Legislative history of the Securities Act of 19331 (“Securities Act”) and the
Securities Exchange Act of 19342 (“Exchange Act” and collectively, the “Acts”).
i. Congress passed the Acts following the 1929 stock market crash that
triggered the Great Depression.
ii. Prior to the passage of the Securities Act, President Roosevelt stated:
“This proposal adds to the ancient rule of caveat emptor the further
doctrine, ‘let the seller also beware.’ It puts the burden of telling the
whole truth on the seller.”3
iii. Similarly, prior to the Securities Act’s passage, Senator Peter Norbeck (RSD)
urged for the passage of legislation that would “definitively fix
responsibility for deception and frauds upon directors and other officials
and with severe penalties for such acts.”4
b. The Acts were intended to be clear statutes with clear violations.
c. Both Congress and the courts have weakened the acts, which is reflected in the
number of cases filed.
i. According to a SEC report issued in April of 1997 that looked at the
number of federal securities class actions filed in 1996, the first full year
after the Private Securities Litigation Reform Act of 19955 (“PSLRA”)
became effective, there was a 34% drop-off from the number of
companies sued in federal court class actions when compared to 1995, a
52% drop-off from the number of suits when compared to 1994, and a
31% drop-off from the number of suits compared to 1993.6
ii. According to data published by National Economic Research Associates,
between 2009 and 2011, plaintiffs filed an average of 144 cases per year
that alleged violations of the Acts. Between 2005 and 2008, the average
was 173 cases per year, a decline of almost 17%.7
1 15 U.S.C. §§ 77a et seq.
2 15 U.S.C. §§ 78a et seq.
3 77 Cong. Rec. 937 (Mar. 29, 1933), reprinted in 1 Federal Securities Laws Legislative History 1933-1982, at 20
4 77 Cong. Rec. 3223-33 (May 11, 1933), reprinted in1 Federal Securities Laws Legislative History 1933-1982, at
5 Pub. L. No. 104-67, 109 Stat. 737 (1995).
6 U.S. Securities and Exchange Commission, REPORT TO THE PRESIDENT AND THE CONGRESS ON THE
FIRST YEAR OF PRACTICE UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
(April 1997), available at http://securities.stanford.edu/research/reports/19970401lreform.html.
7 National Economic Research Associates, Dr. Renzo Comolli et al., Recent Trends in Securities Class Action
Litigation: 2012 Full-Year Review, at 6 (Jan. 29, 2013), available at http://www.nera.com/nerafiles/
Current through 12/19/2013
II. Recent Court Decisions Have Made It More Difficult to Successfully Plead a
Cause of Action Under the Acts.
a. The Elimination of Transnational Jurisdiction
i. Both Section 22 of the Securities Act8 and Section 27 of the Exchange
Act9 vest jurisdiction for violations in the United States District Courts.
The Acts are “silent as to [their] extraterritorial application,” which left
courts to address whether transnational frauds are covered under the
ii. In matters involving fraud, the Circuit Courts had developed the “conduct”
and “effects” tests that permitted jurisdiction when the defendant’s
conduct (or failure to act) occurred within the United States or, if the
conduct occurred abroad, when that conduct caused a substantial effect
within the United States.11 These tests provided investors a remedy in
cases where a company’s stock traded on a foreign exchange, provided the
fraudulent conduct alleged had the requisite nexus to the United States.
iii. In 2010, however, the Supreme Court rejected the “conduct” and
“effects” tests. The Court developed a bright line jurisdictional rule,
holding that section 10(b) of the Exchange Act,12 only applied to
“domestic transactions” regardless of where the fraudulent conduct
occurred or if the conduct caused effects in the United States.13
iv. The Dodd-Frank Wall Street Reform and Consumer Protection Act14
(“Dodd-Frank Act”) amended Section 17(a) of the Securities Act and
Section 10(b) of the Exchange Act to partially restore the “conduct” and
“effect” jurisdictional tests, but only for enforcement proceedings brought
by the SEC or DOJ, not for action brought by private investors.
v. As a result, investors in companies that conduct substantial business in the
United States have no remedy for violations of the securities acts if a
company’s stock trades only on a foreign exchange.
b. Heightened Standard Under Rule 8 of the Federal Rules of Civil Procedure
(“Rule 8”) (for details, see section III.f, infra).
c. Pleading Fraud Under Rule 9 of the Federal Rules of Civil Procedure (“Rule 9”).
i. Under Rule 9(b), complaints alleging fraud must be plead with
8 15 U.S.C. § 77v.
9 15 U.S.C. § 78aa.
10 See Alfadda v. Fenn, 935 F.2d 475, 478-79 (2d Cir. 1991), cert. denied, 502 U.S. 1005 (1991).
11 See id. at 475, 478.
12 15 U.S.C. § 78j(b).
13 Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869, 2883-84 (2010).
14 Pub. L. No. 111-203, §§ 929P(b) & 929Y, 124 Stat. 1376 (2010).
15 See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319 (U.S. 2007) (“Rule 9(b) applies to ‘all
averments of fraud or mistake’; it requires that ‘the circumstances constituting fraud . . . be stated with particularity’
but provides that ‘[m]alice, intent, knowledge, and other condition of mind of a person may be averred generally.’")
Current through 12/19/2013
ii. Most courts have held that claims brought under the Securities Act that
“sound in fraud,” regardless of how the plaintiff labels the claim, require
the plaintiff to satisfy Rule 9(b)’s heightened pleading requirement.16
d. Pleading Scienter Under the PSLRA Is More Difficult Than Pleading Fraud
in Non-Securities Cases.
i. Strong inference:
1. Rule 9(b) states that “[m]alice, intent, knowledge, and other
conditions of a person's mind may be alleged generally.”17 In
contrast, the PSLRA provides that in private actions under the
Exchange Act, where “the plaintiff may recover money damages
only on proof that the defendant acted with a particular state of
mind, the complaint shall . . . state with particularity facts giving
rise to a strong inference that the defendant acted with the required
state of mind.”18
2. President Clinton vetoed the PSLRA, stating that the
heightened standard for pleading scienter “impose[d] an
unacceptable procedural hurdle to meritorious claims being
heard in Federal courts.”19 The PLSRA passed both houses of
Congress over the President’s veto.
3. In Tellabs, Inc. v. Makor Issues & Rights, Ltd., the Supreme Court
noted that “[t]he strong inference standard unequivocally raised the
bar for pleading scienter."20
a. The Court held that “in determining whether the pleaded
facts give rise to a ‘strong’ inference of scienter,” the court
must not only assume the truth of the facts alleged and all
reasonable inferences, but the court must also “take into
account plausible opposing inferences.”21
b. The Court explained: “[T]he inference of scienter must be
more than merely ‘reasonable’ or ‘permissible’--it must be
cogent and compelling, thus strong in light of other
c. The Court concluded: “[a] complaint will survive . . . only
if a reasonable person would deem the inference of scienter
cogent and at least as compelling as any opposing inference
one could draw from the facts alleged. Therefore, a court
16 See, e.g., ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 68 (1st Cir. 2008) (“[w]here section 12(a)(2) claims
are grounded in fraud, Rule 9(b) applies”); Rombach v. Chang, 355 F.3d 164, 171 (2d Cir. 2004) (Rule 9(b) applies
to claims brought under Sections 11 and 12(a)(2) of Securities Act when claims are grounded in fraud and not in
negligence); Shapiro v. UJB Fin. Corp., 964 F.2d 272, 288 (3d Cir. 1992) (same).
17 See, supra note 16.
18 15 U.S.C. §78u-4(b)(2).
19 H.R. Doc. No. 104-150, 104th Cong., 1st Sess. (1995), 141 Cong. Rec. H15215 (1995).
20 551 U.S. at 321 (internal quotation marks and brackets omitted).
21 Id. at 322-23.
22 Id. at 324.
Current through 12/19/2013
may sustain a complaint only if a reasonable person would
deem the inference of scienter at least as compelling as any
4. Group Pleading Doctrine
a. “Under the group pleading presumption, a court may
attribute all statements to the defendants as collective
actions without considering the liability of each individual
b. Because the PLSRA refers to “the defendant,” at least two
United States Circuit Courts of Appeal and many United
States District Courts have held that the PLSRA’s “strong
inference” requirement eliminated the group pleading
doctrine.25 In these jurisdictions, plaintiffs must
specifically plead each individual defendant’s culpable
c. Tellabs did not address this issue because the plaintiffs did
not challenge circuit court’s holding that group pleading is
inapplicable under the Reform Act.26
1. Prior to the PLSRA, all Circuit Courts of Appeal that had
addressed the issue had held that reckless behavior was a sufficient
basis for liability under Section 10(b).27 For example, the Second
Circuit held that a plaintiff could allege facts that “give rise to a
strong inference of fraudulent intent” by, inter alia, “alleging facts
that constitute strong circumstantial evidence of conscious
misbehavior or recklessness."28
2. The PLSRA, however, did not explicitly adopt the Second
Circuit’s rule that allegations constituting “strong
circumstantial evidence” of recklessness are sufficient.
24 Miss. Pub. Emples. Ret. Sys. v. Boston Sci. Corp., 523 F.3d 75, 93 (1st Cir. 2008).
25 See, e.g., Winer Family Trust v. Queen, 503 F.3d 319, 337 (3d Cir. 2007); Southland Sec. Corp. v. INSpire Ins.
Solutions Inc., 365 F.3d 353, 364 (5th Cir. 2004) (collecting cases). See also Phillips v. Scientific-Atlanta, Inc., 374
F.3d 1015, 1018 (11th Cir. Ga. 2004) (not ruling on remaining viability of group pleading, but stating “we believe
that the most plausible reading in light of congressional intent is that a plaintiff, to proceed beyond the pleading
stage, must allege facts sufficiently demonstrating each defendant's state of mind regarding his or her alleged
26 551 U.S. at 326 n.6. Similarly, the issue remains unresolved in the First Circuit. See In re Boston Sci. Corp. Sec.
Litig., 708 F. Supp. 2d 110, 127 (D. Mass. 2010).
27 See Provenz v. Miller, 102 F.3d 1478, 1490 (9th Cir. 1996); Anixter v. Home-Stake Prod. Co., 77 F.3d 1215,
1232-33 (10th Cir. 1996); Van Dyke v. Coburn Enters., Inc., 873 F.2d 1094, 1099-1100 (8th Cir. 1989); Rankow v.
First Chicago Corp., 870 F.2d 356, 366-67 (7th Cir. 1989); McDonald v. Alan Bush Brokerage Co., 863 F.2d 809,
813-15 (11th Cir. 1989); Auslender v. Energy Mgmt. Corp., 832 F.2d 354, 357 (6th Cir. 1987); Warren v. Reserve
Fund, Inc., 728 F.2d 741, 745 (5th Cir. 1984); Dirks v. Sec. Exch. Comm’n, 681 F.2d 824, 844-45 (D.C. Cir. 1982),
rev'd on other grounds, 463 U.S. 646 (1983); Healey v. Catalyst Recovery of Pa., Inc., 616 F.2d 641, 649 (3d Cir.
1980); Hoffman v. Estabrook & Co., 587 F.2d 509, 515-17 (1st Cir. 1978); Rolf v. Blyth, Eastman, Dillon & Co.,
570 F.2d 38, 44 (2d Cir. 1978).
28 Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994).
Current through 12/19/2013
3. The Circuit Courts of Appeal disagree on whether a reckless state
of mind is sufficient to state a claim under the PLSRA.
a. In the Ninth Circuit, a plaintiff must plead “facts that
constitute strong circumstantial evidence of deliberately
reckless or conscious misconduct” and “facts showing mere
recklessness or a motive to commit fraud and opportunity
to do so . . . are not sufficient to establish a strong inference
of deliberate recklessness.”29
b. In the First Circuit, scienter requires either a “conscious
intent to defraud” or “a high degree of recklessness.”30
c. In the Third Circuit, “recklessness . . . remains a sufficient
basis for liability.”31
e. Confidential Informants
i. The PLSRA requires that “if an allegation regarding the statement or
omission is made on information and belief, the complaint shall state
with particularity all facts upon which that belief is formed.”32
ii. Some Circuit Courts of Appeal have ruled that, although plaintiffs are not
required to name sources, they must provide a detailed description of the
iii. Moreover, courts may order sanctions where a confidential informant later
disavows statements attributed to them in a complaint.34
III. Obstacles to Success Under Section 11 of the Securities Act (“Section 11”).
a. Section 11 protects investors from materially untrue statements and material
omissions in registration statements, but it only provides standing to a narrow
class of persons who purchased stock pursuant to a registration statement.35
i. Investors must be able to trace their purchase to the registration
ii. Potential plaintiffs must establish standing by a preponderance of direct
evidence. Proof that the security might have been issued pursuant to the
29 In re Silicon Graphics Sec. Litig., 183 F.3d 970, 974 (9th Cir. 1999).
30 Miss. Pub. Employees' Ret. Sys. v. Boston Scientific Corp., 649 F.3d 5, 20 (1st Cir. 2011) (quoting ACA Fin.
Guar. Corp. v. Advest, Inc., 512 F.3d at 58).
31 In re Advanta Corp. Sec. Litig., 180 F.3d 525, 535 (3rd Cir. 1999).
32 15 U.S.C. 78u-4(b)(1).
33 See, e.g., Institutional Investors Group v. Avaya, Inc., 564 F.3d 242, 263 (3d Cir. 2009); Ind. Elec. Workers’
Pension Trust Fund IBEW v. Shaw Group, Inc., 537 UF.3d 527, 535 (5th Cir. 2008); Makor Issues & Rights, Ltd. v.
Tellabs Inc., 513 F.3d 702, 712 (7th Cir. 2008).
34 See City of Livonia Emple. Ret. Sys. v. Boeing Co., 711 F.3d 754, 762 (7th Cir. 2013) (remanding to District Court
for determination of whether sanctions to award sanction again a plaintiff’s firm); In re Sony Corp., 268 F.R.D. 509
(S.D.N.Y 2010). See also Max Stendahl, Boeing Wants Robbins Geller Sanctioned In Witness Scandal, Law360
(Nov. 25, 2013), http://www.law360.com/articles/491323/boeing-wants-robbins-geller-sanctioned-in-witnessscandal.
35 Demaria v. Andersen, 318 F.3d 170, 176 (2d Cir. N.Y. 2003)
36 See In re Fleetboston Fin. Corp. Secs. Litig., 253 F.R.D. 315, 343-350 & n.29 (D.N.J. 2008)
Current through 12/19/2013
registration statement is not enough.37 Even evidence showing a strong
likelihood that the security could be traced to the registration statement is
not enough. For example, in In re Elscint Ltd. Sec. Litig., the Court held
that evidence showing a statistical probability of 82% that certain
securities could be traced to the registration statement was not sufficient to
support an inference that any one of the plaintiffs more probably than not
purchased new shares of stock.38
b. Statute of Repose – In Police & Fire Ret. Sys. v. IndyMac MBS, Inc.,39 the
Court of Appeals for the Second Circuit recently held that while American
Pipe40 tolling applies to the one year statute of limitation under Section 13 of
the Securities Act,41 it does not apply to the three-year statute of repose.
i. The Second Circuit issues a broad holding, potentially applicable to Rule
10b-542 claims as well.
ii. The holding will potentially prevent institutional investors waiting to file
individual actions until after the class action has progressed through
discovery. It could also encourage early filings by institutional investors
and push institutional investors to opt-out of class actions earlier than
iii. The Second Circuit’s holding in IndyMac appears to conflict with the
Tenth Circuits holding in Joseph v. Wiles.43 The IndyMac plaintiffs have
filed a Petition for a Writ of Certiorari, asking the Supreme Court to
address the question: “Does the filing of a putative class action serve,
under the American Pipe rule, to satisfy the three-year time limitation in §
13 of the Securities Act with respect to the claims of putative class
c. Although courts usually only dismiss on materiality grounds if misstatements
were minor enough that “reasonable minds could not differ on the question of
their importance,”45 a number of doctrines still stand in a plaintiff’s way.
i. “Bespeaks caution” doctrine
1. Under the “bespeaks caution” doctrine, sufficient cautionary
language in a disclosure document can render an alleged omission
or misrepresentation immaterial as a matter of law.46
37 Krim v. PCOrder.com, 402 F.3d 489, 501 (5th Cir. Tex. 2005) (“general statistics say nothing about the shares
that a specific person actually owns and have no ability to separate those shares upon which standing can be based
from those for which standing is improper”) (emphasis in original).
38 674 F. Supp. 374 (D. Mass. 1987).
39 721 F.3d 95 (2d Cir. 2013).
40 Am. Pipe & Constr. Co. v. Utah, 414 U.S. 538, 551 (1974).
41 15 U.S.C. § 77k.
42 17 C.F.R. § 240.10b-5.
43 223 F.3d 1155, 1168 (10th Cir. 2000)
44 Petition for a Writ of Certiorari at i, Police & Fire Ret. Sys. v. IndyMac MBS, Inc., No. 13-640 (Nov. 22, 2013).
45 See ECA, Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 197 (2d Cir.
46 See Halperin v. eBanker USA.com, Inc., 295 F.3d 352, 357 (2d Cir. 2002).
Current through 12/19/2013
2. For example, in Olkey v. Hyperion 1999 Term Trust, the plaintiffs
brought a class action seeking damages for fraud in issuing and
using prospectuses to market mortgage-backed securities, in
violation of Sections 11 and 12(2) of the Securities Act and
Sections 10(b) and 20(a) of the Exchange Act.47 The Second
Circuit affirmed the dismissal by the district court of plaintiffs'
claims on the grounds that, when read as a whole, the allegedly
misleading materials contained in the prospectus bespoke
a. In Olkey v. Hyperion 1999 Term Trust, the prospectuses
included the following specific warnings, among others,
about mortgage-backed securities:
i. “The investment characteristics of Mortgage-
Backed Securities differ from traditional debt
securities. . . . These differences can result in
significantly greater price and yield volatility than is
the case with traditional debt securities. As a result,
if the Trust purchases Mortgage-Backed Securities
at a premium, a prepayment rate that is faster than
expected will reduce both the market value and
yield to maturity from that which was anticipated. . .
ii. “Because of the effect that changes in interest rates
may have on prepayment rates, changes in interest
rates may have a greater effect on the value of
Mortgage-Backed Securities than is the case with
more traditional fixed income securities.”50
iii. “Amounts available for reinvestment by the Trust
are likely to be greater during a period of declining
interest rates due to increased prepayments and, as a
result, likely to be reinvested at lower interest rates
than during a period of rising interest rates. Most
Mortgage-Backed Securities in which the Trust may
invest, like other fixed income securities, tend to
decrease in value as a result of increases in interest
rates but may benefit less than other fixed income
securities from declining interest rates because of
the risk of prepayment.”51
b. The prospectus in Olkey v. Hyperion 1999 Term Trust also
included the following general warnings:
47 98 F.3d 2, 3 (2d Cir. N.Y. 1996)
48 Id. at 5 & 9.
49 Id. at 5-6.
50 Id. at 6.
Current through 12/19/2013
i. “The market value of the Trust's portfolio . . . [is]
dependent on market forces not in the control of the
ii. “A significant decline in interest rates could lead to
a significant decrease in the Trust's net income and
dividends while a significant rise in interest rates
could lead to only a moderate increase in the Trust's
net income and dividends. Changes in interest rates
will also lead to changes in the Trust's net asset
ii. Forward looking statements
1. SEC Rule 17554
a. Creates a safe harbor for forward-looking statements in
registration statements, and other specific documents.55
b. Limits “forward-looking statements” to:
i. “A statement containing a projection of revenues,
income (loss), earnings (loss) per share, capital
expenditures, dividends, capital structure or other
ii. “A statement of management's plans and objectives
for future operations;
iii. “A statement of future economic performance
contained in management's discussion and analysis
of financial condition and results of operations
included pursuant to Item 303 of Regulation S-K (§
229.303 of this chapter) or Item 9 of Form 20-F; or
Item 5 of Form 20-F.
iv. “Disclosed statements of the assumptions
underlying or relating to any of the statements
2. The PLSRA added 15 U.S.C. § 77z-2(c), which provides a safe
harbor for forward-looking statements unless the plaintiff can
show that the defendant made the statement with actual
knowledge of its falsity.
3. The PLSRA contains a broad definition of “forward-looking
statement.” The term “forward-looking statement” means:
a. “a statement containing a projection of revenues, income
(including income loss), earnings (including earnings loss)
per share, capital expenditures, dividends, capital structure,
or other financial items;
54 17 C.F.R. § 230.175.
55 Id. at § 230.175(b).
56 Id. at §§ 230.175(c)(1)-(4).
Current through 12/19/2013
b. “a statement of the plans and objectives of management for
future operations, including plans or objectives relating to
the products or services of the issuer;
c. “a statement of future economic performance, including
any such statement contained in a discussion and analysis
of financial condition by the management or in the results
of operations included pursuant to the rules and regulations
of the Commission;
d. “any statement of the assumptions underlying or relating to
any statement described in subparagraph (a), (b), or (c);
e. “any report issued by an outside reviewer retained by an
issuer, to the extent that the report assesses a forwardlooking
statement made by the issuer; or
f. “a statement containing a projection or estimate of such
other items as may be specified by rule or regulation of the
iii. Opinions are not material unless the speaker did not truly hold the
opinion. “Opinions” include statements that reflect judgments or
subjective thinking. For example in Fait v. Regions Financial Corp.,58
the plaintiffs claimed that certain statements concerning goodwill and
loan loss reserves in the defendant’s registration statement gave rise
to liability under Sections 11 and 12 of the Securities Act. The Second
Circuit Court of Appeals held that a defendant’s statements were
opinions because they were based on subjective estimates by the
d. Even though scienter is not required under Section 11, fraud must be plead with
e. Although reliance and causation are not required under Section 11, “defendant[s]
may, under section 11(e), reduce [their] liability by proving that the depreciation
in value resulted from factors other than the material misstatement in the
f. Heightened pleading under Rule 8.
i. Rule 8 applies to claims under Section 11 that are not based on fraud.
ii. After the Supreme Court’s rulings in Bell Atlantic Corp. v. Twombly,61 and
Ashcroft v. Iqbal,62 Rule 8 no longer only requires “a short and plain
statement of the claim showing that the pleader is entitled to relief”
that “gives the defendant fair notice of what the . . . claim is and the
57 See 15 U.S.C. §§ 77z-2(i)(1)(A)-(F).
58 655 F.3d 105, 110-13 (2d Cir. 2011).
59 See note 23.
60 Akerman v. Oryx Communications, Inc., 810 F.2d 336, 340 (2d Cir. 1987).
61 550 U.S. 544 (2007).
62 556 U.S. 662 (2009).
Current through 12/19/2013
grounds upon which it rests.”63 Now, the plaintiff’s allegations,
stripped of legal conclusions, must state a claim that is not merely
possible, but “plausible on its face.”64
iii. Plaintiffs advancing claims under the Acts must now include enough
facts in their complaint to allow the court to draw a reasonable
inference that the defendant committed the alleged act.65 Historically,
Section 11 was, in essence, a strict liability statute.66 In order to state
a claim, a plaintiff only had to show that the defendant made an
untrue statement or omission in a registration statement and there
was a “substantial likelihood that a reasonable investor would
consider it important.”67 This was especially true as to claims against
issuers, as others had a “due diligence” defense to Section 11 claims.
g. For example, In re Royal Bank of Scotland Group PLC Sec. Litig.,68 arguably
would have turned out differently twenty years ago. In that case, the allegations
i. The registration statement incorporated a Royal Bank of Scotland Group
(“RBS”) Annual Report, which stated that RBS’s “[o]verall credit quality
remained strong,” and that “[r]isk elements in lending and potential
problem loans represented just 1.6% of gross loans and advances to
ii. These statements were materially false and misleading because they
“failed to disclose the extent to which RBS had subprime assets in its
portfolio” and “the amount of RBS’s subprime assets could have
influenced the economic decisions investors made on the basis of RBS’s
iii. The statements were also materially false and misleading because the
Annual Report “failed to disclose any concentration of credit risk arising
from the billions of dollars in subprime assets in RBS’s portfolio” and that
international accounting standards required RBS to disclose
concentrations of credit risks.
63 355 U.S. 41, 47 (1957).
64 Bell Atlantic Corp. v. Twombly, 550 U.S. at 570; Ashcroft v. Iqbal, 556 U.S. at 678.
65 Bell Atlantic Corp. v. Twombly, 550 U.S. at 556; Ashcroft v. Iqbal, 556 U.S. at 678.
66 See In re Fleetboston Fin. Corp. Secs. Litig., 253 F.R.D. 315, 343 n.29 (D.N.J. 2008) (Section 11 “imposes
virtually strict liability on offerors and sellers directly involved in a fraudulent registered transaction”).
67 See Greenapple v. Detroit Edison Co., 468 F. Supp. 702, 708 (S.D.N.Y. 1979), aff’d 618 F.2d 198 (2d Cir. 1980).
68 Civ. A. 1:09-cv-00300-DAB (S.D.N.Y. 2011)
69 In re Royal Bank of Scotland Group PLC Sec. Litig., Amended Complaint at ¶ 95 (S.D.N.Y. Mar. 18, 2011).
70 Id. at ¶ 96.
Current through 12/19/2013
IV. Obstacles to Success Under Section 12 of the Securities Act (“Section 12”) 71
a. Section 12(a)(1)72
i. Section 12(a)(1) creates a cause of action for the offer or sale of
unregistered securities. Plaintiffs are not required to prove scienter,
negligence, materiality, or reliance.
ii. Although the defense of in pari delicto is applicable to all private actions
under federal securities laws, it is especially relevant to actions under
Section 12.73 Plaintiffs who knew about or participated in the violation are
subject to a defense of in pari delicto, where the plaintiff’s culpability is
greater than, or indistinguishable from, the defendant’s, and the plaintiff
cooperated with or induced the defendant’s actions.74
1. Defense is available “only where (1) as a direct result of his own
actions, the plaintiff bears at least substantially equal responsibility
for the violations he seeks to redress, and (2) preclusion of suit
would not significantly interfere with the effective enforcement of
the securities laws and protection of the investing public.”75
2. The Supreme Court noted in Pinter v. Dahl that “the in pari delicto
defense may defeat recovery in a § 12(1) action only where the
plaintiff's role in the offering or sale of nonexempted, unregistered
securities is more as a promoter than as an investor.”76
b. Section 12(a)(2)77
i. Section 12(a)(2) creates a cause of action against persons who offer or
sell a security by means of a prospectus or oral communication, which
contains material misrepresentation or omission.
ii. Essentially, once a plaintiff-purchaser shows that a prospectus contained a
material misstatement, the burden shifts to the defendant to show that the
elements do not exist.78
iii. In Gustafson v. Alloy Co., the Supreme Court narrowed the reach of
Section 12(a)(2) by holding that buyers of stock in private
transactions could not avail them of Section 12(a)(2)’s protections
because private transactions do not involve a “prospectus” as that
term is defined in the Securities Act.79
iv. Reform Act amended Section 12 by adding (b), which significantly
lessened the extent of damages recoverable by a plaintiff.
71 15 U.S.C. § 77l.
72 15 U.S.C. § 77l(a)(1)
73 See Pinter v. Dahl, 486 U.S. 622, 635 (1988).
74 Id. at 637 (1988).
75 Id. at 633
76 Id. at 639.
77 15 U.S.C. § 77l(a)(2)
79 513 U.S. 561, 569-71 (1995)
Current through 12/19/2013
1. Prior to the Reform Act, Section 12(2)80 established that “any
person” who violates the section “shall be liable to the person
purchasing such security from him . . . to recover the consideration
paid for such security with interest thereon, less the amount of any
income received thereon, upon the tender of such security, or for
damages if he no longer owns the security.”
2. Section 12(b) establishes a loss causation requirement not
present in the original text of Section 12(2), allowing
defendants to minimize damages by proving that “any portion
or all of the amount recoverable under subsection (a)(2)
represents other than the depreciation in value of the subject
security resulting from” the Section 12 violation.
V. Other Obstacles to Success Under Section 10(b) of the Exchange Act and SEC
a. Plaintiffs “did not rely on the integrity of the market.”
i. After trial in Gamco v. Vivendi, the United States District Court for the
Southern District of New York held that the plaintiffs traded without
relying on the integrity of the market because, while they alleged that the
defendant failed to disclose its liquidity position, the metric that the
plaintiffs used to determine the intrinsic value of their potential purchase
was “completely independent of liquidity concerns and market price.”81
ii. In Lawrence E. Jaffe Pension Plan v. Household Int'l, Inc., the defendants
challenged all claims to see if investors relied on the integrity of the
market and to see if investors’ claims were properly authorized. The
defendants appear to have reduced their exposure by millions of dollars.82
1. After the jury found the defendants made false or misleading
statements, each class member was required to respond "yes" or
"no" to the following inquiry: “If you had known at the time of
your purchase of Household stock that defendants' false and
misleading statements had the effect of inflating the price of
Household stock and thereby caused you to pay more for
Household stock than you should have paid, would you have still
purchased the stock at the inflated price that you paid?"83
2. The Court dismissed the claims of any class member who failed to
answer the question.84
3. For class members who answered “yes,” the Court determined that
the defendant had successfully rebutted the presumption of reliance
80 The Reform Act added subsection (b) to Section 12 and renumbered Section 12(2) as 12(a)(2).
81 927 F. Supp. 2d 88, 101 (S.D.N.Y. 2013).
82 Lawrence E. Jaffe Pension Plan v. Household Int'l, Inc., 2012 U.S. Dist. LEXIS 135135 (N.D. Ill. Sept. 21, 2012)
83 Id. at *5.
84 Id. at *22-23.
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on the market and ordered those claims proceed to trial on the issue
4. The Court ruled that those class members who answered “no” were
entitled to judgment as to liability because the defendant did not
adequately rebut the presumption of reliance on the market price.86
iii. The Supreme Court recently granted certiorari in Halliburton Co. v. Erica
P. John Fund, Inc., No. 13-317 (to be argued Mar. 5, 2014) (see section
b. The Second Circuit’s ruling in Police & Fire Ret. Sys. V. IndyMac MBS, Inc.,
could easily be extended to eliminate tolling of the five-year statute of repose
applicable to actions under Section 10(b) (see section III.b, supra).
c. Duty to Disclose in Omission Cases –
i. In Basic v. Levinson, the Supreme Court held that “[s]ilence, absent a duty
to disclose, is not misleading under Rule 10b-5.” 87
ii. Duty must specifically run to shareholder from the defendant and cannot
arise from a general duty to disclose truthful and accurate information.88
d. Statements protected from liability
i. Forward-Looking Statements (see above, Section III.c.ii)
1. In 1979 the SEC created safe harbor for forward-looking
statements in specific documents.89
2. PLSRA Safe Harbor –
a. Contains a broad definition of forward-looking statements
b. Once a statement has been identified as forward-looking
and material, in order to be protected it must be
accompanied by “meaningful” cautionary statements or the
defendant must have made the statement without actual
knowledge of its falsity (i.e., statements made recklessly or
without a reasonable basis are protected).
ii. As mentioned above, the bespeaks caution doctrine dictates that sufficient
cautionary language in a disclosure document can render alleged omission
or misrepresentation immaterial as a matter of law.90 This doctrine applies
to forward-looking statements outside of a document specifically protected
by the SEC safe harbor.
85 Id. at *17.
86 Id. at *6-7.
87 485 U.S. 224, 239 n. 17 (1988)
88 See Badger v. S. Farm Bureau Life Ins. Co., 612 F.3d 1334, 1343-44 (11th Cir. 2010).
89 17 C.F.R. §§ 230.175 & 240.3b-6
90 See Halperin v. eBanker USA.com, Inc., 295 F.3d 352, 357 (2d Cir. 2002).
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iii. Most Courts conclude that “vague and general statements of
optimism constitute no more than 'puffery' and are understood by
reasonable investors as such.”91
iv. Opinions –
1. Opinion statements are only actionable if the statement was not
honestly held by the speaker at the time the statement was made.92
2. Any statement that reflects judgment or subjective thinking could
be viewed as an opinion.93
v. Characterizations – as long as material facts are disclosed, a failure to
characterize facts in a negative manner is not actionable.94
vi. Firm Specific Information – the Acts “only require” issuers to disclose
firm-specific information and there is no duty to disclose industry- or
nation-wide economic information.95
vii. Claims alleging mismanagement are not actionable absent specific
misstatements or omissions.96 Similarly, a board’s failure to disclose its
own mismanagement usually is not actionable.97
e. Scienter (discussed further at section II.d, supra)
i. The PSLRA requires “strong inference” of scienter and it is an open
question whether recklessness still suffices.
ii. Insider stock sales – unusual insider stock sales may support an inference
of scienter, but a plaintiff must show that trading involved substantial
amounts and occurred during the relevant period.98
i. The PSLRA codified the requirement that the plaintiff must plead and
prove loss causation in an action under Section 10(b).99
ii. Plaintiffs must directly connect misstatements to the decline in stock
value. Plaintiffs must specifically allege that the misstatement or
omission, when disclosed, caused a drop in stock value.100
iii. Dura Pharmaceuticals, Inc., v. Broudo,101 requires plaintiffs to “provide
the defendant with some indication of the loss and the causal connection
that [they have] in mind.”
iv. Reliance – the “fraud-on-the-market” theory is under scrutiny.
91 See, e.g., In re Advanta Corp. Sec. Litig., 180 F.3d 525, 538-39 (3d Cir. 1999) (citing cases).
92 Virginia Bankshares v. Sandberg, 501 U.S. 1083, 1095-96 (1991).
93 See Fait v. Regions Fin’l Corp., 655 F.3d 105, 110-12 (2d Cir. 2011).
94 See, e.g., Ley v. Visteon Corp., 543 F.3d 801, 808 (6th Cir. 2008).
95 See Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 515 (7th Cir. 1989) (“Issuers need not ‘disclose’
Murphy’s Law or the Peter Principle, even though these have substantial effects on business”).
96 Winer Family Trust v. Queen, 503 F.3d 319, 333 (3d Cir. 2007).
97 Werner v. Werner, 267 F.3d 288, 299 (3d Cir. 2001).
98 See, e.g., City of Dearborn Heights v. Waters Corp., 632 F.3d 751, 761-62 (1st Cir. 2011).
99 15 U.S.C. § 78u-4(b)(4).
100 See, e.g., Emergent Capital Inv. Mgmt. LLC v. Stonepath Group, Inc., 343 F.3d 189, 197-98 (2d Cir. 2003)
101 544 U.S. 336, 347 (2005).
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1. In Basic Inc. v. Levinson,102 the Supreme Court recognized a
presumption of reliance based on a fraud-on-the-market theory.
Courts “may presume that investors trading in efficient markets
indirectly rely on public, material misrepresentations through their
‘reliance on the integrity of the price set by the market.’”103
Therefore, as the law currently stands, investors need not show that
they actually relied on alleged misstatements to state a claim under
Rule 10b-5 and it is the defendant’s burden to rebut the
presumption of reliance.
2. The Court recently granted certiorari in Halliburton Co. v.
Erica P. John Fund, Inc.
a. The issues will be:
i. Whether the Court should overrule or substantially
modify the holding of Basic Inc. v. Levinson, to the
extent that it recognizes a presumption of classwide
reliance derived from the fraud-on-the-market
ii. Whether, in a case where the plaintiff invokes the
presumption of reliance to seek class certification,
the defendant may rebut the presumption and
prevent class certification by introducing evidence
that the alleged misrepresentations did not distort
the market price of its stock.
b. Halliburton argued in its Petition for Certiorari that:
i. The fraud-on-the-market theory is premised on an
economic theory that is now “roundly rejected.”104
ii. The fraud on the market presumption is at odds with
the Court’s recent class action jurisprudence that
“plaintiffs must ‘affirmatively demonstrate . . .
compliance’ with Rule 23 [of the Federal Rules of
Civil Procedure], and thereby ‘prove . . . in fact’
that common issues predominate before a district
court may certify a class.”105
iii. Because the court below found no evidence that
Halliburton’s alleged misrepresentation actually
moved the market price, “Basic should be modified
to require plaintiffs to prove price impact in order to
invoke the presumption in the first instance.”106
102 485 U.S. 224 (1988).
103 Amgen Inc., v. Conn. Ret. Plans & Trust Funds, 133 S. Ct. 1184, 1192 (2013) (quoting Basic Inc. v. Levinson,
485 U.S. at 245).
104 Petition for Writ of Certiorari at 13, Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317 (filed Sept. 9,
105 Id. at 21 (quoting Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2551 (2011)).
106 Id. at 24.
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g. Automatic Stay of Discovery
i. The PSLRA established that in any action arising under the Securities Act
or Exchange Act, “all discovery and other proceedings shall be stayed
during the pendency of any motion to dismiss, unless the court finds, upon
the motion of any party, that particularized discovery is necessary to
preserve evidence or to prevent undue prejudice to that party.”107
ii. Under this regime, courts decide motions to dismiss based on the facts
alleged and the inferences drawn from those facts. Defendants’ input as to
what inferences the court may draw comes from the briefs filed by their
h. Limitations on Who Can Be Sued
i. There is no private right of action for aiding and abetting under
Section 10(b).108 Additionally, as discussed above (see section II.d.4),
the PSLRA essentially eliminated the group pleading presumption.
However, the PSLRA granted the SEC authority to bring actions
under the Exchange Act against “any person that knowingly provides
substantial assistance to another person” who violates the Exchange
Act or SEC regulations.109
ii. The Supreme Court has also held that there is no scheme liability
under the Exchange Act.110
iii. Janus Capital Group v. First Derivative Traders111 held that a
defendant “makes” a statement only if that person “is the person or
entity with ultimate authority over that statement, including its
content and whether and how to communicate it.”
VI. Obstacles to Class Certification
a. The Supreme Court has held that class certification is proper only if “the trial
court is satisfied, after a rigorous analysis, that the prerequisites of Rule 23(a)
have been satisfied,” and that this rigorous analysis may require a court to “probe
behind the pleadings” into the merits of the plaintiff’s case at the class
b. In Amgen Inc. v. Conn. Ret. Plans & Trust Funds, the plaintiffs invoked the
“fraud-on-the-market” presumption.113 As the Court noted, the “fraud-on-themarket”
presumption “facilitates class certification by recognizing a rebuttable
107 See 15 U.S.C. §§ 77z-1(b)(1) & 78u-4(b)(3)(B).
108 See Central Bank of Denver, N.A. v. First Interstate Bank of Denver NA., 511 U.S. 164 (1994).
109 15 U.S.C. s. 78t(e).
110 Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008).
111 131 S. Ct. 2296, 2302 (2011) (emphasis added).
112 Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2551 (2011) (quoting General Telephone Co. of Southwest v.
Falcon, 457 U.S. 147, 157 (1982)). See Comcast Corp. v. Behrend, 133 S. Ct. 1426, 1432 (2013).
113 133 S. Ct. 1184, 1190 (2013).
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presumption of classwide reliance on public, material misrepresentations.”114 The
defendant conceded the efficiency of the market for the securities at issue, but
argued that the plaintiffs had not adequately shown that the alleged misstatements
were material enough to affect the market price.115 The question was whether, at
the class certification stage, the plaintiffs must do more than merely plead that the
defendant’s alleged misrepresentations materially affected the market price of the
securities at issue.116 The Court held that plaintiffs need not prove materiality at
the class certification stage because, in an efficient market, materiality is an
objective question that is common to the class.117
c. Therefore, at the class certification stage, the inquiry focuses on whether the
plaintiff has established the prerequisites for the fraud-on-the-market
i. The alleged misrepresentations were publicly known,
ii. The stock traded in an efficient market, and
iii. The relevant transactions took place “between the time the
misrepresentations were made and the time the truth was revealed.”118
d. In Comcast Corp. v. Behrend, the Supreme Court ruled that a trial court, when
ruling on class certification, could not decline to evaluate the methodology of the
plaintiff’s expert witness’s testimony about damages, even if that evaluation might
ultimately affect the ability of the plaintiff to establish damages at trial. 119 Further,
the Court held that, at the class certification stage, plaintiffs must provide a
classwide damages model that is consistent with their theory of liability.120
e. In Re BP p.l.c. Sec. Litig.,121 provides a good example of how these decisions
have created obstacles to successful securities class action claims. In that case,
the United States District Court for the Southern District of Texas denied class
certification because the lead plaintiffs had failed to demonstrate that the alleged
misrepresentations were publicly known.122 Additionally, the Court refused to
certify the class because the plaintiffs had not met their burden under Comcast
Corp. v. Behrend of “showing that damages can be measured on a classwide basis
consistent with their theories of liability.”123