Wednesday, October 29, 2008

Panelists Address Securities Litigation Landscape

By James Hamilton, J.D., LL.M.

Panelists at the Practising Law Institute's Securities Litigation and Enforcement Institute described a litigation environment that has changed dramatically in recent years. Major Supreme Court decisions such as Dura, Tellabs and Stoneridge have reshaped the scope and pleading requirements for class actions, while the market turmoil has complicated the requirement of pleading firm-specific fraud when stock prices are declining across the board.

Sherrie R. Savett of the Philadelphia firm of Berger & Montague said that the market collapse is not necessarily fatal to plaintiffs in class action fraud cases. She advised that the pleadings should focus on statements made by potential defendants, and suggested that good cases could be made in instances of 1) underwriting failures, 2) failures to disclose exposure before the risk is quantified, 3) accounting improprieties and 4) failure to disclose liquidity problems.

Reed Kathrein of Higgins Berman Sobol Shapiro LLP in San Francisco pointed out that many actions that might have been brought as federal securities class actions are now being brought as derivative claims or actions for breaches of fiduciary duties in state courts. One key problem facing plaintiffs today, Mr. Kathrein noted, is the issue of collectability, as companies file for bankruptcy protection and banks are shuttered. Ms. Savett added that the universe of potential defendants has also been restricted in light of the Stoneridge decision on scheme liability.

Trends

With regard to litigation trends, Bruce G. Vanyo of Katten Muchin Rosenman LLP in Los Angeles observed more than half of the class action cases filed in the first half of 2008, involving claims for more than $4.5 billion, arose from the subprime credit crisis. Much of the activity has been located in New York, as the Southern District of New York has seen nearly as many cases filed in the first half of 2008 as in all of 2007.

Mr. Vanyo did suggest, however, that the common perception that a dramatic stock drop necessarily results in litigation may be misplaced. In the first three months of 2008, only nine percent of issuers who experienced a short-term stock price drop of 30 percent were sued within those 90 days. The number increases to 31 percent, however, if the issuer experienced a 40 percent stock drop.

John P. "Sean" Coffey of Bernstein Litowitz Berger & Grossman LLP in New York suggested that in terms of the decline in traditional securities fraud filings, as opposed to the subprime cases, may be explained in part because of a real decline in fraud. The Sarbanes-Oxley Act has been effective, he said, and the elimination of consulting work from audit firm practice has contributed to better financial reporting.

In terms of the disposition of fraud cases, settlements remain the most common result. Mr. Vanyo said that approximately two-thirds of cases settle, while about a third are dismissed.

Supreme Court Cases

Three recent cases, Dura, Tellabs and Stoneridge, have had a significant impact on securities litigation. With regard to Dura, concerning loss causation, Ms. Savett said that the holding has practically turned the pleading stage of the cases into motions for summary judgment. While she said that the common-sense connection between fraud and loss must be meticulous, she asserted that a "mirror image" relationship between disclosures and stock price changes should not be needed. Experts should be involved from the beginning of the case, she advised.

According to Mr. Vanyo, the result of the Tellabs scienter pleading case was a draw between plaintiffs and defendants. Mr. Coffey said the case could have been a disaster for plaintiffs, as scienter is an element of every case, but that the actual result was not necessarily drastic, as the ruling actually eased the standard in the 1st, 6th and 8th Circuits. Jonathan C. Dickey of Gibson Dunn & Crutcher in New York cautioned, however, that this split between the circuits and the approach to scienter could result in a "balkanization" of securities litigation and circuit-specific pleading.

Finally, Mr. Kathrein described Stoneridge as a case that dealt with reliance rather than particular conduct by the participants. Because the defendants, vendors who contracted with the issuer, made no statements, the plaintiffs could not establish reliance. Although Mr. Kathrein distinguished between third-party conduct in this commercial environment rather than alleged misconduct by financial firms such as investment banks, the panelists largely agreed that Stoneridge significantly narrowed the scope of available defendants.