Oligarch’s Unique Defense Won’t Fly

What do a Siberian prison, a brutal knife attack, and the richest oligarch in Russia all have in common? Why, the Yukos Oil Company securities class action, of course. You see, “in October 2003, the Russian Federation arrested Yukos’ President, Mikhail Khodorkovsky (“Khodorkovsky”), and seized his equity holdings in the Company. Soon thereafter, the Russian Ministry of Taxation charged Yukos with underpaying the previous years’ taxes by approximately $ 27.5 billion” (did he say billion, with a B?) “and the Russian Federation confiscated Yukos’ primary assets, sending the Company into an economic tailspin.”

Judge William H. Pauley III ‘s (SDNY) opinion on the motion to dismiss is long and reaches various results, but is notable for its analysis of the “state doctrine” defense. The what you ask? Don’t feel bad, the Nugget never heard of it either, but apparently it “prevents the courts of the United States from questioning the validity of public acts (acts jure imperii) performed by other sovereigns within their own borders.” See where this is going? Basically, Defendants argued that “the adjudication of this dispute inevitably will require this Court to inquire into the actions and motives of the Russian Government.”

Well, Judge Pauley, in rejecting the argument, first noted that “Defendants have not cited any precedent invoking the act of state doctrine to abstain from adjudicating a securities fraud action.” Of course, even if they had, their new argument seemed destined for failure, as Judge Pauley pointed out that “under the arguments advanced by Defendants, the doctrine would mandate abstention from any action in which a foreign corporation is alleged to have concealed conduct deemed illegal by its home country upon a defendant’s mere assertion that the sovereign’s determination was in error. Such an application of the act of state doctrine would effectively insulate foreign corporations from a large swath of securities fraud claims by United States investors.”

So whatever happened to that Khodorkovsky fellow that fifteen Russian FSB agents arrested as he stepped off his private jet? Well, it looks like he’s pulling a nine year stint in Prison Camp 13 (yes, in Siberia), where he was recently slashed and disfigured by knife wielding attackers (his attorneys say it was orchestrated by the guards). It’s true, really, see here and here. Good thing for Scrushy he didn’t live in Russia, huh?

You can read In re Yukos, issued March 30, 2006, at 2006 U.S. Dist. LEXIS 13794.

Nugget: “Moreover, Plaintiffs’ scienter allegations stem from the Russian Federation’s arrest of two other oligarchs, Boris Berezovsky and Vladimir Gusinsky, who openly criticized Putin.”

Uncertain Terrain

It’s not every day you have a Russian company as a Defendant in a U.S. securities class action, is it? But today is the day, and the spotlight is on Open Joint Stock Company Vimpel-Communications, which has nearly 11,000 employees trying to provide “wireless communications services to customers in Russia and Kazakhstan.” And you think your job is hard. Anyway, Defendants moved to dismiss Plaintiffs allegations that Vimpel “failed to disclose the existence of a tax audit,” and that it “owed back taxes,” and it was up to Judge Naomi Reice Buchwald (S.D.N.Y.) to settle things, and she has.

You see, in evaluating the consolidated amended complaint (“CAC” for short), Judge Buchwald concluded that “based on the facts set forth in the CAC, Russian tax laws present an uncertain terrain for individuals and companies doing business there. None of the facts set forth in the CAC support the conclusion that VimpelCom officers knew (or should have known) that the August 2004 tax inspection would result in adverse consequences to VimpelCom or that the company’s interpretation of tax laws related to VAT was ‘highly unreasonable.’”

“Plaintiffs’ allegations also do not demonstrate how VimpelCom’s public statements during the class period were inconsistent with the existence of the August 2004 tax inspection,” and “the fact that VimpelCom promptly disclosed tax authorities’ preliminary conclusions concerning the company’s tax liability further undermines the allegation that defendants acted recklessly.” As a result, “plaintiffs’ allegations completely fail to support a conclusion that defendants acted with an intent to deceive or defraud the public.”

Result? Dismissed with prejudice.

Want more? For a quick viewpoint on the Russian tax system compared to the U.S., go here.

You can read In re Vimpel, issued March 14, 2006, at 2006 U.S. Dist. LEXIS 10256.

Nugget: “This seems a quintessential case of impermissibly pleading ‘fraud by hindsight.’ Plaintiffs’ allegations do not suggest how VimpelCom could have known that it would owe ‘back taxes’ related to VAT offsets before it received the preliminary act from Russian tax officials. Moreover, the allegations do not suggest why the company should have suspected that its method of handling VAT offsets was improper.”

China Oil Fends Off U.S. Investors

The 10b-5 Daily has been carefully following events related to the relationship between China and securities class actions, posting as recently as last Friday on the emerging issue. This is all very timely, as last week Judge Robert P. Patterson (S.D.N.Y.) issued a ruling in China Aviation Oil (which is majority owned by the Chinese government) regarding Plaintiffs’ request “for Letters Rogatory to effect service on defendants residing in Singapore.” (The company is managed from Singapore).

Judge Patterson, in applying the oft-used “conduct and effects tests” denied Plaintiffs’ request because the complaint did not “indicate any activity by the Defendants in the United States.” He also rejected Plaintiffs attempt to use China Oil’s website as a basis for jurisdiction, holding that “were the Court to view it otherwise, any foreign corporation with a website would be subject to securities fraud litigation in the United States if a United States resident had bought its securities from some market maker in this country.” So looks like this one may have to be litigated somewhere else. Of course, that doesn’t mean investors should shy away from Chinese companies, as other investors have enjoyed a different outcome.

You can read Burke v. China Aviation Oil, issued November 29, 2005, at 2005 U.S. Dist. LEXIS 30124.

Nugget: “Plaintiff’s attempt to equate information obtained via a website with mail directed to the stockholder… is rejected.”

Oh Canada

Where’s a Lead Plaintiff to sue when a Company’s securities are traded on various exchanges located in different countries? Well, if any of it is traded here in the U.S., the investor can try and sue here. But that doesn’t mean the case will actually stay here. You might recall a few months ago, when the Nugget reported on Bayer AG shareholders who were sent packing to Germany because only 8% of the stock was traded on a U.S. exchange. This time, it’s 12% of Canadian based Royal Group Technologies, and you guessed it — the same result. Judge Harold Baer, Jr. (S.D.N.Y.) held that the action should be brought in Canada, as it is an “adequate alternative forum.”

By the way, if you do plan to try this, you might want to have a Plaintiff who hails from the U.S. of A, as the two Lead Plaintiffs (an individual and the Canadian Commercial Workers Industry Pension Plan) in this action were both “Canadian citizens.” This certainly didn’t help matters, as Judge Baer held that “the named plaintiffs’ lack of bona fide connections to this district indicates that their choice of forum should be accorded less deference than that due a resident plaintiff seeking redress.”

You can read In re Royal Group Technologies, issued November 21, 2005, at 2005 U.S. Dist. LEXIS 28688.

Nugget: “While plaintiffs are correct that depositions can be taken abroad pursuant to letters rogatory, live testimony is especially important in a fraud action where the factfinder’s evaluation of witnesses’ credibility is central to the resolution of the issues.”

Foreign Purchasers Sent Packing

So you are a foreigner who purchased securities of Bayer AG on a foreign exchange, but you want to sue here, in the Good Ole’ US of A. Everyone together now, Home, to a new and a shiny place… Well, never mind all of that, because not even Neil Diamond himself can save you now, because Judge William H. Pauley III (S.D.N.Y.) has spoken. True, he did say he will “retain the claims of domestic purchasers.” However, that doesn’t help you, “because United States investors held an exceptionally small percentage,” (eight percent to be exact), “of the total number of shares,” and so “Plaintiffs cannot demonstrate a substantial or significant effect upon United States citizens to support jurisdiction over the Foreign Purchasers.”

Therefore, “the magnitude of Bayer AG’s conduct abroad and the overwhelming number of Foreign Purchasers affected thereby militate against a finding that Congress would have wished the precious resources of the United States courts and law enforcement agencies to be devoted here.” “With respect to the Foreign Purchasers, fraud there might have been, and the Foreign Purchasers may very well have been damaged by its perpetration,” “but the dispute here presented is rightfully resolved in the court of another land.”

But hey, all is not lost right? Since most of the shares are “being held in Germany and in over 130 other countries,” those investors should have no problem getting a class certified in their respective civil law jurisdictions. Better book now for your trip to Leverkusen.

You can read In re Bayer AG, issued September 14, 2005, at 2005 U.S. Dist. LEXIS 19908.

Nugget: “Based on the above, this Court concludes that resting jurisdiction on this eight percent United States investment raises concerns that a ‘very small tail may be wagging an elephant’ of Foreign Purchasers.”

Court Wields SLUSA in Tossing Mutual Fund Action

In October 2003, an investor filed a putative class action in Madison County, Illinois against the Templeton Funds, alleging that the Fund “breached a duty of care owed to investors by using stale pricing information to value securities in their open end mutual funds” (to be more specific, during the interval that elapses between when the Fund sets its share Net Asset Value (or “NAV”) and releases it to the NASD for communication to the public, securities markets in countries such as Japan, Russia, Germany, and Australia have traded for an entire session, thus making the prices stale).

Anyway, a month after the case was filed, Templeton promptly removed the action to the Southern District of Illinois. However, Judge Michael J. Reagan sent the case back to the state court, finding that his federal forum had no subject matter jurisdiction. Over a year later, Defendants again removed the case, “claiming that the Seventh Circuit’s April 5, 2005 opinion in an unrelated case, Kircher v. Putnam Funds Trust, 403 F.3d 478 (7th Cir. 2005), rendered” the action “freshly removable.” Judge Reagan noted that the Seventh Circuit’s opinion held that “SLUSA’s removal and preemption provisions are triggered when four conditions are met: (1) the underlying suit is a “covered class action,” (2) the action is based on state or local law, (3) the action concerns a “covered security,” and (4) the defendant misrepresented or omitted a material fact for employed a manipulative or deceptive device or contrivance “in connection with the purchase or sale” of that security.” Since the judge found that the four conditions had been satisfied, he held removal proper, and further found that “Kircher mandates that this Court dismiss all of Plaintiffs’ state law claims as barred by SLUSA,” as SLUSA “effectively blocks state court litigation of such claims.”

You can read the decision, issued July 12, 2005, at 2005 U.S. Dist. LEXIS 14500.

Nugget: “Plaintiffs — whose briefs focused on removal under 28 U.S.C. § 1446(b) — have not addressed the removability of the case under the above-cited SLUSA provision. Nor have Plaintiffs disputed Defendants’ argument that the allegations in this action are ‘identical’ to those examined by the Seventh Circuit in Kircher.”

Deloitte Ordered to Hand Over Foreign Documents

After reading this one, you might not take blowing off providing a detailed privilege log so lightly next time. You see, in connection with the Parmalat securities litigation, Deloitte Touche Tohmatsu (“DTT”) (known since 2003 simply as the brand “Deloitte”) will be required to “produce documents located in Switzerland that were provided to it by member firms of the Deloitte organization, allegedly for the purpose of obtaining legal advice in connection with an investigation into the Parmalat scandal by the S.D.N.Y. U. S. Attorney.”

First, an understanding of how major international accounting firms are structured is helpful. Basically, “Deloitte and other such organizations consist of individual firms organized under the laws of each of the countries in which business is done, as well as an umbrella entity with which the individual, country-specific firms are affiliated. In Deloitte’s case, DTT is the umbrella organization, and it is organized as a verein under Swiss law, a form of business organization that DTT asserts is analogous to an incorporated membership association. According to DTT, it ‘does not control its member firms’ and performs no accounting or auditing services.”

Well, “when it became apparent that there would be litigation relating to Parmalat, DTT engaged a U.S. law firm to provide legal advice to DTT and on behalf of certain member firms that conducted the Parmalat Audits and which it coordinated. Some member firms provided DTT in Switzerland with documents concerning the Parmalat audits for review by that law firm. Others allowed the law firm to go to their offices in their respective home countries to review documents. To whatever extent DTT possesses or controls documents relating to the Parmalat audits, it asserts, it does so only by virtue of the foregoing. These documents would have been unobtainable by subpoena prior to their transfer to DTT, it contends, and they therefore should be unobtainable now by virtue of the attorney-client privilege.”

Unfortunately for Deloitte, this wasn’t good enough to keep Judge Lewis A. Kaplan (S.D.N.Y.) from telling it to fork the documents over. He began by posing the “threshold question” of “whether these documents would have been obtainable by subpoena in the hands of the DTT member firms.” To that he answered: “there simply is no way to tell on this record.”

Why? Well, first he noticed that “there is no privilege log.” Oops. Nor had DTT disclosed the “identities of the producing firms, the documents as to which DTT asserts privilege, nor the identities of the firms that also retained DTT’s U.S. law firm.” Double oops. Judge Kaplan held that “these are not irrelevant details,” noting that the rules require that any party objecting to disclosure on grounds of privilege produce a privilege log, and that DTT’s failure to provide one is by itself sufficient basis to overrule their objection.

Secondly, “and independent of the prior point, the vagueness and opacity of Deloitte’s presentation prevents anything other than an ill-informed guess as to whether the documents sent to Switzerland by member firms could have been obtained by compulsory process directly from the member firms. It may well be that some or, indeed, all of the producing firms are subject to U.S. compulsory process and perhaps even more likely that the materials could be obtained pursuant to the Hague Convention on Taking Evidence in Civil or Commercial Matters.”

Better fire up that Xerox. What’s the moral? You be the judge. But a good start would sure seem to be providing that privilege log, and perhaps easing up a bit on that perennial favorite two-step called the “overbroad and unduly burdensome” routine.

You can read the decision at 2005 U.S. Dist. LEXIS 12554.

Nugget: “Documents held by an attorney in the United States on behalf of a foreign client, absent privilege, are as susceptible to subpoena as those stored in a warehouse within the district court’s jurisdiction.”

Accounting Firms’ Foreign Subsidiaries in For the Long Haul

In the Parmalat securities litigation, Judge Lewis A. Kaplan (S.D.N.Y.) has ruled that the Italian subsidiaries of Deloitte and Grant Thornton will not be dismissed from the action, despite their argument that they “each are factually and legally separate from their Italian affiliates and therefore cannot be liable for the affiliates’ alleged fraud.” Although the court rejected Plaintiffs’ alter ego argument, it did find that “an agency relationship existed between [Deloitte, Grant Thornton,] and its member firms that conducted the Parmalat audit. As principals, they would be responsible for the actions of their agents and the knowledge and, consequently scienter, of their agents is imputed to them.”

In addressing the causation elements of Dura, Judge Kaplan found it “difficult to imagine that the markets would not have moved on the basis of reports by Parmalat’s independent auditors,” and therefore held that Plaintiffs “have pleaded transaction causation sufficiently.” As for loss causation, the court found Plaintiffs met that hurdle too, holding that “an allegation that a corrective disclosure caused the plaintiff’s loss may be sufficient to satisfy the loss causation requirement, [but] it is not, however, necessary.” The court went on to observe the fact “that the true extent the fraud was not revealed to the public until February – after Parmalat shares were worthless and after the close of the Class Period – is immaterial where, as here, the risk allegedly concealed by defendants materialized during that time and arguably caused the decline in shareholder and bondholder value.”

Last, but certainly not least, Judge Kaplan confessed he “is in substantial sympathy with defendants” with respect to their motion “to dismiss the complaint under Rules 8(a)(2) and (e)(1), [because] at 368 pages and 1,249 paragraphs, it is too long and confusing.” He remarked that “the requirement of pleading fraud with particularity does not justify a complaint longer than some of the greatest works of literature. A complaint of this length, indeed, is an undue imposition on all who are obliged to read it. Nevertheless, a dismissal under Rule 8 is usually reserved for those cases in which the complaint is so confused, ambiguous, vague, or otherwise unintelligible that its true substance, if any, is well disguised. Although plaintiffs’ submission is lengthy, it does not overwhelm the defendants’ ability to understand or to mount a defense, [and therefore] it will not be dismissed under Rule 8.”

You can read the decision, issued June 28, 2005, at 2005 U.S. Dist. LEXIS 12553.

Nugget: “The significance of the corporate form to the development of capital markets and economic progress in general cannot be denied. Nevertheless, the limited liability entity is not an unmitigated blessing. The limitation of liability that encourages capital formation in some circumstances may eliminate disincentives to fraudulent behavior.”

Nugget: “Independent auditors serve a crucial role in the functioning of world capital markets because they are reputational intermediaries. In certifying a company’s financial statements, their reputations for independence and probity signal the accuracy of the information disclosed by the company, the managers of which typically are unknown to most of the investing public.”

Nugget: “Certification by an entity named Deloitte & Touche, Grant Thornton, or one of the small handful of other major firms is incalculably more valuable than that of a less known firm because the auditor “is in effect pledging a reputational capital that it has built up over many years of performing similar services for numerous clients.”

Nugget: “In consequence, allowing those organizations to avoid liability for the misdeeds and omissions of their constituent parts arguably could diminish the organizations’ incentives to police their constituent entities, with adverse consequence for participants in capital markets.”