by T. GormanPosted on Posted in SECActions

The Supreme Court heard arguments in an important securities case on Monday, Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, Docket No. 11-1085. The question for resolution is whether a securities law plaintiff must demonstrate that the claimed misrepresentations are material at the class certification stage in a fraud-on-the-market case.

The resolution of this question is at the intersection of Rule 23, Federal Rules of Civil Procedure and the Court’s decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988). The Rule governs class certification and in subsection (b)(3), central here, requires that the issues common to the class members predominate to permit the case to move forward as a class action. Basic held that a plaintiff can establish the element of reliance on the misrepresentations by utilizing a rebuttable presumption that purchasers relied on the integrity of the market if it is efficient so that a material misrepresentation would be reflected in the price. In essence, the presumption establishes transaction causation, linking the purchaser and the misrepresentation.

Three themes dominated the arguments. First, the critical point under Rule 23(b)(3) is whether the issues common to the class members predominate. When they do the class can be certified. The text of the Rule makes no reference to the merits of the claim. Second, Basic requires that the securities law plaintiff establish that the market is efficient and that the misrepresentation is material to employ its rebuttable presumption. If the misrepresentation is not material by definition it will not impact the market and there can be no presumption. Third, in earlier cases the High Court has hewed close to the text of Rule 23 when considering the class certification question, concluding that the plaintiff need not turn the certification hearing into a resolution of the merits. The Petitioner-Defendants, Respondent-Plaintiffs and the government as amicus tried to weave these themes into their arguments which were also echoed in the questions by the Justices.

Petitioner sought to define the critical issue at the outset of the argument: “Our case is about whether the claim of liability is in a fundamental sense class wide or individual. The heart of a 10b-5 claim is, I bought or sold in reliance on a misleading statement. The question at the class cert stage is whether each individual will have to prove his own reliance directly . . . A market price will reflect a statement if and only if the statement is material and is made publicly on an efficient market. So, absent materiality, the market price cannot be presumed to reflect the statement in question.”

The Chief Justice immediately turned the argument from Basic and materiality to Rule 23 commonality:

Chief Justice: Why is that – why is that the case? I would suppose if there’s no materiality, that means that the effect on the market price just happens to be zero.

Petitioner: That’s exactly correct. And the point here is —

Chief Justice: Well, why isn’t that common to all parties?

Throughout Petitioner’s position, which would require that the question of materiality be revisited throughout the case – at certification, summary judgment and at trial – was discussed. Justice Kagan asked if the rulings by the court on the question could be different at various points. Petitioners asserted they could because “the judge at the class certification stage is required to weigh competing evidence . . . At the summary judgment stage, a judge is precluded from doing that.” At the same time, Petitioner argued that while certifying the class would force a settlement which may not reflect the merits, denying certification would not be the end of plaintiffs’ claims because each could proceed individually and prove reliance. Justice Ginsburg responded, stating “I am really nonplused by your answer that if the judge says it’s immaterial, that doesn’t end it for everybody.”

Later in the argument Petitioner framed the critical choices for the Court: “The real question in this case is the purpose of Rule 23? If you think that the purpose of Rule 23 is to postpone to the merits everything that can be postponed without a risk of foreclosing valid individual claims, we lose. But that’s not the purpose. The purpose is for a court to determine whether all of the preconditions for forcing everyone into a class action are present before you certify.” While affirming that the point of certification is not to pre-try the case, at the same time Petitioner insisted that Rule 23 be read in tandem with Basic.

Respondents claimed that materiality is a merits question that should not be considered at the certification stage. Almost immediately, they encountered difficulty, seemingly undercutting Basic, at least in part:

Justice Sotomayor: “. . . if Basic set forth a presumption, and are you disputing that at the class certification stage a defendant can prove that the market is inefficient?

Respondent: Yes.

Justice Sotomayor: So why shouldn’t we hold Basic to its position that all of its presumptions can be rebutted as well, not just efficiency? Why do we set out efficiency as the one issue that can be rebutted?”

Later, in responding to a similar question from Justice Scalia, Respondents distinguished efficiency: “They all lose [plaintiffs] on the merits if there is no materiality. The question about efficiency . . . and the reason why it is advanced at class certification is because it serves a gate-keeping role in determining whether all the investors can show indirect reliance on the market.” That differs from the question of materiality which is a key element of the merits as Respondents noted in answering questions from Justice Breyer:

Justice Breyer: The publicity of the matter, that is not traditionally a common element of the tort, that is something special to get into this theory.

Petitioner: Correct.

Justice Breyer: With materiality, it is a common element of the tort always; it is traditionally there; it will be litigated, so there is no special reason to or desirability in or need for litigating at the outset.

Petitioner: That’s correct.

Finally the Solicitor General, arguing in support of Respondents, summed up the case for not requiring proof of materiality at the class certification stage: “And so our issue is not with the predicates for the fraud-on-the-market theory. Our issue is with Petitioners equating the predicate for the fraud-on-the-market theory with the actual prerequisites of Rule 23. And this Court made it very clear in Shady Grove that the only question at the Rule 23 stage is whether the prerequisites have been met. The only one that we’re talking about here is predominance. It’s a comparative inquiry between common issues and individual issues.”

A ruling is expected before the end of the term in June.

Hurricane Sandy: The President suggested that those who want to aid the victims of this devastating storm contribute to the Red Cross. The link is here.

Seminar: The ABA’s premier program on securities fraud, the National Institute on Securities Fraud will be held on November 15 and 16, 2012 in New Orleans (here).

Tagged with: , ,

by T. GormanPosted on Posted in SECActions

The SEC’s new cooperation tools have impacted a number of actions. In four cases, as discussed in Part I of this article, the Commission entered into agreements under which it either chose to prosecute or deferred prosecution with a view toward dismissal. In most instances where the agency has acknowledged the cooperation of a party however, an action was brought but the resolution of the case was altered in some fashion.

Reduced sanction

In some cases the Commission acknowledged cooperation while imposing a reduced sanction as in the proceeding against BNY Mellon Securities LLC, In the Matter of BNY Mellon Securities LLC, Adm. Proc. File No. 3-14191 (January 14, 2011). There the Order alleged that the registered broker dealer failed to reasonably supervise the manager on its institutional order desk and the traders under his supervision over a seven year period. During the period the order desk manager failed to meet his duty of best execution to certain customers. Orders were executed at stale or inferior prices which were frequently outside the National Best Bid and Offer at the time of execution. In some instances the orders were executed in cross-trades with a favored handful of accounts held by hedge funds and certain individuals. While the firm did have written procedures, there were none to follow-up on red flags. The Order thus alleged that the firm failed to reasonably supervise within the meaning of Exchange Act Section 15(b)(4)(E) with a view to preventing and detecting violations of Section 17(a).

The broker dealer settled the proceeding, consenting to the entry of a censure. BNY Mellon Securities also agreed to pay disgorgement of $19,297,016, prejudgment interest and a $1 million penalty and to implement certain procedures. The Commission settled on these terms in view of the cooperation and remedial efforts of the broker-dealer which included: 1) Suspending cross-trading and beginning an internal investigation three days after one of the hedge funds involved was charged on an unrelated matter; 2) Terminating the order desk manager for cause; and 3) Self-reporting about two and one half months after commencing its investigation. See also: In the Matter of AXA Advisors, LLC, Adm. Proc. File No. 3-14708 (Jan. 20 2012)(failure to supervise action where employee induced clients to redeem accounts so he could misappropriate funds resolved with censure, adoption of procedures and payment of $100,000 penalty based on cooperation, adoption of procedures and retention of independent consultant);

No penalty

In other instances the SEC has elected not to impose a financial penalty based on the cooperation of the company. A good example of this small group of cases is the proceeding against Arthrocare Corporation, a medical device manufacturer. In the Matter of Arthrocare Corporation, Adm. Proc. File No. 3-14249 (Feb. 9, 2011). There the Order Instituting Proceedings alleged that over a three year period the company inflated its income by overstating and prematurely recognizing revenue primarily in connection with quarter end sales to one customer. The purpose was to meet quarterly goals and street expectations. Eventually Arthrocare was required to restate its financial statements.

The proceeding was settled with a consent to the entry of a cease and desist order which prohibits future violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). No fine was imposed based on the cooperation and remedial efforts of the company which included: 1) Replacing the senior management team; 2) expanding its legal department; 3) creating a position for and hiring a new Compliance Officer position; 4) hiring a new corporate controller and international controller; 5) expanding its internal audit function; 6) instituting quarterly ethics communications from senior management to employees; 7) implementing a sub-certification process as part of its quarterly and annual financial reporting; 8) adopting standard customer contracts with rigorous approval requirements; 9) hiring a contract administrator; and 10) providing regular training on proper revenue recognition and accounting for handling contracts.

During the investigation the company regularly updated the staff on its internal investigation; provided critical documents without waiting for a request; promptly responded to staff requests; routinely granted the staff access to the company’s consulting expert; voluntarily produced witness for testimony who were outside the U.S; and provided the staff with a detailed analysis of its restatement.

Similarly in In the Matter of Fifth Third Bancorp, Adm. Proc. File No. 3-14639 (Nov. 22, 2011) the proceeding was settled with a consent to the entry of a cease and desist order, in this instance based on Exchange Act section 13(a) and Reg FD but no penalty based on the Respondent’s cooperation. The underlying proceeding was based on allegations that the bank selectively disclosed to certain investors that it planned to redeem a class of its trust preferred securities for about $25 per share.

The Order acknowledge “the remedial acts promptly and voluntarily undertaken by Fifth Third – including its compensation of CAP VII TruPS investors harmed by the timing of the disclosure and its adoption and implementation of additional policies and procedures . . .” and the cooperation afforded the staff. In other cases the Commission has made similar statements. See, e.g., In the Matter of GSCP (NJ), Adm. Proc. File No. 3-15514 (Aug. 25, 2011)(no fine imposed on investment adviser that served as portfolio manager for sale of synthetic CDO where the marketing materials failed to disclose the participation of a hedge fund in selecting collateral that had a short position); SEC v. Cinderey, Civil Case No. CV 12-1519 (N.D. Cal. Filed March 27, 2012)(settled action in which bank officer who participated in scheme to circumvent controls to delay recognition of loan losses settled by consenting to an injunction but was not required to pay a civil penalty based on cooperation and fact that he paid a $40,000 fine in an FDIC administrative proceeding).

Reduced penalty

In other instances cooperation resulted in a reduced fine as in In the Matter of Martin Currie, Inc., Adm. Proc. File No. 3-14873 (May 10, 2012). There an investment adviser used assets of one client to rescue another in violation of Advisers Act Sections 206(1) and (2) and Investment Company Sections 17(d) and 34(b). The matter was resolved with a cease and desist order, censure and the payment of an $8.3 million fine. The fine was limited because of cooperation which included: Compensating the fund injured; refunding fees; terminating and/or disciplining those involved; conducting an investigation; and implementing procedures. Similarly in SEC v. Easom, Civil Action No. 2:11-CV-7314 (D.N.J. Filed Dec. 16, 2011) a corporate insider who tipped a cousin – broker who then tipped others entered into cooperation agreement. As a result the insider settled by consenting to a fraud injunction and paying disgorgement of $327 in trading profit and prejudgment interest but only a $10,000 civil penalty. See also SEC v. Wrangell, Case No. 7:12-cv-00274 (E.D.N.C. Filed Sept. 20, 2012)(tippee in insider trading case cooperated and settled by consenting to a fraud injunction, disgorging his trading profits of over $42,000 and paying a reduced penalty of $11,380.99); SEC v. Rooks, Civil Action No. 1:12-cv-02988 (N.D. Ga. Filed Aug. 28, 2012)(same).

Finally, in some instances while the Commission has acknowledged cooperation and apparently mitigated the penalty, but the impact is not readily apparent. SEC v. Pressetek, Inc., Civil Action No. 10-1058 (E.d.N.Y. Filed march 9, 2010) is such a case. There the company was charged with violations of Exchange Act Section 13(a) and Reg FD. The action centered on conversations about the performance of the company by its chairman and CEO with an investment adviser to a fund which owned a substantial block of Pressetek stock.

In an unusual step, the complaint acknowledged the cooperation of the company and its remedial acts which included revising its corporate communications policies and governance principles, replacing its management team, appointing new independent board members and creating a whistleblower hotline. Nevertheless, the company settled with the Commission by consenting to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint and paying a $400,000 fine. The impact of the cooperation was not specified.

Similarly, in SEC v. Long-Short term, Inc., Civil Action No. 1:11-cv-1127 (E.D.Va. Filed Oct. 18, 2011), an action based on false statements made during options trading seminars, the Commission acknowledged the cooperation of the defendants and noted that they retained counsel who evaluated the company, instituted new policies and installed procedures to prevent a reoccurrence. Yet both defendants consented to the entry of permanent injunctions prohibiting future violations of Exchange Act Section 10(b). The company paid a penalty of $750,000 while the co-founder paid $150,000. See also In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Admin. Proc. File No. 3-14204 (January 25, 2011)(misuse of customer order flow information, improper mark-ups and downs results in failure to supervise charge settled with cease and desist order and civil penalty of $10 million, although cooperation acknowledged); In the Matter of JSK Associates, Inc., Adm. Proc. File No. 3-14296 (March 14, 2011)(investment adviser and two others charged in action based on failure to disclose compensation; each settle by consent to cease and desist order; adviser paid disgorgement of over $60,000; and individuals each paid civil penalty of $10,000; resolution based on prompt cooperation and remedial efforts).

Conclusion

The Commission’s new cooperation tools have been employed in a series of cases. Few have resulted in either a non-prosecution or deferred prosecution agreement. The circumstances under which either of these types of agreements have been utilized are limited, typically reflecting the type of case on which the 2002 Seaboard Release was based.

Yet there seems to be little reason for restricting the use of these agreements to such limited circumstances. Seaboard represented a decision not to prosecute. There was no formal mechanism to obtain disgorgement, impose a civil penalty or insure the implementation of remedial measures to prevent future violations.

The Commissions new cooperation tools solve this dilemma. With either a non-prosecution or deferred agreement the agency can obtain as part of the arrangement disgorgement, a civil penalty and require the implementation of policies and procedures which can help prevent future repetition. Indeed, a deferred prosecution agreement can serve as a kind of time limited mini-injunction, conditioning dismiss at a future point in time on: 1) The payment of disgorgement and/or a penalty as appropriate; and 2) the continued implementation of policies and procedures which reform the company and its culture to prevent a future reoccurrence of the wrongful conduct. Accordingly, there is no reason not to broaden the application of these tools which would better serve their goal of encouraging self-reporting and cooperation while speeding investigations.

Finally, while in many instances the Commission has detailed the cooperation and remedial efforts involved, that is not true in each case. A better explication of the efforts which earned the company “cooperation credit” and a reduced sanction provides added guidance to the market place encouraging cooperation. Overall, experience to date suggests that these initiatives represent the adoption of new tools which will well serve the enforcement program in the future.

Hurricane Sandy: The President suggested that those who want to aid the victims of this devastating storm contribute to the Red Cross. The link is here.

Seminar: The ABA’s premier Securities Fraud seminar will be held in New Orleans on November 15 and 16, 2012 (here).

Tagged with: , , ,