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From the Pages of The Pomerantz Monitor: Senator Specter Introduces Two Bills That Could Prove Very Important to Plaintiffs

As Susan Weiswasser reports in the current issue of The Pomerantz Monitor, two pieces of legislation recently introduced in the United States Senate, both sponsored by Arlen Specter of Pennsylvania, could, if passed, prove very important to plaintiffs. Both would effectively overrule Supreme Court decisions that made surviving motions to dismiss or getting relief for the acts of secondary actors in securities cases more difficult.

The Anti-Twombly Act. The first bill deals with the way plaintiffs have to present claims in their complaints to survive a motion to dismiss. Rule 8 of the Federal Rules of Civil Procedure requires, among other things, that a plaintiff make “a short and plain statement of the claim showing that the pleader is entitled to relief.” The standard for deciding whether a complaint satisfied Rule 8 was established in the 1957 Supreme Court case Conley v. Gibson. The Court held that the Federal Rules “do not require a claimant to set out in detail the facts upon which he bases his claim.” It stands to reason that plaintiffs very often will not have detailed facts available until after they have filed suit and obtained discovery from the defendants. The language the Conley Court used to describe this standard — that dismissal is improper “unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief” — would be quoted by courts reviewing motions to dismiss for the next 50 years.

Then, in 2007, the Court decided Bell Atlantic v. Twombly, and created a new standard — often referred to as the “plausibility standard” — which requires that, to survive a motion to dismiss, a plaintiff must provide “enough facts to state a claim to relief that is plausible on its face." Ashcroft v. Iqbal, decided earlier this year, reinforced Twombly’s message noting that “[t]he plausibility standard is not akin to a ‘probability requirement,’ but it asks for more than a sheer possibility that a defendant has acted unlawfully.” Since Twombly was decided, it is reported that motions to dismiss have been filed with much greater frequency.

Senator Specter’s bill would restore the pleading standard set forth in Conley v. Gibson. In his comments introducing the bill, Specter, a lawyer, made the point that “[n]ot until a plaintiff has had access to relevant information in the defendant’s possession during the discovery process . . . can the plaintiff normally offer evidence to support the complaint’s allegations.” Since the Federal Rules do not allow federal courts to pass on the merits of a case until plaintiffs have submitted evidence, either on summary judgment or at trial, Specter expressed the inappropriateness of requiring plaintiffs to do more than provide defendants with notice.

The Anti-Stoneridge Act. Second on Specter’s agenda is a bill that will restore securities fraud liability for aiders and abettors. While Congress had not specifically created a private right to sue aiders and abettors under the securities laws, until 1994 courts had allowed suits against accountants, lawyers, business associates and the like who assist primary violators in carrying out schemes to defraud investors.

In Central Bank of Denver v. First Interstate Bank of Denver, the Supreme Court dealt a serious blow to investors,  holding that no private right of action for aiding and abetting could be had under the securities laws. Thus investors lost the ability to pursue wrongdoers who often played an indispensable role in perpetrating a fraud in spite of not being primary violators. Analyzing Congress’s intent as expressed in the text of the statute, the Court ruled that a cause of action against one who had not committed the manipulative or deceptive act could not be inferred. The majority discounted arguments that the availability of such a claim functioned as a deterrent to those who might provide behind-the-scenes assistance to actual violators of section 10(b).

Less than a year later, Congress introduced the Private Securities Litigation Reform Act (PSLRA). The SEC, which had filed a friend-of-the-court brief in Central Bank in support of maintaining the aiding and abetting cause of action, pressed Congress to overturn the Central Bank decision in the new law. Congress refused, delegating the right to bring an action for aiding and abetting to the SEC alone. The bill passed over President Clinton’s veto.

Recently, the Court had another look at who could be sued for securities fraud. In Stoneridge Investment Partners v. Scientific-Atlanta, where the Pomerantz firm represented plaintiffs, the Court considered whether the Central Bank decision barred a suit against a party who engaged in deceptive conduct but made no public statements about that conduct. The Court ruled that deceptive acts could create primary liability under the securities laws, as long as investors relied on those deceptive acts. Because the deceptions in Stoneridge were directed at the auditors, rather than the public, the Court held that investors could not have relied on them and thus could not prevail.

Senator Specter’s bill would recreate the private right of action for aiding and abetting, so that “any person that knowingly or recklessly provides substantial assistance” to a primary violator could be held liable for securities fraud. Specter is likely to have support for this bill beyond investors and the plaintiffs’ bar. As Specter pointed out in his introduction of the bill, Judge Gerald Lynch of the federal court in Manhattan recently wrote in an opinion that Congress’s choice to deny investors a private right of action against aiders and abettors:

“may be ripe for legislative reexamination. While the impulse to protect professionals and other marginal actors who may too easily be drawn into securities litigation may well be sound, a bright line between principals and accomplices may not be appropriate. There are accomplices and there are accomplices: after all, in the criminal context when the Godfather orders a hit, he is only an accomplice to murder – one who ‘counsels, commands, induces or procures’ but he is nonetheless liable as a principal for the commission of the crime. Likewise, some civil accomplices are deeply and indispensably implicated in wrongful conduct.”

From the Pages of The Pomerantz Monitor: Institutional Investors Have Greatly Strengthened Securities Litigation

As Adam Prussin reports in the July/August issue of The Pomerantz Monitor, Congress instituted the "lead plaintiff" provisions of securities law to encourage institutional investors to become more involved in securities class action lawsuits. Since investors with the largest losses are favored as lead plaintiffs, institutions, with greater assets, typically have a leg up on individual investors. Is that good or bad?

As reported in the D&O Diary, a blog that follows securities litigation developments, a recent academic study concludes that institutions have heeded the call and that, when they act as lead plaintiffs, they get better results than individual investors do. The D&O Diary quotes the authors:  

institutional investor involvement in securities litigation not only enhances investors’ success in seeking financial recovery, but also improves the quality of the companies’ corporate governance. [It] is an effective corporate monitoring tool for institutional investors.

The study, published earlier this year by professors at LSU, Prairie View A&M, Purdue and the University of Houston, examined all 1,811 securities lawsuits filed between January 1, 1996 and July 20, 2005 that had been resolved by June 1, 2006. Two hundred eighty-six of these had an institutional investor as lead plaintiff. Although this is about 16% of the total, that percentage had reached more than 30% for cases filed in 2004. Today, institutional investors, especially public and union pension plans, are lead plaintiffs in most of the really large class action securities cases filed. 

The authors found that cases with institutional lead plaintiffs are 38.2% less likely to be dismissed on motion than cases without them; and that all else being equal, cases with institutional lead plaintiffs produced total settlement amounts about 60% higher on average than cases without them. The authors also found that within three years of the lawsuit filing, defendant companies that faced institutional investor lead plaintiffs experienced greater improvement in board independence than those facing individual lead plaintiffs. The authors conclude that: 

institutional investors’ involvement in securities litigation enhances not only investors’ success in seeking financial recovery, but also the quality of the defendant firms’ corporate governance . . . institutional investors could use litigation as a mechanism to discipline management and to secure the long-term health of the firm.

The study confirms that institutions have much to contribute to the enforcement of federal securities laws, and that more and more of them are stepping up to the plate.

From the Pages of The Pomerantz Monitor: LAMPERS Takes on Excessive Compensation

As reported by Fei-Lu Qian in an April PomTalk post, the Louisiana Municipal Police Employees’ Retirement System (“LAMPERS”) took the responsible step in demanding answers and accountability from directors of Chesapeake Energy by filing a “books and records” demand in a state court of Oklahoma. If the demand is granted, shareholders of Chesapeake will be able to examine the company’s corporate documents to see if the board’s approval of a $75 million bonus to its chief executive officer was proper. In the May/June issue of The Pomerantz Monitor, Marc Gross more fully explains the background of the lawsuit commenced by Pomerantz on behalf of LAMPERS to recoup the $75 million bonus.

The extraordinary bonus was awarded to Chesapeake’s CEO and co-founder, Aubrey McClendon. McClendon’s total compensation for 2008 was $105 million, making him the highest paid executive in the country at a time when the company’s earnings plummeted 50% and stock price tumbled 60%. The company claims that it granted the bonus – five times McClendon’s average annual compensation, including both salary and bonus – to reward him for his role in selling off certain oil and gas properties during 2008.

The real purpose of the bonus, we submit, was to bail out McClendon from his personal financial problems precipitated by the fall in the company’s share price. In other words, Chesapeake used corporate funds to insulate its CEO from the consequences of the corporate meltdown, while shareholders got stuck with their losses

The bail out was even larger than at first appeared. After the lawsuit was filed, Chesapeake issued a Proxy Statement indicating that it also agreed to pay McClendon over $12 million for his personal art collection.

In its opposition to our lawsuit, Chesapeake argues that if it weren’t for the bonus, McClendon might have jumped ship in favor of other opportunities. This seems far fetched, given that McClendon founded the company and still has a sizable stake in its wells. Moreover, the Board had other ways to insure his retention, like lowering the share ownership requirement – which it did – and providing loans to help him meet his obligations.

A similar books and records strategy was used successfully at the start of the Disney/Ovitz excess compensation case, and is favored by Delaware courts. Although Chesapeake is an Oklahoma corporation, that state follows Delaware corporate law.

We believe that the Chesapeake case warrants support by other public pension funds concerned with corporate governance reforms, either by direct intervention or a letter to the court. If ever there was a time to draw the line on excess compensation, it is now.

In pursuing this claim, Pomerantz harkens back to its roots. The firm’s first major case was Gallant v. Mitchell, where Abe Pomerantz sought to recoup interest-free loans that officers of National City Bank awarded themselves to tide them through the Great Depression (loans which they ultimately forgave). After trial, Abe recovered $1.8 million, a small fortune in the 1930’s.

Beazer's CEO Must Go

CtW Investment Group which is affiliated with Change to Win, a group of unions representing 6 million workers, has called for the removal of Beazer Homes USA Chief Executive Officer Ian McCarthy for his “stunning leadership failure.” In a letter to Laurent Albert, the Chairman of Beazer’s Nominating/Corporate Governance Committee, CtW states that a “decisive action by Beazer’s independent directors is required to restore investor, creditor, customer and regulatory confidence.”

Specifically, CtW claims that Mr. McCarthy has failed to give shareholders long term value, while garnering egregious compensation of more than $57 million over the past five years and “allowing his management team to violate federal law, improperly account for land development costs and sale-leaseback transactions, and provide undisclosed loans to executives.” Further, CtW argues that the Company’s failure to hold Mr. McCarthy accountable shows “a troubling lack of independent leadership.”

Indeed, CtW questions the independence of Beazer’s “non-executive” chairman Brian Beazer and believes that Mr. Beazer is really acting “more like an adjunct CEO.” For example, Mr. Beazer’s longstanding relationship with Mr. McCarthy dates back nearly 30 years. Moreover, in 2006, while other non-employee directors in the Company “received $35,000 plus $1,500 per board meeting, with an additional $5,000 for committee chairs,” Mr. Beazer received $225,000 in base salary, 2,500 stock options and 2,000 restricted shares under the Company’s Stock Incentive Plans. As such, Institutional Shareholders Services classified Mr. Beazer’s annual salary as one of “‘the most highly compensated officers of the company.”

CtW demands that the Company replaces Mr. McCarthy; names an independent board chairman; and establishes a Legal and Regulatory Compliance Committee to restore the Company’s credibility. 

Investors Demand Disclosure of Global Warming Risks

In the latest "green" move, the financial officers of ten states have joined environmental groups in demanding that corporations disclose the financial impact of global warming on their operations in future filings with the SEC.

Ceres, a group that includes both environmental activists and institutional investors, made the official petition to the SEC this Tuesday; they were joined by numerous state financial officers and several heavyweight institutions, including the NY state and city comptrollers and the California state government pension funds.

The need for similar disclosures has long been recognized. For instance, companies have historically been required to disclose material environmental risks - such as the cost of cleaning up a toxic site. The issue going forward, however, is whether and to what extent companies should be required to disclose the financial impact they will be facing as a result of global warming.

This issue has gained momentum in the past week as the Democratic majorities in both houses of Congress have been finalizing their legislative approach to global warming issues. Any new legislation that comes out of this effort could put significant cost burdens on businesses as they adapt their technologies to meet the new regulatory requirements. Moreover, as the impact of global warming becomes more apparent, companies may face increased costs of doing business in certain regions, as well as significant weather-related risks These risks, investors argue, should be disclosed and itemized. Investors are also asking for disclosure of details such as individual greenhouse gas emissions.

Ceres pointed out that corporate titans like Allstate and Exxon have little or no discussion of the impact of global warming on their operations or the risks they face as a result. The groups argues that such disclosure is necessary as the impact of global warming becomes a "material" risk.

Further details about the proposal maybe found in the Tuesday edition of The New York Times.

Fraud Schemes Are Still Present

A new study by the Deloitte Forensic Center found that corporate fraud schemes continue to be a problem even after tough legislation such as the Foreign Corrupt Practices Act and the Sarbanes-Oxley Act. In analyzing 344 SEC’s accounting and auditing enforcement releases (“AAERs”) between 2000 and 2006, the study concluded that between 2001 and 2002, the number of AAERs doubled and then rose by an additional 43% in 2003. This finding is significant because “despite increased enforcement efforts by the SEC – financial statement fraud remains a public concern.”

The most common type of fraud scheme was revenue recognition with 41% of the total. Within revenue recognition, some of the most popular types were recognition of fictitious revenue and recognizing inappropriate amount of revenue from swaps, round-tripping or barter arrangements. The next set of most popular fraud was manipulation of various financial statement items such as expenses and assets which accounted for more than a third of all fraud schemes.

Moreover, as one of the purposes of the SEC issuing these AAERs is to report any antifraud actions that the agency has taken, it is taking more time for the SEC to release a typical AAER. This delay is creating a significant lag time, in years, between the initial fraud and the SEC issuing the AAER. Specifically, the lag time is on average 4.7 years from the start of a fraud scheme to the issuance of the final release. It is clear from the findings of this study that there is a continuous need for private enforcement as a supplement to an overwhelmed SEC.

Chairman of House Committee Says No to Mandatory Arbitration

The Chairman of the House Financial Services Committee, Congressman Barney Frank has given his support in opposing any move by the Securities and Exchange Commission that would take aware shareholders’ rights to sue companies. Recently, the SEC has announced that it is considering rules to permit public companies to resolve disputes with their shareholders through mandatory arbitration. This essentially would eliminate a shareholder’s right to bring his grievances to the courts.

In a letter to SEC Chairman Cox, Congressman Frank stated that such a move would “represent a drastic change in shareholder rights and is not one a public company should be permitted to impose unilaterally.” Congressman Frank wants a “vigorous open consideration and debate” on any proposed rules that would limit shareholders’ rights. Furthermore, Congressman Frank criticized any elimination of shareholder rights in favor of arbitration that “would allow a company to insulate itself from litigation from its shareholders, even where it engaged in fraud, by making it uneconomic for most individual shareholders to bring suit.” Congressman Frank also notes that shareholders would be extremely limited in their options to appeal decisions made be arbitration panels and thus, investors would be “losing their rights under federal securities laws in order to invest in our public markets.”

Private Securities Fraud Lawsuits Still At Historic Lows

As if you needed more facts to dispel the arguments by Secretary of Treasury Paulson and others -- that US securities markets are too regulated and subject to litigation -- the Institute for Shareholder Services recently reported that only 30 new federal securities class actions were filed in the first quarter of 2007. On a pro-rata basis, this translates into 120 new federal securities class actions for the year -- a slight increase from 2006, but significantly below historical levels.

As many of our readers know, the number of securities fraud cases declined significantly after enactment of the Private Securities Litigation Reform Act in 1995.  Despite this empirical fact, Paulson would have you believe that the opposite is true and that Congress or the SEC must act quickly to make private lawsuits even more difficult.  Similarly, despite the fact that only one securities class action named an auditor as a defendant in 2006, the accounting industry is spending significant time and resources trying to persuade decision makers in Washington that such litigation is a threat to their very existence.

While facts have never stood in the way of Paulson and his ilk, their arguments about the threat posed by private litigation are particularly misplaced.