After over three years and 656 postings, Securities Litigation Watch is closing up shop as a stand-alone blog. Going forward, SLW will be folded into the ISS Corporate Governance Blog, which we encourage you to check out to keep up-to-date on all the latest developments in the securities litigation arena.
Thank you to all of you who have read SLW through the years and provided encouragement and feedback along the way.
In an article in the November 16, 2006, New York Law Journal, Prof. John Coffee writes that notwithstanding what he labels some "dubious reporting" by the New York Times, he has not recommended to the Paulson Committee that "any private cause of action under Rule 10b-5 could and should be eliminated by SEC rule-making." He writes that his proposal (which is set forth in detail in this October 2006 law review article) actually is far more modest:
But the boldest and most fundamental of the reforms that I would recommend asks the SEC to adopt an exemptive rule under § 36 of the Securities Exchange Act of 1934 that would shield a non-trading public corporation from liability for monetary damages under Rule 10b-5. This would not eliminate a private cause of action under Rule 10b-5, but it would force the plaintiff's bar to sue and settle with corporate officers and agents--i.e., auditors, underwriters, and law firms--instead of treating the corporate entity as the deep pocket that paid everything. Such litigation is entirely feasible, as shown by the fact that in the Enron and WorldCom cases, which are the two largest settlements in securities class action history, the bankrupt corporate entity was not sued, yet record recoveries were obtained.
He also notes that § 36 could be used to "recast securities litigation" in another way, by providing auditors with a partial exemption in the form of a ceiling against catastrophic liability.
Judge Blake in the USDC for the District of Maryland has issued this opinion awarding attorneys' fees in the massive $1.1 billion Royal Ahold settlement. Some quick but notable points:
1. Class counsel (Entwistle and Cappucci) was permitted under its retainer agreement with lead plaintiff COPERA to seek up to 20% of the settlement amount, but instead sought just 15% ($163.3 million, or a multiplier of 3.21 times the lodestar of $50.8 million).
2. The Court awarded Class Counsel 12% ($130.6 million), lopping off nearly $33 million from the requested amount. The Court stated:
I agree with plaintiffs that the range of comparable settlements should include some below $1 billion as well as those few that substantially exceed $1 billion.9 Strictly on a percentage comparison approach, a 12% fee award appears to me a reasonable percentage of the class recovery.Application of the Barber factors, some of which already have been addressed, also supports an award of this magnitude. On the one hand, settlement was achieved well before trial, presumably aided by significant concessions about the fraud at U.S. Food Service and the existence of “side letters” related to the joint venture consolidation. While some of the legal issues were familiar, others were more difficult and, at least as to subject-matter jurisdiction, novel in this Circuit. While the case was not “undesirable,” lead counsel was required to and did devote exceptional resources to the prosecution, facing some risk of non-recovery as the fee was entirely contingent under the retainer agreement with COPERA, and Royal Ahold’s financial position was unclear. The global aspect of the case raised additional practical and legal complexities, as did the parallel criminal proceedings in another district. The settlement obtained is among the largest cash settlements ever in a securities class action case and represents an estimated 40% recovery of possible provable damages. The notice process appears to have been very successful not only in reaching but also in eliciting claims from a substantial percentage of those eligible for recovery.
The court concluded by noting (listen up Lies, Damn Lies and WSJ Law Blog!) that
Finally, plaintiffs’ counsel were vigorous and extremely competent in their litigation against equally well-qualified defense firms.
Three years ago I looked at the flurry of SEC enforcement activity at that time and suggested a new tagline for the SEC: "SEC Everywhere". Four days later, as if on cue, SEC Chairman William Donaldson was asked at the Securities Industry Association conference why the SEC enforcement staff did not detect abuses in the mutual fund industry before they were uncovered by New York Attorney General Eliot Spitzer. Donaldson reportedly said, "We have had a full plate. We can't be everywhere." (See my follow-up post: "SEC Not Everywhere)".
So we've been in this "SEC Not Everywhere" holding pattern for three years. BNA Securities Law Daily reports that yesterday, however, ironically at the same Securities Industry Association conference, SEC Enforcement Director Linda C. Thomsen said that
she wants the enforcement division to cover all areas and issues--not just those in the headlines. Speaking at a seminar in New York, Thomsen said, "We want to make sure we are everywhere."
Accordingly, SLW is officially changing the status back to "SEC Everywhere". But you might want to check back in four days.
As discussed in advance here, Alexei Barrionuevo of the New York Times has this excellent article about the deposition of Andrew Fastow in the Enron case, which ended November 2 after eight and a half days of apparent drama, drudgery and even some comedy. According to the article, Fastow did not produce any smoking guns, but exhibited an impressive consistency over the nine days of his questioning.
The article also recounts an interesting event on the first day of the deposition:
Tensions were high that first morning, according to several people who witnessed the deposition. About 30 lawyers packed into the main conference room, sitting on either side of Mr. Fastow. Almost 40 more watched on video feeds in two overflow rooms.
Suddenly, four shadowy figures with ropes appeared, hanging outside the windows of the main room, which had the blinds drawn. A marshal scrambled to the windows. One lawyer for a major bank said the figures resembled ninjas. It turned out they were window washers.
“A lot of uncomfortable smiles broke out,” Mr. Heaton said....
Finally, the article suggests that my pre-deposition estimate that the Fastow depo would end up being a $3.2 million event was too high:
The deposition drew lawyers representing 10 major banks and top Enron executives who have not been charged with crimes. It was also streamed live over the Internet so law firms in New York, London and elsewhere could listen in.
With the typical lawyer in the case billing about $450 an hour, the legal fees just to follow the testimony could cost at least $2.1 million, and the overall price tag of the litigation is expected to reach hundreds of millions of dollars.
Doing the math on the NYT estimate, the article is assuming 7 hours days for each of the 70 lawyers, at $450/hour, for 9.5 days. I assumed 10 hour days, which is the key difference between the estimates. Not that it really matters but the article notes that the depo went from 9 am-6 pm most days, with only occasional breaks. That's 9 hours right there, and when you add in the travel time ... I'm thinking that my 10 hour/day estimate is probably closer to what was billed in this case.
Who says SEC filings are boring?
Yesterday, the details of former New York Knick coach Larry Brown's settlement with the team over the termination of his contract were first announced not on ESPN or even a blog like Deadspin.com, but rather in the Cablevision Form 10-Q (Cablevision owns the Knicks). According to the 10-Q filed November 8,
On June 22, 2006, the New York Knicks, a division of Madison Square Garden, L.P., notified the then-head coach of the Knicks, Larry Brown, that his employment had been terminated with cause pursuant to his employment agreement with the Knicks. Mr. Brown disputed the Knicks’ right to terminate his employment with cause and the matter was referred to the Commissioner of the National Basketball Association (“NBA”), who had the authority under the agreement to resolve all disputes. On October 30, 2006, the parties reached a settlement of this matter under which the Knicks agreed to pay Mr. Brown $18,500 of the disputed amount in connection with his employment agreement, which amount has been accrued for in the accompanying financial statements as of September 30, 2006.
According to this article on ESPN.com, the settlement was indeed first disclosed in the SEC filing and is actually for $18.5 million (the filing apparently states all dollar figures, even in the text, in millions).
In his February 2006 speech to the US Chamber Institute for Legal Reform, SEC Commissioner Atkins veered way off of his topic of litigation reform to deliver a message to corporations: stop treating the Commission like a rubber stamp by prematurely disclosing your settlement offers to, or "settlements in principle" with, the SEC staff!
He stated:
It has become a common occurrence lately that I see public companies disclosing an agreement, or settlement, "in principle" with the SEC. I can't tell you how frustrated this makes me. To understand my frustration, you must understand the context in which these situations arise.Often in the SEC enforcement process, public companies, or sometimes their regulated subsidiaries such as broker-dealers, decide to pursue a settlement with the Commission. In the settlement process, the settling party deals directly with our enforcement staff, but the staff does not have the authority to bind the Commission to the terms of a settlement. Simply put, the settling party is offering to the enforcement staff to settle the matter based on certain violations of the securities laws, with certain remedies such as bars, penalties, or disgorgement, and in return the enforcement staff is agreeing to recommend to the Commissioners that they approve the settlement as offered.
At this stage nothing is final, and because of that lack of finality I find it hard to believe that the agreement by the staff to recommend settlement to the Commission is, by itself, necessarily an event that must be reported to shareholders. Although we Commissioners have deep respect for the work of enforcement staff, I can assure you that the next step in the process is not a rubber stamp approval by the Commission.
In fact, this Commission has shown that it does not own a rubber stamp! Proposed settlements have been, and will continue to be, disapproved or modified by the Commission when they do not meet the policy objectives of investor protection, as well as other factors. Those of you who follow closely the workings of the SEC or who practice before us know very well what I am talking about.
And yet companies routinely continue to do this, the most recent example being the press release by Twinkie-maker Interstate Bakeries. Interstate announces in its press release that
it has submitted an offer of settlement to the staff of the Division of Enforcement of the U.S. Securities and Exchange Commission (SEC) in connection with a previously disclosed SEC investigation. On January 28, 2005, IBC announced that the SEC had issued a formal order of private investigation concerning matters related to a previously announced investigation by IBC's audit committee into the manner for setting its workers' compensation reserves and other reserves.The proposed settlement is subject to approval by the Commission. IBC has been informed that the staff of the Division of Enforcement has determined to recommend the settlement to the Commission. However, IBC cannot give assurance that the Commission will approve the proposed settlement.
It is unclear to me why companies continue to do this in the face of the Commission's clear, albeit informal, guidance on this. Anyone have any thoughts on this?
Fast Times at Ridgemont High (1982)
Jefferson's Brother: My brother's gonna kill us! He's gonna kill us! He's gonna kill you and he's gonna kill me, he's gonna kill us!
Jeff Spicoli: Hey man, just be glad I had fast reflexes!
Jefferson's Brother: My brother's gonna $#!+!
Jeff Spicoli: Make up your mind, dude, is he gonna $#!+ or is he gonna kill us?
Jefferson's Brother: First he's gonna $#!+, then he's gonna kill us!
Jeff Spicoli: Relax, alright? My old man is a television repairman, he's got this ultimate set of tools. I can fix it.
According to several articles such as this one from Bloomberg, the SEC brought 574 enforcement actions in fiscal 2006 (which ended September 30), 9% fewer than the 630 cases it brought in 2005. According to the article:
The drop was largely a result of reduced staff, SEC Chairman Christopher Cox said in the statement. The agency restricted hiring in 2006 because it had to close a $48.7-million budget gap triggered partly by cost overruns in building a new headquarters in Washington.
As elaborated on in this Washington Post article,
Cox attributed the decline to temporarily reduced staff levels. The SEC as a whole lost 155 employees last year -- including 43 in the enforcement unit -- compared with fiscal 2005. A total of 3,696 people worked at the agency in 2006, with 1,189 in the enforcement division. The agency is reviewing its staffing levels and plans to restore some of the unfilled positions, officials said.
The message here from the SEC seems to be that its enforcement program suffered somewhat because it was "grappling with staffing cuts" (as the Post put it), but that they are actively trying to restore these positions and this situation will hopefully be resolved soon. That is a plausible response but it strikes me as quite different from the message the SEC sent out in August 2004 when it was similarly reported that the number of SEC enforcement actions in fiscal 2004 would be declining for the first time in many years. At that time, then-Chairman William H. Donaldson took the "half-full" approach, and declared that the decline was, in fact, "encouraging" in that it could indicate that the SEC's efforts are having a deterrent effect. He was reportedly "quick to add that it was too early for the SEC to declare victory in the war on corporate corruption." Chairman Cox could have seized on the continued decline in enforcement actions (down from as many as 679 in 2003) as additional encouraging news, but he seems to have taken the opposite approach: that fewer cases equates to a bad situation that may require a response (i.e., hire more people).
So my question: Is the fact that there are fewer enforcement actions year-over-year a good thing or a bad thing? Or neither?
And to the SEC, guest blogger Jeff Spicoli says, "Make up your mind, dude!"
After a flurry of recent coverage in the NY Times and elsewhere of the Paulson Committee and the prospect that it may soon recommend, among other things, that the SEC "dis-imply" a private cause of action under Rule 10b-5 against corporations, the plaintiffs' bar is finally shooting back. In this article in Business Insurance, several prominent members of the plaintiffs' securities class action bar were not shy about voicing their concern and outrage over this prospect:
"Securities lawsuits have fallen off sharply in the last few years and yet they want to further cripple them," said Bill Lerach, a prominent class-action lawyer from San Diego, Calif., law firm Lerach Coughlin Stoia Geller Rudman & Robbins L.L.P. "Why? Because it's the one effective weapon that shareholders have."
***
"I think it's outrageous," class-action attorney Stanley Grossman, senior partner at Pomerantz Haudek Block Grossman & Gross L.L.P. in New York, said of the proposals.
"We keep reading every day about more and more fraud," he said. "What the SEC is saying is 'we can't handle it all. We need companies to do the internal investigation.' Well, if they're so overwhelmed, how are they going to pick up all of these cases of the plaintiffs' bar?"
***
Another prominent class-action attorney, Sean Coffey, who helped win a $6.15-billion settlement for investors in WorldCom Inc., said the proposed curbs on shareholder litigation suggest that corporate America has already forgotten the string of business scandals that took place in recent years.
"The body isn't cold yet, and they are already acting like there were no corporate scandals," said Mr. Coffey, of the law firm Bernstein, Litowitz, Berger & Grossman. "It's mind-boggling."
This article from the Financial Times notes that according to Barney Frank, the congressman "widely expected take over the chair of the House financial services committee if the Democrats retake the chamber," the creation of a global securities regulator should be considered.
Observing the growing need for cooperation between the US and foreign regulators such as the UK's Financial Services Authority, the article states:
"Doesn't that sound like fun," Mr Frank said of such co-operation. "Joint action is theoretically [good] but what does that mean? In American baseball, if the runner and the ball arrive at the base at the same time, the tie goes to the fielder. Who breaks a tie if there is a disagreement over policy between the SEC and FSA?"(emphasis added).
OK, so there is at least the prospect of a global securities regulator down the road, which is interesting. But is it as interesting as Frank's proclamation that in American baseball, the "tie goes to the fielder?"
Anyone who has played or coached baseball has heard the expression the "tie goes to the runner" many times. So what is this new rule that Mr. Frank is making up? Indeed, a Google search shows that there are only 5 (!) reported mentions of the phrase "tie goes to the fielder" in the history of the Internet, or whatever it is that Google scours. That compares to 12,200 mentions of the phrase "tie goes to the runner"
And yet... I think Mr. Frank may actually be right. According to baseball rule 7.08(e),
7.08 Any runner is out when-
(e) He fails to reach the next base before a fielder tags him or the base, after he has been forced to advance by reason of the batter becoming a runner.
Assuming there can be such a thing as a "tie" between the runner reaching the base and the ball reaching the fielder, it would seem to follow in such a case that the runner has failed to reach the base before the fielder tagged the base, and is therefore out.
So, Barney Frank, you appear to be correct. SLW salutes your willingness to buck popular wisdom, coin a new phrase, and tie it all back to securities litigation.
Any reader thoughts on this important issue?
Posting will screech to a halt for the rest of this week as SLW heads across the pond for the 2006 ISS Corporate Governance Conference in London. Stuart Grant of the US law firm Grant & Eisenhofer and Hilton Mervis of the pan-European law firm SJ Berwin will join me for a panel on the role of European institutions in US securities class action litigation.
Let me leave you by emptying my "To Blog" folder with these quick hits:
1. How's That Safety Net?
The first checks to defrauded WorldCom investors should be going out shortly in the SEC's $750 million settlement with the company. The first wave of checks will total approximately $150 million, and will provide claimants with a recovery of 2% of their Eligible Loss Amount. Another wave of cash will go out later, and will apparently provide investors with an additional 3% of their Eligible Loss Amount.
The SEC says in its press release that this "shows that even when things go terribly wrong, there is a safety net for injured investors." By my math, this "safety net" would return $5,000 to an investor who had an Eligible Loss of $100,000 in this case.
2. Statute of Limitations Expires in AOL Case
Did you read the Alec Klein's "Stealing Time: Steve Case, Jerry Levin, and the Collapse of AOL Time Warner" yet, which I recommended way back when? If you did you'll be surprised to learn that, according to this article in the Washington Post, the 5 year statute of limitations in the case has now passed, and prosecutors were unable to make a case against any AOL execs other than two mid-level persons.
The article states that
Despite a lengthy investigation by the U.S. attorney's office for the Eastern District of Virginia, lawyers involved in the case now say the government will not be able to bring criminal charges against top AOL executives over transactions in which the Dulles Internet service provider and its business partners allegedly sought to artificially boost each other's revenue numbers as the dot-com bubble was bursting in 2000 and 2001.
3. Not Appearing in the SEC Litigation Releases
A Minnesota federal court let the SEC have it last week, ruling that the SEC must actually review documents requested to be released under FOIA before asserting that it cannot release the documents without harming ongoing law enforcement efforts. As discussed in this Dow Jones article, the Court wrote that it
adamantly disapproves of the manner in which the SEC has conducted itself as it relates to Gavin's requests. The SEC has shirked its responsibility by brazenly refusing to conduct a document-by-document review-despite a direct order from the Court.
The SEC told the Court that a review of the requested documents would have cost over $2 million. The Court ruled that the group requesting the documents would be required to pay any such costs.
Nathan Carlile of the Legal Times has this lengthy and occasionally quite funny profile of David Lat, who writes the Above the Law blog we previously discussed here.
Reflecting upon Lat's highly unusual journey that has led to him to a career as a legal blogger, the article concludes by comforting us that
if this doesn’t last — and if, eventually, Lat’s story becomes just the familiar cautionary tale about a federal prosecutor who poses as a woman to post gossip on the Internet only to be exposed by a New Yorker writer and sign a lucrative blogging deal — he says things will still be OK.
Our options backdating securities class action list has been updated to add Michaels Stores, Inc. The number of companies on the list now stands at 20.
Let's put it this way. My company, ISS' Securities Class Action Services, has an entire business that focuses on researching and identifying new securities class actions. We have a team of people whose JOB is to research this stuff every day, 24X7. However, until today we did not have any record of a case filed October 2, 2006 against Forward Industries, which was the subject of a "notice" published to the class announcing the filing of the complaint. How is this possible?
Because the notice used was what many refer to as "buried notice," buried in the back pages of the Investors Business Daily. As I wrote almost two years ago,
Yes, the PSLRA does allow for notice by "widely circulated national business-oriented publication" or "wire service." As I have argued in the links above, however, (1) the industry standard in the year 2005 is to place such notices on a national business wire, and (2) there is no legitimate reason to deviate from this standard by providing "stealth" (but apparently legally adequate) notice through some random hard copy business publication such as IBD.
Two years later, this is even more true. Everyone who is interested in learning about securities class action filings monitors the wire services for announcements about such filings. No institutions or anyone else that I know of scans all of the "widely circulated national business-oriented publications" looking for random hardcopy announcements, nor should they be required to do so.
Since early September 2006, a committee composed of "independent ... U.S. business, financial, investor and corporate governance, legal, accounting and academic leaders" has fairly quietly been conducting a study into how to improve the competitiveness of the U.S. public capital markets. Next month this committee (The Committee on Capital Markets Regulation, also referred as the "Paulson Committee" because it will present its recommendations to US Treasury Secretary Henry Paulson), will issue an interim report with recommendations on several topics. Most notably for this blog, these topics include "Liability issues affecting public companies and gatekeepers (such as auditors and directors) with a focus on securities class action litigation...."
An article in today's BNA Securities Law Daily states that John Coffee, a professor at Columbia University School of Law, said at a recent ALI-ABA conference that he is an adviser to the panel and has suggested several reforms designed to mitigate the threat of securities litigation. According to the article, Coffee believes that in the "near future," the Paulson Committee can be expected to make recommendations "to impose limits on securities class actions" and that the "SEC could take some action to change the role of [the] securities class action" in the next 6 months.
Among the possible changes that could result, Coffee said, were the eye-opening ideas that:
1. The SEC could "dis-imply" a private cause of action under Rule 10b-5 against corporations, leaving enforcement of that rule to the government, not private plaintiffs. The SEC might also "dis-imply" such a private cause of action with respect to the corporation only when the SEC has sued the corporation. Coffee states in the article that "That idea does have some support."
or
2. "Stock drop" cases could be moved out of the courts and into the arbitration arena.
The Paulson Committee's recommendations are due out by the end of November 2006. If either of these ideas are among them, look for a barrage of deafeningly loud disapproval from the plaintiffs' bar and consumer groups.... Stay tuned.
Kudos to Curtis Kennedy, the Denver attorney who successfully challenged the attorneys' fee award in the Qwest Communications securities litigation, and did so at a reasonable cost to the class. As discussed in this article, the court in the Qwest case recently approved the $400 million settlement of shareholder claims against Qwest, but reduced attorney fees by $36 million--from $96 million to $60 million. Kennedy, representing the Association of U S West Retirees, fought the $96 million in attorney fees requested by lead counsel in the case, law firm Lerach Coughlin, calling the fees "excessive and tantamount to winning the lottery."
According to another article in today's Rocky Mountain News, while Kennedy could attempt to obtain a percentage of the $36 million he helped save the class, he is not doing so. Rather, he is seeking only $40,500, which according to the article is "the 90 hours Kennedy spent on the case times his hourly rate of $300 times 1.5." Kennedy states in the article that he declined to seek a percentage of the $36 million because "I just think that would be hypocritical after asking the judge to apply moderation" to the $96 million request by Lerach Coughlin.
I must admit I didn't see this one coming. Courtesy of the WSJ Law Blog we've just learned about Esquire Bank, "the first bank in the country to specialize in serving trial lawyers." Esquire Bank opened its doors in Brooklyn, New York last week.
I know there is a joke in here somewhere but I'm pretty much speechless. I guess all I can muster at this point is "Watch out for that lender liability!"
Our options backdating securities class action list has been updated to add Marvell Technology Group, Ltd. and Meade Instruments, Inc.. The number of companies on the list now stands at 19.
The eagerly awaited deposition of former Enron CFO Andrew Fastow in the massive Enron securities class action that is still going pending against numerous large investment banks (many other defendants have settled) may occur soon. According to this article in the NY Times, plaintiffs' counsel in the case has asked the Court to schedule the deposition soon, before Fastow is assigned to a prison. Fastow is currently in solitary confinement in a Houston detention center, awaiting assignment.
The article notes that the deposition of the now-cooperating Fastow will be critical to the case, and "will take an estimated 10 days, plus more than two weeks of preparation, said one lawyer involved in the case. Some 80 lawyers will probably to want to attend."
Whoa--80 lawyers? By my quick math, 80 lawyers billing 10 hours per day for 10 days, at a rate of $400/hour* adds up to a $3,200,000 deposition. And that just for the event itself, not including any of the preparation that these 80 lawyers will need to do.
Hopefully this deposition will prove more fruitful than the discovery to date in the case. The article notes that so far in the case, millions of pages of documents and hundreds of other depositions have amounted to very little information for the plaintiffs:
Despite truckloads of documents from Enron and the banks, and millions of dollars spent on the case so far, civil lawyers had struggled to learn much of anything from the banks’ own employees. Plaintiffs’ lawyers took 175 depositions from bank officials over the last 18 months, most of them running 15 hours long. Yet nearly all of those officials either exercised their Fifth Amendment right to not testify or said they did not recall anything relevant, according to two lawyers involved in the case.
* I'm three years removed from private practice so I'm guessing on the $400/hour average billing rate of the presumably high-level lawyers who will be present. I guess I'm excluding people like 4-digit man Ben Civiletti. Anyone care to refine my estimate?
The SEC says the butler did it. Insider trading, that is.
Which raises the obvious question: What's the point of even being a butler these days if you aren't allowed to trade based on confidential faxes coming into your mansion regarding your master's acquisition of a dormant shell company that will be used as a vehicle to acquire and exploit the commercial rights to Elvis Presley's name and likeness?
I mean, once that's taken away from you, what's left?
Way back in April 2004, I wrote an article entitled "Beware the No-Spin Zone," which discussed the days immediately following the conclusion of an SEC investigation or settlement in which companies must be particularly careful not to "spin" the resolution beyond its actual terms (or risk the wrath of the SEC).
To recap that article, on Wednesday, March 10, 2004, a company called AGCO Corp., which had been the subject of an informal SEC inquiry into its accounting practices, received great news in a letter from the SEC that stated: This [the previously announced] inquiry has been terminated, and no enforcement action has been recommended to the Commission. We are providing this information under the guidelines in the final paragraph of Securities Act Release No. 5310. Later that same day, the Atlanta Journal-Constitution reported that AGCO had publicly announced the end of the SEC's inquiry. The newspaper quoted the company's CEO as stating: "It's a good day…. When you're sure that you haven't done anything wrong--but to the outside world it looks like you're guilty of something--it's a real relief to be vindicated from any accusations." The CEO reportedly added that although AGCO was not going to make the SEC's letter public, "They confirmed that all procedures are accurate and in accordance with prescribed accounting procedures…. The issue, as far as we're concerned, is closed and we can now devote more time to the management of the business and the company." It is unclear what communications, if any, occurred between the SEC and AGCO following the Wednesday publication of the article in the Atlanta Journal-Constitution. By Thursday afternoon, however, AGCO had issued what must have been a painful press release titled, "AGCO Corrects Reports Regarding Letter Received from SEC." This press release included a very different quote from AGCO's CEO: The termination of the SEC inquiry does not indicate that our accounting procedures or disclosures are correct or that we have been vindicated. That is not what the SEC letter said, and I want to correct what was reported in the media. All the letter said was that the inquiry was terminated. Neither that letter nor anything else said by the SEC staff in any way suggested that AGCO's accounting or related disclosures are correct. Painful lessons such as this one have led corporations to respect the "No-Spin Zone" in recent years, and helped them to avoid turning what should be a positive development into a negative one. Indeed, a "default" corporate statement seems to have evolved in the past couple years in response to notice from the SEC of the termination of an investigation: companies now simply say that they are pleased that "the matter is behind us." For example, consider these four statements from the last 12 months announcing that the SEC had terminated investigations: Years later, the lesson still seems to be that if a company really wants to put an SEC investigation "behind it," it must respect the No-Spin Zone.
Our options backdating securities class action list has been updated to add Jabil Circuit, Inc. The number of companies on the list now stands at 17.
While we are on the subject, check out this post by Pat McGurn on SLW's sister (father? big brother?) blog, the ISS Corporate Governance Blog. Commenting on reports of a bizarre grant of backdated options by Cablevision Systems to a deceased person, Pat says of these Sixth Sense grants ("I pay dead people") that:
In coming days, you should expect to see banner headlines screaming: "Pay For No Pulse" and "Can't Fog a Mirror Grant." Leading the parade, Columbia Law Professor John Coffee dryly quipped to the WSJ this am that "trying to incentivize a corpse suggests (the board) was not complying with the spirit of shareholder-approved stock-option plans." I checked the plan text and I can say that Jack is right, shareholders didn't authorize Sixth Sense grants.
Looking for a way to spend some of that spare non-billable time while still staying firmly on topic? Check out Dealbreaker.com and AbovetheLaw.com, two relatively new sister blogs that cover the "gossip"/cocktail party discussion-side of Wall Street and law, respectively. We're just getting to know Above the Law, but Dealbreaker is already firmly on our good side due to its blanket coverage of SLW-favorites David Pajcin and Eugene Plotkin.
Really? The answer to my request to the SEC back in July for an RSS feed on its Investor Claims Funds page is just "No"? Or maybe you're just still thinking it over? Maybe the RSS feed guy has been on vacation?
C'mon, SEC! It'll just take you a minute. Slap that RSS feed on there. Pretty please?
"The correlation of volatilities, historical and implied in terms of the S&P and just a general strong dropoff in the five-day volatility, making new highs, so those are all things I look at."--David Pajcin, November 22, 2005
Barney Gimbel has an excellent and quite thorough article in the current issue of Fortune ("Partner in Crime," Oct. 2, 2006) about the exploits of David Pajcin and Eugene Plotkin, the brain trust behind "Insider Trading, Inc."
The article includes information from a Fortune interview with Plotkin (the first interview with him to date), as well as some priceless material from the SEC's questioning of Pajcin. According to the article, the SEC brought Pajcin in for testimony on November 22, 2005, and asked him, among other things, about the purchase by numerous people connected to him (including his Croatian aunt) of out-of-the money call options in Reebok. Although Pajcin did not know it at the time, the SEC had already figured out that the securities Pajcin and his contacts purchased were consistently either (1) merger or acquisition targets in deals worked on by Merrill Lynch (a Merrill Lynch analyst has already pleaded guilty to insider trading in this case) or (2) companies that were about to be profiled in Business Week's market-moving Inside Wall Street column.
The article states that in response to the SEC's question, Pajcin
admitted advising many of the people involved in the case to buy Reebok, but only because he thought the stock was a bargain, not because he knew anything about a pending merger.
Plotkin held forth for the better part of seven hours on that subject, talking at mind-numbing length about the metrics he said he had applied to the stock. The SEC's Black then summarized this at length, concluding, "Have we covered all the components of your analysis with respect to Reebok specifically that you can remember, sitting here today?"
Pajcin added a few things: "The correlation of volatilities, historical and implied in terms of the S&P and just a general strong dropoff in the five-day volatility, making new highs, so those are all things I look at."
About half an hour later, Black changed the subject to Business Week. Pajcin said he didn't read it often. His answers became short. When he was shown some copies of the Inside Wall Street column, he said he wasn't familiar with it. Then when he was shown articles that had appeared the day he had sold stocks of the companies mentioned, he looked like "a deer in headlights," according to a lawyer who was present. His explanation? He had probably gotten the tips from two guys he had met in Croatian nightclubs, whom he knew only as "Carlo" and "Vladimir."
UPDATE: The Fortune article is available online here.
Hmphhh.... Now this certainly is odd.... For some reason, when the SEC wins a case on summary judgment (like this one against Paul R. Johnson), the decision shows up on the SEC Litigation Releases page. But when the SEC loses a case on summary judgment, and in the process has its misuse of quotation marks compared to Britney Spears, the decision does not show up on the SEC Litigation Releases page. Very curious.
I think it must just be some kind of technical glitch. Yeah, the server must be down. I'll keep checking.
The WSJ had a Review and Outlook piece yesterday entitled "The Milberg Effect," which argues that the projected drop-off in securities class action cases in 2006 suggested by a recent study is due to a reduction in the number of cases filed by the law firm Milberg Weiss. According to the WSJ piece,
According to Cornerstone, a research firm that tracks litigation, law firms filed 179 class actions last year. The first six months of this year saw only 61, a rate that would result in about 123 class actions for the year -- or a decrease from 2005 of 56 suits. Meanwhile, according to publicly available press releases, Milberg Weiss filed 91 of last year's suits. Yet in the first six months of this year, having come under prosecutorial scrutiny and lost many lawyers, the firm has filed only 17. At this rate, Milberg would tally about 34 suits for the year -- or 57 fewer than 2005.
These numbers are more than a coincidence, and should put to rest the assumption that Sarbanes-Oxley or better corporate governance standards are producing fewer causes of legal action. Securities lawyers have long understood that most class actions have little or no substance but are manufactured by the plaintiffs bar to pad their own pocketbooks.
This is simply wrong. Contrary to the conclusion in the piece above, the projected overall drop-off of 56 class actions in 2006 and the projected Milberg drop-off of 57 class actions filings is a coincidence. The flaw in the WSJ's analysis is that it rests on the false assumption that each of the companies that are the subject of a securities class action are sued by only one law firm. That is not the case.
To develop this point a bit, the Cornerstone study projects that at the current rate, 123 companies will be the subject of a securities class action lawsuit this year--56 fewer than in 2005. It is critical to note here, however, that virtually all (let's conservatively go with 90%) of these 123 cases will involve multiple complaints filed by multiple law firms. Indeed, many companies will be sued by a dozen or more different law firms. Using this conservative 90% figure, if Milberg does file 57 fewer complaints in 2006, this drop-off will only impact the total number of companies that are the subject of a securities class action in the 10% of Milberg's filings where it is the only law firm to file a complaint. So we're looking at a possible reduction of 5 or 6 cases (5.7 to be exact), not 57 cases.
The Milberg Effect? Not so much.
Courtesy of Overlawyered.com, I found this inspiring Disclaimer on the Nelson Rocks Preserve website. Nelson Rocks Preserve is an outdoor recreation area located in West Virginia that is apparently tired of people suing them when they fall off cliffs, get bit by snakes, etc. They are responding with a disclaimer that reminds would-be users of the preserve of important things like "a whole rock formation might collapse on you and squash you like a bug" or
...climbing is extremely dangerous. If you don't like it, stay at home. You really shouldn't be doing it anyway. We do not provide supervision or instruction. We are not responsible for, and do not inspect or maintain, climbing anchors (including bolts, pitons, slings, trees, etc.) As far as we know, any of them can and will fail and send you plunging to your death. There are countless tons of loose rock ready to be dislodged and fall on you or someone else. There are any number of extremely and unusually dangerous conditions existing on and around the rocks, and elsewhere on the property. We may or may not know about any specific hazard, but even if we do, don't expect us to try to warn you. You're on your own.
Inspired by Nelson Rocks, I have come up with a securities disclosure version of their disclaimer, designed to meet all of the MD&A "Risk Factors" needs of your favorite public company. It looks like this:
ITEM 1A: RISK FACTORS
Risks Related to our Business and Ownership of our Securities
Our business is unpredictable and unsafe. The stock market, including the market for our securities, is dangerous. Many books have been written about these dangers, and there's no way we can list them all here. Read the books.
The path to success for our business is littered with land mines. Seriously—anything could happen. Our competitors try their best every day to crush us, and they could succeed. We could get rich and complacent following our IPO and fail to innovate. Our customers could abandon us. Key members of our management team could quit to sail their yachts around the world for a decade. We could grow so fast that our business spirals out of control. Any or all of these could occur and our business would go down the toilet, along with your investment.
Real dangers are present even if none of the above occurs. New technologies may be developed that will render ours obsolete. A patent troll could come along who claims to own the intellectual property rights to our technology, costing us tens of millions of dollars in defense costs (best case) or destroying our entire business (worst case). Third parties such as malicious hackers could emerge to undercut our business. Even the government could torpedo us by passing new laws that hurt our business. The bottom line is that our business and the stock market are unsafe, period. Live with it or stay away.
Totally unforeseen things can happen. There could be a SARS epidemic. There could be a terrorist attack. There could be a natural disaster, such as a hurricane. A herd of elephants could escape from the zoo and trample our headquarters, squashing our business and your investment like a bug. Don't think it can't happen.
Even if none of these things happen, the stock market could go down for no reason whatsoever. That is to say, you may make a wise investment, we may work our tails off, our business may thrive, and you may still lose all of your money. It happens all the time.
If you engage in particularly dangerous trading such as uncovered options or naked short selling, you may lose everything you own. This is true whether you are experienced or not, trained or not, educated or not, or intelligent or not. It's a fact, such trading is extremely dangerous. If you don't like that, don’t do it. You really shouldn't be doing it anyway. We do not provide supervision or instruction. We are not responsible for the financial ruin that may result. As far as we know, any of these types of trades can and will fail and send you plunging to your financial death. You're on your own.
Financial bail-out services are not provided by our company. If you lose your shirt investing in our company after reading all this, don’t come running to us (or your class action lawyers). We assume no responsibility.
By investing in our business, you are agreeing that we owe you no duty of care other than not being crooks. We promise you nothing else. This is no joke. We won't even try to warn you about any dangerous or hazardous conditions not required of us by the SEC, whether we know about it or not. If we do decide to warn you about something, that doesn't mean we will try to warn you about anything else. We and our employees or agents may do things that are unwise and dangerous. In fact, we probably will. Sorry, we're not responsible. We may make bad decisions or give out mistaken guidance. Don't listen to us. In short, INVEST IN OUR COMPANY AT YOUR OWN RISK. And have fun!
Quick--
What is the difference between the following allegations:
1. "company insiders noticed the revenue and earnings shortfall by the start of the Class Period-in very late April 2004"
and...
2. "company insiders noticed the revenue and earnings shortfall by the start of the Class Period-in very late April 2004"
The PSLRA Nugget has the answer here.
Our options backdating securities class action list has been updated to add Aspen Technology. The number of companies on the list now stands at 16.
There's simply no way to sugarcoat it. It's just a reeeeeeeeeaaaallllllly bad day as an SEC attorney when:
(a) you lose your insider trading case on summary judgment because the court finds that the SEC's complaint fails even to raise a genuine issue of material fact worth taking to a jury, and
(b) a federal judge writes (see footnote 3 in this opinion) that your inability to use quotation marks properly is "not unlike Britney Spears...." According to the Honorable C.N. Clevert, Jr. of the U.S. District Court for the Eastern District of Wisconsin,
By putting the word “tour” in quotes, the SEC indicates that Krueger used that word in his testimony – a misleading indication, at best. Perhaps the SEC is not unlike Britney Spears in its inability to use quotation marks correctly. In her now-infamous interview with Matt Lauer, the erstwhile pop star said, “I think 90 percent of the world agrees that the tabloids have kind of gone a little ‘far’ with me lately.” Interview by Matt Lauer with Britney Spears in L.A., Cal. (June 15, 2006) (putting the word “far” in air quotes). See also US Weekly Magazine, http://www.usmagazine.com/blog/category/air-quotes/ (“As evidenced in her Dateline interview, [Britney Spears] has a knack for misusing air quotes, placing them in between words or around the wrong ones.”)
Thanks to the WSJ Law Blog for tracking this down.
SLW will resume blogging in earnest following Labor Day. Apologies for the extended break!
I stumbled upon a website today--ThinkExist.com--that purports to be a Quotation Search Engine and Directory with over 300,000 quotations by over 20,000 authors. You know-- Shakespeare, Benjamin Franklin, Mark Twain... and me? To my extreme surprise, 9 of these quotations are from me! (Click here for a list of my pearls of supposed wisdom).
I don't know what to say about this discovery other than, to borrow a quote from one of my fellow "quoted authors,"
“Please accept my resignation. I don't want to belong to any club that will accept me as a member!”--Groucho Marx
Our options backdating securities class action list has been updated to add Zoran Corp. and Apple Computer. The number of companies on the list now stands at 15.
The SLW Spin Police have been placed on alert following this statement by Milberg Weiss in a press release from August 8, 2006:
"Milberg Weiss Bershad & Schulman LLP is the most respected and effective plaintiff's law firm in the United States."
Securities Litigation Watch entered the blogosphere 3 years ago today, with this rookie-caliber post about an SEC subpoena enforcement action against RJ Reynolds. These first 3 years of SLW-ing have been fun, educational, and rewarding in many ways, and I appreciate the many readers who have offered feedback and encouragement along the way.
Thanks!
Bruce Carton
Several of the comments piling up regarding my Sharesleuth.com/Achilles' Heel post take issue with the notion that the pre-publication trades made by Mark Cuban are based on "nonpublic" information. The gist of these comments is that the information assembled by Sharesleuth.com is all from the public domain, based on Sharesleuth.com's own due diligence, etc. so how can it be "nonpublic?"
The answer to that question is that the nonpublic element of this plan relates to which company Sharesleuth.com will be writing about. Assume that Sharesleuth.com generates enough of a following that its investigative reports are able to move the market--which will be the likely result if Sharesleuth.com proves that it can expose previously unknown fraud within public companies. Does anyone not associated with Sharesleuth.com know which company the next Sharesleuth.com report will be about? Of course not--that's not public information. Would you like to know which company the next report is about in advance so that you could take advantage of the imminent decline in the price of that stock? You tell me.
The nonpublic element, therefore, is knowing the specific company about which a market-moving publication is going to issue a report or article. This is exactly what was involved in the Winans (WSJ) case, as well as in the numerous cases involving people who begged/borrowed/stole pre-publication copies of Business Week so that they could trade in advance of the market-moving information in its "Inside Wall Street" column. There was no specifically "nonpublic" information contained in the actual WSJ or Business Week articles, either.
Our options backdating securities class action list has been updated to add Broadcom Corp. The number of companies on the list now stands at 12.
The Mark Cuban-backed Sharesleuth.com, discussed in detail here, has found the previously unexploited Achilles' Heel of the insider trading laws and fired an arrow deep into it. The result is that for the first time, a legal form of what most people would consider "insider trading" exists and can be replicated by anyone with (a) the resources to hire a skilled investigative journalist, (b) the ability to generate a readership on the Internet.
To recap, Sharesleuth.com is a new web publication--basically a blog--backed by businessman Mark Cuban. Cuban has hired a business reporter named Chris Carey, formerly of the St. Louis Post-Dispatch, to run the publication and conduct investigations to "identify suspect companies." Once identified, Sharesleuth.com says it will "shine a spotlight on questionable companies," and will "name names and show our evidence, by linking to documents, photographs and other information." What makes Sharesleuth.com unique and controversial, however, is the fact that it discloses right up front that Cuban is going to make personal investments based upon the information discovered, and do so prior to the publication of this information on the website.
In short, the business model for Sharesleuth.com is that Cuban takes short positions in advance of the publication of the stories published on Sharesleuth.com with the hope and expectation that the negative stories will be read by other investors. These investors will then presumably sell the stock, drive down the stock price and enrich Cuban. And repeat.
For those who believe that there is a flat prohibition on insider trading based on material, nonpublic information, the fact that such a business model could be legal may be surprising. As I have written before, however, there is no such prohibition:
The root of the problem with the "insider trading laws" is that there really aren't any. The offense of insider trading stems from Section 10(b) of the Securities Exchange Act of 1934, a vague statute that prohibits the employment of "any manipulative or deceptive device" in connection with the purchase or sale of securities. Although insider trading is sometimes loosely defined as any trading based on "material, nonpublic information," the legal definition flowing from case law is much more complicated and relies heavily on concepts such as fiduciary duty and the "familial duty of trust and confidence."
For instance, in the 1980s, football coach Barry Switzer attracted the attention of the SEC when, after overhearing a corporate executive discuss the imminent "liquidation" of a public company merger, he profitably traded on that information in advance of the liquidation. The SEC brought an enforcement action against Switzer alleging insider trading.
Although Switzer's conduct would seem to meet any commonsense definition of insider trading, he nonetheless defeated the SEC's case against him. The court ruled that the necessary "duty" had not been breached--because the corporate executive was unaware that Switzer had overheard his discussion of the liquidation, the executive had not breached his fiduciary duty to the company. Accordingly, because Switzer's potential liability as a "tippee" under Section 10(b) would have been derivative of his "tipper's" liability, the court's finding that the executive did not breach his fiduciary duty meant that Switzer's trading based on nonpublic information was actually legal.
In numerous ways, Sharesleuth.com's model is identical to the illegal trading scheme carried out by R. Foster Winans, the WSJ reporter who traded in advance of the WSJ's Heard on the Street column and ultimately went to prison over it. The difference is that the WSJ had a confidentiality policy in place protecting its information, and Winans breached his duty to the WSJ by trading on that information. Similarly, as I have written about extensively, many people have been sued by the SEC or face criminal charges for learning/stealing the information to be published in Business Week's Inside Wall Street Column, and trading in advance of its publication. Again, a fundamental part of the cases against them was Business Week's confidentiality policy regarding its data.
Sharesleuth.com has no such policy--to the contrary, it flat-out promises to trade based on its information. As a result, most people who have analyzed the legality of the Sharesleuth.com business model seem to agree that it does not constitute insider trading and is legal. This no doubt includes Sharesleuth.com/Cuban's own lawyers. (The ethics of this plan are another issue altogether and have been the subject of some heated debate).
All of which leads me back to where this post started--the Achilles' Heel of the insider trading laws. That Achilles' Heel, in my opinion, is that the law does not flatly prohibit insider trading based on material, nonpublic information. Rather, as discussed above, it prohibits some such trading, but excuses other trading if there is no legal "duty" under the circumstances not to trade. Such arbitrariness has not been a systemic problem to date because the "excused" insider trading has always been a one-off, non-repeatable type of situation, e.g., the trader who overhears inside information on a plane and profits from it. Prior to Sharesleuth.com, there has not been, to my knowledge, a "replicable-on-demand" model that avoids the insider trading laws while permitting an investor to trade on nonpublic information.
This is not to say that the Sharesleuth.com business model is necessarily a lay-up. For the model to be profitable, the investigative reporter involved will need to be able to find compelling evidence of fraudulent or questionable public companies that has not yet been discovered. In addition, the publication must generate an audience of critical mass that finds it credible and trades based upon its findings. Assuming all of this can be accomplished, however, the first company that makes its money from legal insider trading will have been created—with a business model that can be duplicated by anyone with similar resources and abilities. If this occurs, Congress and the SEC may need to give serious thought to whether it is time to refine the insider trading laws.
The Criminal Complaint filed today by federal prosecutors against three former executives of Comverse Technology (the former CEO, CFO and General Counsel) for options backdating is available here, courtesy of the WSJ Law Blog.
Before your eyes glaze over and you hit the "Back" key to go read about something less arcane than strike dates, compensation accounting rules, etc., just know that the stuff in the Criminal Complaint is pretty fascinating. The FBI agent providing the statement in the Criminal Complaint gets deep into the details of the alleged scheme at Comverse, including the creation of a secret slush fund account called Phantom in which options to fictitious employees were stashed and later awarded to favored employees for recruitment and retention.
The Criminal Complaint also details the alleged cover-up of the scheme when the WSJ started asking questions about options grants in March 2006, which according to the complaint included evidence tampering and numerous misstatements and half-truths to company lawyers, the company's auditors, the WSJ, and the Special Committee hired to investigate the matter.
One of the more interesting statements in the Criminal Complaint is that according to the defendants, the backdating practice was shut down in April 2002 because of "the advent of Sarbanes-Oxley and a more stringent enforcement 'environment.'"
