I. Efficient Market Theory
a. New information about stocks are quickly processed, digested, and realized by the market, evident by the impact on stock prices
i. Efficiency depends on how and to what extent the market digested the information and the rate information is digested
1. For example, if the market is slow in correcting after corrective statement, the market might not be so efficient after all
ii. What would increase the likelihood information is realized by market on a quicker basis?
1. Disclosure
2. Liquidity
3. Analyst
II. Fraud on the Market Theory
a. Investor plaintiff need not prove he or she had access and knowledge and thereby, reliance on information because information would inadvertently impact the market immediately information becomes public under efficient market theory
III. Class Action
a. Compensation
i. Circularity problem – corporation paying damages to investors who overpaid their shares due to false information caused by the corporation itself; however, many of those investors would still be SHs at the time of lawsuit. The concern is that money is coming out of corporate treasury to compensate the current SHs. Essentially, SHs’ investments are partially removed to repay them since the transfer isn’t cost free.
1. The problem is the source of compensation – corporate treasury. The circularity problem is alleviated if the source of compensation is corporate treasury.
a. Alternate sources:
i. Directors and officers, if the lawsuit named individuals as defendants
ii. Insurance
ii. Diversification
1. SH might have sold shares at inflated price, which offsets its damage from the fraud or even benefits from the fraud, rendering compensation unnecessary.
b. Deterrence
i. Managers are responsible for the fraud but their conduct isn’t deterred unless they are named defendants.
ii. SHs are reluctant to sue managers since corporation generally has greater wealth than individuals and insured against lawsuits.
c. In general, the court’s decision is influenced by the judges’ view of CA’s social utility in terms of compensation and deterrence. The court would strike down the CA if the social utilities aren’t served through CA.
IV. Lead Plaintiff
a. Why does PSLRA mandate the court to appoint a lead plaintiff?
i. To avoid professional plaintiffs who tend to carry very small holdings at the time of corrective disclosure in stock drop cases and would race to the courthouse to initiate CA proceedings and settlement usually follows.
ii. To avoid lawyer driven cases.
1. What is wrong with a lawyer driven case?
a. Lawyer’s motivation is to drive a quick settlement for quick attorney fees regardless whether there is merit to a case. Attorneys would not concern too much on the adequacy of settlement price as long as they get their cut.
i. Note that lawyers fund the legal proceedings
b. The concern is that investors pay for the settlements but they are not sufficiently compensated.
b. In Re Cardinal Health
i. Under PSLRA, lead plaintiff would be the SH with the largest financial interest – most wealth invested.
ii. The law generally favors institutional investors since they usually have the greatest financial interest and are most sophisticated.
1. Note that sophistication satisfies the adequacy requirement under Rule 23(a)
iii. 4 factor test:
1. Fourth factor: the approximate losses suffered during the class period
iv. Aggregation of plaintiffs – plaintiffs aggregate their losses to create the largest financial interest to become the lead plaintiff
1. PSLRA permits aggregation.
2. Concerns:
a. Large size might render the group unmanageable.
b. Court doesn’t like a group of individuals with no previous connections.
c. Court doesn’t like an aggregate of unsophisticated individuals.
d. Aggregation might seem like attorney driven litigation.
v. Unique defenses
1. No reliance – defeats fraud on the market theory since without reliance, injuries would be atypical to the class, defeating typicality.
a. Shares were purchased regardless of misstatement/ omission; shares were purchased atypical of the class.
i. Example: SH purchased majority of shares at the time of corrective disclosures
b. The lack of reliance on public information.
i. Note that reliance is a rebuttable presumption under fraud on the market
c. Nonpublic information – the decision to purchase might be based on different information than that of the market
2. Adequacy
a. PSLRA states that presumptive lead plaintiff could be rebutted by another plaintiff who introduces unique defenses that rebut adequacy (or typicality).
i. However, presumptive lead plaintiff needs only to make preliminary showings of adequacy, typicality, and largest financial interest in order to be lead plaintiff.
V. Class Certification
a. The standard for class certification is vigorous analysis, involving:
i. Merits of facts that pertain to class certification should be examined.
1. Mini-trial to examine those facts should be conducted.
ii. Judges have sufficient discretion in terms of acquiring evidence to satisfy Rule 23.
b. Predominance; difficulties in establishing predominance
i. Individual reliance on market information – defeats fraud on the market theory
1. The source of the reliance plays a factor in determining whether there is common reliance predominates over individual reliance.
a. For example, reliance on different sources, memo and oral presentations might give rise to too much individual reliance.
b. Access to nonpublic information (private placement) pretty much defeats common issues predominance.
ii. Court inquiry as to whether the market is in fact efficient (under 2nd Circuit)
1. Note that IPO market isn’t an efficient market and does not benefit from fraud on the market theory
iii. Merits – whether the court believes the merits would survive in litigation.
iv. Social utility; value of litigation – whether there could be compensation and deterrence outside of litigation
1. Compensation – funds set up to compensate investors
2. Deterrence – separate action against wrongdoers
v. Third parties – whether the misstatements were made by third parties.
1. Court emphasizes less on third parties as opposed to issuers even though misstatements still entered and tainted the market regardless of source of misstatement. The less emphasis shows the court’s increased skepticism on fraud on the market theory.
vi. Under 2nd Circuit, market efficiency is paramount.
c. Loss causation – proximate cause
i. To recover on loss causation, the misstatement must have caused the injury and only damages resulted from the misstatement could be recovered.
ii. Under 5th Circuit, to gain class certification, plaintiffs must prove that defendants’ alleged misrepresentation proximately caused the price drop and NOT other factors.
1. Note that loss causation is extremely difficult to prove without incurring high expenses
2. But note that inquiry into loss causation involves merits and might resemble a mini-trail.
. ‘untrue statement of a material fact’ – material misrepresentation
d. ‘omit to state a material fact’ – half-truth; misleading interpretation
i. Note that a pure omission is not covered by 10b5; only omissions that would be necessary to make a statement not misleading are covered under 10b5
e. Santa Fe
i. Absent allegations of misstatement or half-truth, there are no standings to sue under 10b5.
1. Claims of unfairness and breach of fiduciary duty belong to state courts.
a. Note that a duty to disclose arises only when SHs are voting; if otherwise, there won’t be a fiduciary duty to disclose
ii. To craft a pure 10b5 complaint, plaintiffs must allege defendant fraudulently provided misstatements or omitted material information.
iii. Sufficient particularity is needed in pleading to prevent dismissal under PSLRA.
iv. Note that if plaintiffs brought a pure 10b5 action based on reliance on misstatements, they would’ve lost their right for appraisal at state court
f. 10b5 Derivative Claims – plaintiffs can complain that the corporation was defrauded in connection with sales/ purchase of securities.
i. BOD is the corporation. For the action to stand, at least one director must be deceived. If there is full disclosure to all directors, then the decision would be protected by BJR as long as the directors of interest are disinterested and independent.
1. Whether there is deception depends on how much the director of interest knows.
g. Duty to Disclose; Omissions
i. Half-truth – failure to disclose information necessary to make the other information disclosed not misleading.
ii. True omission – failure to disclose material information known.
1. However, 10b5 isn’t violated absent a duty to disclose.
iii. Abbott – duty to disclose
1. Periodic disclosures – a system of periodic disclosure rather than continuous disclosure. The duty to disclose arises only on a periodic basis.
a. So long a periodic report (10K, 10Q, 8K) is accurate at the time of disclosure, there is no duty to correct.
b. Silence is not a fraud, absent a duty to speak.
c. Note factor of reliance on periodic reports, investors based investment decisions on these reports
iv. Real time disclosure – the current standard adopted after Abbott; to ensure immediate disclosure without significant gaps in between
1. 10K – snapshot of company’s position at the end of its fiscal year.
2. 10K form – line item disclosure, identifies what is needed to be disclosed.
a. S-K – non-financial information
b. S-X – financial information
3. Before 13(l), all 10K reports are due 90 days after end of fiscal year.
4. With 13(l), 10K reports are due 60 days after the end of fiscal year.
a. Companies defined as large accelerated filers have to file within 60 days after end of fiscal year.
b. Companies defined as accelerated filers have to file within 75 days after end of fiscal year.
5. *There is no duty to update as long as the filing is correct when filed.
a. Note that there is no duty to correct information if the corporation was not involved in the dissemination of that information
