Class Action Defense Review : Antitrust, Employment Discrimination, Securities Fraud and Unfair Competition Lawyer & Attorneys: Cozen O'Conner Law Firm: Philadelphia

The 2012-13 Supreme Court term has been a hotbed of class action activity, with the justices set to decide at least half a dozen cases that will directly affect class action litigation. Although none of this term’s decisions is likely to have the impact of the Court’s recent decisions in Wal-Mart Stores v. Dukes or AT&T Mobility v. Concepcion, the sheer number of opinions expected this spring promises significant clarifications of some murky areas. These include:
 

  • Whether a plaintiff may defeat removal under CAFA by stipulating that he or she will not seek more than the $5 million jurisdictional threshold on behalf of the class. In Standard Fire Insurance v. Knowles, the Eighth Circuit denied permission to appeal a district court’s determination that such a stipulation was sufficient, after affirming the validity of a jurisdictional stipulation in a similar case. Is the Eighth Circuit correct, or does such a stipulation improperly bind members of a class that the named plaintiff does not yet represent?

• The extent to which the Supreme Court’s 2011 decision in Wal-Mart requires courts to delve into the merits of a lawsuit when considering class certification motions. In Comcast v. Behrend, the Third Circuit affirmed the grant of class certification in an antitrust action, despite the district court’s decision not to resolve disputes about the relevant market and the existence of classwide impact at the class certification stage. Instead, the Third Circuit held that it was sufficient for the court to determine that the class could establish the relevant market through common proof, that the element of antitrust impact was capable of proof through evidence common to the class, and that the plaintiffs had presented a common methodology to determine damages on a classwide basis. Does Wal-Mart, which included a footnote implying that merits inquiries are appropriate in applying Rule 23(b), require more?

• The extent to which the plaintiff in a securities fraud class action must establish that the alleged misrepresentation was material in order to obtain class certification based on a “fraud on the market” presumption. In Amgen v. Connecticut Retirement Plans and Trust Funds, the Ninth Circuit held that a plaintiff need only plausibly allege materiality at the class certification stage. Did the Ninth Circuit get it right, or does failure to establish materiality at the class certification stage preclude a finding that classwide issues predominate?

• Whether a defendant renders a class action moot by offering full relief to the named plaintiff prior to class certification. In Genesis HealthCare v. Symczyk, the Third Circuit held that in a collective action brought under the Fair Labor Standards Act—which, unlike a Rule 23 class action, requires “class” members to affirmatively consent to participation in the class—an offer of judgment to the named plaintiff, though made before any other plaintiffs had “opted in,” did not moot the lawsuit as to the “class.” Can a defendant thwart a class action pre-certification by settling with the putative class representative, or must the Article III “case or controversy” requirement be read more broadly in class actions? And is the answer different for FLSA actions than for Rule 23 class actions?

• Whether a class arbitration waiver can be held invalid if it prevents plaintiffs from enforcing their federal statutory rights. In In re American Express Merchants’ Litigation, the Second Circuit struck down a class arbitration waiver on the ground that the waiver had the practical effect of precluding potential class members from enforcing their Sherman Act claims. Does the Supreme Court’s 2011 opinion in AT&T Mobility, which held that the Federal Arbitration Act’s general protection of arbitration clauses preempted a state common law unconscionability doctrine, apply more broadly, or is there an exception where the waiver might interfere with enforcement of another federal statute?

• How specific an arbitration clause must be in order to support a finding that the parties consented to class arbitration. In Oxford Health Plans v. Sutter, the Third Circuit affirmed an arbitrator’s finding that the parties had agreed to class arbitration based on a contractual provision mandating simply that “all” disputes be submitted to arbitration. Is such language sufficient for an arbitrator to find consent, or must an arbitrator infer that the parties did not contemplate class proceedings absent an explicit reference to class arbitration?

With all of these cases pending before the Court, as well as several controversial issues percolating in the lower federal courts, the first half of 2013 could be a high-water mark for class action developments. Stay tuned.

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Recent class action jurisprudence has been increasingly permissive toward courts considering the merits at the class certification stage. This week, however, the Supreme Court placed a firm limit on this practice, unanimously striking down a Fifth Circuit rule requiring securities class action plaintiffs to prove “loss causation” as a prerequisite for class certification.

In Erica P. John Fund, Inc. v. Halliburton Co., the sole obstacle to class certification was Fifth Circuit precedent that securities fraud plaintiffs must first prove a causal connection between the material misrepresentation and the economic loss suffered by investors, i.e., “loss causation.” As articulated by the Fifth Circuit in affirming the denial of class certification, proving loss causation meant showing “that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in the losses.” The Fifth Circuit reasoned that this element was necessary to establish that reliance was capable of resolution on a classwide basis; otherwise, according to the Fifth Circuit, individual issues would predominate over common issues, and resolving the dispute as a class action would be inappropriate.

According to the Fifth Circuit, loss causation was necessary to invoke the “fraud on the market” presumption articulated by the Supreme Court in 1988 in Basic Inc. v. Levinson. In Basic, the Court held that securities fraud plaintiffs may invoke a rebuttable presumption of reliance based on the theory that the market price reflects all public information, including the alleged misstatements, and that an investor who buys stock at the market price therefore relies on the misstatements in doing so. While Basic requires plaintiffs seeking to invoke this presumption to prove such fundamental facts as the public availability of the misrepresentations, the efficiency of the market in which the stock traded, and the occurrence of a stock purchase between the making of the misrepresentation and the revelation of the truth, the Fifth Circuit added loss causation to the list of prerequisites.

This precedent was in conflict with decisions of the Second, Third, and Seventh circuits, which have not required proof of loss causation at the class certification stage. In resolving the split, the Court soundly rejected the Fifth Circuit rule, holding that “[l]oss causation addresses a matter different from whether an investor relied on misrepresentation, presumptively or otherwise, when buying or selling a stock.” While reliance relates to the facts surrounding the investor’s decision to buy or sell, loss causation requires a decline in the value of the stock subsequent to that decision, which may have occurred for reasons unrelated to the correction of the misrepresentation.

In essence, the Court’s decision draws a line between commonality—a critical issue at the class certification stage—and the merits. The presumption of a fraud on the market is a step toward resolving the element of reliance on a classwide basis; by successfully invoking the presumption, class counsel avoids the need for individual adjudications of each class member’s knowledge and state of mind at the time of the transaction. The loss causation requirement, however, effectively required plaintiffs who have established common reliance to show, in order to obtain class certification, that their reliance caused injury. As the Court recognized, while the absence of economic loss may ultimately doom the lawsuit on the merits, it has nothing to do with whether common issues predominate over individual ones. For this reason, it is not terribly surprising that even this Court, which is hardly known for a predisposition toward class action plaintiffs, unanimously struck down the Fifth Circuit rule.

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Last month, parties involved in In Re Tremont Securities Law, State Law and Insurance Litigation sought preliminary court approval of a $100 million settlement that would resolve class action claims against certain investment funds (and numerous affiliated companies and individuals) that acted as so-called “feeder funds” for Bernard Madoff. The case is pending in the United States District Court for the Southern District of New York. This settlement agreement may provide a road map for future settlements of similar claims in connection with Madoff or the host of other large Ponzi schemes that have recently been uncovered.

Beginning in December, 2008, multiple class-action complaints were filed against various investment funds operated by Tremont Group Holdings, Inc. and its subsidiaries. These so-called “feeder funds” took the money provided by individual investors and invested some or all of it with Bernard Madoff. Of course, that money was lost. Generally, the complaints sought damages from the feeder funds and various related individuals and companies, including Massachusetts Mutual Life Insurance Company and Oppenheimer Funds, Inc. The complaints were consolidated into a single action, alleging that $3 billion of the plaintiffs’ money was lost. It is unclear whether the amount alleged reflects the amount listed on Madoff’s books, or if it reflects the money that investors actually contributed. The plaintiffs alleged numerous claims, including common law claims for breach of contract and breach of fiduciary duty and securities law claims. In support of their claims, the plaintiffs made the types of factual allegations frequently found in Ponzi scheme-related cases, including:

• The Tremont defendants did not adequately investigate Madoff before investing “billions of dollars”;
• The Tremont defendants “turned a blind eye” and ignored “red flags”;
• All of the settling defendants were in possession of, or had access to, information that others had relied upon in declining to invest with Madoff; and
• The Tremont defendants failed to disclose information to investors regarding outside managers, like Madoff.

The plaintiffs also sought to recover from the parent companies of Tremont, contending that the parent companies aided and abetted the Tremont defendants’ breach of fiduciary duties, and that the parent companies were liable as “control person(s)” under the securities laws.
Pursuant to the proposed global settlement agreement, in exchange for resolving the securities law, state law, and insurance-related claims, the plaintiffs would receive the following:

• The initial $100 million cash payment;
• Any cash and cash equivalents that remain after the wind down of Tremont Group Holdings, Inc. and its subsidiaries;
• A 50% interest in litigation pursued against third-party insurers (to date, at least $6 million); and
• Assignment of various legal claims of many Rye and Tremont Funds against certain third parties.

The settlement agreement also provides for payment to limited partners and/or shareholders in the investment funds covered by the settlement. It is important to note that, at this time, the parties are seeking preliminary approval by the court. Pursuant to Rule 23(e), the parties will need to seek final approval after notice and the opportunity to comment has been provided to members of the proposed class of plaintiffs.

Another potential issue for the parties was recently introduced when Irving Picard, the trustee liquidating Madoff’s investment company, filed a $2.1 billion action against Tremont. Filed under seal in December, 2010, the trustee’s suit was recently unsealed. It will be interesting to see what impact, if any, the trustee’s claim has on the proposed settlement.

Contributing author:  F Brenden Coller

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In Iowa Public Employees’ Retirement System v. MF Global, Ltd., the United States Court of Appeals for the Second Circuit made clear that the bespeaks caution doctrine applies to forward-looking statements only and not to characterizations that communicate present or historical facts. Any company that makes public statements should take heed. Disclosures about risks will cover forward-looking statements; but where a plaintiff can show that an allegedly false or misleading statement pertains to present or historical facts, the company may find itself embroiled in securities litigation.

When MF Global went public in July 2007, it characterized its risk management system as “robust.” Six months later, one of its brokers lost $141.5 million in a single morning speculating in wheat futures. In doing so, the broker took positions “vastly in excess of” MF Global’s trading limits and collateral requirements. In wake of the enormous loss, which the firm absorbed, MF Global’s stock plummeted. The lawsuit followed. Plaintiffs alleged that MF Global’s characterization of its risk management system was a misrepresentation and that the firm failed to disclose relevant information about its risk management. The defendants argued that plaintiffs’ claims should be dismissed because the statements regarding risk management were forward-looking and covered by the bespeaks caution doctrine. The United States District Court for the Southern District of New York agreed with MF Global and dismissed the complaint for failure to state a claim.
 

Reversing in part and remanding, the Second Circuit held that the district court’s decision “misstates the threshold test, and applies the bespeaks-caution doctrine too broadly.” The Second Circuit noted that “there is a discernable difference between a forecast and a fact, and courts are competent to distinguish between the two.” Although it declined to “draw a line” between forecast and fact, the Second Circuit offered the following guidelines:

• A “non-forward-looking statement” is one that “provides an ascertainable or verifiable basis for the investor to make his own prediction”;
• Statements or omissions as to the operations in place and present intentions as to future operations may be non-forward-looking;
• Statements containing both forward-looking and non-forward-looking elements are severable; and
• The bespeaks caution doctrine will not apply to characterizations that communicate present or historical fact as to measures taken to reduce risk.

The Second Circuit remanded the issue to the district court to analyze the plaintiff’s claim under the proper standard, as articulated in its opinion.

The Second Circuit’s decision provides fair warning to all companies that there is a limit to the bespeaks caution doctrine. Companies need to be particularly careful and precise when making statements that could be construed as non-forward-looking.
 

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In Malack v. BDO Seidman, LLP, the Third Circuit affirmed the district court’s denial of class certification in a putative securities class action and rejected the so-called “fraud-created-the-market” theory. The unanimous panel concluded that “[t]he fraud-created-the-market theory lacks a basis in common sense, probability, or any of the other reasons commonly provided for the creation of a presumption.” (Id. at 35.) With its decision, the Third Circuit contributed to a circuit split on this issue, which may prompt the Supreme Court to address this issue sometime soon. Compare, e.g., Shores v. Sklar, 647 F.2d 462, 464 (5th Cir.1981) (en banc) (setting forth the fraudcreated-the-market theory), with, Eckstein v. Balcor Film Investors, Seventh Circuit, 1993 (rejecting the theory).

In affirming the district court, the Third Circuit concluded that the fraud-created-the-market theory is not an appropriate basis for creating a presumption of reliance and lacks any grounding in common sense or probability. The panel concluded there is nothing in the process of bringing a security to market that would “imbue the security with any guarantee against fraud.”  Those entities involved in the issuance of the security, such as the underwriter, auditor, and legal counsel, have an interest in marketing the security at the highest (possibly inflated) price possible. The panel concluded that it “runs counter to common sense” to rely on such interested parties to be a “bulwark against fraud.”  Likewise, because the SEC does not regulate the merit of disclosures in connection with a security, investors cannot reasonably rely upon it to prevent fraud.

This is an important decision in the Third Circuit. Reliance is an essential element of a securities fraud claim. It can be extremely difficult to establish reliance on a class-wide basis with respect to securities that are not traded in an efficient market. And that challenge can frequently lead to denial of class certification, as it did in Malack, because individual questions of reliance would likely predominate over other questions common to the class. As a result, the fraud-created-the-market theory is very important to would-be plaintiffs. Without that presumption of reliance, obtaining class certification becomes exceedingly difficult. And, as a practical matter, if class certification is denied in a securities fraud case, that almost always ends the case.
 

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