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Securities Litigation and Enforcement
Rutgers University, Camden School of Law
Simon, Samuel

very different realms of 1933 Act of IPOs (state of mind doesn’t matter) and 1934 Act regulating aftermarkets; principles aren’t interchangeable

under 1934 Act, Ps should show scienter which means intent to defraud, manipulate, mislead investors;

1942 – SEC adopted Rule 10b-5

1946 – only gov’t brought suits, sporadic, intermittent, no developed jurisprudence;

Kardon v. Nat’l Gypsum Co. (read p. 19) – implied private action to bring suit; began private right of action; all fraud cases need state of mind requirement in pleadings FRCP 9(b) consistent w/ 8(a)ßVERY IMPORTANT!!

Difficult to bring b/c private individual didn’t know what went on behind company walls

Instated higher burden “clear and convincing evidence” standard but eventually moved higher

Courts –

§ SEC can bring suit but can only seek injunctions and no criminal enforcement powers; has ancillary equitable remedy of disgorgement which compels co. to return illicitly gained profits; can get fines under certain situations; can refer severe cases to prosecutors but they don’t have to take it

o Enforcement used to belong to FTC before SEC was created; SEC came into creation b/c Wall St. wanted more flexible agency that could also view enforcement from companies’ perspective; 80% of SEC staffers move to private bar or do defense work

o Gets annual appropriation from Congress so they have to be careful not to antagonize Congressmen who receive contributions from companies that have stake in not being sued by SEC; 10-15 yr appropriation might solve this; state forces (AGs) might pursue b/c they aren’t affected by Congress’ budgetary actions (Elliot Spitzer)

§ DOJ can bring criminal cases but often don’t

o Can convene grand jury, need unanimity voting for conviction; beyond a reasonable doubt standard of proof; very few ADAs developed interests in security cases b/c of other federal crimes that need attention; no mens rea and most criminal securities actions arise from stupidity and arrogance; budgetary considerations (too many lost securities cases will result in funds being diverted to more convictions)

§ Private parties can bring suits; implied right of action in aftermarket; supplement to gov’t enforced actions (most used)

§ Judiciary enforces private CoA needs standing, reliance, state of mind, secondary liability (aider & abetter, conspiracy, etc.), SoL, damages (how measured and in what amt)

5 ways to lose a case:

As discovery continues, evidence doesn’t fit proof or contradicts.

Company becomes insolvent or bankrupt.

No money left in corporate treasury for litigation and abandon suit.

Expert witnesses fall apart or defense witnesses come across being more credible

Changes in law and trial judges

After sustaining complaint, there’s motion for s/j. P can lose on s/j OR can lose at trial OR lost at JNOV OR lose at motion for new trial (vacated judgment) OR lose in appeals

Securities Exchange Act of 1934

10(b)/SEC Rule 10b-5

implied right of action under Exchange Act (aftermarket, secondary buyers)

State Common Law – 10(b) right of action more attractive than under state common law; reliance on untruthfully set prices needs to be shown

Blue Sky Laws (statutory) – all require the registration of all securities offerings and sales, as well as of stock brokers and brokerage firms

requires privity even though privity is destroyed through interposition of agent (broker)

courts didn’t agree with brokerage firms as P’s alter ego b/c a buyer can only sue broker

requires old CL requirement of detrimental reliance


“any manipulative or deceptive device or contrivance”

Affirmatively misrepresent past, current, or future info or omit material info that’s necessary to not make a statement misleading

10b deals heavily with omissions

Allegation of breach of fiduciary duty doesn’t violate federal law (Sante Fe Industries)

99.9% of corps regulated under state law and federal gov’t didn’t want to impinge on states


· duty to disclose

no system of continuous disclosure b/c co. would be turning out repeated press releases that would be of no interest to average person and be trivial info

silence, absent an affirmative legal duty to speak up , isn’t actionable (Gallagher v. Abbot Labs)

· duty to update

modify or supplement prior statement that although accurate when made, has since become inaccurate or misleading in light of subsequent developments

affirmative in 2nd/3rd Circuit; 7th Circuit rejected duty to update

· duty to correct

duty is on issuer

When a statement already made is later discovered to have been false when made; requires co. to redress intentional or negligent misrepresentations as well as statements that it believed to be true but subsequently learned were materially false, incomplete, or misleading

Entanglement – analyst directly says to company’s reps and they participate in approving brokerage’s report even when its false; inextricably interwoven

Adoption/Adaptation – analyst report that company knows is false but company adopts it explicitly and goes along w/ it or implicitly does nothing to correct falsehoods

Agency issues – analyst isn’t company’s agent in traditional sense; widely disseminated info enters marketplace;


· Must have materiality – something that would be of interest to average investor in determining whether to make a transaction;

classic instance of mixed issue of fact and law (reasonability)

courts have ruled revenues and income are always material

puffery is always meaningless; 99% of statements are up to jury and subject to dispute

TSC v. Northway (standard): substantial likelihood (preponderance of evidence) that reasonable shareholder would consider it important in deciding how to vote;

does it significantly alter mix of info that is out there?

Reasonable investor – hypothetical construct of whether an action was negligent or appropriate; no exact definition that can be enshrined in law b/c its too malleable

Indication that problem has occurred when news revealed to investment community, there is significant increase in volume of activity and major price movement measured in percentages (correlation, and not causation)

Hard Info – verifiable; objective fact

Soft Info – subjective or some sort of futuristic aspect; includes hard info w/ speculative purposes; no duty to correct under PSLRA

Bright light test (Basic v. Levinson) – absolutely no materiality until agreement in principle on merger is reached regarding price and structure of the deal.

ßSCOTUS rejects this; Congress sets quorum of SCOTUS and cant sit if fewer than 6 justices (28 US 1); 4-2

ts to chance it

Can always amend complaints but be careful about how many times you amend b/c of possibility of trigger dismissal motion

States of Mind

Intentional (willful, deliberate) – D&O insurance companies don’t insure against this type of conduct

P. 115 – In re Silicon Graphics; most restrictive as deliberate recklessness; Ps asked to not reviewed by SCOTUS b/c didn’t want it applied to all Circuits; keep this “beast” locked up and keep litigation practice of this alive and that Court will erect impossible std

scienter becomes greater to encompass recklessness b/c it’s partially intentional and negligent; make sure to not overprove P’s case along lines of intentional behavior

Recklessness (1 leg intentional, 1 leg negligent)

DISPUTED as to sufficiency for 10b-5 violation; highly unreasonable conduct involved inexcusable negligence but an extreme departure from standards of ordinary care and presents danger of misleading buyers/sellers that is either known to D or is so obvious that the actor must’ve been aware of it

Negligence – deviation from std of care

Entirely Innocent Conduct

What’s a partnership?

Not a person; creature of state law; joint arrangement for permanency

Int’l partnership are creatures of country

Find decisions of that state to discuss legal scenarios where state of mind of partnership is vital or decisive

State of mind of partnership is its partners’ state of mind (Uniform Partnership Act)

Amtrak is corporation created by Congress (NRPC) ß1 such example

Even if non-partner employee (senior manager) acted w/ scienter, courts will impute the behavior to supervising partner

Law firms and accounting firms are often defendants in securities cases

Courts will most likely treat some LLPs as corporations b/c they insulate similarly partners from liability and judges are always leveling the playing field to balance statutes and case law


Purchaser-Seller Requirement

In Connection with”; bought or sold, not attempt or hope to buy/sell (Birnbaum) to have standing

Rule prevents vexatious litigation, strike suits, discovery abuse (Blue Chip Stamps)

Forced Seller Exception – scheme consisting of deceptive tender offer followed by short form merger that squeezed out those who hadn’t previously tendered their shares

De Facto Seller Exception – trust beneficiaries who alleged fraud in connection w/ trades made by their trustees (p. 145-46) to Purchase-seller requirement –

Division over how these pre-Blue Chips exceptions are handled