Rubber Stamp This

Hey there, Mr. CEO. Yeah, you. Think you can just sign those Sarbanes certifications and head off to the Racquet Club for a quick game of squash and a white wine Spritzer (or whatever it is you drink)? Well, you had better think again, especially if you work for (yep, I said it, work for) the shareholders of the American Italian Pasta Company.

That’s right, Judge Ortrie D. Smith (W.D. Mo) (Clinton ’95) has ruled that “by signing the Sarbones-Oxley certifications and the Annual Reports filed with the SEC, [the CEO] indicated he had reviewed and was familiar with the underlying facts giving rise to those documents — meaning he was either aware of the improper accounting, was reckless with regard to the public reports of AIPC’s finances, or had not conducted any review and did not act in accordance with the certifications.” Take your pick.

You can read IN RE AMERICAN ITALIAN PASTA COMPANY, issued June 19, 2006, at 2006 U.S. Dist. LEXIS 40548.

Nugget: “The Court is not intending to imply those who sign such certifications are strictly liable for misstatements. However, it is a factor that may, in appropriate circumstances, demonstrate the person certifying the pronouncement has merely ‘rubber stamped the numbers’ and thereby acted recklessly.”

Ostrich Defendants

“A defendant whose head is in the sand with respect to corporate earnings likely has his head in the sand with respect to his Sarbanes-Oxley certification as well.” So says Judge James L. Robart (W.D. Wash.) in the Watchguard securities class action. He also said that “although the passage of Sarbanes-Oxley may make it somewhat more reasonable to infer that a certifying Defendant whose head is in the sand is being deliberately reckless, it does not transform the PSLRA’s requirement of falsity-plus-scienter into a requirement of falsity-plus-a-Sarbanes-Oxley-certification.”

So “because the PSLRA places the burden on Plaintiffs to plead facts giving rise to a ‘strong inference’ that a defendant’s head was above the sand, or was at least deliberately recklessly buried in the sand, its defendant-friendly provisions trump the plaintiff-friendly Sarbanes-Oxley Act, at least in this case.”

Result? Case dismissed with leave to amend.

You can read In re Watchguard, issued April 21, 2006, at 2006 U.S. Dist. LEXIS 27217.

Nugget: “Corporate officers make mistakes. If the market is efficient, it will punish corporations whose mistakes are too frequent or too egregious. Securities fraud, however, requires much more than a mistake — it requires a misstatement that was either intentional or deliberately reckless.”

Right Back Where We Started

After an unscheduled stop at the Eleventh Circuit, Judge Steven D. Merryday (M.D. Fla.) seemed a bit frustrated in the Tello v. Dean Witter action. Why? Well, because, as he put it, “the circuit court leaves unclear both why the issue of ‘inquiry notice’ might be resolvable by the district court without a jury and why resolution of a motion to dismiss pursuant to Rule 12(b)(6) requires an evidentiary hearing.” Indeed, he said he “is unaware of any precedent except this case for that procedure.”

But, pushing forward, he ordered limited discovery on the statute of limitation issue anyway, which eventually resulted in the submission by both sides of “memoranda accompanied by thirty-two exhibits comprising hundreds of pages of deposition, newspaper and magazine stories, business journal articles, online message-board postings, newspaper and magazine circulation data, annual corporate reports, and pertinent stock transactions–all of which the parties supplemented at the December 19, [2005] hearing by two hours of vigorous oral argument.” At the end of all this (which no doubt must have been overwhelmingly fun), Judge Merryday observed that “unsurprisingly, the plaintiffs’ theory places inquiry notice on October 1, 2002, after the effective date of Sarbanes-Oxley,” and of course “equally unsurprisingly, the defendants’ theory places inquiry notice on or before August 14, 2000.”

The result? Judge Merryday said that “because the circuit court acknowledges that resolving a disputed issue of inquiry notice is within the exclusive province of a jury, and because the plaintiffs in this case have demanded and perfected their right to a jury trial, the district court interprets the circuit court’s mandate to require a determination whether, without improperly invading the province of the jury (that is, without resolving a “genuine issue of material fact”), the district court can identify the moment at which the plaintiffs were on “inquiry notice” of the alleged, actionable fraud.” So “after affording the parties a full hearing on the inquiry notice question, the district court finds no such moment.” “The parties’ irreconcilable versions of the pertinent history present genuine issues of material fact resolvable only by a jury.”

So, after four years of litigation, it seems like the action is about where it was the day it was filed. Sounds like a great system, huh?

You can read Tello V. Dean Witter, issued January 25, 2006, at 2006 U.S. Dist. LEXIS 5211.

Nugget: “This remand to the district court results in an unusual event: a proceeding to determine a fact that the circuit court finds dispositive of a motion to dismiss under Rule 12(b)(6), Federal Rules of Civil Procedure (the disposition of which, to say the least, normally involves no judicial fact finding).”

Sarbanes Certifications Back to Bite Execs

Think those Sarbanes Oxley certifications your CEO and CFO signed won’t add to Plaintiffs’ scienter allegations? Well, think again, at least if you are the former executives in the Lattice Semiconductor securities class action. You see, the execs argued that execution of the “certifications does not raise a strong inference” of scienter, because they “are required of every CEO and CFO of publicly traded companies, without exception.”

But Judge Ann Aiken (D. Or.), in finding this argument “unpersuasive,” concluded that the “certifications give rise to an inference of scienter because they provide evidence either that defendants knew about the improper journal entries and unreported sales credits that led to the over-reporting of revenues (because of the internal controls they said existed) or, alternatively, knew that the controls they attested to were inadequate (because [the Controller] had made unauthorized or improper entries that overrode the internal controls).”

Hey, can’t blame them for trying, right?

You can read In re Lattice Semiconductor, issued January 3, 2006, at 2006 U.S. Dist. LEXIS 262.

Nugget: “The Sarbanes-Oxley certifications, in combination with plaintiffs’ allegations of regular finance meetings, extensive access to databases, periodic reports and special reports, and the allegations that they were micromanagers, are sufficient to create a strong inference of actual knowledge or of deliberate recklessness.”

Sarbanes 304 Finally Addressed

In what appears to be the first time in a reported securities class action decision, a court has addressed the issue of whether private investors can seek to disgorge personal profits from the CEO and CFO under Section 304 of Sarbanes-Oxley. In the Qwest action, Judge Robert E. Blackburn (D. Colo.) took a look at the provision, which could force the two execs to pay back “any bonus or other incentive-based or equity-based compensation” earned “during the 12-month period following the first public issuance” of a “accounting restatement” made “as a result of misconduct.”

Qwest’s CFO, Robin Szeliga, argued that Plaintiff “does not have standing to assert a claim under § 304 because the statute provides only for reimbursement to the issuer which, in this case, is Qwest.” Judge Blackburn agreed, holding that Plaintiff “is not entitled to the reimbursement required by the statute” because he “is not asserting derivative claims on behalf of Qwest.” Therefore, Plaintiff “does not have standing to assert a claim against” the CFO under § 304 and it “should be dismissed.”

Plaintiffs probably shouldn’t feel too bad though. First, they just negotiated a $400 million partial settlement. And second, the other two reported decisions on Sarbanes 304 are both derivative actions, and both courts ruled that Plaintiffs had no authority to bring 304 claims as the statute does not provide them with a private right of action. Guess the SEC is going to have to enforce 304. Remains to be seen if they are ever going to get serious about it though.

You can read In re Qwest, issued September 12, 2005, at 387 F. Supp. 2d 1130.

Nugget: “Qwest restated its GAAP revenues for this period from $ 40.674 billion to 37.8 billion, an overstatement of $ 2.874 billion, and its losses from $ 4.802 billion to $ 30.290 billion, an understatement of $ 25.488 billion.”