Securities Litigation and Arbitration

Written by David Welch, Esq.

...Continued from Control Person Liability Post on September 21, 2009:

The success or failure of a pre-hearing Motion to Dismiss a control person liability claim may at times depend on which standard the arbitrators or judge choose to adopt: the “culpable participation” standard or the “potential control standard.” Although some courts are bound by precedential case law to apply a certain standard, many jurisdictions have not definitely selected an appropriate standard and arbitrators, after all, are free to apply whichever standard they deem appropriate.

Thus, parties involved in control person liability disputes often commit significant efforts to advocating the standard that best suits their needs. Although defective control person liability claims can be dismissed under the “potential control” standard, as discussed below, it generally behooves control persons to advocate in favor of the application of the “culpable participation” standard.

The “Culpable Participation” Standard

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The SEC has approved FINRA's Proposed Amendments to the Industry and Customer Codes of Arbitration that clarify the definition of "associated person" making it conform to the FINRA By-laws, streamline procedures related to the distribution of the Discovery Guide, and clarify that customers could be assessed hearing session fees based on their own claims for relief in connection with an industry dispute.

FINRA provides an explanation of the changes, which apply to claims filed on or after January 18, 2010, along with the new rules in their entirety in Regulatory Notice 09-74. The changes, in pertinent part are as follows:

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A bill proposed by Senator Christopher Dodd would require brokers to register as advisers with the Securities and Exchange Commission. This means that brokers would be subjected to the Investment Advisers Act of 1940, requiring them to act as a fiduciary to their clients.

The Dodd bill differs from the proposed Investor Protection Act approved Oct. 28 by the House Financial Services Committee in that the House bill would require the SEC to write regulations defining the fiduciary standard for advisers. The Senate bill, however, extends the fiduciary duty to broker-dealers by eliminating the broker-dealer exclusion from the Investment Advisers Act. The current exemption spares brokers from registering as advisers if the advice they provide to clients is “solely incidental” to selling products.

Under the Dodd’s proposed legislation, an Office of the Investor Advocate would also be created within the Securities and Exchange Commission.

The new office would report yearly to Congress on the twenty most pertinent issues facing investors. The report would also include data indicating the length of time that each issue has remained on the list and what actions were taken by the SEC or FINRA, if any, to resolve the problem(s).

An Investor Advocate would appointed to lead the Office and would have the power to employ independent counsel, research staff, and other services that Investor Advocate feels necessary.

The draft bill can be found here.

The SEC recently settled two actions for selling short within the five days prior to an offering. The two proceedings, In the Matter of First New York Securities LLC, (Oct. 20, 2009) and In the Matter of Perceptive Advisors LLC, (Oct. 20, 2009), involved alleged violations of Rule 105 of Regulation M. Rule 105 prohibits the cover of a short sale with securities obtained from an offering if the short sale occurs during the five business days before the pricing of the offering. In the case involving New York Securities, the firm was alleged to have violated Rule 105 on two separate occasions, once in September 2005 and again in January 2007. Overall, according to the SEC, the firm made profits of approximately $40,000. Perceptive Advisors was alleged to have violated Rule 105 on five different occasions resulting in profits of around $245,000.

Each firm settled with the SEC and agreed to pay disgorgement of profits as well as a civil penalty. New York Securities’ penalty was about $20,000 and Perceptive Advisors agreed to pay a penalty of $125,000. Each firm also consented to the settlements without admitting or denying any of the allegations.

The SEC’s Order for each proceeding can be read here (New York Securities) and here (Perceptive Advisors).

For more on what constitutes a violation of Rule 105 read here.

Written by Arpan Parmar*

In April 2009, FINRA’s Board of Governors established a Special Review Committee to conduct an internal review of FINRA’s examination program as it relates to FINRA member firms associated with R. Allen Stanford and Bernard L. Madoff. The Committee consisted of four FINRA public governors: Ellyn L. Brown, Brown & Associates; Harvey J. Goldschmid, Dwight Professor of Law at Columbia University; Joel Seligman, President of the University of Rochester; and, Committee Chair, Charles A. Bowsher. The Board asked the Committee to recommend changes in the examination program to improve member oversight, fraud detection capability and FINRA’s monitoring of compliance with examination program policies. In September 2009, the Committee provided a report of their findings.

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NY OCA: Volunteer Attorney Program

Volunteer Attorney Program

The sharp downturn in the economy has had a profound impact on the justice system and the legal community. The number of unrepresented litigants in court has increased dramatically. At the same time, substantial numbers of attorneys find themselves unexpectedly unemployed.

In response to these concerns, the court system has established the Volunteer Attorney Program, offering attorneys opportunities to volunteer to serve the courts and the public.

Under the Program, attorneys can volunteer to provide advice and assistance to unrepresented litigants (Pro Bono Volunteer Attorney); or, they can serve in a judge’s chambers, performing legal research, writing and related functions (Chambers’ Volunteer Attorney).

Attorneys can volunteer full-time or part-time, on a schedule that is convenient to them. Participating attorneys select the court in which they want to serve and the type of cases they prefer to handle (subject to availability).

Mr. Sienko's original post can be found here.

Written by Christine Lazaro, Esq.

Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, Paul E. Kanjorski (D-PA), released discussion drafts of three pieces of legislation on October 1st. The drafts include the Investor Protection Act, the Private Fund Investment Advisers Registration Act, and the Federal Insurance Office Act.

In a press release, Chairman Kanjorski stated “With these three bills we will address many of the shortcomings and loopholes laid bare by the current financial crisis. The Investor Protection Act will better protect investors and increase the funding and enforcement powers of the U.S. Securities and Exchange Commission. We must ensure that investor confidence continues to increase for the betterment of our financial system.”

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Written by Arpan Parmar*

The Second Circuit Court of Appeals issued an opinion vacating and remanding a district court opinion that denied the Securities and Exchange Commission’s (“SEC”) motion for a preliminary injunction against an alleged computer hacker and insider trader on July 22, 2009, SEC v. Dorozhko, Docket No. 08-0201-cv. This case represents an important win for the SEC in an age where technology often outpaces securities law.

In early October 2007, the defendant, Oleksandr Dorozhko opened an online trading account with Interactive Brokers LLC (“Interactive Brokers”) and deposited $42,500 into that account. That same month, IMS Health, Inc. (“IMS”), was scheduled to announce its third-quarter earnings during an analyst conference call scheduled for October 17, 2007 at 5 p.m. IMS had hired Thomson Financial, Inc. (“Thomson”) to provide investor relations and web-hosting services, which included managing the online release of IMS’s earning reports. Prior to the open of the securities markets on October 17th, an anonymous computer hacker attempted to gain access to IMS’s earnings report from Thomson’s secure server. At 2:15 p.m., minutes after Thomson actually received the IMS data, that hacker successfully located and downloaded the IMS data from Thomson’s secure server. Beginning at 2:52 p.m., Dorozhko, who had not previously used his Interactive Brokers account to trade, purchased $41,670.90 worth of IMS put options that would expire on October 25th and 30th, 2007.

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Written by David Welch, Esq.

As a general rule, when there is a significant and sustained drop in the stock market, there is a significant increase in law suits and arbitration claims against stock brokers. In addition to stock brokers, plaintiffs’ lawyers will often try to name “control persons” individually to increase the settlement pool or insulate the viability of their claim against a possibly insolvent broker. Control person liability claims in the realm of broker-dealers are typically brought under §20(a) of the Securities Exchange Act. Interestingly, in a recently settled case brought by the SEC against Nature's Sunshine Products, Inc. (not a broker-dealer), the SEC named individual executives of the company under §20(a) and did not alleged that the executives had personal knowledge of the underlying Foreign Corrupt Practices Act (“FCPA”) violations.

This is noteworthy because there is somewhat of a split among the courts about what needs to be alleged under §20(a) to bring a control person into a case or arbitration. Generally, the courts are divided between one standard that requires some level of participation on the part of the control person, and another that maintains that participation is not required. Thus, it will be interesting to see if plaintiffs’ attorneys, who advocate for the broadest of standards, will try to use the SEC’s decision not to allege knowledge as support for their control liability claims. Although it is plausible that they will try to do so, that fact remains that such an argument would be without merit because, among other reasons, the FCPA is an entirely different animal than the typical violations brought against brokers.

Control person liability is defined under §20(a) as:

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Written by Arpan Parmar*

On September 17, 2009, the SEC unanimously proposed a rule amendment that would prohibit the practice of flashing marketable orders.

Rule 602 of Regulation NMS requires every national securities exchange to make the best bids and offers available in the consolidated quotation data that is widely disseminated to the public. However, the rule excludes bids and offers communicated on an exchange that are executed immediately after communication or cancelled if not executed immediately after communication. Orders that are immediately executed or cancelled have come to be known as flash orders.

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Written by Christine Lazaro, Esq.

Bloomberg.com reports that, as Congress discusses regulatory reforms, judges are issuing rulings with national impact. For example, last week, U.S. District Judge Shira Scheindlin threw out a key free-speech defense that credit raters had used for years to thwart investors’ fraud suits. Click here for the full story.

Written by Christine Lazaro, Esq.

The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) are holding joint meetings to seek input from the public on harmonization of market regulation. The first meeting is being held at the CFTC on September 2nd, and the second meeting will be held at the SEC on September 3rd.

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The amendments to Rules 13402, 13403 and 13406 of the Arbitration Code for Industry
Disputes (Industry Code) change the criteria for determining panel composition when
the claim involves an associated person in industry disputes. Specifically, the
amendments to the rules of the Industry Code:

- require that the parties receive a majority public panel for all industry disputes
involving associated persons (excluding disputes involving statutory employment
discrimination claims, which require a specialized all public panel);

- clarify that in disputes involving only member firms, parties will receive an all
non-public panel; and

- provide that if a party amends its pleadings to add an associated person to a
previously all-member firm case, parties will receive a majority public panel.

The full text of the new rules can be read here.

Written by David Welch, Esq.

Efforts to conceal Rule 105 violations, like those which were alleged by the SEC in its complaint against New York hedge fund, Colonial, LLC (see previous post), are often referred to as “Sham Transactions.” A Sham Transaction is when a hedge fund or broker-dealer receives shares as part of an offering, sells them on the open market, and almost immediately buys them back in an attempt to technically change them from being labeled as “offering shares” to “open market shares.” The motivation to make this quick change is to surreptitiously use the newly labeled open market shares to cover short sales, because covering short sales with “open market shares” instead of “offering shares” is technically outside of the scope of Rule 105.

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Written by David Welch, Esq.

In the wake of the ubiquitous economic troubles and consequent hasty finger-pointing, many commentators predicted that the largely unregulated hedge fund industry would be effectively dismantled by over-reactive regulatory authorities. Although such draconian responses have yet to be seen, some level of increased regulation has occurred.

On July 7, 2009, the United States District Court for the Southern District of New York found a New York hedge fund, Colonial Fund LLC, and its adviser, Colonial Investment Management LLC, were liable for violations of Regulation M, Rule 105. The Court found that Colonial Fund LLC engaged in illegal trading relating to eighteen registered public offerings and ordered defendants to pay disgorgement of profits totaling more than $1.4 million. The fund was controlled by Cary G. Brody, who was required to pay a civil penalty of $450,000.

The goal of Rule 105 is to maintain the integrity of the offering price by ensuring it is based on market forces (supply and demand) and not “artificial forces" (market manipulations).

In that regard, two actions have to occur to trigger a violation of Rule 105:

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From the "Securities Docket: Global Securities Litigation and Enforcement Report," July 9

Webcast: “2009 Mid-Year Review - Securities Litigation and Enforcement”

On July 9, 2008, Securities Docket will host a webcast entitled, “2009 Mid-Year Review - Securities Litigation and Enforcement.” The webcast, which is part of BrightTalk’s Securities Litigation Summit, will be a follow-up and update to the popular “2008 Year in Review” presented in January 2009.

Sign up through BrightTALK for free here: http://www.brighttalk.com/webcasts/4885/attend

The Securities and Exchange Commission's public comment period on the uptick rule concludes June 19. In sum, the outstanding questions is whether short sale price restrictions or circuit breaker restrictions should be imposed on the market.

Comments can be submitted here.

Comments submitted thus far express a wide range of opinions. For example, one writer suggested that reinstating the uptick rule is necessary for "national security."

Not to go unnoticed, of course, is Jim Cramer and his continuing campaign for a reinstating the uptick rule. It appears from the SEC's website that Cramer petitioned over 5,000 people to submit a template letter urging the SEC to instate a "price test" rule. Cramer's letter can be viewed here.

Written by Christine Lazaro, Esq.

FINRA filed a proposed rule change with the SEC on April 24, 2009, to expand its BrokerCheck service. BrokerCheck is a free tool offered by FINRA which allows investors to check the professional background of current and former FINRA-registered securities firms and brokers. BrokerCheck currently allows individuals to look up member firms and associated persons (brokers) who have been registered with FINRA within the past two years.

The proposed changes would expand BrokerCheck so that certain information would be permanently available. Specifically, FINRA proposes that records relating to final regulatory actions against brokers would be permanently available. FINRA describes a final regulatory action as “any final action by the SEC, Commodity Futures Trading Commission, a federal banking agency, the National Credit Union Administration, another federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization as those terms are used in the uniform registration forms.”

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Written by Christine Lazaro, Esq.

On May 6th, the Securities and Exchange Commission filed a suit against two lawyers, Albert J. Rasch, Jr. and Kathleen R. Novinger, both with Albert J. Rasch & Associates in Costa Mesa, California, and Sandra B. Masino and her company 144 Opinions, Inc. Suit was filed in the U.S. District Court for the Northern District of Georgia.

The complaint alleges that the defendants operated a legal opinion mill. 144 Opinions promoted itself as a “Restricted Stock Service” that provided legal opinions letters relating to the removal of restrictive legends on unregistered stocks. According to the complaint, Masino worked with Rasch & Associates along with the shareholder’s broker-dealer and the issuer’s transfer agent, to obtain the necessary paperwork to smooth the process of selling restricted stock. Between 2007 and the first four months of 2008, Masino prepared and Rasch or Novinger executed a total of 1,312 legal opinions.

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Written by Lauren Buonome*

The Fifth Circuit Court of Appeals issued an opinion on March 5, 2009 (revised on March 18, 2009), Citigroup Global Markets v. Bacon, vacating and remanding a district court opinion that granted Citigroup Global Market’s (“Citigroup”) motion to vacate an arbitration award. The arbitration claim, brought by Debra Bacon (“Bacon”), was filed in 2004 against Citigroup. Bacon asserted her husband had withdrawn funds from her account without authorization, totaling $238,000, and that Citigroup was liable for permitting such unauthorized withdrawals. The arbitration panel found for Bacon, awarding her $218,000 in damages and $38,000 in attorney fees. Consequently, Citigroup filed in the district court to vacate the award, citing § 10 of the Federal Arbitration Act (“FAA”).

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Written by David Welch, Esq.

The SEC met this past Wednesday and voted to review whether short sale price restrictions or circuit breaker restrictions should be implemented, and whether such measures will provide market stability and restore investor confidence. Reinstating some version of the uptick rule, irrespective of its precise details and actual impact on short selling, may in and of itself restore investor confidence. That is, even if short selling does not actually contribute to market volatility, and even if the uptick rule does not actually prevent short selling, just the knowledge that an uptick rule exists may encourage an otherwise apprehensive investor to ease back into the stock market.

"Clearly, the practice of short selling has both strong supporters and detractors. Today, we begin what will be a very deliberative process to determine what is in the best interests of investors,” SEC Commissioner, Mary Schapiro said.

Although many blame short-sales for causing a snowball effect on stocks already under pressure, Schapiro said there is no "specific empirical evidence" that the absence of the uptick rule fueled the recent descent in the market.

In fact, the SEC repealed the uptick rule, which had been active since the Depression, in 2007 when a test by the SEC (which removed the uptick rule for one-third of the stocks in the Russell 3000 index) found it could be eliminated without causing significant harm. Skeptics of the 2007-test point out that the rule wasn’t tested during a volatile or downward pressurized market.

The five possible uptick rules the SEC voted to consider are as follows:

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Written by David Welch, Esq.

Last week, before the Senate Banking Committee, SEC Chairman Mary Schapiro made it clear that she intends to consolidate oversight of financial services firms and subject them to stricter regulatory controls. Currently, FINRA and the SEC share supervision of broker-dealers and investment advisers. Investment advisers are required to abide by a “fiduciary duty” standard and brokers are held to a standard of “suitability.” Arguments regarding which standard is more stringent aside, Schapiro views the inconsistency as an encumbrance on regulatory oversight and implied that a uniform standard is on the horizon.

Schapiro and FINRA CEO, Richard Ketchum, explained that enforcement of the uniform standard will be consolidated under the purview of FINRA, for brokers and advisers alike. In his testimony before the banking committee, Ketchum stated:

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Written by David Welch, Esq.

A lot has been said lately about naked short selling and its potential for market manipulation. Short selling, aka, "covered" short selling, occurs when a trader sells a borrowed stock with the intent to buy it back elsewhere at a lower price and pocket the difference. A short sale is considered “naked” if the trader has not made arrangements to borrow (or "cover") the stock before he sells it. Naked short sales that are never “covered” sometimes result in a “failure to deliver” and it is this practice that has produced divided factions regarding ethics and the need for greater regulation.

Those against naked short sales claim that the practice can be used to manipulate the market because more shares can be sold short than actually exist, which in turn:

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Written by Christine Lazaro, Esq.

FINRA filed a proposed rule change with the SEC on March 11, 2009, seeking to amend the Code of Arbitration Procedure for Customer Disputes (Rule 12206) and the Code of Arbitration Procedure for Industry Disputes (Rule 13206), to clarify that the rules toll the applicable statutes of limitation when a person files an arbitration claim with FINRA.

Current Rule 12206(a) provides that “no claim shall be eligible for submission to arbitration under the Code where six years have elapsed from the occurrence or event giving rise to the claim.” Rule 12206(c) provides that “The rule does not extend applicable statutes of limitations…However, where permitted by applicable law, when a claimant files a statement of claim in arbitration, any time limits for the filing of the claim in court will be tolled while FINRA retains jurisdiction of the claim.” Rule 13206 contains identical language. FINRA has proposed deleting the phrase “where permitted by applicable law” from Rule 12206(c) and Rule 13206(c).

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Written by Christine Lazaro, Esq.

On March 12th, the Securities and Exchange Commission filed a suit against two brokers, David Harrison Baker ("Baker") and Daniel Schreiber ("Schreiber"), and the broker-dealer with which Schreiber was associated, Granite Financial Group, LLC ("Granite"), and Brian Travis ("Travis") and Nicholas Peter Vulpis, Jr. ("Vulpis"), two employees of a hedge fund investment adviser. Suit was filed in the U.S. District Court for the Southern District of New York, and alleged that Travis and Vulpis solicited bribes in exchange for routing hedge fund trades, and the associated commissions, to Baker, Schreiber and Granite.

The complaint alleges that Travis and Vulpis received at least $312,000 in personal benefits such as international air travel (including for family members), hotel arrangements, fully-paid vacations, daily car service, computer equipment, and monthly rent payments for a personal residence; and that Baker, Schreiber and Granite received a total of approximately $10,702,105 in commissions from trades that Travis and Vulpis directed to them.

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Written by David Welch, Esq.

The Quadruple Witch is a term used to describe the occurrence, which happens only 4 times a year, of 4 different types of derivative instruments expiring in a single day. The 4 derivative instruments are (1) Stock Index Futures, (2) Stock Index Options, (3) Stock Options, and (4) Single Stock Futures.

In the US market, Stock Index Options and Stock Options expire every month, while Single Stock Futures and Stock Index Futures expire four times per year in March, June, September, and December. The combined expiration of these four derivative instruments creates the “Quadruple Witching."

The Quadruple Witch day can be slightly more volatile as options holders begin to exercise their options contracts and roll forward to contracts with later expiration dates. This Friday is a Quadruple Witch day and thus, according to theory, this week could be more volatile than usual.

Citigroup was recently in the news related to a violation occurring on a Quadruple Witch day (See previous post, here).

According to FINRA, who fined Citigroup $2 million:

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Written by David Welch, Esq.

On March 9th, the SEC charged Locke Capital Management with falsely creating a billion dollar client in order to establish credibility and lure investors. See news release, here.

On March 11, the SEC announced that it fined Merrill $ 7 million for failure to protect confidential “Squawk Box” information. See news release here.

And lastly, on March 17th, FINRA released that it fined Citigroup $2 million for Range of Trade violations, including, failure to monitor trading systems at the opening of a Quadruple Witch Expiration Friday. See news release, here. Quadruple Witch Friday happens 4 times a year when 4 different types of derivative instruments expire. In theory, this causes more volatility on that day and throughout the week in which the day falls. This Friday, March 20, 2009, is a Quadruple Witch Expiration Friday.

Article written by Christine Lazaro, Esq.

At the G-20 Finance Ministers and Central Bank Governors meeting on March 14, 2009, U.S. Treasury Secretary Timothy Geithner announced that the United States would soon release a comprehensive framework for regulatory reform.

Geithner stated:

“We have committed to broad principles to guide the reform of the financial system:
First, all institutions that are important to the stability of the financial system should come within a much stronger framework of oversight, with clearer rules of the game that are enforced more evenly and consistently across countries.

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Article Written by David Welch, Esq.

Effective April 13, 2009: The Securities and Exchange Commission Approved Amendments to Require FINRA Arbitrators to Provide an Explained Decision upon a Joint Request From the Parties.

FINRA has announced that the new rule (outlined in an earlier post here) will become effective on April 13, 2009. Under the new rule, FINRA will require arbitrators to provide an explained decision upon a request from both parties.

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Written by David Welch, Esq.

About two weeks ago, on March 3, 2009, the Securities and Exchange Commission approved FINRA’s proposal to adopt NASD Interpretive Material 2110-7 as a stand-alone FINRA rule which will be renumbered as “FINRA Rule 2140.” Securities and Exchange Commission Release No. 34-59495 (March 3, 2009); File No. SR-FINRA-2008-052.

The new Rule, which codifies a long-standing FINRA policy, provides that it "shall be inconsistent with just and equitable principles of trade…to interfere with a customer’s request to transfer his or her account in connection with the change in employment of the customer’s registered representative[.]

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Written by David Welch, Esq.

Securities and Exchange Commission 17 CFR Part 242. Release No. 34-56206. Short Selling in Connection with a Public Offering.

Current economic conditions lend itself to increased short selling and, consequently, shorting has come under increased scrutiny by the SEC. Rule 105 of Regulation M prohibits purchasing securities as part of an “offering” if that security was also shorted within the five days immediately preceding the “pricing” (or within the period between the registration statement and the pricing, whichever is shorter).

Put another way, two actions have to occur to trigger a violation of Rule 105:

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FINRA fined Robert W. Baird & Co. $500,000 for supervisory violations relating to its fee-based brokerage accounts and ordered the company to return $434,510 in fees to 154 customers. FINRA found that customers were charged fees in accounts that were not generating any activity, otherwise known as “reverse churning.”

According to FINRA Baird failed to adequately review or supervise its fee accounts and allowed numerous customers to remain in the program despite conducting no trades for at least eight consecutive quarters. These accounts paid over $269,000 in fees during the inactive quarters.

According to Andrew Stoltmann at Investmentfraud.PRO, this type of fee based account has become more prevalent in the past 7 years and Baird is only one firm out of many who engaged in so-called reverse churning. Recent actions involving firms such as AXA Advisors, Morgan Stanley, SunTrust Investment and Wachovia Securities ranged from $700,000 to $6.1 million.

Written by David Welch, Esq.

Written by David Welch, Esq.

Under the new rule, parties to an arbitration may require an arbitrator to provide an explanation of decision if the request is made jointly (by both parties) 20 days prior to the first scheduled hearing date. An arbitrator must provide a fact-based award stating the general reason(s) for the arbitrator's decision. However, the rule does not require the arbitrator to include legal authorities and/or damage calculations.

The chairperson required to write the explained decision will receive an additional honorarium of $400 and will allocate the cost to one party or between/among all parties. The 20 day deadline coincides with the time that parties must exchange documents and identify witnesses they intend to present at the hearing. In FINRA's view, this establishes a clear deadline, gives the parties sufficient time to request an explained decision, and provides notice to the arbitrators that an explained decision will be required before the hearing begins.

The new rule is likely an attempt by FINRA to appease a common perception among customers that the arbitration process favors the industry. Although FINRA has conducted studies and published results that tend to discredit the validity of industry favoritism, FINRA maintains that the mere perception of inequity is a concern that they are taking steps to eradicate.

Two broker-dealer side securities litigators from Sutherland Asbill & Brennan LLP conducted a study that concluded broker-dealers can benefit from fighting proceedings brought by the SEC and FINRA. The study says that firms who fought proceedings brought by the SEC won a dismissal 19% of the time and FINRA complaints that were fought were dismissed 15% of the time. With regard to fines, respondents to SEC charges convinced the judge to lower the fines 83% of the time and FINRA respondents succeeded in reducing fines roughly 50% of the time.

Another interesting but not surprising statistic published by the study is that respondents who hired counsel were overwhelmingly more successful than those that did not. SEC respondents represented by counsel succeeded in getting approximately 22% of charges dismissed, and FINRA respondents with counsel succeeded in getting approximately 19% of charges dismissed. SEC and FINRA respondents without counsel went 0-for-16 from January 2006 through December 2007.

Clearly, the terrible rate of success for pro-se respondents is a testament to the unfortunate pay-to-play factor in our justice system that favors those with resources to hire a lawyer. However, another possible factor not discussed in the study is that a respondent who believes he or she is guilty or liable, may be less likely to fight or spend money on counsel. If true, this factor would slightly skew the pool of pro-se respondents towards a lower “success” rate.

Read the study results here.

Written by David Welch, Esq.

Written by Dan Fried, Esq.

In In re: American Express Merchants' Litigation, 06-1871-cv, decided on January 30, 2009, the Second Circuit ruled for the first time that the class action waiver provision within a contract between American Express Co. and merchants is unenforceable under the Federal Arbitration Act. The Court held that to enforce this agreement would "grant Amex de facto immunity from antitrust liability by removing the plaintiffs’ only reasonably feasible means of recovery."

The Court did not go so far as to rule that class action waiver provisions are either void or enforceable per se, focusing solely on the provision contained in the specific contract being argued before them.

The Court also held that the authority to determine the enforceability of a class action waiver is a matter for the courts, not the arbitrator.

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Although Luparello's testimony was comprehensive, the overarching theme was that disparate treatment by fractured regulatory authorities fosters failed oversight. His testimony emphasized the need for "a consistent level of protection no matter which financial professionals or products [investors] choose." See his entire testimony here.

Written by David Welch, Esq.

Written by David B. Harrison, Esq.

In Cozzarelli v. Inspire Pharmaceuticals, Inc., 549 F.3d 618 (4th Cir. Dec. 12, 2008), the Fourth Circuit applied the strict pleading standards for scienter set forth by the PSLRA and interpreted by the Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, Ltd., ---U.S. ----, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). The Court affirmed the District Court’s dismissal, finding that plaintiffs failed to raise a strong inference of wrongful intent required to support their securities fraud claims.

Plaintiff class sued biopharmaceuticals company, Inspire, for violations of the federal securities laws, alleging defendants made false and misleading statements regarding clinical trials of a new drug, diquafasol, a treatment for dry eye disease. Plaintiffs alleged that defendants fraudulently misled investors as to the trial’s likelihood of success in meeting the FDA's standards for approval.

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Written by David Welch, Esq.

Despite the Supreme Court's ruling in Tellabs, the Second Circuit continues to apply its two prong motive and opportunity or strong circumstantial evidence test. In ECA and Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., Case No. 0-1786-cv (2nd Cir. Jan. 21, 2009) the Second Circuit affirmed the District Court’s dismissal for failure to sufficiently plead scienter.

The case addressed the issue of whether the complaint adequately alleged (1) a false statement or omission of material fact, and (2) a strong inference of scienter.

A plaintiff must establish that the defendant made a materially false statement or omitted a material fact, with scienter. The complaint must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(1), (2); Tellabs, 127 S. Ct. at 2508.

The Second Circuit's test required that the complaint allege facts that show either:

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Written by David Welch, Esq.

In Waldman v. Wachovia Corp., 2009 WL 86763 (S.D.N.Y. Jan. 12, 2009), the Court found that maintaining a discovery stay with regard to documents already produced to state and federal authorities would unduly prejudice plaintiffs because the documents could be determinative of plaintiffs’ decision whether to continue pursuing the case.

This case addressed the issue of when a discovery stay reaches the point of undue prejudice.

The PSLRA states that “in any private action arising under [federal securities law], 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.” 15 U.S.C. § 78u-4(b)(3)(B).

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Written by David Welch, Esq.

In In re Hydrogen Peroxide Antitrust Litigation, No. 07-1689 (3d Cir. Dec. 31, 2008), the Third Circuit vacated a district court’s decision to certify a class in an antitrust lawsuit, and held that the lower court left unanswered disputed elements of Federal Rule of Civil Procedure 23.

The Court stated that the requirements set out in Rule 23 are not mere pleading rules." Szabo, 249 F.3d at 675-77. The court may “delve beyond the pleadings to determine whether the requirements for class certification are satisfied.“ Newton, 259 F.3d at 167.

Plaintiffs moved to certify a class of purchasers of hydrogen peroxide and other chemicals, alleging that the defendant manufacturers had fixed prices in violation of the Sherman Act. The district court granted the motion and defendants appealed arguing that plaintiffs failed to satisfy Rule 23(b)(3)’s requirement that common questions of law or fact predominate.

The Third Circuit held that three key aspects are necessary for class certification. “First, the decision to certify a class calls for findings by the court, not merely a “threshold showing” by a party, that each requirement of Rule 23 is met. Factual determinations supporting Rule 23 findings must be made by a preponderance of the evidence. Second, the court must resolve all factual or legal disputes relevant to class certification, even if they overlap with the merits-including disputes touching on elements of the cause of action. Third, the court’s obligation to consider all relevant evidence and arguments extends to expert testimony, whether offered by a party seeking class certification or by a party opposing it.”

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Written by David Welch, Esq.

In the Ninth Cirucit, if you don't meet pleading standards under a segmented approach, maybe a "holistic" approach will work.

Rubke v. Capitol Bancorp LTD, 2009 WL 69278 (9th Cir. Jan. 13, 2009) and Zucco Partners, LLC v. Digimarc Corp., 2009 WL 57081 (9th Cir. Jan. 12, 2009) alter the approach to evaluating scienter allegations by first using a segmented analysis, and second using a holistic approach. It appears to give plaintiffs a second bite at the apple.

The complaint alleged that Capitol Bancorp, Ltd. and CEO Joseph Reid misled investors by incorporating two fairness opinions in a registration statement issued to minority shareholders. The plaintiffs also alleged that defendant’s registration statement omitted information related to a prior offer for the holding company’s shares, future income projections, likelihood of a premium on fair value of shares, and a strategy of board members to convince minority shareholders to sell their shares to Capitol.

The district court dismissed the complaint for failure to meet the pleading standards of the Private Securities Litigation Reform Act, and the Circuit court affirmed, stating:

“The First Amended Complaint has also failed to allege with particularity that Capitol made any of the statements or omissions “intentionally or with deliberate recklessness.” Daou, 411 F.3d at 1015. The complaint’s allegations about Pedisich’s telephone calls do not adequately plead that the defendants in this case had the requisite mental state. The complaint’s remaining allegations concerning Capitol’s mental state allege nothing but “motive and opportunity,” which is not enough to create a strong inference of scienter. Silicon Graphics, 183 F.3d at 974…These allegations are hardly indicative of scienter…Even considered holistically, under Tellabs, these motive allegations cannot support a strong inference of scienter.”

Written by David Welch, Esq.

Written by David Welch, Esq.

The Ninth Circuit issued its first analysis of Tellabs in Zucco Partners, LLC v. Digimarc Corporations, 2009 WL 57081 (9th Cir. Jan. 12, 2009).

The case was dismissed based primarily on the confidential witnesses' lack of personal knowledge but the interesting part was that the Ninth Circuit seemed to imply that the new Tellabs standard is less strict than the Court's previous standard (or, at least confirmed that Tellabs didn't raise the standard).

They applied a dual part test for pleading scienter: first, a segmented evaluation of each allegation, then a "holistic" evaluation under Tellabs.

Examples of the Court's perspective on the new Tellabs standard compared to the Ninth Circuit's previous standard:

"Tellabs did not materially alter the particularity requirements for scienter claims established in the court's previous decisions, but instead only added an additional "holistic" component to those requirements."

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Written by David Welch, Esq.

The court in In re Cooper Companies Inc. Securities Litigation, 2009 WL 32568, 13 (C.D.Cal., Jan. 5, 2009) granted Plaintiffs' Motion for Class Certification according to Rules 23(a) and 23(b)(3).

In re Cooper addressed certification of a class alleging false statements regarding the company's overall business condition and the proper time for a court to address the common reliance element of fraud-on-the-market.

Federal Rule of Civil Procedure 23 sets forth two sets to maintain a class action. First, the proposed class must satisfy the four requirements of Rule 23(a): (1) the class is so numerous that joinder of all members is impracticable; (2) there are questions of law or fact common to the class; (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class; and (4) the representative parties will fairly and adequately protect the interests of the class. FED.R.CIV.P. 23(a).

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Written by David Welch, Esq.

Rosenberg v. Gould, --- F.3d ----, 2009 WL 50721 (11th Cir. Jan 09, 2009).

The district court held, and the 11th Circuit affirmed, that the complaint failed to satisfy the heightened standard for pleading scienter.

This case addressed whether a complaint alleging that a CEO (and the company) who granted and received backdated options in 2000 and 2001, and overstated earnings between 2004 and 2006, satisfied the heightened standard for pleading scienter, under section 10(b), of the Securities Exchange Act, 15 U.S.C. § 78j(b).
The Private Securities Litigation Reform Act of 1995 imposed a heightened standard for pleading scienter. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S.Ct. 2499, 2504, 168 L.Ed.2d 179 (2007). A plaintiff must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). “An inference of scienter must be more than merely plausible or reasonable-it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Tellabs, 127 S.Ct. at 2504-05.

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The SEC adopted FINRA’s recommendation to limit motions to dismiss before an investor presents his or her case. Under the new rule, if a party brings a dispositive motion before the claimant has presented, it can only be granted on three grounds: the parties have settled in writing, there is a factual impossibility, or a party doesn’t file a claim within six years of the events at issue.

The Wall Street Journal reported that FINRA proposed the new rule in response to repetitive filings of dispositive motions that raise the cost of arbitration for retail investors. In adopting FINRA’s rule, the SEC has undoubtedly reduced costly motion practice and paved the way for investors to have a hearing of their case on the merits. For more on the rule itself, click here and here.

According to solo practitioner, John Castro, Esq., “the economic downturn and recent corporate scandals, like Madoff, have already increased the amount of investor arbitration claims. It’s even apparent on the New York State Bar Association's listserv; attorneys are sending referrals and asking me advice more and more frequently. This new rule will only add to the number of securities cases brought before an abitrator.”

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