the U.S. District Court for the Southern District of New York dismissed a putative securities class action brought against Gildan Activewear, Inc. and two of its officers and directors. See In re Gildan Activewear, Inc. Securities Litigation, No. 08 Civ. 5048 (HB), 2009 BL 140830 (S.D.N.Y. Jul. 01, 2009).
After posting record profits every quarter and meeting or exceeding its earnings projections throughout the 2007 fiscal year and the first quarter of fiscal year 2008, Gildan reduced its earnings guidance in April 2008 as a result of problems it had been experiencing with its textile facility in the Dominican Republic and its acquisition of Kentucky Derby Hosiery in July 2006. The company’s stock price fell 30 percent after the announcement and the plaintiffs subsequently brought suit.
Judge Baer dismissed the action brought under sections 10(b) and 20(a) of the Securities Exchange Act of 1934 for failure to sufficiently plead scienter under the Private Securities Litigation Reform Act. As the court correctly noted, “[s]cienter can be established by alleging sufficient facts to show either (1) that defendants had the motive and opportunity to commit fraud, or (2) strong circumstantial evidence of conscious misbehavior or recklessness.” Id. at *7 (citing ATSI Commc’ns v. Shaar Fund, Ltd., 493 F.3d 87, 99 (2d Cir. 2007)).
With respect to the former, the plaintiffs sought to establish motive and opportunity by pointing to the insider trading of the two individual defendants. The court held that neither the timing (well in advance of all relevant press releases) nor the volume of shares transacted (between 4.9 and 22.5 percent of the individual defendants’ holdings) were probative of scienter. Similarly, Judge Baer observed that 99 percent of the total alleged insider trading, both by volume and value, “occurred pursuant to a non-discretionary Rule 10b5-1 trading plan, which undermines any allegation that the timing or amounts of the trades was unusual or suspicious.” Id. at *10. Finally, the court found the absence of any allegations of other insiders trading Gildan stock “undercuts any finding of the requisite strong inference of scienter.” Id.at *9.
With respect to the latter, the plaintiffs did not establish recklessness sufficiently probative of a strong inference of scienter. Though the plaintiffs alleged that problems at the Dominican facility made it “impossible” or “patently unrealistic” for Gildan to achieve its projected earnings, the plaintiffs did not allege any facts to suggest what information in the company’s possession (namely internal modeling data) revealed at the time, or what effect the models might have had on Gildan’s financial results. The court concluded, “while it would be troubling if the Company had been aware that the problems at the Dominican facility contradicted their bullish comments about projected earnings, Plaintiffs have failed to allege with the requisite specificity exactly what contemporaneous data Defendants had, even to be able to suggest such knowledge.” Id. at *11. The court also rejected finding any inference of scienter from the plaintiffs’ general allegations of the individual defendants’ senior positions at Gildan.
Lastly, Judge Baer also held that Gildan’s statements were “simply vague expressions of optimism” that corporate executives are entitled to make. Id. at *12–13.
S.D.N.Y. Cites Similarities to Stoneridge in Dismissing Case
The U.S. District Court for the Southern District of New York dismissed, without leave to amend, claims against Motorola and Scientific-Atlanta for purportedly violating section 10(b) of the Securities Exchange Act of 1934 by entering into a scheme with Adelphia intended to “artificially inflat[e]” Adelphia’s EBITDA, because those claims were not materially different from the scheme at issue in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. See In re Adelphia Commc’ns Corp. Sec. & Derivative Litig., No. 03 MDL 1529 (LMM) (S.D.N.Y. June 16, 2009).
Under the scheme, Adelphia would buy cable boxes from Motorola and Scientific-Atlanta at a premium on the contract price, and Motorola and Scientific-Atlanta would pay Adelphia the equivalent amount as “marketing support payments.” Judge Lawrence McKenna determined the Stoneridge decision required the complaint to be dismissed, because “nothing [Scientific-Atlanta or Motorola] did made it necessary or inevitable for [Adelphia] to record the transactions as it did,” and the decision foreclosed the argument that the news reports about Motorola’s and Scientific-Atlanta’s “multi-hundred million dollar” sales of cable boxes were “statements relating to a security.” Consequently, Judge McKenna concluded that, under Stoneridge, it would be futile to replead to include both the facts relied upon by the news stories and the public’s reliance on those stories.
S.D.N.Y. Adopts Order Compelling Vivendi’s U.S. Auditor to Produce Documents
The U.S. District Court for the Southern District of New York adopted a magistrate judge’s order compelling Vivendi’s U.S. auditor (Ernst & Young LLP) to produce documents responsive to a nonparty subpoena. See In re Vivendi Universal, S.A. Sec. Litig., Nos. 02 Civ. 5571, 03 Civ. 2175 (RJH)(HBP) (S.D.N.Y. May 28, 2009).
The plaintiffs sought Vivendi’s U.S. auditor’s documents relating to its audits of Vivendi’s U.S. subsidiaries at the request of Vivendi’s French statutory auditors. The U.S. auditor objected, claiming that producing the documents would violate French law and subject it to criminal prosecution. After conducting the generally required comity analysis, Judge Richard Holwell concluded that the magistrate judge’s determination was neither clearly erroneous nor contrary to law and, accordingly, ordered the U.S. auditor to produce the subpoenaed documents (approximately 38 boxes of material).
The first two factors weighed in favor of production. “[T]he United States has a strong interest in enforcing its securities law and ensuring the compliance of its citizens with the Federal Rules of Civil Procedure.” The only French interest in this issue—which involved an American company’s auditing of American companies in accordance with American accounting principles—was that the U.S. auditor’s audits of Vivendi’s American subsidiaries were “pursuant to instructions from French accounting firms.” Second, there was not a “realistic threat of prosecution,” even though the U.S. auditor presented a legal expert who declared that the “possibility of . . . criminal prosecution was not remote.” The third factor was neutral, as the subpoenaed documents were “directly relevant” but the plaintiffs had not shown they were “crucial” to their case. Even though the fourth factor weighed against production—the U.S. auditor withheld the documents “on advice from French counsel”—it was “not enough to overcome the first two factors tipping in favor of production.” Although the court could not order the documents produced simply because it had jurisdiction over the U.S. auditor who had custody of the documents, the court concluded that the four factors in the required comity analysis favored enforcing the subpoena.
On June 11, 2009, the U.S. auditor filed a motion requesting that Judge Holwell reconsider this decision.
S.D.N.Y. Certifies Class in Suit Alleging Sections 10(b) and 20(a) Violations by Seven NYSE Specialist Firms
In a decision recently unsealed in May, the U.S. District Court for the Southern District of New York certified a class, and appointed CalPERS and Market Street Securities as class representatives, in a lawsuit against the seven New York Stock Exchange (NYSE) specialist firms. See In re NYSE Specialists Sec. Litig., No. 03 Civ. 8264 (S.D.N.Y. Mar. 14, 2009). The suit alleges that those firms violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by trading for their own benefit (in violation of the NYSE priority rules) instead of maintaining the two-sided auction market.
Judge Robert Sweet determined that the proposed class satisfied Rule 23’s requirements. As to the four Rule 23(a) requirements, the class representatives satisfied numerosity by identifying 1.1 million trades violating the priority rules and satisfied commonality by identifying six common issues. Further, the class representatives’ claims were typical, even though CalPERS used a specific benchmark for its investment decisions and Market Street was a market maker on the Philadelphia Stock Exchange. The court also noted that, “[s]tanding alone,” Market Street’s president’s comment that he “certainly wondered why [he] didn’t get certain trades” did not give rise to inquiry notice or a statute-of-limitations defense. Moreover, CalPERS and Market Street were adequate representatives: They bought and sold stock and could represent both buyers and sellers without “any ‘allegiance.”
Judge Sweet rejected arguments that damages and the need for subclasses should prevent class certification; those, he explained, could be addressed later. Judge Sweet also explained that the proposed class satisfied Rule 23(b)(3)’s predominance and superiority requirements. As for predominance, CalPERS’ algorithm would allow it to prove misrepresentations on a classwide basis, and scienter could be proven by reference to testimony that “high-level members of the Specialist Firms” knew about those violations. Additionally, the class representatives could prove, under Basic v. Levinson, that the class relied upon “the efficiency and fairness of the NYSE,” and could prove individual damages through CalPERS’ algorithm, including “the price an investor would have received ‘but for’ the Specialist Firms’ alleged misconduct.” Finally, class treatment would be superior to the alternative option (prohibitively expensive individual cases), because class treatment would “promote economy and uniformity,” avoid double recovery, and act as “an essential supplement” to the SEC’s civil and criminal investigations.
Subprime Dismissal for City of Cleveland
In one of the more unconventional lawsuits borne out of the subprime meltdown, on May 15, 2009, Judge Sara Lioi of the U.S. District Court for the Northern District of Ohio dismissed an action brought by the City of Cleveland against over 20 financial institutions involved in the securitization of subprime mortgages. See City of Cleveland v. Ameriquest Mortgage Securities, Inc. [PDF], No. 1:08 cv 139 (N.D. Oh. May 15, 2009).
One of the cities hardest hit by the subprime crisis, Cleveland brought this diversity suit sounding in public nuisance, claiming that subprime lending was categorically inappropriate for the city and blaming defendants for its epidemic of foreclosures. The defendants individually and jointly filed eight motions to dismiss, presenting numerous arguments, four of which the court found were independently sufficient to support dismissal of the case.
The court first agreed with the defendants that the plaintiff’s claims were preempted by Ohio state law. Specifically, the court found the city’s complaint constituted a form of municipal regulatory action seeking to indirectly regulate “the origination, granting, servicing, or collection of loans or other forms of credit,” in contravention of Ohio Revised Code § 163.
Second, Judge Lioi held that the economic loss rule precluded the plaintiff’s claims. As a general matter, the economic loss rule precludes recovery in tort for purely economic losses not arising from tangible physical harm to property. The plaintiff advanced two categories of damages: the diminished tax receipts resulting from the foreclosure crisis, and the cost of maintaining and demolishing the “blighted post-foreclosure properties.” With respect to the former category, the court rejected these damages outright as purely economic in nature. With respect to the latter category, the court held that the plaintiff’s claims were similarly barred because the city did not allege that it had an interest in the properties when the physical damage occurred. Indeed, the only tangible physical harm to property took place when the homeowners were going through foreclosure and not when the city had any interest in the subject properties.
The court next rejected the public nuisance claim on the basis that the defendants were immune because subprime lending was heavily regulated—even expressly encouraged by the state and federal legislatures—and the city did not challenge the defendants’ compliance with those regulations. Judge Lioi followed “a long line of decisions” holding that “a showing that the challenged conduct is subject to regulation and was performed in conformance therewith insulates such conduct from suit as a public nuisance.” The court disagreed with the plaintiff’s attempt to distinguish its challenge to securitization from a challenge to the regulated subprime lending itself, holding:
[I]f the underlying lending activity was lawful, it is impossible to say that supporting that activity by supplying funds and creating [mortgage-backed securities]—at least one step removed from the actual lending—was itself unlawful. Stated the other way, the City’s public nuisance theory cannot succeed against Defendants unless the subprime lending Defendants allegedly facilitated also constituted a public nuisance.
Lastly, Judge Lioi held that the city’s complaint failed to establish proximate causation, because both categories of damages alleged by the city were dependent on the existence of intervening foreclosures suffered by third-party subprime borrowers. Rejecting the argument that resolution of causation issues is improper on a motion to dismiss, the court found the plaintiff’s allegations failed to satisfy the directness requirement set forth in Holmes v. Securities Investor Protection Corp., 503 U.S. 258 (1992), because the complaint did not allege any direct relationship between the alleged injury and the defendants’ conduct, and the city’s losses were contingent upon the insolvency of non-parties.
The complaint was dismissed with prejudice. The City of Cleveland is expected to appeal the decision.
Securities Fraud Jury Verdict Against Household International
In what is only the seventh jury verdict in a securities class action since the passage of the Private Securities Litigation Reform Act, on May 7, 2009, a jury found Household International and three of its former executives liable for issuing 16 false and misleading statements to investors. See Lawrence E. Jaffe Pension Plan v. Household International Inc., no. 02-cv-05893, in the U.S District Court for the Northern District of Illinois.
Now part of HSBC, Household was a leading consumer finance firm, focused on issuing credit cards, auto financing, and mortgages to subprime borrowers. The seven-year-old class action was filed in August 2002, shortly after the company disclosed that it had earned almost $400 million less than it had reported. The complaint alleged that Household had failed to record certain expenses and properly account for co-branding arrangements.
The case is now headed into the damages phase, where plaintiffs may be seeking as much as $1 billion. HSBC has stated publicly that it strongly disagrees with the verdict and “will ask the court to overturn the decision.”
No Undue Prejudice to Plaintiffs from PSLRA Stay of Discovery in Auction Rate Securities Class Action
On April 7, 2009, Judge William H. Pauley III denied a motion to lift the Private Securities Litigation Reform Act (PSLRA) stay of discovery in yet another class action filed in the wake of the collapse of the auction rate securities market. See Brigham v. Royal Bank of Canada [PDF], 08 Civ. 4431 (S.D.N.Y. April 7, 2009). The lead plaintiff brought the securities class action against Royal Bank of Canada, and affiliated corporations (RBC), alleging violations of the 1934 act in connection with RBC’s underwriting, marketing, and sale of auction rate securities.
After the case was filed, RBC entered into settlement agreements with the Securities Exchange Commission and state regulators, whereby it offered to repurchase over $850 million in auction rate securities from its retails investors and reimburse certain eligible investors. Contending that he would suffer undue prejudice if he had to make decisions regarding the future of the litigation without all of the information that RBC made available to the regulators, the lead plaintiff sought to partially lift the PSLRA stay of discovery.
Pursuant to the PSLRA, a court may only lift the mandatory stay of discovery to preserve evidence or prevent undue prejudice to the plaintiffs. Judge Pauley recognized that recent opinions in the Southern District appear to diverge on the meaning of undue prejudice in this context.
The court distinguished the case at bar from two “exceptional circumstances” that could merit lifting the stay, for example (i) when the defendant is insolvent or (ii) when plaintiffs would be disadvantaged by discovery proceeding in other actions against the defendant. Judge Pauley similarly rejected the plaintiffs’ argument that the stay otherwise may be lifted if the objective of Congress in enacting the PSLRA—preventing plaintiffs from filing frivolous lawsuits—is not implicated.
The court held that while access to the documents produced to the regulators would make Brigham’s decision whether to continue the litigation easier, “the plaintiff’s inability to plan a litigation strategy is not evidence of undue prejudice.”
This decision constitutes the latest of several cases in the Southern District of New York to rule on whether the PSLRA stay of discovery creates undue prejudice to plaintiffs in auction rate securities class actions. Judge Pauley noted that two recent decisions in the Southern District of New York were split on the issue. As the court followed the decision of Judge McKenna in In Re UBS Auction Rate Sec. Litig., 08 Civ. 2967 (S.D.N.Y. Nov. 21, 2008), that the stay does not impose undue prejudice on the plaintiffs, similarly situated plaintiffs in future auction rate securities cases may have a greater challenge in lifting the PSLRA stay of discovery.
Southern District of New York: “No State Court Has Subject Matter Jurisdiction over Covered Class Actions Raising 1933 Act Claims”
Last month, U.S. District Judge William H. Pauley III denied the plaintiff’s motion for remand in yet another opinion interpreting the anti-removal provision of the Securities Act of 1933 (the 1933 act).
In Knox v. Agria Corp [PDF], 08 Civ. 7651 (S.D.N.Y. Jan. 27, 2009), plaintiff Robert Knox filed a putative class action in New York Supreme Court asserting claims under the 1933 Act that tracked the allegations of three federal securities class actions pending in the Southern District of New York. After the defendants removed the action pursuant to 28 U.S.C. 1441(a) and the jurisdictional provisions in section 22(a) of the 1933 act as amended by the Securities Litigation Uniform Standards Act of 1998 (SLUSA), Knox moved the court to remand.
The question before Judge Pauley was whether the anti-removal provision of section 22(a), as amended by SLUSA, allows for removal of covered class actions raising only 1933 act claims.
SLUSA amended the 1933 act to define “covered class actions” and “cover securities.” A “covered class action” is a lawsuit where damages are sought on behalf of more than 50 people, and a “covered security” is a security traded nationally and listed on a regulated national exchange. 15 U.S.C. §§ 77p(f)(2)–(3). While claims arising under federal law are generally removable to federal court, section 22(a) of the 1933 act contains an “anti-removal” provision that states: “Except as provided in section [16(c)] of [the 1933 act], no case arising under [the 1933 act] and brought in any State court of competent jurisdiction shall be removed to any court of the United States.” 15 U.S.C. § 77v(a). Section 16(c) provides that “[a]ny covered class action brought in any State court involving a covered security, as set forth in subsection (b), shall be removable to the Federal district court . . . and shall be subject to subsection (b).” 15 U.S.C. § 77p(c). Subsection (b), in turn, prohibits state or federal courts from hearing any covered class action raising state or common law claims based on untrue statements or deceit in the sale of a nationally traded security. See 15 U.S.C. § 77p(b).
The court began its analysis by noting that lower courts were divided on this issue. Judge Pauley observed that “SLUSA was intended to curtail the proliferation in state courts of securities fraud class actions (federal or state) beyond the reach of the PSLRA’s heightened pleading standards.” The court cautioned that a “constricted approach” would threaten “to spawn federal securities fraud class actions in state courts where they could proceed under the PSLRA radar”—a “bizarre result” that “would shift the center of gravity of federal securities fraud class actions under the 1933 Act from federal to state courts.”
The court’s resolution of this issue turned on the phrase “any state court of competent jurisdiction.” In an admitted departure from the analysis of certain other courts, Judge Pauley reasoned that “because the anti-removal provision only applies to claims brought in a state court of competent jurisdiction, once SLUSA stripped state courts of subject matter jurisdiction over covered class actions raising 1933 Act claims, the reach of the anti-removal provision receded, leaving covered class actions raising 1933 Act claims exclusively for federal courts.” As such, the court denied the plaintiff’s motion to remand, holding that “no state court has subject matter jurisdiction over covered class actions raising 1933 Act claims.”
Given the identical nature of the case to the three federal securities class actions pending in the Southern District of New York, Judge Pauley ordered consolidation with the other cases under the caption In re Agria Corporation Securities Litigation, 08 Civ. 3536.
Ninth Circuit Interprets Tellabs: “Dual Inquiry” for Scienter
On January 12, 2009, the Ninth Circuit clarified the impact of the U.S. Supreme Court’s decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007), on the requirements for pleading scienter in a 10b-5 action. See Zucco Partners v. Digimarc Corp. [PDF], --- F. 3d ---, No. 06-35758 (9th Cir. 2009).
In reaffirming the heightened requirements for pleading scienter, the Ninth Circuit in Digimarc explained that Tellabs did not materially alter the particularity requirements established in its previous holdings. Rather, Tellabs added an additional “holistic” component to those requirements. Thus, following Tellabs, a district court in the Ninth Circuit will “conduct a dual inquiry”: first, the court 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, the court 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.
On September 13, 2004, Digimarc publicly announced that it had erroneously accounted for internal software expenditures and that due to these accounting errors it had likely overestimated earnings for the previous six quarters. While “there was no question that Digimarc erroneously capitalized expenditures,” the district court determined that the plaintiffs’ complaint failed to allege scienter with the requisite particularity to survive dismissal under the Private Securities Litigation Reform Act’s (PSLRA’s) heightened pleading standards.
After analyzing the allegations of scienter individually and then in the aggregate, the Ninth Circuit affirmed the District of Oregon’s dismissal, finding that the plaintiffs’ allegations, though “legion” and “voluminous,” were not pled with the particularity required to survive a Rule 12(b)(6) dismissal under the standards enumerated in Rule 9(b) and the PSLRA.
Finding that the more plausible inference was that “there was no specific intent to fabricate the accounting misstatements at issue here,” the court stated:
[T]he plaintiffs in this case assume that compiling a large quantity of otherwise questionable allegations will create a strong inference of scienter through the complaint’s emergent properties. Although Tellabs instructs us to view such compilations holistically, even such a comprehensive perspective of Zucco’s complaint cannot transform a series of inadequate allegations into a viable inference of scienter. We therefore affirm the district court’s dismissal of the Second Amended Complaint with prejudice.
The court also affirmed the denial of leave to amend the complaint
Seventh Circuit: CAFA Trumps the Anti-Removal Provisions of Section 22 of the Securities Act
The U.S. Court of Appeals for the Seventh Circuit has made it more difficult for plaintiffs bringing securities actions in state court to prevent removal to federal court, holding that the Class Action Fairness Act of 2005 (CAFA) trumps the Securities Act of 1933.
In Katz v Gerardi, No. 08-8031 (7th Cir. January 5, 2009), an opinion authored by Chief Judge Frank Easterbrook, the Seventh Circuit diverged from the Ninth Circuit’s recent decision in Luther v. Countrywide Home Loans Servicing, 533 F.3d 1031 (9th Cir. 2008), which held that the “general grant of the right of removal of high-dollar class actions does not trump” section 22(a) of the Securities Act, which contains a “specific bar to removal of cases arising under the . . . Act.”
In rejecting the Ninth Circuit’s holding, the court held that “Luther failed to recognize that § 22(a) of the 1933 Act is not a subset of the 2005 Act,” and thus “the canon favoring preservation of specific statutes arguably affected by newer, but more general, statutes” was inapplicable.
Further, in finding that all securities class actions covered by CAFA are removable subject only to the three enumerated exceptions contained in § 1453(d) of CAFA itself, the court held that “Section 1453(d) leaves no doubt about how the 1993 Act, 1934 Act, and 2005 Act fit together,” and that to read § 22(a) differently would “make most of §1453(d) pointless.”
The dispute in Katz arose from a real estate investment trust merger in 2007. While the Seventh Circuit remanded the case to the Northern District of Illinois, the case is now set to be transferred to a related action in Colorado, which was filed federally as a contractual dispute subject to arbitration. See Stender v. Gerardi, No. 07-cv-2503 (D. Colo.).
Inspire Pharmaceuticals Dismissal Affirmed
On December 12, 2008, in an opinion written by Circuit Judge J. Harvie Wilkinson III, the Fourth Circuit affirmed the dismissal of a securities class action brought against defendant Inspire Pharmaceuticals Inc. in the Middle District of North Carolina.
The plaintiffs’ primary allegation in Cozzarelli v. Inspire Pharmaceuticals Inc., 549 F.3d 618 (4th Cir. 2008), was that the defendant overstated the prospects for an experimental drug that the company was developing to treat dry eye disease. More specifically, the plaintiffs’ theory was that Inspire and its directors intentionally misled the public to believe that a “confirmatory trial” mandated by the FDA was likely to succeed, thereby artificially inflating the price of Inspire’s stock.
With respect to the plaintiffs’ 10b-5 claims, Judge Wilkinson agreed with the District Court that there was a “substantial question” as to whether plaintiffs had satisfied the PSLRA’s requirements for pleading falsity with specificity, but found it “quite clear” that the “plaintiffs failed to allege facts giving rise to a strong inference of scienter.”
Following Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2509–10 (2007), the Fourth Circuit held that the inference that defendants acted with the non-fraudulent intent to protect their competitive advantage was “more powerful and compelling than the inference that defendants acted with an intent to deceive.” In finding that the plaintiffs’ allegations were “conclusory,” “improbable” and in one case “ignore[d] reality,” the court held that the plaintiffs were “stringing together a series of isolated allegations without considering the necessary context.”
The court also noted that “the complaint quotes selectively from various reports by investment analysts,” and held that “[i]f we inferred scienter from every bullish statement by a pharmaceutical company that was trying to raise funds, we would choke off the lifeblood of innovation in medicine by fueling frivolous litigation— exactly what Congress sought to avoid by enacting the PSLRA.”
With respect to the plaintiffs’ claims under sections 11 and 12(a)(2) of the Exchange Act, the Fourth Circuit held that plaintiffs failed to allege that the prospectuses in question were false or materially misleading with the particularity required by Rule 9(b). Moreover, the court noted that there were “serious doubts” as to whether plaintiffs “‘nudged the[se] claims across the line from conceivable to plausible,’ as required by the minimal pleading standards of Rule 8” and delineated by the Supreme Court in Bell Atl. Corp. v. Twombly, 127 S. Ct. 1955, 1974 (2007).
