It's Now Time to Resurrect Our Investor Protection Laws

The National Association of Securities and Consumer Law Attorneys has long fought for the protection of investor rights. But back in 1994, Christopher Cox, our current SEC chairman....the chairman under whose watch this current financial fraud crisis occurred, helped lead the charge to make it nearly impossible to bring a suit against big corporatations who were committing securities fraud. That law was innocently called the Private Securities Litigation Reform Act, or PSLRA.

Again,  in 1998, Mr. Cox was part to the Congress who struck down state laws protecting investors with the passage of the the Securities Litigation Uniform Standards Act, or SLUSA.

One needs ask whether the current crisis is based on lax standards permitting fraud, misrepresentations and omissions to go unanswered as a result of these laws. Like the bust of the dot.com bubble a few years earlier (and the failures of Enron, Worldcom and Tyco ) which Wikepedia ( http://en.wikipedia.org/wiki/Dot-com_bubble  ) defines as having been caused by a "canonical "dot-com" company's business model [which] relied on harnessing network effects by operating at a sustained net loss to build market share (or mind share)," the investment banks, General Electrics, etc. all relied on a similarly "comical" business model of lending (at unrealistic rates, or with cheap introductory rates) at a net loss to build assets whidh they could then sell or pawn off on cash rich investors. As with the dot.com's the "motto "get big fast" reflected this strategy." And also like the dot.coms, where "companies relied on venture capital and especially initial public offerings of stock to pay their expenses," and the "novelty of these stocks, combined with the difficulty of valuing the companies, sent many stocks to dizzying heights and made the initial controllers of the company wildly rich on paper, ' in the investment banks and other asset lenders relied on the Schwabs and Ameritrades, to funnel investor's hard earned cash into novel derivatives (mortgage backed securities and asset-back securities) which were impossible to value, and whose credit risk was unsupported.

Everyone recognizes the need to regulate such out-of-control activity. A need to go back to the days of accountablity. But we cannot do this with big corporations being protected from decieving the public and immune from lawsuit. NASCAT has a recommendation. In a press release dated September 22, 2008, NASCAT states:

“During the past two years, even while Wall Street firms were handing out tens of billions of dollars in bonuses to executives, many of these same firms had misrepresented the value of mortgage backed securities (MBS) and collateralized debt obligations (CDOs) held on their own books and sold to other investors.  At the same time, the actual subprime mortgage loan originators misrepresented the strength and integrity of their lending policies and procedures.  On Friday, Federal Reserve Chairman Bernanke said our problem stems from what in fact were ‘lax underwriting practices’ that were not truthfully disclosed.  Had these corporations been honest about their practices and the true value of, and risks inherent, in these securities, the current crisis may never have developed as it did.

“These practices were not victimless excesses stemming from market exuberance. The calculated wrongdoing of many financial executives has now placed the hard won savings and retirements of the majority of Americans at risk.  At risk are the pensions covering many of NASCAT’s clients including public school teachers, firemen, policemen, union workers and the individual retirement accounts and plans of tens of millions of more Americans. 

“Recognizing this wrongdoing for what it was, state attorneys general, our frequent allies in the fight to uphold investor protection and recover fraud losses, had begun in 2003 to investigate the abusive and misleading practices of subprime mortgage lenders that they believed violated state laws.  Had the efforts of state attorneys general not been halted by the Bush Administration’s federal preemption of the authority of state consumer protection law and law enforcement officers, the subprime mortgage based crisis now upon us might well have been averted.  Certainly, there would be far fewer ‘bad’ sub-prime mortgages sold by loan originators to packagers and marketers of mortgage-backed securities that taxpayers are now being asked to buy.

“Given these facts, as Congress weighs the proposal to federalize vast parts of our financial system and give the executive branch unbridled authority over our markets, law makers should be mindful of the hard-taught lessons of post-Depression American history.  In addition to this bailout plan, the next Administration and Congress will be considering regulatory reforms to ensure such a crisis is not repeated.  As Congress moves forward on all fronts, NASCAT urges it and the next Administration to consider these lessons of experience:
-- The authority of federal and state regulators and state attorneys general should neither be diminished nor curbed by any new actions by the legislative or executive branches of our federal government in its effort to address this financial crisis in our capital markets.

-- As we face and work through a financial crisis of unknown magnitude, the SEC should halt its reckless push to shift America’s corporate accounting system from our proven U.S. rule-based Generally Accepted Accounting Standards and regulatory oversight to the more lax and less regulated International Accounting Reporting Standards.  This is no time to endanger investor protection by giving corporate and financial institutions  greater latitude in reporting their financial results.

-- Investor civil actions remain, in the Securities and Exchange Commission’s traditional words, ‘a necessary supplement to the Commission's efforts.’ In addition to helping police securities markets, private law suits provide the primary method for defrauded investors to recover their losses. It would be a tragic error to further dilute the rights of private investors to take actions against those who perpetrate fraud and abuse.

-- The shields against corporate and financial institution accountability erected by the Supreme Court that protect from liability those who knowingly aid and abet securities fraud and otherwise knowingly engage in schemes to defraud and mislead investors should be removed by Congress.  There is little doubt that these shields against liability helped embolden corporate and financial players to engage in massive wrongdoing and take trillion dollar risks at the expense of investors, homeowners and, now, taxpayers.”

I would add to this list, to reform the PSLRA by dropping the pleading standard that requires evidence to be pled when it is secretly held by the corporation, bringing back aiding and abetting liability, creating private rights of action to sue mutual fund investment advisors under the provisions of the Investment Company Act of 1940, adding a private cause of action against conspirators, and eliminating SLUSA preemption of state law claims which touch upon fraud or misrepresentation....just as a start.


Cornerstone's 2007 Securities Settlement Analysis

Kevin LaCroix's The D & O Diary Blog reports that Cornerstone Research released its review and analysis of 2007 securities class action settlements:

Cornerstone’s press release emphasizes that the aggregate dollar value of all settlements was down 60% compared to 2006, but the full report emphasizes that, when the four largest settlements are removed from the analysis, the aggregate value of all settlements in 2007 exceeded all prior years except the unprecedented year of 2006.

Of interest here is the question of Professor Grundfest concerning the uptick of activity now underway as a result of the "subprime crisis" and whether that will mean more and larger settlements 3-5 years from now. I certainly agree that there is a crisis for investors, and agree that there will be a flury of settlements from these suits which began to be filed last summer. As I lectured at the PLI Institute in September, the demise of securities fraud class actions was nothing more than a temporary lull waiting for the next new financial bubble to crash. All you need to do is follow the money. In the 80's it went into the Savings and Loans, in the 90's into High Tech and in the first decade of the 2000s it flowed into mortgages.

I predict that when this mess is sorted out, we will see that the unsuspecting small investor has been left holding the bag by mutual fund managers chasing yields.

For more on Kevin's analysis of the Cornerstone report, go to his blog.  Links to the report are also there.


Supremes Toss Suit Against Bankers Tied to Enron Scheme to Defraud

Suit against bankers tied to Enron debacle is tossed by Supreme Court: WSJ Law Blog heralds the opinion in its typical anti-plaintiffs lawyer rehtoric

The_jump_20n January 22, the Los Angeles Times reported that he Supreme Court dismissed the "huge lawsuit growing out of the Enron debacle that sought to hold Wall Street bankers liable for scheming with the executives of the defunct Houston energy trader."
Lawyers for investment funds and pension plans, including the University of California's pension plan, had sued Merrill Lynch and the other bankers, seeking to recover more than $30 billion that was lost when Enron folded in 2001. They argued that all the key players in the scheme that fooled stockholders should be forced to pay.
In dismissing the appeal of the Regents of the University of California vs. Merrill Lynch, the court appeared to doom the big lawsuits still pending against Enron's bankers.

Today's ruling is the most recent of a spate of decisions in which the courts have favored businesses. Last week, the Supreme Court rejected the notion of "scheme liability" in a closely watched stock fraud case involving a cable TV company and its vendors. In a 5-3 ruling, the court said suits for stock fraud are limited to the company that sells stock to the public, not bankers and other firms that had done deals with the company.

And last year, a U.S. appeals court panel in New Orleans also rejected the Enron-related lawsuit. It ruled that Merrill Lynch and the other investment bankers had not directly deceived those who bought Enron's stock.
Lawyers for the investors appealed to the Supreme Court and urged the justices to say that all those who profit from deception should pay. That appeal was formally rejected in a one-line order this morning.
In what has become its typical response (touting for so called "tort-reformers") to the knee-capping of investors' rights, the WSJ's Law Blog, by Peter Lattman, turned the knee-capping into a victory against "extortion":

Now let’s not shed too many tears for the Enron plaintiffs. They and their lawyers, led by Bill Lerach, collected $7.3 billion in settlements from Wall Street banks before the case was scuttled by the Fifth Circuit last year. Tort-reform advocate Ted Frank, in a NY Sun op-ed today, says this amounted to extortion. Yesterday’s ruling, he wrote, “closes an underreported chapter in American litigation history: how trial lawyers used the Enron scandal to successfully and legally extort billions of dollars from investment banks with a legally meritless lawsuit.”

Meritless!!! The Supreme Court never said meritless! They only said they believed Congress did not want investors to recover through the use of private lawsuits, and tried to justify what Congress never said through the use of mumbo jumbo economic theory involving unsupported fear of things like foreign investors fleeing our markets if fraudsters were held accountable.

It has always seemed strange to me that people seem more concerned about the money being made by those who protect their rights, than about the money being made by those who steal from them.

Fortunately, based on the comments to the WSJ Law Blog, most readers disagree with the journal and see the result as wrong. Their comments are worthy or republication and so, as of today, they are as follows:

Report offensive comments to lawblog@wsj.com

enron is sad, what is even sadder is supreme court decision that will insulate banks who in my opinion benefitted tremendously from their participation in the scheme.

Comment by beaches love dough - January 23, 2008 at 9:53 am

Is it me or is everyone ignoring the fact that the SEC can still pursue action against these organizations under the current law (10(b)(5) - I think?). Simply put, the SCOTUS said that, under the current statute, there is no private cause of action against these alleged aiders and abetters. How is this so terrible?

Comment by UB2L - January 23, 2008 at 10:04 am

What evidence is there that the banks KNEW that Enron was cooking the numbers? If they knew, then they should of course be held liable. But no solid evidence has been presented to date…
In oter words, the ruling does not insulate banks or any 3rd party. If you can present solid evidence of knowledge and/or complicity at initial hearings & discovery, then you can proceed to trial. If not, then stop looking for deep pockets to rob…

Comment by Anony-moose - January 23, 2008 at 10:06 am

Terrible because plaintiffs lawyers can’t make millions extorting banks and accountants

Comment by Anon - January 23, 2008 at 10:06 am

I hit the submit button accidentally. Why not seek a change in the law by lobbying Congress (since, as shareholders, you have some amount of disposable income)? Or, pressure the SEC to prosecute/investigate these alleged crimes. I don’t get it, the law does not create a private cause of action - so the plaintiff’s bar/shareholders gets upset because the SCOTUS interprets the law according to its plain language instead of seeking change in the appropriate manner - through the legislature, not the courts.

Comment by UB2L - January 23, 2008 at 10:08 am

Hey UB2L. No, the educated are not ignoring the fact that the SEC can pursue action against aiders and abettors (which in the case of Enron is a monumental sugar coating) but are cognizant of the fact that the SEC’s recovery is capped based on ill-gotten gains of third parties only, NOT damages. A straw and suction power would not have been able to dry the floor of the Titanic as it was taking on water.

Why do you think the Chamber of Commerce is pushing the idea? because businesses get off with not a slap on the wrist, but SPF 100 lotion to protect them from the burn. Duh.

Comment by UB2L call home - January 23, 2008 at 11:16 am

You have a problem with exorbidant lawyer’s fees - fine - so do I. They often ask for way too much. But don’t use that as an excuse to deny justice for legitimate victims. This angle is just your cop out and Chamber back rub.

Comment by UB2L call home - January 23, 2008 at 11:19 am

Fed R ACiv Proc 23.1, Derivative Rights of Shareholders permits shareholders the right to pursue causes of actions when the Corporation fails to do so. While FR Civ P 24, Intervention and FR P 25 Substitution of parties allows the pursuit of an assignable right. The Sup Ct has not stated anything invalid, it stated that the case of Finding of Fact that the investment banks were complicit has not been proven by the “red herring” doctrine. No Proof, no pudding.
When a case is submitted to the US Sup Ct many legal entities and schools take a shot at review, with essays and prediction papers on the probability and outcome of the case (whether it will be docketed and what the decision shall be). When a redress pursuit wishes to punish a distant party there must be a “protocol” of proof of willful misconduct or gross negligence. Even employees within had no idea. Now that one knows what the Court wants, the only question is how many alternative pathways will the Courts permit for another bite at the apple.

Comment by www.laserhaas.wordpress.com - January 23, 2008 at 11:19 am

Lastly, Enron was the worst case of fraud America had to offer and the high court repulsively bless this. As other articles on this topic noted, this IS AN ABSOLUTELY HORRID MESSAGE to send corporations, markets and our economic machine. If the Supreme Court had not been sold to the Chamber things would be very different for you. The law is lost in the corporate sea.

Comment by UB2L call home - January 23, 2008 at 11:22 am

“SEC can still pursue action against these organizations under the current law (10(b)(5)”

are you serious. What has the SEC in all its understaffed, underpayed glory going to do. They enter into deferred prosecution agreements in return for a bribe of millions. Look at hte AOL time warner case. Deferred prosecution agreemnts for a few million dollars. The system is broken, corrupted by teh chamber of pigs and all the corporate lobbysists. Did you read the Supreme Court decision. It is not reasoned on law, but an overwhelming concern for companys’ interests. Dissent was the only thing on point in Stone Ridge.

Comment by UB2L relies on faulty premise - January 23, 2008 at 11:51 am

extorting banks and accountants. You mean corporations are free to financially plunder, rape and pillage the US shareholder.

Comment by ANON is clueless - January 23, 2008 at 11:56 am

I’m sure they will assert a theory of primary liability for the 10(b) violation on a new interpretation of what constitutes a statement and reliance. And then let the courts explain how such blatant frauds (where there is no statement and no reliance) does not establish 10(b) liability. And then congress will act.

Comment by a lawyer with class(es) - January 23, 2008 at 12:09 pm

Securities suits ought to be outlawed. Everyone knows that.

Comment by Tort Reform - January 23, 2008 at 4:50 pm

I do not see how those who have responded to my posts have answered my questions (instead they have derided me without actually attacking my position). My question is: If the law doesn’t permit(which according to the text of the law and judicial cannons of statutory interpretation)a private cause of action for shareholders per se, why not seek change in the legislature? Can the detractors here not answer that or is the answer simply, “We don’t want to.” If that is the case, then too bad. No one sold out to the CoC, the Court merely interpreted the law the way it was written. Shareholders can still sue 3rd parties so long as there is reasonable reliance on a intentionally misleading statement (or loosely, simply a misleading statement) to the shareholders’ detriment, which did not happen here. I am not saying that what Enron did was right, nor am I saying that 3rd parties should be protected; however, I am saying that Courts are constrained by the law and now the law says that there is no private cause of action for scheme liability (3rd party fraud). Seek your changes and retribution/redress of grievances in the legislature in the form of a bill permitting a private cause of action; then sue till your hearts’ are content. God, you guys are such a bunch of children, “Give me what I want now (the Courts legislating a cause of action for shareholders) or I am going to throw a temper tantrum in the corner until you do (exhibited by the posters on this blog)!!!” Perhaps your problem with my reasoning is that I don’t agree with you by default - I have read the opinion and find it legally correct and quite neutral. BTW, as a means of inciting more hate-filled rhetoric against my views, I believe shareholders and fear of risk are the reason why this Country is facing recession or even worse, depression (i.e. see the history on the great depression - too many shareholders selling in the face of economic woes without anyone buying causes a chain reaction whereby everyone suffers). I wonder if the public can sue shareholders for bailing on companies, who depend on their cash investments for funding, because the shareholders pulled out when the going got tough?

Comment by UB2L - January 23, 2008 at 5:07 pm

Laser and UB, you guys are delusional morons.

Comment by 'Nuff said. - January 23, 2008 at 10:52 pm

When the author of the PSLRA drops a major hint that no, the way Stoneridge was decided was NOT the intent of Congress …you would figure the Supreme Court would get the hint for the bigger decision in Enron that was to come.

Not only did the Supreme Court outright reject giving Enron victims their day in court (at the urging of the SEC which usually carries the most weight in this regard), but they did so without even commenting. (parroting the Chamber of Commerce’s amicus does not count) Talk about a kick to the groin when one is already down on their knees and out.

Dr. Judekyll meets Mr. Political Hyde. This is what happens when politics takes over the law.

Comment by @#$%^&* pissed investor - January 24, 2008 at 5:55 am

I can only imagine how the Enron victims are feeling right now. Then again, imagining does not put me in their shoes so I guess I could never imagine the horrors the victims must be feeling right now. May God give you all strength and hope.

Comment by @#$%^&* pissed investor - January 24, 2008 at 6:04 am

Any of these “justices” able to moonlight over to Europe?

Societe Generale Uncovers Massive Fraud


Comment by @#$%^&* pissed investor - January 24, 2008 at 6:45 am

5:55 am. It is a wake up call for investors in the US markets. My advice is less equities, more fixed investments. Trust no corporation in an environment where fraudsters have been super insulated by the Supremes like this. Be smart and be careful not to be treated like a wheel barrow at a manure pit.

Comment by Boots are meant for walking - January 24, 2008 at 9:01 am

Watch for the \”Flight of the Benjamins\”. A boon for international markets.

CNBC has a show called American Greed. Perhaps they could dedicate a show to the topics of this thread.

Comment by Not to be confused with Flight of the Conchords - January 24, 2008 at 10:05 am

There is in essence a “Code” that is widespread across the financial community.

When you talked about Sarbanes Oxley there is an underlying issue that people are should be taking a look at with this legislation.

The first step is that most states have employment at will.

The second step is that most companies require employees to sign off on an ethics
statement to ensure that they are not performing illegal acts.

The third step is that if an employee uncovers a potential illegal or Fraudulent act they
are potentially labeled as a non team player.

The forth step is that if the employee brings up the illegal act the company is free to fire the employee at will.

The fifth step is that there may be potential political issues that might cause the
complaint about the company to be ignored or hidden.

The sixth step is that the person who is fired usually does not have the money or
resources to litigate against the company for defamation issues or to bring to the
surface the issues without the fear of retaliation or gainfully obtaining future

The seventh step is that by the time the issue surfaces at the company the Fraud might
be wide spread and may have occurred at the third party level in which may have been
the source of the actual Fraud.

The eighth step is that the Supreme Court ruling already has indicated that investors do not have the right to litigate against a third party even though they may be potentially the source or abetted the Fraud.

The ninth step is that the financial statements that are being issued by the companies are not uncovering the Fraud so that the investor is really in the dark. (i.e. Off Balance Sheet Mortgages) All you keep hearing is that once one write down is completed
another one awaits.

The tenth step is to realize that unless a person adheres to the “Code” the ability of the person to work in the future or to bring up these issues without retaliation will continue which will ultimately make the potential Fraudulent acts to continue.

If I recall when the Enron issue occurred there was a push to try and make the
accounting in company financial statements to be clear and concise so that the average investor understands what is going on. The bottom line is that is all about the Cash and since most companies file consolidated financials a lot of issues do not surface since there is intercompany eliminations that might hide the potential Fraud. Maybe they should require a segmented Cash flow statement to show intercompany loans between
all affiliated companies as well as off balance sheet accounting. This way an investor would absolutely know where the potential problems will lie.

There is the real problem and unless people see if for what it is all the continued talk
will not resolve the real issue at hand.

Unless the shell games stop people will continue to loose the cash that they invest.

It is probably safer to invest in their own future by paying down their own debt before investing without adequate protections.

Remember people have invested their futures in all of these vehicles in order to provide for future pension benefits.

The year end (2007) increase in the market after the first month has almost been fully
eliminated. Sounds like the people who invested their monies in the 401K plans who
entrusted their money to earn adequate returns did not materialize.

If it continues on its present course what will be left?

At least they will be in control of their own cash.
It is all about who controls the check book.

The supreme court ruling might be giving a false read about responsible business ethics.

If you remember they talked about clear and concise financial reporting.

How can this continue to occur if they were supposed to learn from Enron. If they did then the CDO issues should have been avoided or minimized.

It appears that no one has learned the lessons of the past.

Pay no attention to the person behind the curtain…..

If business ethics was restored then there would be no reason to sue. Currently only the people with money can sue to protect their interests. The people who cannot afford proper counsel are put into very difficult positions. The idea of a class action lawsuit was there so that investors were afforded some protection to litigate against big corporations since an individual could not afford to litigate independently.

Now with the Supreme Court ruling with regard to third party litigation, unless
financial disclosures are in place to give clear and concise information with regard to the true financial position of a corporation, investors may be left out in the dark. This has created a shell game environment in which if the cash has exchanged hands at the
third party level good luck on recovering your cash. This will no longer be an option.
All the pension money that has been invested at the corporate level might be lost due to negligence at the third party level. What really is interesting is that the corporation might know that there is Fraud at the third party level. Most corporations might know
this verbally (Code) but you can rest assured that they would not have any electronic
documentation to incriminate themselves or attach themselves at the third party level. This is the business ethics that has materialized.

Most of the executives remove themselves from incrimination by verbally managing their company and not supporting their positions in writing. This is supported by D&O
coverage only at the officer level. They make sure that they have ample coverage in
the event Fraud issues come up and there are golden parachute packages in place that in the event they get caught these are contracts in which they might get paid anyway when they are removed from their positions.

Where does this leave the incentive for people who work at the corporations to
uncover potential Fraud? These are the same people who are creating the third party
business relationships in which the Fraud might be taking place.

Do you really think that all the people of Enron did not know what was going on before it was too late?

Do you really think that all the people involved in the CDO crisis did not know what
was going on?

I would think not…………

WASHINGTON — The Supreme Court rejected Tuesday the appeal of a $40 billion
lawsuit against Wall Street firms that did business with Enron Corp., striking a fatal
blow against the class-action investor lawsuit.

All business ethics are gone. It might be a good idea for people to pull their money out
of the market so that they can hold on to the money that they earn or save.

They are better off paying off debt and the retirees are better off with conservative
bank rates since all the investor protections appear to be eliminated. Let’s hope that the regulators ensure that each bank is meeting the required liquidity requirements so that
our bank accounts are protected.

Just imagine if lawsuits come out against the banks for the CDO mess in which the regular financials did not disclose the off balance sheet problems. Are we going to
hear that the bank investors or depositors can not sue the third party people due to the
Stoneridge ruling? It appears to be so…..

This is giving the appearance that there is no ramifications for moving the cash to
another entity (third party) which might be the source of the Fraud.

Is the current ruling giving the appearance that the shell games that are played on city
streets is OK?

This appears to be insane…..

What is next?

Comment by RS - January 24, 2008 at 10:43 am

Statutory interpretation coming from chamber-colored glasses is the problem. Correct interpretation is never possible when those glasses are dawned to protect the Supremes’ eyes from the bright flash created by the firing of the judicial cannon that is aimed directly at even the most egregious of cases.

As for the rest of your daffy remarks, I shall not even dignify such nonsense with a response of my own.

Candles in the wind,

Comment by reply to UB2L - January 23, 2008 at 5:07 pm - January 24, 2008 at 2:38 pm

A little late but I just seen the news on a local news channel talking about pension. If Martin Luther King, Jr. were alive today to see what has happened to our “justice” system, he would not be saying: “I have a dream”, but “I have nightmares”. I think I will marry a Canadian I am so disgusted by what is happening to this country.

And before you go there, no, I am not a lawyer. I don’t like lawyers, but what I hate even more are travesties of justice like this. Shred the law books, this supreme court has made them outdated and largely obsolete. Corruption runneth deep. It is amazing how many flips of the coin in the big court land on business heads and consumer tails - in reference to where people get screwed. A despicable bunch and showing of power abuse like no other. Supreme Clowns! And these clowns have the final word which makes me so mad! Arggh!

Comment by I hate lawyers, but hate the SUPREME COURT even more - January 24, 2008 at 4:58 pm

Just when they thought they were safe---Tellabs: The Return of Judge Posner

What a difference 2 days make. In the wake of Stoneridge, we have proof that securities fraud class actions have not been thrown out of the ballpark, yet. Today, Judge Posner took on Congress and the Supreme Court and, following up on my baseball metaphor on Stoneridge, drew a wide strike zone for plaintiffs seeking to retire the "motion to dismiss" inning of the PSLRA.
In reaffirming the Seventh Circuit's reversal of a district court's dismissal of a securities fraud complaint against Tellabs, Judge Posner’s opinion allows plaintiffs allegations to slide right past the Supreme Courts court’s 8-1 ruling in Tellabs --- drawing wide boundaries for calling  "compelling" and "cogent" inferences. These are Judge Posner's calls against defendants arguments:

Strike One ---The gravity of the risk can create a "strong inference" of scienter:

[L]iability requires proof of the defendant's "scienter," which is to say proof that he either knew the statement was false or was reckless in disregarding a substantial risk that it was false. ... A popular definition of recklessness in this context is "an extreme departure from the standards of ordinary care ... to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it." .... This looks like two criteria--knowledge of the risk and how big the risk is--but as a practical matter it is only one because knowledge is inferable from gravity ("the danger was either known to the defendant or so obvious that the defendant must have been aware of it"). When the facts known to a person place him on notice of a risk, he cannot ignore the facts and plead ignorance of the risk. ...

Strike Two---Plaintiffs do not need to plead facts of actual knowledge required by the "safe harbor" for those portions of forward looking statements relating to present facts:

The fact that all the statements challenged in this case that we found in our earlier opinion to be materially false are in the present tense is not decisive on the question whether the statements include predictions: "Our earnings are certain to double" is in the present tense, but is a prediction. But a mixed present/future statement is not entitled to the safe harbor with respect to the part of the statement that refers to the present. When Tellabs told the world that sales of its 5500 system were "still going strong," it was saying both that current sales were strong and that they would continue to be so, at least for a time, since the statement would be misleading if Tellabs knew that its sales were about to collapse. The element of prediction in saying that sales are "still going strong" does not entitle Tellabs to a safe harbor with regard to the statement's representation concerning current sales.

Strike Three---First Out! ---Posner then throws his wit as hard as he can at both Congress and the

Supreme Court, revealing, an intellectual distaste for the PSLRA's "strong inference" requirement, and a conclusion that all reasonable inferences must still be drawn in favor of the plaintiff:

To judges raised on notice pleading, the idea of drawing a "strong inference" from factual allegations is mysterious. Even when a plaintiff is required by Rule 9(b) to plead facts (such as the when and where of an alleged fraudulent statement), the court must treat the pleaded facts as true and "draw all reasonable inferences in favor of the plaintiff." .... To draw a "strong inference" in favor of the plaintiff might seem to imply that the defendant had pleaded facts or presented evidence that would, by comparison with the plaintiff's allegations, enable a conclusion that the plaintiff had the stronger case; and therefore that a judge could not draw a strong inference in the plaintiff's favor before hearing from the defendant. But comparison is not essential, and obviously is not contemplated by the Reform Act, which requires dismissal in advance of the defendant's answer unless the complaint itself gives rise to a strong inference of scienter. For a defendant will usually have evidence to present in his defense; and so a complaint that on its face, and without reference to the defendant's case, creates only a weak or bare inference of scienter, suggesting that the plaintiff would prevail only if there were no defense case at all, would be quite likely to fail eventually when the defendant had a chance to put on his case, which would normally be after pretrial discovery. Apparently Congress does not believe that weak complaints should put a defendant to the expense of discovery in a securities-fraud case, which is likely to be complex-as this case is.

Strike One ---Posner makes the call that "apparent authority" and "respondeat superior" are still alive as a grounds for securities fraud liability----perhaps as an apology for having been forced to previously rule that the "group pleading" doctrine did not survive the PSLRA. Posner calls this "corporate scienter:

To establish corporate liability for a violation of Rule 10b-5 requires "look[ing] to the state of mind of the individual corporate official or officials who make or issue the statement (or order or approve it or its making or issuance, or who furnish information or language for inclusion therein, or the like) rather than generally to the collective knowledge of all the corporation's officers and employees acquired in the course of their employment." .... A corporation is liable for statements by employees who have apparent authority to make them.
The court in the Southland Securities case said that corporate scienter could be based on the state of mind of someone who furnished false information that became the basis of a fraudulent public announcement. Suppose he had knowingly supplied the false information intending to help the company. His superiors would not be liable for failing to catch the mistake, but Southland implies that the corporation would be liable, just as it would be in a common law tort suit.
Strike Two--- Using "corporate scienter" to get around the arguments defendants and judges often make, that plaintiffs must plead "who knew what and when", Posner teaches us that all we need are sufficient facts to infer that "management" knew that true facts:
The critical question, therefore, is how likely it is that the allegedly false statements that we quoted earlier in this opinion were the result of merely careless mistakes at the management level based on false information fed it from below, rather than of an intent to deceive or a reckless indifference to whether the statements were misleading. It is exceedingly unlikely. The 5500 and the 6500 were Tellabs's most important products. The 5500 was described by the company as its "flagship" product and the 6500 was the 5500's heralded successor. They were to Tellabs as Windows XP and Vista are to Microsoft. That no member of the company's senior management who was involved in authorizing or making public statements about the demand for the 5500 and 6500 knew that they were false is very hard to credit, and no plausible story has yet been told by the defendants that might dispel our incredulity.
All this is not to say that the plaintiffs could name "management" as a defendant or, less absurdly, name each corporate officer. That would be an example of "the group pleading doctrine[, which] is a judicial presumption that statements in group-published documents including annual reports and press releases are attributable to officers and directors who have day-to-day control or involvement in regular company operations." ..... As we held in our firs t opinion, the doctrine is inconsis tent with the "strong inference" requirement. ....But it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud. Suppose General Motors announced that it had sold one million SUVs in 2006, and the actual number was zero. There would be a strong inference of corporate scienter, since so dramatic an announcement would have been approved by corporate officials sufficiently knowledgeable about the company to know that the announcement was false.
Strike Three---Two Outs!---Posner next makes the call that, while the Seventh Circuit has rejected "channel stuffing" allegations in the past, they are alive and well  when, as in Tellabs, they are so suspect and the goods come back:
Another possible, though again very unlikely, example of innocent misunderstanding is the charge of "channel stuffing." The term refers to shipping to one's distributors more of one's product than one thinks one can sell. A certain amount of channel stuffing could be innocent and might not even mislead-a seller might have a realistic hope that stuffing the channel of distribution would incite his distributors to more vigorous efforts to sell the stuff lest it pile up in inventory. Channel stuffing becomes a form of fraud only when it is used, as the complaint alleges, to book revenues on the basis of goods shipped but not really sold because the buyer can return them. They are in effect sales on consignment, and such sales "cannot be booked as revenue. Neither condition of revenue recognition has been fulfilled-ownership and its attendant risks have not been transferred, and since the goods might not even be sold, there can be no certainty of getting paid. But those strictures haven't stopped some managers from using consigned goods to fatten the top line-that is, the revenue line-of the corporate income statement." ....(Similarly, Tellabs could not properly record revenue on its contract with Sprint before actually transferring title to 6500 systems to Sprint.) The huge number of returns of 5500 systems is evidence that the purpose of the stuffing was to conceal the disappointing demand for the product rather than to prod distributors to work harder to attract new customers, and the purpose would have been formed or ratified at the highest level of management.
Strike One---Finding these inferences to be "at least as compelling," as defendants suggestions or innocence,  Posner calls a strike on the Supreme Court's use of the word "cogent" as being still another requirement:
So the inference of corporate scienter is not only as likely as its opposite, but more likely. And is it cogent? Well, if there are only two possible inferences, and one is much more likely than the other, it must be cogent. Suppose a person woke up one morning with a sharp pain in his abdomen. He thought it was due to a recent operation to remove his gall bladder, but realized it could equally well have been due to any number of other things. The inference that it was due to the operation could not be thought cogent. But suppose he went to a doctor who performed tests that ruled out any cause other than the operation or a duodenal ulcer and told the patient that he was 99 percent certain that it was the operation. The plausibility of an explanation depends on the plausibility of the alternative explanations. .... As more and more alternatives to a given explanation are ruled out, the probability of that explanation's being the correct one rises. "Events that have a very low antecedent probability of occurring nevertheless do sometimes occur (the Indian Ocean tsunami, for example); and if in a particular case all the alternatives are ruled out, we can be confident that the case presents one of those instances in which the rare event did occur." ....Because in our abdominal-pain example all other inferences had been ruled out except the 1 percent one, the inference that the pain was due to the operation would be cogent. This case is similar. Because the alternative hypotheses-either a cascade of innocent mistakes, or acts of subordinate employees, either or both resulting in a series of false statements-are far less likely than the hypothesis of scienter at the corporate level at which the statements were approved, the latter hypothesis must be considered cogent.

Strike Two---Posner then applies this strike zone to to the CEO who wanted the court to walk him by calling for a  stronger inference that he was just an ignoramus, with fast ball directed at his plea that he could not have possibly had any motive. Posner concludes that the fear of a stock drop on the revelation of such bad news is sufficiently inferred:

And at the top of the corporate pyramid sat Notebaert, the CEO. The 5500 and the 6500 were his company's key products. Almost all the false statements that we quoted emanated directly from him. Is it conceivable that he was unaware of the problems of his company's two major products and merely repeating lies fed to him by other executives of the company? It is conceivable, yes, but it is exceedingly unlikely.

Against all this the defendants argue that they could have had no motive to paint the prospects for the 5500 and 6500 systems in rosy hues because within months they acknowledged their mistakes and disclosed the true situation of the two products, and because there is no indication that Notebaert or anyone else who may have been in on the fraud profited from it financially. The argument confuses expected with realized benefits. Notebaert may have thought that there was a chance that the situation regarding the two key products would right itself. If so, the benefits of concealment might exceed the costs. Investors do not like to think they're riding a roller coaster. Prompt disclosure of the truth would have caused Tellabs's stock price to plummet, as it did when the truth came out a couple of months later. Suppose the situation had corrected itself. Still, investors would have discovered that the stock was more volatile than they thought, and risk-averse investors (who predominate) do not like volatility and so, unless it can be diversified away, demand compensation in the form of a lower price; consequently the stock might not recover to its previous level. The fact that a gamble-concealing bad news in the hope that it will be overtaken by good news-fails is not inconsistent with its having been a considered, though because of the risk a reckless, gamble…. It is like embezzling in the hope that winning at the track will enable the embezzled funds to be replaced before they are discovered to be missing.

STRIKE THREE ---And finally, Posner calls as a final strike the unexpected curve ball at the Supreme Court's suggestion that the use of confidential witnesses requires a "heavy discount'---unexpected  since the Supreme's picked up on that suggestion from the Seventh Circuit itself:

The defendants complain, finally, about the complaint's dependence on "confidential sources." The 26 "confidential sources" referred to in the complaint are important sources for the allegations not only of falsity but also of scienter. Because the Reform Act requires detailed fact pleading of falsity, materiality, and scienter, the plaintiff's lawyers in securities-fraud litigation have to conduct elaborate pre-complaint investigations-and without the aid of discovery, which cannot be conducted until the complaint is filed. Unable to compel testimony from employees of the prospective defendant, the lawyers worry that they won't be able to get to first base without assuring confidentiality to the employees whom they interview, even though it is unlawful for an employer to retaliate against an employee who blows the whistle on a securities fraud, 18 U.S.C. § 1514A, and even though, since informants have no evidentiary privilege, their identity will be revealed in pretrial discovery, though of course a suit might never be brought or if brought might be settled before any discovery was conducted.

The problem with this argument-besides the seeming flimsiness of the asserted need for anonymity-is that allegations based on anonymous informants are very difficult to assess. This concern led us to suggest in Higginbotham v. Barter International, Inc., supra, 495 F.3d at 756-57, that such allegations must be steeply discounted. But that was a very different case from this one. The misconduct alleged consisted of frauds committed by Baxter's Brazilian subsidiary, but because the suit was against the parent, the plaintiffs had to show that the parent knew about the Brazilian fraud. The subsidiary had tried to conceal it from its parent as well as from the Brazilian government. There was no basis other than the confidential sources, described merely as three ex-employees of Baxter and two consultants, for a strong inference that the subsidiary had failed to conceal the fraud from its parent and thus that the management of the parent had been aware of the fraud during the period covered by the complaint.

The confidential sources listed in the complaint in this case, in contrast, are numerous and consist of persons who from the description of their jobs were in a position to know at first hand the facts to which they are prepared to testify, such as the returns of the 5500s, that sales of the 5500 were dropping off a cliff while the company pretended that demand was strong, that the 6500 was not approved by Regional Bell Operating Companies, that it was s till in the beta stage and failing performance tests conducted by prospective customers, and that it was too bulky for customers' premises. The information that the confidential informants are reported to have obtained is set forth in convincing detail, with some of the information, moreover, corroborated by multiple sources. It would be better were the informants named in the complaint, because it would be easier to determine whether they had been in a good position to know the facts that the complaint says they learned. But the absence of proper names does not invalidate the drawing of a strong inference from informants' assertions.

And then, with words sweet to the ears of investors, Posner retires the inning, and tells the plaintiffs that,once again, they are up to bat:

We conclude that the plaintiffs have succeeded, with regard to the statements identified in our previous opinion as having been adequately alleged to be false and material, in pleading scienter in conformity with the requirements of the Private Securities Litigation Reform Act. We therefore adhere to our decision to reverse the judgment of the district court dismissing the suit.

Posner has defined the strike zone. The Judges in the Seventh Circuit must take heed of  the broad outer boundaries of that mysterious "strong inference" requirement, and the requirement of finding those inferences to be "at least as compelling" and "cogent."


What a difference a day makes...

Two big results today for investors --- just one day after the plaintiffs bar fell into depression over the  Supreme Court decision in Stoneridge (see post below) --- a jury verdict of $280 million for securities fraud committed by Apollo Group, and a 21-month jail sentence with $15million in penalties for options backdating by Brocade CEO Reyes. Unfortunatley in Brocade the Judge denied restitution for shareholders ...which is why we need private civil cases like Apollo Group:

KPHO Phoenix
Apollo Group Ordered to Pay $280M
The Associated Press - 54 minutes ago
By doing so, jurors said, Apollo violated federal securities laws. The verdict, which comes after a two-month trial in US District Court in Phoenix, ...
Apollo Loses Lawsuit, Must Pay Up to $277.5 Million (Update4) Bloomberg
all 160 news articles »

The Associated Press
Former Brocade CEO Reyes sentenced to 21 months in stock-option case
San Jose Mercury News,  USA - 1 hour ago
A jury of three men and nine women spent six days in August deliberating the case, before returning a guilty verdict on 10 criminal charges, ...
Denied new trial, Brocade’s Reyes to be sentenced FinancialWeek (subscription)
all 211 news articles »

Thank goodness we still have jurys in both civil and criminal cases.

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