Securities Class Actions

bankinchains.jpgThe prudent answer to this question should be probably not, but we can hold out hope.

A FINRA panel recently upheld a class action exclusion in a broker-dealer agreement to arbitrate contained in its customer agreement.  In other words, the provision prohibits a customer from seeking class action status against the broker-dealer, forcing all customer complaints to be brought in arbitration.

FINRA has since appealed this decision to its National Adjudicatory Council.  As such, the issue will not be firmly grounded for some time.  In the interim, what should broker-dealers do.

At a minimum, broker-dealers should immediately revisit their customer agreements.  Until the FINRA appeal is exhausted, it may make sense to include a provision barring customer class actions.

Although this issue remains in flux, there is a window of opportunity to limit the claims brought against you.  Act now or regret it later.

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The U.S. Court of Appeals for the Third Circuit found that two founders of a metal components business were not liable in a securities fraud lawsuit although both had improperly looted millions of dollars of corporate assets. See Gallup v. Clarion Sintered Metals Inc., 3d Cir., No. 11-4004, 7/26/12, and

Essentially, the investors had not shown reliance to prove their Securities Exchange Act of 1934 Section 10(b) claim.  However, the court did allow them to continue — albeit in state court– with their other claims after documenting a pretty elaborate scheme to depress the price of the stock and cover-up their fraud.  Interestingly, the court did indicate that the plaintiffs had not read any of the financial statements the company issued.  Thus, although they may have a claim for breach of fiduciary duty or improper management, those claims are not sounded in federal securities law.

Consequently, the moral of the story, if you want to sue, at the very least, keep up-to-date with the company’s newsletters and financials!!

Ernest Badway, recently, appeared on one of the top-rated business programs in India, The Firm, to discuss United States District Court Judge Barbara Jones’ dismissal of a major securities class action involving a major, Indian based, multi-national company, Satyam.  The Firm airs on CNBC-India.  The video is in two parts.  Please click ‘Next’ icon on the bottom right hand of the video window to continue viewing the story:

I previously wrote about how the Food and Drug Administration and Department of Justice used the responsible corporate officer doctrine to charge former Purdue Pharma executives and in-house counsel with criminal liability and career-ending debarment for “off-label” drug marketing, even though the charged parties did not personally participate in the conduct or even know about it.  Recent court activity may significantly reduce such exposure for similarly-situated individuals, with ripple effects spreading through many legal sectors, including shareholder suits.

In a game-changing decision released on December 3, 2012, the Second Circuit Court of Appeals reversed the conviction of Alfred Caronia, a pharmaceutical sales representative who had been convicted of conspiring to introduce a misbranded drug into interstate commerce.  The evidence at trial included recordings of Mr. Caronia’s statements to doctors that Xyrem, a drug that the FDA approved for narcolepsy, could also be used to treat various other conditions for which the FDA had not approved the drug.

Mr. Caronia argued that the prosecution violated his First Amendment right to free speech.  The Second Circuit agreed, and in reversing his conviction narrowly read the scope of the Food, Drug, and Cosmetic Act “as not criminalizing the simple promotion of a drug’s off-label use because such a construction would raise First Amendment concerns.”  Mr. Caronia’s conviction relied on off-label promotion, and was therefore invalid.

Depending on one’s perspective, pharmaceutical representatives promoting off-label uses for their products are either modern snake oil salesmen or critical conduits of information to medical treatment providers regarding cutting-edge therapies.

Setting this debate aside, the Caronia decision could upend the current FDA regulatory and enforcement regime regarding off-label marketing, with wide-ranging effects.  In addition to the government’s revitalization of the responsible corporate officer doctrine, recent years have witnessed:  (1) the government attempt to prosecute in-house counsel for obstructing an off-label marketing investigation; (2) the government require, in settlement of misbranding charges, corporate integrity agreements that prohibit compensation of the sales force based on sales goals; and (3) scores of whistleblower lawsuits, False Claims Act actions, and the follow-on class-action shareholder lawsuits involving off-label marketing.

This could all change if the Supreme Court affirms the Second Circuit or if other appellate courts agree that prosecutions for “off label” marketing violate free speech rights.

Over the years and, most certainly, since the passage of the Private Securities Litigation Reform Act, plaintiffs’ lawyers have used confidential witnesses in their pleadings. 

Plaintiffs’ lawyers, typically, do not name these witnesses in their complaints to avoid motions to dismiss and other legal actions.  However, over the last several years, court decisions have become increasingly critical of this approach, requiring confidential witness disclosure to occur, most notably, in Federal Rule of Civil Procedure 26 initial disclosures.  Not to be outdone, Plaintiffs’ lawyers have responded by trying to hide these confidential witnesses among other witnesses named.

Nonetheless, recently, some courts have even required that these so-called confidential witnesses be named at the motion to dismiss stage to assist the court in determining if the defendants motion to dismiss should be granted.  Most notably, the Second Circuit Court of Appeals has approved this process in the Campo v. Sears Holdings Corp., 2010 WL 1292329, No. 09-3589-cv (2d Cir. Apr. 6, 2010).

Additionally, plaintiffs have also run a risk that, when they refuse to name a confidential witness, their action could result in dismissal and/or sanctions.  Some cases have revelaed that confidential witnesses may, ultimately, recant their story as the litigation progresses.  This was vividly seen in the City of Livonia v. Boeing Company case,,39, where the confidential witness recanted, subjecting plaintiffs to a Federal Rule of Civil Procedure 11 sanctions.

Thus, there are dangers in using confidential witnesses in securities litigation, and defendants  should be ready to respond.

In response to the Supreme Court’s decision in Morrison v. National Australia Bank where the Supreme Court said that there was no private right of action for lawsuits that involved transnational fraud, the SEC has taken a position that has angered some. 

As many know, the Dodd-Frank Act confirmed the SEC’s jurisdiction as it relates to potential foreign involvement.  However, the SEC was not so quick to support such a stance for private litigants.  In particular, the SEC believes that Congress could either clarify the Morrison test or take no action.

This no action position has engendered much criticism from SEC Commissioner Aguilar.  Commissioner Aguilar believes that Congress should revert to the pre Morrison test of conduct and effect, and ignore the Supreme Court’s s decision.

Accordingly, it will be interesting to see if Congress responds to this recommendation from the SEC, since it required the SEC , through the Dodd-Frank Act, to conduct this study and make this report to Congress. 

We previously blogged on the Argentina bond case.  See  Now, to update our readers, the United States District Court for the Southern District of New York has vacated the attachment orders previously placed on the Republic of Argentina’s assets held at the Federal Reserve Bank of New York.  The Court indicated that it was reluctantly compelled by the law and the facts to do so, and, as such, could not move forward the attachment.  Alas, at least, we still have Evita

In an intriguing case out of the United States District Court for the Western District of Missouri, a plaintiff’s purchase of condominium units with an option to participate in the rental program did not involve an investment contract under either the federal or Missouri securities laws.  The court, thus, dismissed the plaintiff’s securities claims. 

The court believed that the purchases of these condos with rental options did not rise to the level of an investment contract requiring adherence to the securities laws.  In particular, the court considered if the transaction qualified as an investment contract, analyzing if there was an investment of money, common enterprise, and the reasonable expectation of profits to be derived from the efforts of others, among others things.  The court focused on the uncertainties of both vertical and horizontal commonality required under the common enterprise element test.  In determining that there was a lack of horizontal commonality, the court found that the plaintiffs were not sold securities.  The court also noted that there was no requirement to participate in the rental program as well.

As such, this interesting case has effects in both the real estate and securities markets that have suffered greatly during the recession.  This decision may lead to an increased use of these types of programs.

Recently, the United States District Court for the Eastern District of Washington attacked the attorney’s fees and expenses filed by plaintiff’s attorneys in a securities fraud suit. 

The judge was not pleased that the attorneys had submitted a six figure bill with expenses and disbursements that it considered excessive.  In particular, the court sited a meal where two attorneys had purchased 2 – $72 bottles of wine and included a $60 tip.  The court thought that this bill was outrageous.  Similarly, the court believed that hotel and airfare expenses were incredibly excessive for this type of securities claim.  The court reduced the fee award by nearly 70%.

This case truly points out to lawyers that, when submitting fee requests to the court, courts are more reluctant to award large fees.

Late last week, one of my colleagues sent me an e-mail where he copied 8 other people, half of them I could not identify if my life depended upon it.  I then heard about the person who had a Twitter account with over 17,000 follwers, and was now being sued by his former employer over ownership of the account– really, does anyone think the person knows 17,000 people?  Firms and persons working in financial services industries generate trillions of e-mails every year, encompassing the mundane to the critical. 

These firms and their employees also seem to be involved in numerous civil, regulatory and criminal investigations and litigations.  Much of the vast amount of money in legal fees paid to defend these firms and their employees (sums that sometimes greatly exceed the GDP of several developing countries) often relate to e-mail review and production.  General counsels and firm management looking for ways to save money on these bills should, initially, read my article that was published in the New Jersey Law Journal, outlining the “CC” problem and ways of clamping down on this terrible plague afflicting our society,

Once read, please do your part in stopping this madness because the dollar you save maybe your own!!