Securities Fraud Archives - Shopfloor

NAM Asks Supreme Court to Protect Manufacturers from Frivolous Securities Fraud Lawsuits

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The 2nd Circuit Court of Appeals has interpreted securities laws as requiring disclosure of information about uncertain future conditions, which potentially subjects many public companies, particularly manufacturers, to increasing and unwarranted civil suits. Because of these concerns, the National Association of Manufacturers (NAM) filed an amicus brief in November 2016, asking the U.S. Supreme Court to review the 2nd Circuit’s decision in Leidos, Inc. v. Indiana Public Retirement System. After the Supreme Court agreed to hear this case, the NAM filed another amicus brief addressing the merits of the case on June 28.

This case concerns liability for securities fraud under Section 10(b) of the Securities Exchange Act of 1934 based on a failure to disclose adverse “trends” and “uncertainties,” which requires management to use its judgment in describing known trends and uncertainties that are “reasonably likely” to occur. This is part of necessary disclosures of many reports required of publicly traded manufacturing companies under federal securities laws, including quarterly and annual reports. The 2nd Circuit’s decision calls for far more disclosure than a pure materiality standard, and it calls for disclosure of purely “soft” information, all of which makes it easily susceptible to hindsight pleading.

The Supreme Court needs to resolve this issue because there is an express circuit split between the 9th and 3rd Circuits, on the one hand and the 2nd Circuit on the other. The 9th and 3rd Circuits hold that not disclosing a “trend” or “uncertainty” does not give rise to 10(b) liability, while the 2nd Circuit has held that it does. The 2nd Circuit’s holding will open up a significant new category of securities fraud claims, and, contrary to earlier Supreme Court decisions, it subjects companies to securities fraud liability for omitting disclosures, even when the “omitted” information is not necessary to make any affirmative statement not misleading. This represents a dangerous precedent and exposes issuers to ever-increasing litigation, and the hindsight problem is exacerbated by the fact that it concerns disclosures of “soft information” that are often subjective.

If the 2nd Circuit’s ruling is allowed to stand, plaintiffs might start pleading everything as a “trend” or “uncertainty” that should have been disclosed. Public companies could be exposed to “fraud-by-hindsight” litigation if shrewd plaintiffs allege that an event was known to management as being reasonably likely to occur, including knowledge of “soft information.” This issue is a slippery slope where manufacturers may be subject to private suits for securities fraud for failing to disclose information that may not be material.

Because the 2nd Circuit’s ruling introduces more uncertainty into an area that demands certainty and predictability, the logical outcome for companies is to over-disclose potential “trends and uncertainties” so that they might mitigate the increased likelihood of being sued for securities fraud. As the Supreme Court first anticipated more than 40 years ago, such a rule of law will “lead management simply to bury the shareholders in an avalanche of trivial informationa result that is hardly conducive to informed decision-making.” A win in this case would significantly limit public company exposure to liability for securities fraud as well as provide clarity regarding disclosure obligations.

Thankfully, Not Included in the Senate Financial Regulation Bill

By | Briefly Legal, Economy, Labor Unions | No Comments

Wrapping up loose ends in our blogging on the Senate financial regulation bill, we should note that the Senate did not consider Sen. Arlen Specter’s amendment to overturn the U.S. Supreme Court’s ruling in Stoneridge v. Scientific Atlanta, which would have expanded liability in securities fraud litigation to manufacturers and suppliers who took no part in the scheme. The NAM had “Key Voted” against the amendment, which would have empowered class-action attorneys to find more deep pockets they could dig into.

The reality is that with Sen. Specter’s defeat in the Pennsylvania Democratic Senate primary, he loses much of his ability to push unpopular legislation like the Stoneridge amendment.

Legislation from Sen. Herb Kohl (D-WI), on the other hand, definitely remains in play, even though his amendment, to overturn the U.S. Supreme Court’s decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc., was not considered. The amendment, S.Amdt. 3788 also known as the Discount Pricing Consumer Protection Act, would have made resale price maintenance agreements per se violations of federal antitrust laws. Passage would be disservice to consumers and invite more litigation. (See this Shopfloor post for an explanation.)

Unfortunately, the Senate bill — S. 3217, converted into H.R. 4173 — does include “proxy access” provisions to federalize corporate governance rules and allow outside groups — unions, activists, etc. — to force their way into corporate decisionmaking to the detriment of the shareholders.

McClatchy covers the story today, Senate financial overhaul could bring change to the boardroom”:

Many lawmakers weren’t even aware that the provision was in the bill, said Sen. Judd Gregg, R-N.H., blaming the size of the 1,400-plus page bill.

“It is an inappropriate idea, especially inappropriate for the federal government to bury it in this bill. This language applies to every publicly traded corporation in America, not just the financial institutions. Why is it buried in this bill? It should not be in there,” Gregg said.

Financial Regulation or Drive Accountants to Ruin Act?

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Sen. Mike Enzi (R-WY), the only accountant in the U.S. Senate, took to the Senate floor Thursday to explain why the amendment by Sen. Arlen Specter (D-PA) to expand liability in securities litigation would be so detrimental to investment. 

The National Association of Manufacturers opposes the Specter amendment (Key Vote letter) because it could render a manufacturer liable for some other company’s securities fraud, the only connection being that the other company sold the manufacturer’s products. Accounting firms, financial consultants and other third parties are also alarmed at the Specter amendment’s attempt to turn them into deep-pocket defendants.

As Sen. Enzi stated:

[The Specter amendment] standard only requires that one knows of the “improper conduct,'” not that he “knows that the conduct is improper.” This is a critical and unacceptable difference. To be clear, the standard does not even meet what is used by the SEC to prosecute criminal aiding and abetting charges. The SEC standard is significantly higher. Because the standard in this amendment is so flawed, we would be opening thousands of innocent small businesses to secondary charges of fraud.

Again, we are not talking about criminal charges. These charges would be strictly considered in a civil court. Keeping this standard would give profit-motivated trial lawyers a vague statutory standard to work from–not a good combination. They would be able to cast a wide net for defendants, and this opens professionals in their company to the costs of discovery and trial, in addition to potential liability for damages awarded in the rest of the criminal case.

Let’s not forget we are talking about accountants, tax preparers, and attorneys who aid everyday companies. This means these professionals would be faced with a standard of evidence they cannot refute or argue, and they could likely be facing unfounded charges. …

Their options under this standard would be pleading out for millions of dollars, even if innocent, or losing even more in the long process of discovery and trial in order to defend themselves and their work. All this for someone who may not even know the criminal or have known that the person’s actions were criminal. Is this how our country’s legal system is supposed to work? Are we going to incentivize frivolous lawsuits? The Specter amendment standard may even go so far as to hold these professionals liable for not finding fraud.

For another, non-manufacturing perspective on the dangers of the Specter legislation (first written as S. 1551) we commend analysis by Kevin LaCroix of the D&O Diary blog, who comments on issues related to directors and officers’ liability. In “Specter’s “Aiding and Abetting” Bill: Why it Could Pass and Why it Matters” last year, LaCroix wrote: Read More

Returning to the Pre-Stoneridge Standard of Suing Everybody

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The Wall Street Journal‘s editorial today, “Dodd’s Lawsuit Makeover“:

We like to think of the 1995 Private Securities Litigation Reform Act as Senator Chris Dodd’s finest hour. Joining with House Republican Chris Cox, Mr. Dodd led an override of a Bill Clinton veto to end the scourge of “strike suits.” Prior to the law, trial lawyers would wage legal biltzkrieg against companies guilty only of a falling stock price. Since its enactment, lawyers have had to present some evidence of actual fraud before launching fishing expeditions under the civil discovery process.

So imagine our surprise to find, buried on page 795 of Mr. Dodd’s new financial regulation bill, a gift for every member of the securities trial bar that opposed his earlier reforms. We’ll have more to say about the rest of Mr. Dodd’s legislative opus, but his about-face on securities litigation is among the most dismaying of the flaws within its 1,136 pages.

The Connecticut Democrat would create new civil liability for anyone “aiding and abetting” those who violate the securities laws, making these new defendants just as liable as people who actually commit a fraud.

The provision is akin to Sen. Arlen Specter’s S. 1551, to extend liability for securities fraud to third parties — such as suppliers and manufacturers — not directly involved with the fraud. This is an attempt to return to the more-litigious lay of the land that existed before the U.S. Supreme Court’s 2008 decision in Stoneridge v. Scientific-Atlanta. (ScotusWiki entry.) In casting as wide as net as possible through “scheme liability,” trial lawyers hoped to catch big settlements from non-culpable companies. (The NAM was involved as a friend of the court. See our Legal Beach entry for more.)

Enacting the provision would further discourage investment in U.S.-traded companies and do nothing to create jobs — except in the law offices that specialize in these sorts of shakedowns.

Earlier posts on Stoneridge.


Sen. Specter Wants to Expand Reach of Securities Fraud Lawsuits

By | Briefly Legal, Economy, General | No Comments

Sen. Arlen Specter (D-PA) chaired a Senate Judiciary Committee hearing last week on his bill, S. 1551, the Liability for Aiding and Abetting Securities Violation Act. Specter’s legislation would return securities fraud litigation to the world before the Supreme Court’s ruling in Stoneridge v. Scientific Atlanta, that is, allow suits against third-party vendors (for example, manufacturers and suppliers) not directly involved in fraud schemes.

The National Association of Manufacturers regarded the Stoneridge case as one of the most important decided by the U.S. Supreme Court in 2008. The NAM had filed a brief in 2007 arguing that expanded liability was not provided for in the statute, and that such expansion would have chilled legitimate commerce, harmed the economy, encouraged frivolous claims, increased the costs of litigation, and encouraged coercive settlements.  The arguments would obviously apply to Sen. Specter’s legislation, as well.

Hence we cite the prepared statement of Adam Pritchard, Frances and George Skestos Professor of Law at the University of Michigan Law School:

S. 1551 would tear down the safeguards that the Court adopted in Stoneridge and Central Bank, creating the potential for the securities laws to be injected into a wide range of ordinary commercial transactions. As Justice Kennedy recognized in Stoneridge, expanding liability to secondary actors would undermine the United State’s international competitiveness and raise the cost of capital because companies would be reluctant to do business with American issuers. Issuers might list their shares elsewhere to avoid these burdens, thereby further fueling the flight from America’s securities markets.

Commercial counterparties of the sort named as defendants in Stoneridge and Central Bank are just a sideshow to S. 1551’s real purpose. The goal of the bill is to rope in more “deep pocket” defendants to feed the plaintiffs’ bar’s lucrative class action machine. That class action machine generates enormous fees that support the “pay to play” political contributions that plaintiffs’ lawyers use to persuade state pension funds to bring the lawsuits that help keep the machine rolling.

By offering up additional targets to the class action bar, S. 1551 promises to worsen the fundamental problems that make America’s securities class action regime so dysfunctional and destructive of shareholder wealth. Securities class actions are already an enormous drain on America’s capital markets. S. 1551 would make a bad situation worse.

Consider the effects of a more litigious, expensive and capricious economic environment on manufacturers planning for expansion as the recession comes to a close and growth returns.