A Whole Lot of No Fraud

OK, here’s a hint for all you ’33 Act groupies. If you allege that your Section 11 claim “is the stuff of a quintessential fraud claim” then, um, you’re probably not going to win an argument that your claim doesn’t, well, sound in fraud. I mean try and imagine being slated to do the oral argument in that one? No, Your Honor, quintessential fraud means so much fraud that there actually isn’t any fraud — I mean, that’s a lot of no fraud Judge.

But, believe it or not, that seems to be exactly what Plaintiffs in the Capital Bancorp action did (at least in writing, and we’re sure not on purpose), and it brought a swift ruling from Judge Phyllis J. Hamilton (N.D. Cal.) (Clinton Class of ‘00) who noted that — are you ready for the cliffhanger ending — “plaintiffs’ complaint “sounds in fraud.”

Result? Complaint dismissed with partial leave to amend.

You can read Rubke v. Capital Bancorp, issued June 16, 2006, at 2006 U.S. Dist. LEXIS 43745.

Nugget: “Where the complaint makes a wholesale adoption of the securities fraud allegations for purposes of the 1933 § 11 claim, the Ninth Circuit has held that the district court is not required to sift through allegations of fraud in search of some ‘lesser included’ claim of strict liability. It may dismiss. If it does so, it should ordinarily accept a proffered amendment that either pleads with the requisite particularity or drops the defective allegations and still states a claim.”

Too Much Fraud

“This is a classic fraud case masquerading as a negligence claim.” At least that’s what Judge Charles R. Breyer (N.D. Cal.) says about the 1933 Act claims in the Leadis Technology (NASDAQ LDIS) securities class action. You see, in throwing out the entire action, Judge Breyer held that “while plaintiffs need not prove fraud, the gravamen of the Complaint is nevertheless ‘grounded in fraud.’ Thus, the heightened pleading standard of Rule 9(b) applies.” He also noted that “Plaintiffs have admitted the Complaint fails to meet the particularity requirements of Rule 9(b), and the Court agrees.” Therefore, “since plaintiffs have further represented to the Court that an amendment to the Complaint would be futile, defendants’ motions to dismiss are GRANTED WITH PREJUDICE.”

For the Third Circuit’s and another District Judge’s views on the sound in fraud doctrine, take a look here and here.

You can read In re Leadis, issued March 1, 2006, at 2006 U.S. Dist. LEXIS 11152.

Nugget: “This is a quintessential fraud claim. Despite plaintiffs’ best efforts to mask this reality and merely plead a negligence claim, their allegations necessarily depend on defendants’ knowledge of these on-going occurrences and their decision to mislead investors by making the disclosures in forward-looking-rather than present-tense-statements.”

Third Circuit Clamps Down on Sound in Fraud Rule

If you’ve ever litigated 1933 Act and 1934 Act claims together, than you’ve no doubt made or defended the “sound in fraud” argument. If you’re a Plaintiff, you know the frustration of trying to draft the two claims together while alleging fraud on one hand — and negligence on the other. And if you’re a Defendant, you know how fun it is to try to convince the Judge that Plaintiff should have done just that. Well Plaintiffs, you finally may have found a sympathetic ear in the Third Circuit.

You see, in the Suprema Specialties (the melted cheesemaker) securities class action, the Panel reversed most of Judge William H. Walls’ (D. N.J.) complete dismissal of both ’33 and ’34 Act claims, holding that “where, as here, individual defendants are accused in separate claims of the same complaint of having violated Section 11, Section 12(a)(2), and Section 10(b), the Securities Act claims do not sound in fraud if ordinary negligence is expressly pled in connection with those claims. In such a case, the fraud allegations cannot be said to ‘contaminate’ the Section 11 and Section 12(a)(2) claims if the allegations are pled separately.” “Here, ordinary negligence is alleged in the Section 11 and Section 12(a)(2) claims, and those claims are pled separately from the Section 10(b) fraud claims against the same defendants. That is enough to avoid triggering Rule 9(b). A contrary result would effectively preclude plaintiffs from filing suit under Section 11 and Section 12(a)(2) as well as Section 10(b)(5). There is no suggestion that Congress intended such an incongruous approach.”

“In short, the reputational concerns that animate Rule 9(b) with respect to a defendant accused of fraud are not implicated when a defendant stands accused of nothing more than negligence.” So, “because the Section 11 and Section 12(a)(2) claims of the plaintiffs here were expressly negligence-based and pled distinctly in the complaint from the fraud-based claims, it was error for the District Court to hold that they sound in fraud. Accordingly, we will vacate the dismissal of these claims.”

Be sure to also check out the decision for rulings on inside trading, accountants’ liability, and tracing issues.

You can read In re Suprema, issued February 23, 2006, here, or at 2006 U.S. App. LEXIS 4307.

Nugget: “To be sure, the ‘sounds in fraud’ determination for Securities Act claims will not always be clear cut in cases where the plaintiff simultaneously raises claims against the same defendants under a provision that requires a showing of scienter, like Section 10(b). But where the plaintiff has exercised care in differentiating asserted negligence claims from fraud claims and in delineating the allegations that support the negligence cause of action as distinct from the fraud, the determination is straightforward.”

Buried Warnings Insufficient

Here’s a word to all of you future securities class action Defendants out there. Make sure those “warnings” in your IPO papers are upfront and personal. Why? Because in the NYFIX action, Judge Janet C. Hall (D. Conn.) has rejected Defendants’ attempt to rely on its risk disclosures, holding that “while not any more obscure than many other disclosures in the report, they are not prominently referenced in the table of contents, appear towards the end of the report, and are in the same font as most of the report. Thus, although the court does not hold that the disclosures were legally insufficient to put an investor on inquiry notice, it also cannot hold, as a matter of law, that they were sufficient for this purpose.”

Judge Hall also stymied Defendants’ argument that investors should have been on inquiry notice of the alleged fraud years before the truth was revealed, finding that an “important factor” “is that NYFIX’s financial statements were audited and approved by an accounting company.” Thus, she held that “it is not reasonable to expect a person of ordinary intelligence to examine them in detail for accounting errors.”

Of course, it didn’t much matter for these Plaintiffs, as Judge Hall dismissed the entire action because the ’33 Act claims sounded in fraud, and Plaintiffs failed to plead scienter. She gave them 21 days to amend, so perhaps we’ll see this one again down the road.

You can read Johnson v. NYFIX, issued October 26, 2005, at 2005 U.S. Dist. LEXIS 25899.

Nugget: “Considering that an accounting firm found the accounting to be proper, it would be unfair to expect investors with far less accounting expertise to pick apart NYFIX’s accounting.”

Dura a Dud Again

Judge Harvey Bartle III (E.D. Penn.) has finished evaluating Defendants’ motions to dismiss in the Vicuron Pharmaceuticals securities class action. In denying their requests to toss the 1933 and 1934 Act claims against the company and its officers and directors, the court evaluated the shareholders’ claims that “defendants made numerous materially false and misleading statements concerning anidulafungin,” a drug “in development for the treatment of esophageal candidiasis (‘EC’).”

The court had little trouble finding intent as “anidulafungin was Vicuron’s lead product in development, which in itself supports a finding of scienter for alleged misrepresentations as to it.” As for loss causation, Judge Bartle recognized that Dura held that “artificial inflation itself is not enough.” But that didn’t help Defendants, as the judge found that “loss causation has been adequately pleaded” because Plaintiffs alleged (1) that “as a result of the partial disclosure by the Company of the FDA letter, including the shocking news regarding the lack of support for a label claim for EC, the price of Vicuron plummeted,” (2) that “when investors were informed of the implications of the ‘approvable letter’, the true impact of the relapse rate data and the unproven superiority of anidulafungin in the treatment of refractory disease, the market price of Vicuron stock collapsed,” and (3) that “the amended complaint also specifically states that plaintiffs and other members of the Class were deceived and caused to purchase Vicuron securities at inflated prices and to sustain damages.”

Finally, the court rejected Defendants’ sound-in-fraud argument, which attempted to apply Rule 9(b) to the 1933 Securities Act claims. Judge Bartle held that “plaintiffs have drafted this claim without reference to any mental state,” and “while the amended complaint specifically incorporates the foregoing paragraphs into the § 11 claim, it also reads: ‘Plaintiffs for the purposes of this claim, disclaim any allegations of fraud.’”

You can read In re Vicuron, issued July 5, 2005, at 2005 U.S. Dist. LEXIS 15613.

Nugget: “In the amended complaint, plaintiffs have emphasized certain text of excerpted portions in bold and italicized lettering. We interpret the distinction to indicate that the emphasized portions are what plaintiffs claim to be actionable. We will read the plain text portions as simply context for the emphasized portions.”

Ninth Circuit Amends Daou Decision. Holds Fast on Loss Causation.

When the Ninth Circuit issued its opinion in the Daou securities class action this past February, the U.S. Supreme Court hadn’t yet decided Dura Pharms., Inc. v. Broudo, 125 S. Ct. 1627 ( 2005). However, the day after Dura was decided on April 19, 2005, the panel, consisting of Circuit Judges Betty B. Fletcher, Harry Pregerson, and Melvin Brunetti ordered the parties to brief Dura’s impact on their original opinion. Sort of makes one wonder why they just didn’t wait a couple more months for Dura to be decided before issuing the original opinion. How much could two more months hurt an appeal that was filed during Thanksgiving of 2002? At any rate, the old opinion has been amended, and unless you saved a copy of it, you might want to grab it here before the judges send it to that warehouse where they put the Ark in the first Indiana Jones film.

What’s the bottom line? Well, it seems Dura didn’t change the final result (that Plaintiffs sufficiently alleged loss causation and damages) one bit. However, consistent with Dura, the Ninth Circuit modified the final three factors it uses to evaluate the basic elements of a securities fraud claim from causation, reliance, and damages to “a connection with the purchase or sale of a security, transaction and loss causation, and economic loss.” In analyzing these three factors, the Panel knocked the first one out in a single sentence, saying “plaintiffs have sufficiently alleged a connection.” The court also disposed of the economic loss prong in two sentences, holding that the complaint’s “assertions of a steep drop in Daou’s stock price following the revelation of Daou’s true financial situation” are sufficient. The only real discussion occurred in the analysis of the causation requirements. In a somewhat fact-specific analysis, the court held that Plaintiffs allegations regarding the “disclosures of Daou’s true financial health, the result of prematurely recognizing revenue before it was earned, led to a “dramatic, negative effect on the market, causing Daou’s stock to decline to $ 3.25 per share, a staggering 90% drop from the Class Period high of $ 34.375 and a $ 17 per share drop from early August 1998.” Draw your own conclusion, but the italics in that sentence was added by the court, not the Plaintiffs.

The other significant holding in the case (which didn’t change from the original opinion, but is interesting nonetheless) relates to 1933 Act claims sounding in fraud. The court accepted the doctrine, and found Plaintiffs ’33 Act claims did in fact sound in fraud. However, it also found that Plaintiffs met Rule 9(b)’s standard for pleading fraud with particularity, and refused to dismiss those claims. For reasons unknown, Plaintiffs appear to have incorporated the ’34 Act allegations into their ’33 Act counts. The court seemed persuaded that this makes all the ’33 Act claims sound in fraud. Might not want to do that next time.

You can read the amended decision, issued June 21, 2005, here or at 2005 U.S. App. LEXIS 1641.

Nugget: “As long as the misrepresentation is one substantial cause of the investment’s decline in value, other contributing forces will not bar recovery under the loss causation requirement but will play a role in determining recoverable damages.”