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Outline Securities Litigation Outline

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Securities Litigation I. SS 10(b) of the Exchange Act and Rule 10b-5 A. In general, SS 10(b) of the Exchange Act proscribes, by the use of any instrumentality of interstate commerce, "any manipulative or deceptive device or contrivance" in connection with the purchase or sale of a security. B. Rule 10b-5 bars by use of any means or instrumentality of interstate commerce or the mails or any facility of any national exchange: i. (1) To employ any device, scheme or artifice to defraud, (2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or (3) to engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person, ii. In connection with the purchase or sale of a security. C. There is an implied right of action under SS 10(b) and Rule 10b-5. See Superintenddent of Ins. v. Bankers Life & Cas. Co.; see also Herman & McLean v. Huddleston ("[A] private right of action under Section 10(b) . . . and Rule 10b-5 has been consistently recognized for more than 35 years. The existence of this implies remedy is simply beyond peradventure.") D. Standing: To have standing to sue in a private action under Rule 10b-5, the plaintiff must be an actual purchaser or seller of the securities. See Blue Chip Stamps v. Manor Drug Stores. (pg. 16) i. The test often applied is whether the purchaser had absolute discretion. a) Under the SS 2(a)(3) of the Securities Act, "sale or sell" includes "every contract of sale or disposition of a security for value."
? "Value" need not be cash or property; relinquishing or granting a right is enough.
? A pledge of a security as collateral is enough. Rubin v. United States(pg. 16)
??? ?Contracts to sell are sufficient even though no sale ever takes place. So is a contingent right to receive stock for value. Yoder v. Orthomoelcular Nutrition Institute (pg. 16) E. ELEMENTS i. (1) Material Misstatement or Omission a) Misstatement or Omission
? A material fact need not be a "fact" in the historical sense; it may include false statements of future intent.
? Projections are actionable if not made in good faith or made with reckless indifference.
? The line between a misstatement and an omission
? This is not always easy to draw.
?????One consequences of the distinction is that for omissions, there is a presumption of reliance. See Affiliated Ute
? Duty to Correct
? "A duty to disclose arises whenever secret information renders prior public statements materially misleading, not merely when that information completely negates the public statement." In re Time Warner Securities Litigation 1


A statement need only be corrected if it was incorrect when made. Gallagher v. Abbott Laboratories
?????BUT "[A] projection is not rendered false when the world turns out otherwise." Gallagher v. Abbott Laboratories
? Duty to Update
? Generally, the mere possession of material nonpublic information does not of itself give rise to a duty of disclosure. See Gallagher v. Abbott Laboratories
? BUT Some courts recognize a duty to update:
? Second Circuit: There is a duty to update in the Second Circuit. See In re Time Warner Securities Litigation
? "[W]hen a corporation is pursuing a specific business goal and announces that goal as well as an intended approach for reaching it, it may come under an obligation to disclose other approaches to reaching that goal when those approaches are under active and serious consideration." In re Time Warner Securities Litigation
?????ASIDE: There is a duty to update required by various stock exchanges (e.g., the NYSE states that a listed company "is expected to release quickly to the public any news or information which might reasonably be expected to materially affect the market for securities.")
? Seventh Circuit: There is no duty to update in the Seventh Circuit. See Gallagher v. Abbott Laboratories
? "We do not have a system of continuous disclosure. Instead firms are entitled to keep silent (about good news as well as bad news) unless positive law creates a duty to disclose." Gallagher v. Abbott Laboratories
? Updates are due "not when something 'material' happens, but on the next prescribed filing date." Gallagher v. Abbott Laboratories
? Statements that mislead by omission include half-truths. See SEC v. Gabelli
? Where a voluntary statement is made, there is a duty to speak completely (i.e., avoid half-truths). See, e.g., First Virginia Bankshares v. Benson
? A breach of a fiduciary duty is generally a matter for state law claims and not for a 10b-5 action. See Santa Fe Industries v. Green
??? ?BUT where there is an actual misrepresentation, the claim will fall under the purview of Rule 10b-5. See Goldberg v. Meridor (finding a violation of Rule 10b-5 based upon issuing stock in exchange for assets where there were misleading disclosures regarding inadequate consideration) b) Materiality
? In general
? To fulfill the materiality requirement "there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." TSC Industries, Inc. v. Northway, Inc. (pp. 172


? An omitted or misstated fact can be either qualitatively or quantitatively material.
? See, e.g., Matrixx Initiatives Inc.v. Siracusano (finding that adverse reaction reports to the use of Zicam were not rendered immaterial simply because there were not enough of them to be statistically significant) (pg. 18)
? Rules of Thumb
? Prof Saunders mentioned a 10% effect on revenues or profits as an old rule of thumb. (pg. 18)
? The Securities Regulation book speaks of a common rule of thumb used to be that a misstatement regarding a financial statement item of 5% or less is not material.
? BUT the SEC staff rejects this approach as too limited in scope. See SEC Staff Accounting Bulletin No. 99
? This bulletin reminds lawyers and accountants to assess materiality in light of the total mix of information; a change of less than 5% could still be material if, for example, it masked a change in sales or earnings trend, changed a loss into income, or vice versa, hides a factor to meet analysts' expectations, concerns a segment of the business that has been identified as playing a significant role in operations, and the like.
? Materiality is generally considered a question of fact
? BUT some lower courts treat materiality determinations as a question of law. See, e.g., Longman v. Food Lion, Inc. (pg. 18)
?????In Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, the Supreme Court determined that materiality did not have to be determined at the class certification stage. (pg. 19) Contingent or Speculative Information or Events
? "[W]ith respect to contingent or speculative information or events . . . materiality 'will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.'" Basic Inc. v. Levinson (quoting SEC v. Texas Gulf Sulphur Co.) (pp. 594-95)
? "[I]n order to assess the probability that the event will occur, a factfinder will need to look to indicia of interest in the transaction at the highest corporate levels." Basic Inc. v. Levinson (pg. 595)
? Indicia of interest includes (1) board resolutions, (2) instructions to investment bankers, and (3) actual negotiations between principals or their intermediaries. Basic Inc. v. Levinson (pg. 595)
? "To assess the magnitude of the transaction to the issuer . . . , a factfinder will need to consider such facts as [1] the size of the two corporate entities and
[2] of the potential premiums over market value." Basic Inc. v. Levinson (pg. 595)
? Merger Discussions 3


In Basic, the Court noted that there is "no valid justification for artificially excluding from the definition of materiality information concerning merger discussions, which would otherwise be considered significant to the trading decision of a reasonable investor." Basic Inc. v. Levinson (pg. 594)
? See also In re Woldcom Sec. Lit (finding that statement denying merger negotiations was material)
?????But see Phillips v. LCI International Inc. (finding the statement "we're not a company for sale" in the middle of merger negotiation was not material)

? "Everyone knows that someone trying to sell something is going to look and talk on the bright side. You sell a product by bad mouthing it." Eisenstadt v. Centel Corp. (pg. 607)
? "It would be unreasonable for investors to attach significance to general expressions of satisfaction with the progress of the seller's efforts to sell, just as it would be unreasonable for them to infer from a potential bidder's apparent lack of enthusiasm that the bidder was uninterested rather than just jockeying for a better price." Eisenstadt v. Centel Corp. (pg. 607)
? "The heart of a reasonable investor does not begin to flutter when a firm announces that some project or process is proceeding smoothly, and so the announcement will not drive up the price of the firm's shares to an unsustainable level." Eisenstadt v. Centel Corp. (pg. 607)
? "'Going smoothly' may mean nothing more than - going; but it means at least that . . . ." Eisenstadt v. Centel Corp. (pg. 607)
? "Where puffing is the order of the day, literal truth can be profoundly misleading, as senders and recipients of letters of recommendation well know." Eisenstadt v. Centel Corp. (pg. 607)
?????In Eisenstadt, the court found that the statement that the auction process was "going smoothly" was not materially misleading as "'[g]oing smoothly' may mean nothing more than - going; but it means at least that . . . ." Thus, the court found that such a statement was merely puffery. Statements of Opinion
? If you lie about what your opinion is, that is material. See Virginia Bankshares, Inc. v. Sandberg (pp. 608-09)
? Objective Falseness
? An assertion of "fairness" could be false because the price was not fair or high.
? This is objective falseness and can be a basis for liability.
? Subjective Falseness
? An assertion of "fairness" could be false because the person making the statement did not believe the price was fair, even if objectively the price was high or even fair.
? This is subjective falseness and is NOT a basis for liability 4


because of its dependence on matters that are not objectively verifiable.
? BUT, if there is objective evidence that you lied about what your opinion is, then that is material.
??? ?In this case, because there was objective evidence before the directors that was inconsistent with their professed opinions, the plaintiffs had pled more than a mere subjective disbelief or undisclosed motive. Forward-Looking Information (e.g., projections, forecasts, etc.)
? In General
? Soft information (e.g., projections) describes events or activities that will occur, if at all, at some future date.
? E.g., Item 303 of Regulation S-K, the MD&A, requires management to disclose trends that are likely to affect the firm's financial performance, liquidity, or capital resources as well as the effects of inflation on operations.
? The line between present and future can be difficult to draw.
?????"The challenges are behind us" is a forward-looking statement. Harris v. Ivax (pg. 19)
? TEST: Does the statement "use current facts only to describe an expectation for the future?" See In re WebMD Health Corp. Sec. Lit. (pg. 19)
?????"[C]ases involving forward-looking statements are unique. . . .
[P]redictions of future performance are inevitably inaccurate because things almost never go exactly as planned. . . . [P]laintiffs must allege 'specific facts which illustrate that the company's predictions lacked a reasonable basis. . . . Projections which turn out to be inaccurate are not fraudulent simply because subsequent events reveal that a different projection would have been more reasonable.'" Moss v. Healthcare Compare Corp. (pg. 611)
? Some Courts: Apply the "guaranty standard"
? Under this alternative test, the Fourth Circuit sometimes determines that whether a forward-looking statement is harmless by a test similar to that employed with respect to puffery.
? The alternative test holds that before a forward-looking statement is material it must rise to the level of a guarantee. See Hillson Partners Ltd. Partnership v. Adage, Inc. (pg. 616)
??? ?This "guaranty standard" is sometimes employed in other Circuits. See, e.g., Lasker v. New York State Electirc & Gas Corp. (pg. 616)
? The "Bespeaks Caution" Doctrine
? The first line of defense for a "missed" forecast under the case law is whether the forecast was accompanied by meaningful cautionary language.
? Under the "bespeaks caution" doctrine, meaningful cautionary language negates the materiality of the alleged misrepresentation or omission. See 5

Kaufman v. Trump's Castle Funding (pg. 614)
? When a "document's forecasts, opinions or projections are accompanied by meaningful cautionary statements, the forwardlooking statement will not form the basis for a securities fraud claim if those statements did not affect the 'total mix' of information the document provided investors." Kaufman v. Trump's Castle Funding (pg. 614)
? "In other words, cautionary language, if sufficient, renders the alleged omissions or misrepresentations immaterial as a matter of law." Kaufman v. Trump's Castle Funding (pg. 614)
? BUT "a vague or blanket (boilerplate) disclaimer which merely warns the reader that the investment has risks will ordinarily be inadequate to prevent misinformation." Kaufman v. Trump's Castle Funding (pg. 615)
? "To suffice, the cautionary statements must be substantive and tailored to the specific future projections, estimates or opinions . . . which the plaintiffs challenge." Kaufman v. Trump's Castle Funding (pg. 615)
? In Kaufman, the court concluded that the cautionary language in the prospectus was sufficient because it "clearly and precisely cautioned that the bonds represented an exceptionally risky, perhaps even speculative, venture, and that the Partnership's ability to repay the bonds was uncertain." Kaufman v. Trump's Castle Funding (pg. 615)
? "'[B]oilerplate' warnings won't do; caution must be tailored to the risks that accompany the particular projections." Asher v. Baxter International, Inc. (pg. 622)
? Examples of boilerplate language include "all businesses are risky" or "the future lies ahead." See Asher v. Baxter International, Inc. (pg. 622)
? "[T]he cautions need not identify what actually goes wrong and causes the projections to be inaccurate; prevision is not required." Asher v. Baxter International, Inc. (pg. 622)
? In Parnes v. Gateway 2000, the court dismissed the suit where the meaningful cautionary language stated that "the Company has experienced, and may continue to experience, problems with respect to the size of its work force and production facilities and the adequacy of its management information systems and inventory controls." (pg. 615)
? In contrast, in Gray v. First Winthrop Corp., the court held that the statement that a real estate project was "subject to the risk inherent in the ownership of real estate" was not sufficient cautionary language. (pg. 616)
??? ?In contrast, in Semerenko v. Cendant Corp., the statement that the forecast was subject to "known and unknown risks and uncertainties including, but not limited to, the outcome of the Audit Committee's investigation" was not sufficient cautionary language. (pg. 616) 6


Statutory Safe Harbor for Forward-Looking Statements
? The Private Securities Litigation Reform Act (PSLRA) added SS 27A to the Securities Act and a parallel provision in SS 21E of the Exchange Act.
?????These sections provide for a statutory safe harbor for forward-looking statements
? The PSLRA defines a "forward-looking statement" as one of six categories:
? (1) A statement concerning a projection of revenues, income, etc.
? (2) A statement of plans or objectives of management for future operations etc.
? (3) A statement of future economic performance
? (4) A statement of the assumption underlying (1) - (3)
? (5) A report by an outside reviewer retained by the issuer to the extent that the report assesses a forward-looking statement by the issuer
? (6) A statement containing a projection or estimate on such other items as may be specified by rule
?????SS 27A(c)(1) of the '33 Act and SS 21E(c)(1) of the '34 Act provide two alternative safe harbors whereby a person is shielded from liability in private actions for forward-looking statements:
? (1) The first safe harbor reaches a forward-looking statement that "is accompanied by meaningful cautionary statements identifying the important factors that could cause actual results to differ materially from those in the forward-looking statement."
? Important factors means the stated factors identified in the cautionary statement must be relevant to the projection and must be of a nature that the factor or factors could actually affect whether the forward-looking statement is realized. PSLRA Conference Committee Report (pg. 618)
? Failure to include the particular factor that ultimately causes the forward-looking statement not to come true will not mean that the statement is not protected by the safe harbor. PSLRA Conference Committee Report (pg. 618)
? "As long as the firm reveals the principle risks, the fact that some other event caused problems cannot be dispositive. Indeed, an unexpected turn of events cannot demonstrate a securities problem at all, as there is no 'fraud by hindsight.'" Asher v. Baxter International, Inc. (pg. 620)
? "[T]he cautions need not identify what actually goes wrong and causes the projections to be inaccurate; prevision is not required." Asher v. Baxter International, Inc. (pg. 622)
? "'[B]oilerplate' warnings won't do; caution must be tailored to the risks that accompany the particular projections." Asher v. Baxter International, Inc. (pg. 622)
? Examples of boilerplate language include "all businesses are 7

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