Legal Malpractice and Its Avoidance Legal Malpractice Enron's

Legal Malpractice and Its Avoidance

Legal Malpractice Enron’s Professional Intersection The Cross-Hairs of Accounting and Law Professional Liability Joint Representation, Conflicts, Ethical Considerations The Lawyer’s Fiduciary Duty The Right and Duty to Defend Reliance on the Advice of Counsel A Guide to potential Liability Insurance for Investment Professionals The Sentinels, Madoff and Dodd-Frank Reform

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Tuesday, April 9, 2002 Professional Liability ENRON'S PROFESSIONAL INTERSECTION By Norman B. Arnoff In December 2000 an article was written for this column which addressed the professional liability risks for auditors and the lawyers who are asked to report to auditors on litigation that had a material impact on the financial statements subject to audit. [FN1] In such contexts lawyers, restrained by applicable evidentiary privileges and the client confidentiality obligation, cannot always effectively inform the auditor. Even where the lawyers' reports are both consistent with professional standards and not affected by privilege or confidentiality obligations, the auditor does not generally review with counsel prior to the publication of the financial statements the accounting determinations that have significant legal implications and the footnote disclosures. Audit failure in this context, therefore, can be more effectively prevented when such a pre-release review by the lawyer handling or managing the litigation does take place. Enron's professional intersection, while not identical, is quite similar in that the audit failure resulted from the ineffective coordination and focus of legal and auditing expertise. The accounting treatment of certain transactions and relationships that had significant legal implications and the attendant disclosures were, in the last analysis, ultimately left to the auditor without the benefit of an independent legal determination and review. By understanding the material risks of this professional intersection in the audit process, we can here, too, take the right path to reform.

'U.S. v. Simon'

In 1969 the United States Court of Appeals for the Second Circuit with Judge Henry Friendly writing the opinion of the Court, in the context of a criminal prosecution of auditors for their responsibility for a false and misleading financial statement footnote, addressed issues similar to the ones in Enron [FN2] . The court noted, almost as a preface to its opinion, "[w]hile every criminal conviction is important to the defendant, there is a special poignancy and a corresponding responsibility on reviewing Judges when, as here, the defendants have been men of blameless lives and respected members of a learned profession." [FN3] The trial focused on transactions between two affiliated companies that had a single office and were dominated by the same chief executive officer and principal shareholder.

Funds were advanced by one affiliate to the other and as a result the principal-shareholder caused the issue of negotiable notes which were endorsed in blank so that the principal could obtain cash to effect securities transactions for his own account and meet related margin calls. In a five and a half year time span the company whose financial statements were in issue loaned to its affiliate $16 million and in turn the affiliate loaned $13 million to the principal. By the "certification" date the auditors learned the affiliate was not in a position to repay its debt and accordingly, it was arranged that the principal post collateral, eighty (80%) percent of which was the lending company's securities. When cash became stringent and the transactions problematic, corporate counsel listed the securities as collateral and at the auditors request the securities were assigned to counsel as trustee. There were errors in the list furnished by counsel and the auditors also did not check the list by any verification

procedures. Third party commercial lenders had prior liens on many of the securities. After the completion of the audit and before the mailing of the financial statements to public shareholders, the securities collateral also significantly declined in market value. Shortly thereafter a check to the IRS "bounced" and bankruptcy ensued.

The core case against the auditors was premised on the fact that the footnote did not disclose the make-up of the collateral and the fact of the post audit market decline. Eight defense expert witnesses, described by the court as "an impressive array of leaders of the profession" testified that except for the erroneous netting of accounts receivable owed by each company to its affiliate, the footnote treatment of the accountants receivable from the company's affiliate was consistent with both Generally Accepted Auditing Standards (GAAS) and Generally Accepted Accounting Principles (GAAP). Further these experts testified additional disclosures of the collateral's make-up and post-audit decline in market value was not necessary and its absence did not defeat a fair presentation of the company's financial position. Nor did the experts believe the borrowings of the principal from the affiliate to finance his stock transactions had to be disclosed. The Court of Appeals in reviewing the criminal conviction, nonetheless, significantly held literal compliance with GAAS and GAAP did not insulate the auditors from criminal liability. The court in a message to all professionals in the capital markets and financial services industries that lasts to and through this day, articulated the proposition that professionals are responsible to get to and state the truth, especially when they know or should know the real facts. The court held:

It is quite true that there was no proof of motive in the form usual in fraud cases. None of the defendants made or could make a penny from ... putting out false financial statements.... Ordinary commercial motivation is thus wholly absent.

Even If there were no satisfactory showing of motive, we think the Government produced sufficient evidence of criminal intent. Its burden was not to show that the defendants were wicked men with designs on anyone's purse, which they obviously were not, but rather that they had certified a statement knowing it to be false. As... [the Court] said ... long ago, 'while there is no allowable inference of knowledge from the mere fact of falsity, there are many cases where from the actors' special situation and continuity of conduct an inference that he did know the untruth of what he said or wrote, may legitimately be drawn. [FN4]

Thus professional liability risk exists even when there is literal compliance with professional standards.

The Powers Report

A Special Investigative Committee of the Board of Directors of Enron Corporation headed by William C. Powers Jr. rendered a written report Feb. 1, 2002. The report discussed the partnerships that served as Special Purpose Entities (SPE) which kept liabilities off of Enron's balance sheets, generated significant income for Enron which was subsequently restated, and the conflicting ownership and controlling interests of Enron's CFO and other personnel in the SPE and off-balance-sheet partnerships. The respective roles of Enron's internal accountants, Arthur Andersen, Enron's in house counsel, Vincent and Elkins, Enron's outside counsel, and most significantly the related party transaction disclosure issues presented by the footnotes and the proxy statements, are also addressed.

Enriching Enron's CFO

The Powers Report emanated from the Special Committee's mandate to conduct an investigation of related party transactions. The investigation turned up information such as the significant enrichment of Enron's CFO and other employees by reason of their participation in the SPE and non-compliance with Enron's Code of Conduct of Business Affairs, not previously disclosed. Further the report significantly noted that "[m]any of the most significant transactions apparently were designed to accomplish favorable financial statement results, not to achieve bona fide economic objectives or to transfer risks." [FN5] In reference to these related party transactions that the legal and audit professionals had to confront the Special Committee also found:

Enron's publicly-filed reports disclosed the existence of the ... partnerships. Indeed, there was substantial factual information about Enron's transactions with these partnerships in Enron's quarterly and annual reports and in its proxy statements. Various disclosures were approved by one or more of Enron's outside auditors and its inside and outside counsel. However, these disclosures were obtuse, did not communicate the essence of the transactions completely or clearly, and failed to convey the substance of what was going on between Enron and the partnerships.... The disclosures also asserted that the related party transactions were reasonable compared to transactions with the third parties, apparently without any factual basis.... There was an absence of forceful and effective oversight by Senior Enron Management and in-house counsel, and objective and critical professional advice by outside counsel at Vincent and Elkins, or at Andersen. [FN6] (Emphasis added)

The Report also noted Andersen's consulting roles and the fees earned from those services included advice on the structuring of the partnerships so that it would meet the SPE non-consolidation rules, i.e., essentially the sine qua non was an outside investor with a minimum ownership interest of three (3%) percent who had control of the entity. It was also noted "Vincent and Elkins, as Enron's longstanding outside counsel, provided advice and prepared documentation in connection with many of the transactions ... [and] also assisted Enron with the preparation of its disclosures of related-party transactions in the proxy statements in Enron's periodic SEC filings."(Emphasis added) Further the Report, which discussed corporate governance as well professional responsibility issues noted that "[m]anagement and the Board relied heavily on the perceived approval by Vincent and Elkins of the structure and disclosure of the transactions." [FN7]

Auditor-Legal Issues

AU 336, Using the Work of a Specialist, sourced in SAS (Statement on Auditing Standards) No. 73, makes permissible and appropriate auditor reliance on the work and analysis of specialists including lawyers. Management or the auditors can engage a specialist and rely on that work as evidential matter in performing substantive tests to evaluate material financial statement assertions. The standard states,

[T]he auditor is not expected to have the expertise of a person trained for or qualified to engage in the practice of another profession or occupation.... During the audit, however, an auditor may encounter complex or subjective matters potentially material to the financial statements. Such matters may require special skill or knowledge and in the auditor's judgement require using the work of a specialist to obtain competent evidential matter.

... Examples of the types of matters that may... require... using the work of a specialist include... [i]nterpretation of technical requirements, regulations, or agreements (for example, the potential significance of contracts or other legal documents or legal title to property.) [FN8]

Where specialists are to be engaged the auditors are to assess their qualifications. Further, they are to evaluate the relationship of the specialist to the client, especially circumstances that might impair the specialists' objectivity. They are to obtain an understanding of the specialist's methods and assumptions, although the appropriateness and reasonableness of the methods and assumptions used and their applications are stated to be the responsibility of the specialist. However, if the auditor believes the specialist's findings are unreasonable additional procedures have to be employed, including obtaining another opinion. An unresolved matter should also cause the auditor "to conclude that he or she should qualify the opinion or disclaim an opinion because the inability to obtain sufficient competent evidential matter as to an assertion of material significance in the financial statements constitutes a scope limitation." [FN9]

The standard also goes on to state that generally the auditor should not refer to the work or findings of the specialist in that it might be misunderstood to be "a qualification of the auditors' opinion or a division of responsibility neither of which is intended." This is to be avoided as "...there may be an inference that the auditor making such reference performed a more thorough audit than an auditor not making such reference."

AU 9336

AU 9336 provides guidance with respect to Financial Accounting Standards Board (FASB) Statement No. 125 Accounting For Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. Utilization of this standard is to assist in interpreting transactions similar to those that occurred between Enron and its off-balance sheet partnerships. The auditor is to give consideration to whether an asset transfer can be revoked, whether a transfer of financial assets would likely be deemed to be a true sale at law, whether the transfer and transferee are affiliated, whether transferred assets are beyond the reach of a bankruptcy trustee, and whether entities truly qualify to be an SPE making remote the possibility that they would enter bankruptcy or receivership. Significantly the section states "...determinations about whether the isolation criterion has been met to support a conclusion regarding surrender of control is largely a matter of law ... [t]his aspect of surrender of control, therefore, is assessed primarily from a legal perspective." [FN10] (Emphasis added)

This section also gives some guidance to auditors as to when to rely on the legal opinion furnished or when it is inadequately premised on hypothetical transactions and/or qualified to limit the scope of the opinion so that reliance cannot be placed upon it. The accounting standard, however, is not definitive and carries with it the material risk of the auditor stepping beyond the scope of his expertise and ultimately making a legal judgement.

For Reform

In the context of the Enron bankruptcy there is now a temptation to jump to easy criticism of both Arthur Andersen and Vincent and Elkins in respect to the related party transactions addressed by the Powers Report. This is anything but a sound approach. A closer look at both the facts and the current authoritative accounting literature relating to auditors interacting with lawyers in the audit process demonstrates there are systematic flaws which could lead to other financial disasters with other public companies served by other law and auditing-accounting firms. To avoid future recurrences we should develop insights from the events such as those that occurred in United States v. Simon and Enron and thereby enhance professional standards for both lawyers and auditors, especially when those professionals are required to coordinate their

respective expertise and disciplines in the audit process. In this way we will be able to best serve the securities laws' core-remedial purpose, and follow a correct path to reform.

Points for Discussion

Points to consider and to discuss are the following: (1) accounting-auditing firms do not have to divest themselves of their consulting arms, but should adhere to a strict rule that the same company should not be both an audit and consulting client; (2) fiduciary duty codes should be promulgated for accounting-consultants, which would include reporting obligations to audit committees and the auditors of accounting irregularities and internal control problems discovered and not corrected in their engagements; (3) in respect to public companies meeting certain defined criteria established by the SEC and other self-regulatory organizations, accounting treatments that have to be "assessed from a legal perspective" should be addressed by independent counsel - counsel not regularly engaged by the company - that will make the required legal judgement and also do a legal review of the footnote disclosures; and (4) in respect to other public companies whose financial failure may not have such a devastating impact as Enron, the auditor as well as the audit committee should jointly select legal counsel for the legal judgement and review, who may or may not be counsel regularly engaged.

Independent legal counsel will have inquiry power and authority to get to the facts that will support his judgement. Lawyers will have ultimate responsibility to make legal judgments. In situations where independent legal counsel will make the legal judgment and review, auditors also will not be placed in the position of having to shop around for another opinion after having found the first lawyer's opinion to be unreasonable. Nor will the auditor be placed in the position of having to qualify or disclaim where a conflict remains unresolved; the issues will be resolved by independent counsel.

Further the fact of the utilization of this legal judgement and review procedure, including who legal counsel is and the circumstances of his appointment should be disclosed. Not only will the responsibilities of the company and its professionals be identified, but if the procedures are correctly applied there will be a higher comfort level for the user of the financial statements and a corresponding strength in our capital markets.

Conclusion

Woodrow Wilson wrote "the whole purpose of democracy is to take counsel with one another so as not to depend upon the judgement of any one man but upon the common counsel of all." [FN11] The points for consideration addressed hopefully will be part of a collective and meaningful discussion leading to the best path for reform of our professional standards so to avoid the material risks of Enron's Professional Intersection.

Norman B. Arnoffis a lawyer in New York City. He is a member of the professional liability committee of the New York County Lawyers' Association. Ted Felixand Moshe Levitan, certified public accountants of the firm of Lazare Levine & Felix, assisted in the preparation of this article.

FN1. N.Y.L.J., Dec. 12, 2000, "Professional Intersection: Lawyers' Responses to Auditors' Letters," by Norman B. Arnoff and Sue C. Jacobs. See, also for discussion of issues related to the article, the following: N.Y.L.J., Aug. 8, 2000, "Professionalism's First Principle: Fiduciary Responsibility," by Norman B. Arnoff and N.Y.L.J., Apr. 25, 2000, "The Fiduciary Duty Standard of Causation," by Norman B. Arnoff and Sue C. Jacobs.

FN2. U.S. v. Simon, 425 F2d 796, 1969, U.S. App. LEXIS 10070, Fed. Sec. L. Rep. (CCH), at 93.

FN3. Id. at 425 F.2d 798-799.

FN4. Id. at 425 F.2d 809.

FN5. Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp., Executive Summary and Conclusions, Summary of Findings, at 4.

FN6. Id., Public Disclosure at 17.

FN7. Id., Outside Professional Advisers, at 25-26.

FN8. Statement on Auditing Standards 73, Using the Work of the Specialist, AU 336 at 292.

FN9. Id., AU 9336, Using the Work of a Specialist: Auditing Interpretations of 336, at 295.

FN10. Id.

FN11. Woodrow Wilson, "The New Freedom." The authors wish gratefully to acknowledge the contribution of Ted Felix and Moshe Levitan, Certified Public Accountants of the firm of Lazare Levine & Felix, for their assistance in the preparation of this article.

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END OF DOCUMENT

Covering The Case Law Of Brokerage House Disputes Vol. 2012 • No.1

SLAs 2012 | 1-6 • Published 9/12 The Cross-Hairs Of Accounting And Law: The Vectors of Litigation Risk By Norman B. Arnoff* and Paul I. Immerman**

Introduction To avoid the debilitating threat of The Professional The Dodd-Frank Wall Street Reform litigation costs and regulatory sanctions, Accounting Standards and Consumer Protection Act is a work the better approach is to make a careful Both FAS5: Accounting For Contingen- in progress. The legislative intent is to accounting and legal analysis that requires cies, promulgated in 1975 by the Financial recapture by more effective concentration the sophistication and sensitivity of both Accounting Standards Board (“FASB”), on specific and inherent risks -- as well the legal and accounting professions and and FASB’s promulgation in July 1, 2009 as more effective coordination among the less costly premiums of complete and of the Accounting Standards Codification regulators -- the transparency and market material disclosure in all documents given (“ASC”) 450 provide the starting points integrity lost over the last number of to investors and lenders or filed with the for analysis when contingent liability is- years. There also should be additional regulators. Above all, sound preventive sues arise in the litigation context. methods of addressing and avoiding measures must be taken to avoid costly systemic risks. and protracted securities litigation. FAS5 states, “a contingency is defined as an existing condition, situation, or set of Consonant with that is the subject of Accounting For circumstances involving uncertainty as to this article, which is the enhancement Litigation Uncertainties possible gain... or loss... to an enterprise of professional responsibility and the Coordination among litigation and that will ultimately be resolved when one necessary coordination of different corporate counsel and the company’s or more future events occur or are likely disciplines when overlapping issues accountants in the context of determining to occur... When a loss contingency ex- arise in the respective engagements of contingent liabilities from threatened ists, the likelihood that the future event or accountants and lawyers. or pending litigation offers an excellent events will confirm the loss or impairment template for illustrating the opportunities of an asset or the incurrence of a liability In the public or private offering context, law that exist for these professionals to not can range from probable to remote... [T] and accounting issues become intertwined merely do their jobs, but to serve their he terms probable, reasonably possible, in highly challenging ways that present to corporate client and public investors and remote identify three areas within both professions the difficult objectives by advancing market integrity and that range....” (Emphasis Added). of not only making the correct analysis in transactional transparency. Particularly terms of their own professional discipline, with large securities class actions and “Pending or threatened litigation” and but of their colleague’s discipline as well, other complex litigation, the need to weigh “actual or possible claims and assess- so that there is the required transparency. the risks of an unfavorable outcome, ments” are two of the uncertainties where This clearly is essential for the company to disclose the nature and probabilities the fundamental distinctions between making a securities offering, whether it is of litigation risks, and to quantify those cont’d on page 2 a public or private offering. The capital- risks for reserve purposes provide the professional with considerable challenges raising function cannot be impaired and, TABLE OF CONTENTS therefore, the broadest disclosure is and, at the same time, tantalizing prospects mandated. to serve well. Feature Article 1

* Norman B. Arnoff is a lawyer practicing in New York City. His practice consists of representing brokers, Case Summaries 6 broker-dealers, investment advisers and adviser representatives before the SEC and other regulators and in securities arbitration and litigation (primarily defense) disputes. Legal and accounting malpractice litigation and insurance defense and coverage work are also specialties. Table of Cases 47 ** Paul I. Immerman is a securities lawyer practicing in New York City in the areas of capital markets (’33 and ’34 Acts), Sarbanes-Oxley, M&A and structured notes. 1 Securities Litigation Commentator Vol. 2012 • No.1

The Cross Hairs cont’d from page 1 probable, reasonably possible and remote indicate the nature of the contingency there is no basis for accrual but there still must be given more precise definition and and shall give an estimate of the possible remains a sufficient threshold of risk. application in the financial reporting pro- loss or range of loss or state that such an cess in respect to the accrual of the loss estimate cannot be made.” (Emphasis Disclosure has to take place in virtually contingency, i.e., reporting it as a liability. Added) all circumstances except when the possibility of liability is remote. FAS5 also sets FAS5 provides that “[a]n estimated loss Further “disclosure is not required as to a forth the qualification that the mere “fil- from a loss contingency... shall be ac- loss contingency involving an unasserted ing of a suit or formal assertion as a claim crued by a charge to income if ... infor- claim or assessment when there has been or assessment does not automatically in- mation available prior to the issuance of no manifestation of a potential claim or dicate that the accrual of a loss may be the financial statements indicates that it is assessment... [or] an awareness of... [the] appropriate.” probable that an asset has been impaired possible claim or assessment unless it is or a liability had been incurred at the date considered probable that a claim will be ASC 450 does not substantially amend of the financial statements... [and] [i]t is asserted and there is a reasonable possi- FAS5. It merely clarifies it. Whether the implicit in this condition that it must be bility that the outcome will be unfavor- governing professional standard was or is probable that... future events will occur able.” (Emphasis Added) FAS 5 or ASC 450, accrual of a liability confirming... the loss... {Additionally} would clearly be inappropriate for litiga- [t]he amount of loss can be reasonably In other words, disclosure is required tion, claims, or assessments whose un- estimated… {in respect to an accrual}.” when there is a probability that the claim derlying cause is an event or condition (Emphasis Added) will be asserted and the reasonable possi- occurring after the date of the financial bility exists of an unfavorable outcome in statements but before those financial state- FAS5 further provides: the period covered by the financial statements are issued. Disclosure, however, in “Disclosure of the contingency shall be ment. The disclosure is triggered by the this context is appropriate. made when there is at least a reasonable “reasonable possibility” of an unfavorable possibility that a loss or an additional loss outcome. While “probable” is the standard Accrual may be appropriate for litigation, may have been incurred…. Even if an ac- for liability determinations, disclosure of claims, or assessments whose underlying crual is not made…, [t]he disclosure shall litigation risks is still appropriate when cont’d on page 3

BOARD OF CONTRIBUTING LEGAL EDITORS Richard P. Ryder, Editor-in-Chief SENIOR CONTRIBUTING EDITORS Sarah G. Anderson Jack D. Ballard Paul J. Dubow Attorney at Law Ballard & Littlefild, LLP Arbitrator • Mediator Charleston, SC Houston, TX San Francisco, CA

David C. Franceski, Jr. Pete S. Michaels William D. Nelson Stradley Ronon Stevens & Young, LLP Michaels, Ward & Rabinovitz, LLP Rothgerber Johnson & Lyons, LLP Philadelphia, PA Boston, MA Denver, CO

CONTRIBUTING EDITORS Carlton R. Asher, Jr. Philip J. Hoblin, Jr. James L. Komie Greenberg Freeman, LLP Attorney at Law Schuyler Roche & Crisham, P.C. New York, NY White Plains, NY Chicago, IL

Noah D. Sorkin Burton W. Wiand AIG Advisor Group Wiand Guerra King PL New York, NY Tampa, FL securities litigation commentator is a semi-quarterly publication of Securities Litigation Commentator, Inc., P.O. Box 112, Maplewood, NJ 07040. Business Office: 93 Riggs Place, South Orange, NJ 07079. Tel: 973-761-5880. FAX: 973-761-1504. E-Mail: help@ sacarbitration.com. WebSite: www.sacarbitration.com. Copyright © 2012 Securities Litigation Commentator, Inc. No part of this publication may be reproduced in any manner without the written permission of the publisher. subscription information: Regular Subscription (semi-quarterly newsletter only): $350/year, regular rate. Preferred Subscription (semi-quarterly newsletter and weekly email Alert): $695/year, regular rate. 2 Securities Litigation Commentator Vol. 2012 • No.1

The Cross Hairs cont’d from page 2 cause is an event occurring on or before terprise by a regulatory authority such as accountant reviewing the facts and figures the date of an enterprise’s financial state- the SEC is an excellent example of when should have concluded that the company’s ments even if the enterprise does not be- disclosure is not only required but accrual financial statements were misstated and come aware of the existence or possibility may be prudent. that as a result the public was likely to be of the lawsuit, claim, or assessment until mislead. (Emphasis Added) after the date of the financial statement. If the judgment is that the assertion is This may seem nonsensical, but, unlike probable, then a second judgment must be “GAAP and the anti-fraud rules the immediacy of public disclosures, made as to the degree of probability of an promulgated under §10(b) of the 1934 financial statements are historical ren- unfavorable outcome. If an unfavorable Act serve similar purposes, and courts derings, prepared well after the fact and outcome is probable and the amount of have often treated violations of the former published with the facility and advantage loss can be reasonably estimated, accrual as indicative that the latter were also of hindsight. Often, that hindsight is in- of a loss is required. If an amount of loss violated.... Nevertheless, the prohibitions formed by revelations arising after the cannot be reasonably estimated, accrual contained in the GAAP and in section date of the financial statement. is not appropriate. Disclosure is nonethe- 10(b) are not perfectly co-extensive. In less appropriate and more likely than not some circumstances, courts have found Among the factors that should be consid- the soundest course. The disclosure, how- defendants liable for securities fraud ered are the nature of the litigation, claim, ever, should be grounded in the true facts under §10(b), despite having complied or assessment, the progress of the case and applicable law and not merely be a with GAAP, while in other circumstances, (including progress after the date of the fi- mechanical application to avoid profes- courts have discharged defendants nancial statements but before those state- sional liability and liability to the board from §10(b) liability, notwithstanding ments are issued), the opinions or views and management. deliberate violations of GAAP.” of legal counsel and other advisers, the experience of the enterprise in similar cases, The Cases And The Law Discretionary judgment is a constant in the experience of other enterprises, and any Accounting standards that deal with liti- dealing with litigation uncertainty and decision of the enterprise’s management as gation uncertainty are easily stated. The therefore there is a relatively high bar to to how the enterprise intends to respond to challenge is in the application and the establish professional and civil liability. the lawsuit, claim, or assessment. variables that come into play in order to The Guenther Court recognized, where distinguish what is probable from what is there is litigation uncertainty, an easy to A decision to contest the case vigorously reasonably possible, and whether the li- overcome threshold in order to accrue a or a decision to seek an out-of-court set- ability or possible liability can be reason- liability does not exist. The Court held: tlement will affect whether the liability ably estimated. Those standards, however, “‘GAAP is a term of art that encompasses is to be accrued or merely disclosed. The when interpreted and applied in the con- a wide range of acceptable procedures…. fact that legal counsel is unable to express text of litigation or its anticipation, can be GAAP are far from being a canonical set an opinion that the outcome will be favor- informative tools, both to defend against of rules that will ensure identical account- able to the enterprise should not necessar- and to prevent liability in securities and ing treatment of identical transactions…. ily be interpreted to mean that the condi- professional liability litigation. [GAAP] rather tolerates a range of ‘rea- tion for accrual of a loss is met. sonable’ treatment, leaving the choice In SEC v. Guenther1, the Court held: “... among alternatives to management. Ac- With respect to unasserted claims and to give rise to section §10(b) liability counting concepts are flexible, {and} cir- assessments, an enterprise and its pro- for fraud, the mere second-guessing cumstances will give rise to fraud only fessional advisers must determine the of calculations will not suffice; the where differences in calculating are the degree of probability that a claim may be Commission must show that the defendants’ result of a falsehood, ‘not merely the dif- asserted and the possibility of an unfavor- judgment - at the moment exercised - was ference between two permissible judg- able outcome. An investigation of an en- sufficiently egregious that a reasonable cont’d on page 4 Where do YOU go for broker-dealer case law? SECURITIES LITIGATION COMMENTATOR

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3 Securities Litigation Commentator Vol. 2012 • No.1

The Cross Hairs cont’d from page 3 3 ments’.... A reasonable accountant may PEC Solutions Inc. Securities Litigation The Court also recognized “‘the estimation choose to apply any variety of acceptable was a class action involving securities of probable losses in a large loan portfolio procedures when preparing a financial fraud allegations, premised upon account- is more of an art than a science’…. Indeed statement....” (Emphasis Added) ing fraud. The Court held not only was the complaint cited … different standards particularity required in the pleading in or accounting authorities that address ac- This forgiving professional judgment order to survive a motion to dismiss, but counting for loss contingencies, much of rule2, however, is not an absolute shield that the allegations of misrepresentations which in turn contain numerous subparts from liability. What cannot and should not are to be addressed in terms of the total- or considerations.…” be disregarded is that disclosure is virtu- ity of the facts, i.e., “‘a court should not ally always prudent, even when the facts consider each relevant factual allegation In Biver County Retirement BD v LCA and circumstances would not require it solely in isolation…, but rather as a part Vision Inc..,6 the Court held in order to because the possibility of litigation and a of the overall factual picture painted by be sufficient to give rise to an inference successful claim being asserted is remote. the complaint.” (Emphasis Added) of scienter “‘…[the] allegations of accounting violations… [have to be]… so The possibility of falsity and material Not only must the total mix of information simple, so basic and pervasive in nature, omission necessitates an evaluation of the be considered but it is also a settled proposi- and so great in magnitude, that they total mix of information before liability tion that violations of accounting standards should have been obvious to a defen- can be adjudged. The Court held in the cit- are not in and of themselves violations of dant.” (Emphasis Added) The accounted case: “A misinterpretation is considered the anti-fraud provisions. Further misstate- ing violations were not “‘so simple, ‘material’ if it has been established there is ments and omissions are not actionable basic, or pervasive in nature’’’ as to be a substantial likelihood that the misrepre- when they are not considered “material obvious to the defendant. sentation would have been viewed by the because in light of the quality of the com- reasonable investor as having significantly pany’s disclosures, any additional disclo- In NVIDIA Corporation Securities Litiga- altered the ‘total mix’ of information made sures could not have altered the ‘total mix’ tion,7 the Court addressed in the context available…. A determination of material- of information available to an investor.” of a securities class and fraud action the ity requires delicate assessments of the two key issues that must be resolved be- inferences that a reasonable shareholder Moreover, in respect to litigation uncertain- fore a liability can be accrued. Not only would draw from a given set of facts and ty there is a threshold of required predict- must there be ‘probable loss’ but the ac- the significance of those inferences to the ability and certainty when a liability should counting charges must be “‘reasonably shareholder…. Although materiality gen- be accrued. The Court in Alphastar Insur- estimable’ before the end date of the pe- erally presents a factual question, the is- ance Group Limited et al. v. Arthur Ander- 4 riod covered by the financial statement. sue may be decided as a matter of law in son et al. held: “… the defendants could an appropriate case upon a showing that not have misrepresented the likely outcome Further, if the violation of accounting ‘a reasonable investor could not have been of the … litigation because the outcome standards are to have any probative val- swayed by an alleged misrepresentation, could not have been predicted with the type ue the allegations, especially where the or omission.’ Cautionary language that of likelihood required by F.A.S.5.” Private Securities Litigation Reform Act relates directly to the issue on which plain- (‘PSLRA’) is applicable, must have spe- tiff claims to have been misled can render Neither general fraud allegations nor alle- cific and concrete content coupled with the alleged misrepresentation or omis- gations of accounting violations, without the allegation of knowledge or reckless sions immaterial as a matter of law…” more, constitute sufficient allegations of disregard by the wrongdoer that the er- (Emphasis Added) accounting fraud. In Local 295/Local 851 ror will have a material impact on the fi- Employer Group Pension Trust v. Fifth 5 nancial statement and as a result make a The Guenther case also stands for the Third Bancorp, the Court held, however, likely difference to the investor in regard proposition that expert testimony is nec- accounting violations can be indicative of to his or her investment decision. Nor is essary to inform the adjudicator of the fraud. Specificity is not merely required to there a more liberal standard of pleading facts with respect to the interpretation state the nature of the error but its magni- or proof for the SEC when it brings en- and application of professional standards. tude as well. The Court held: “Accounting forcement actions.”8 Qualified experts, however, are not per- violations, standing alone, do not create mitted to opine upon ultimate issues that an inference of scienter…. If however, Conclusion And A Further usually are conclusions of law. Issues the accounting errors are sufficiently basic Recommendation such as whether the defendant aided and and large, their existence in combination Accounting for litigation uncertainty abetted any breach of fiduciary duty by with other factors may support the req- takes lawyers and accountants to a profes- the officers and directors of the issuer are uisite scienter …. ‘In order to establish sional intersection that can have serious, good examples. The latter is both an ulti- scienter based on accounting violations..., unintended consequences unless FAS5 mate legal issue and beyond the scope of the complaint must allege ‘extreme’ in and ASC 450 are understood. This is true expert opinion. your face facts that ‘cry out scienter.’” in terms of how they are interpreted and (Emphasis Added) cont’d on page 5 4 Securities Litigation Commentator Vol. 2012 • No.1

The Cross Hairs cont’d from page 4 applied as an accounting standard in the sonably estimable in amount, a liability is cipitating factor to cause litigation. Again financial audit and reporting process, as accrued if such an event took place within it is good to remember what Justice Louis well as to what legal effect these stan- the fiscal year. However, that is not the Brandeis said in this context, i.e., “sun- dards are to be given by the courts. The end of the story. The law is forgiving with light is the best disinfectant” and that standards are clear in principle but diffi- respect to professional and civil liability, precept, which should be internalized by cult to apply and therefore require clear, because in this context the judgment of the members of both professions, is the sensitive, and cooperative communication both the legal and accounting professions best means both to avoid professional and between the legal and accounting profes- must address complex, sensitive and diffi- civil liability and to best serve the client sions. An interactive dialogue is not only cult questions. It should be recognized the and the investing public. Accurate and a means to avoid the pitfalls of profession- only real liability exposure occurs when material disclosure on an ongoing basis is al liability but most importantly best serve there is a failure to disclose material facts, always the soundest and best professional the client. (Emphasis Added) so opting for disclosure is a given. advice to be given, as well as the safest way to avoid the systemic risks that in- When an event may be reasonably pos- Some will view such disclosure as an here in the professional practices of both sible to result in a liability, it must be invitation to litigation. However, non- lawyers and accountants. disclosed. When it is probable and rea- disclosure can be an even stronger pre-

End Notes 1. 395 F.Supp.2d 835, Fed. Sec. L. Rept. P 93,512 (U.S.D.C. Nebraska. 2005) 3. 2004 WL 1854202 (E.D. Va. 2004) 6. 2009WL806714 (U.S.D.C. S.D. Ohio 2009) 2. Baltimore Associates LLC v. Thimmesch, 2007 WL 5662124 (U.S.D.C. Ari- 4. 383 B.R. 231 (US Bankruptcy Court SDNY 2008) 7. 2010WL4117561 (U.S.D.C. N.D. Cal 2010) zona. 2007); In re; K-Tel International Inc. Securities Litigation 107F. Supp 2d 5. 731 F. Supp 2d.689 (U.S.D.C. Ohio, Western Division 2010) 8.SEC v. Leslie, 2012WL116562 (U.S.D.C. N.D. Cal 2012) 994 (U.S.D.C. Minnesota 2000)

OUT OF THE FIRE, INTO THE FRYING PAN. Bear Stearns hedge fund managers, Ralph Cioffi and Matthew Tannin, must have considered themselves lucky when they were found not guilty of securities fraud in a criminal trial. Prosecutors in that case accused the two of giving rosy forecasts for the performance of the hedge funds that they knew were on the verge of collapse. However, the two did not escape unscathed by any means; the SEC pursued a civil proceeding against them and reached a settlement in which Cioffi and Tannin, while not admitting to any liability, agreed to be barred from the securities industry for three years and two years, respectively, and to pay a total of $900,000 in disgorgement and $150,000 in penalties. (NOTE: For a summary of the Court’s approval of the settlement, with further details on the background of the case, see SLA 2012-26.) Source: “Ex-Bear Stearns Managers To Settle SEC Suit For $1M,” by Lana Birbrair, www.law360.com (2/13/12).

FREE FOUR-WEEK TRIAL SUBSCRIPTION SAC’s E-MAIL OF SAC’S ARBITRATION ALERT ALERT SERVICE On a weekly basis since early August 1999, the Securities Arbitration Commentator has offered an E-Mail Alert Service, known as SAC’s Arbitration Alert,which keeps subscribers up- to-date on recent court decisions, rule filings, notable Arbitra- NAME tion Awards, and other interesting and timely information. It is a great way to get news “bullets” on matters of the moment ORGANIZATION -- and -- when you want more detail, call SAC for hard-copy ADDRESS back-up materials. Much of this material will be published as well in our print newsletter, the Securities Arbitration CITY/STATE/ZIP Commentator, but we designed the Arb Alert for lawyers, neutrals and experts who need to stay current with events and EMAIL developments affecting securities/commodities arbitration. Try a free four-week trial subscription to this timely service. Just MAIL TO: Securities Arbitration Commentator complete and mail this coupon or e-mail us today. ATTN: SAC’s Email Alert Service P. O. Box 112 Maplewood, NJ 07040 Please visit SAC’s Website for details about our products and services: WWW.SACARBITRATION.COM 5

Joint Representation, Conflicts, and Ethical Considerations

Norman B. Arnoff and Sue C. Jacobs

Our sense of professional responsibility and sensitivity to the Ethical Considerations (EC) and Disciplinary Rules (DR) in the Lawyers Code of Professional Responsibility are critical to our law practices if we wish to avoid legal malpractice claims and disciplinary sanctions. This article will address the pro-typical conflicts arising from joint representation that reoccur on both the plaintiffs’ and defendants’ side in any civil action. Ethical Considerations

• And Disciplinary Rules. Civil litigation lawyers, whether representing plaintiffs or defendants, if they are to represent multiple clients, always need to have a heightened consciousness of actual and potential conflicts and the EC and DR that provide the intelligent guidance essential to avoid serious professional problems. The pertinent ECs are EC5-1, EC5-3, EC5-14 and EC5-16. The pertinent DRs are DR5-101 and DR5-105. The pertinent text quoted below should be read, re-read and internalized so that addressing conflict issues becomes second nature and our response will not only be intuitively right but right in fact.

The pertinent ECs and DRs are as follows:

EC5-1: The professional judgment of a lawyer should be exercised, within the bounds of the law, solely for the benefit of the client and free of compromising influences and loyalties. Neither the lawyer’s personal interests, the interests of other clients, nor the desires of third persons should be permitted to dilute the lawyer’s loyalty to the client.

EC5-3: The self-interest of a lawyer resulting from ownership of property in which the client also has an interest which may affect property of the client may interfere with the exercise of free judgment on behalf of the client. If such interference would occur with respect to a prospective client, a lawyer should decline proffered employment.

EC5-14: Maintaining the independence of professional judgment required of a lawyer precludes acceptance or continuation of employment that will adversely affect the lawyer’s judgment on behalf of or dilute the lawyer’s loyalty to a client. This problem arises whenever a lawyer is asked to represent two or more clients who may have differing interests, whether such interests be conflicting, inconsistent, diverse, or otherwise discordant.

EC5-15: If a lawyer is requested to undertake or to continue representation of multiple clients having potentially differing interests, the lawyer must weigh carefully the possibility that the lawyer’s judgment may be impaired or loyalty divided if the lawyer accepts or continues the employment. The lawyer should resolve all doubts against the propriety of the representation…. If a lawyer accepted such employment and the interests did actually come to differ, the lawyer would have to withdraw from employment with likelihood of resulting hardship on the clients; and for this reason it is preferable that the lawyer refuse the employment initially…. Simultaneous representation in unrelated matters of clients whose interests are only generally diverse, such as competing economic enterprises, does not by itself require consent of the respective clients. Likewise a lawyer may generally represent parties having antagonistic positions on a legal question that has arisen in different cases, unless representation of either client would be adversely affected. Thus, it is ordinarily not improper to assert such positions in cases pending in different trial courts.

EC5-16: Thus, before a lawyer may represent multiple clients, the lawyer should explain fully to each client the implications of the common representation and otherwise provide to each client information reasonably sufficient, giving due regard to the sophistication of the client, to permit the client to appreciate the significance of the potential conflict, and should accept or continue employment only if each client consents, preferably in writing. If there are present other circumstances that might cause any of the multiple clients to question the undivided loyalty of the lawyer, the lawyer should also advise all of the clients of those circumstances. …In all cases in which the fact, validity or propriety of client consent is called into question, the lawyer must bear the burden of establishing that consent was properly obtained and relied upon by the lawyer.

DR5-101: A lawyer shall not accept or continue employment if the exercise of professional judgment on behalf of the client will be or reasonably may be affected by the lawyer’s own financial, business, property or personal interests, unless a disinterested lawyer would believe that the representation of the client will not be adversely affected thereby and the client consents to the representation after full disclosure of the implications of the lawyer’s interest. DR5-105:

A: A lawyer shall decline proffered employment if the exercise of independent professional judgment in behalf of a client will be or is likely to be adversely affected by the acceptance of the proffered employment, or if it would be likely to involve the lawyer in representing differing interests, except to the extent permitted under DR5-105 1200.24.

C: In the situations covered by DR5-105 [1200-24] (A) and (B), a lawyer may represent multiple clients if a disinterested lawyer would believe that the lawyer can competently represent the interest of each and if each consents to the representation after full disclosure of the implications of the simultaneous representation and the advantages and risks involved. Joint Representation

• And Attorney-Client Privileged Communications and Confidences. Apart from conflicts of interests that are motivated by property and other economic reasons, serious attention in the arbitration and civil litigation context has to be focused on those conflicts that relate to the inconsistencies of the clients’ respective positions and the implications as well for the sharing and disclosure of privileged communications and confidential information. Criminal cases more frequently inform us of conflict issues, but these lessons should be adopted as well in a civil context. Basic to most conflicts that are not driven by economic self-interest is the material inconsistency between the position of the different clients, i.e., the testimony of one of the clients exculpates him but inculpates the other lawyer’s client. Conflicts of this nature occur more often than not in a criminal case, however, the dynamics of what happens is just as evident in other contexts. United States v. Cooper, et al.1 was a prosecution of a father, mother and son for wire fraud and conspiracy arising from false statements about the son’s work. The family engaged one counsel to represent all. Upon the government’s request, the court addressed conflict issues in the context of joint representation. The court addressed the inherent conflicts arising from a group of parties charged on the same set of facts and the compounding of the difficulties when one lawyer represents multiple clients and more significantly how such conflicts are dealt with so individual choice of counsel is respected but does not compromise the integrity of legal processes whether in court or arbitration. The court held: Whenever two or more defendants are jointly charged and are represented by the same counsel or by counsel who are associated with the same law firm, a question arises whether the interests of the defendants conflict so that joint representation would be ineffective. … This Court held a hearing for consideration of the propriety of joint representation of the defendants. At the hearing, each of the defendants individually responded to an examination by the Court and by…[counsel] as to their consent to and understanding of the implications of the joint representation. Each defendant consented to…[the lawyer’s] joint representation. … It is settled that “requiring or permitting a single attorney to represent codefendants, often referred to as joint representation is not per se violative of constitutional guarantees of effective assistance of counsel.” Holloway v. Arkansas, 435 U.S. 475, 482 98 S.Ct. 1173, 1178, 55 L.Ed.2d 426 (1978). We have never held that the possibility of prejudice that “inheres in almost every instances of multiple representation” justifies the adoption of an unflexible rule that would presume prejudice in all such cases. See Cuyler v. Sullivan, 446 U.S. 335, 348, 100 S.Ct. 1708, 1718, 64 L.Ed.2d 333 (1980). Instead, we presume prejudice “only if the defendant demonstrates that counsel ‘actively represented conflicting interests’ and that ‘an actual conflict of interest adversely affected his lawyer’s performance.”

…[A] trial court must anticipate potential conflicts and take appropriate measures to protect the right to effective counsel when a conflict “is likely to arise.” … …[T]he relative culpability of each codefendant may become a pivotal aspect of his or her defense. A single attorney cannot raise arguments as to the lesser culpability of a defendant without compromising the defense of the others. One of the defendants may have made or may make statements to counsel which support his or her defense while weakening the defense of another codefendant. In such an event, joint counsel for codefendants may be placed in the unethical position of having to “cross-examine” one of his clients to support the defense of another client. In addition, if defendants have varying levels of culpability, a single attorney may not provide an effective statement at closing or sentencing.

While it is true that a “defendant may waive his right to the assistance of an attorney unhindered by a conflict of interest,”…a trial court must find that the waiver is made “knowingly, intelligently, and with the awareness of the likely consequences of the waiver.” United States v. Dolan, 570 F.2d 1177, 1181 (3d Cir. 1978). In determining whether a waiver is valid, a trial court must be cognizant that “a defendant may be competent to stand trial, but not competent enough to understand the complex, subtle, and sometimes…unforeseeable dangers inherent in multiple representation.

…[W]e are sensitive…to the fact that financial considerations may have affected the codefendants’ decision to retain a single attorney. Joint representation may result in lesser attorney’s fees for the [defendants]…and this consideration may have undermined the voluntariness of each defendant’s waiver of the right to separate counsel. … [A]n attorney must consider “the likelihood that conflict will eventuate…and, if it does whether it will materially interfere with the lawyer’s independent professional judgment in considering alternatives or foreclose courses of action that reasonably should be pursued on behalf of the client.” For the reasons stated above, the Court does find in this case that the probability of conflict is too great to permit joint representation. (Emphasis added). ‘New York v. Allah’

As noted, conflicts may or may not require an attorney’s withdrawal. In most cases informed consent and waiver after inquiry by the court in a criminal case or by counsel in a civil case can avert the problem. The New York Court of Appeals in New York v. Allah2 in the context where defense counsel was not present at a critical stage of the proceeding and one of the other counsel was asked to undertake the additional representation, held: Where codefendants are represented by the same attorney, the trial court must inquire, on the record, whether each defendant has an awareness of the potential risks involved in that course and has knowingly chosen it…. Only after sufficient admonition by the trial court of the potential pitfalls of joint representation can it be said that a defendant’s right to the effective assistance of counsel is adequately safeguarded….If such admonition appears on the record, appellate courts can determine whether a defendant’s decision to pursue joint representation is an informed one. … …[T]he record indicates that the court, by proper inquiry, took the necessary precautions to ensure that the defendant perceived the potential risks inherent in joint representation by counsel for the codefendants. Thus, we cannot conclude that defendant’s decision to pursue joint representation in this case was an informed one. Respondent’s argument that defendant consented to the joint representation in open court is unavailing. ‘United States v. Poston’

Criminal and civil cases as far as the issue of conflicts arising from joint representation are significantly different with respect to the degree of care that must be extended in a criminal case as opposed to a civil matter, nonetheless, there has to be care and concern shown in every context. The standards, however, utilized in a criminal context can be adapted in all civil contexts including arbitrations. In United States v. Poston3 the U.S. Court of Appeals for the Eighth Circuit articulated the standards for informed consent and effective waiver as follows:

[The] district court should address each defendant personally and forthrightly advise him of the potential dangers of representation by counsel with a conflict of interest. The defendant must be at liberty to question the district court as to the nature and consequences of his legal representation. Most significantly, the court should seek to elicit a narrative response from each defendant that he has been advised of his right to effective representation, that he understands…the details of his attorney’s possible conflict of interest and the potential perils of such a conflict, that he has discussed the matter with his attorney or if he wishes with outside counsel and that he voluntarily waives his Sixth Amendment protections…. It is, of course, vital that the waiver be established by “clear, unequivocal and unambiguous language.” …Mere assent in response to a series of questions from the bench may in some circumstances constitute an adequate waiver, but the court should nonetheless endeavor to have each defendant personally articulate in detail his intent to forgo this significant constitutional protection. Recordation of the waiver colloquy between defendant and judge will also serve the government’s interest by assisting in shielding any potential conviction from collateral attack, either on Sixth Amendment grounds or on a Fifth or Fourteenth amendment “fundamental fairness” basis. … “The defendant must voluntarily and with full knowledge of the consequences decide on dual representation. The court should address each defendant personally and advise him of the potential danger of dual representation. The defendant should have an opportunity and be at liberty to question the trial court on the…nature and consequences of dual representation and the entire procedure should be placed on the record for review.”

‘Camera v. Bombard’ Joint representation can be challenged either by the former client or another party in the litigation whether criminal, civil or arbitration. For the challenge to be effective, however, there must be a showing by the party challenging the representation that it be prejudicial to one of the clients or litigants. In Camera v. Bombard4 the Court held:

“When a potential conflict arises, either where a court has assigned the same counsel to represent several defendants or where the same counsel has been retained by codefendants…the proper course of action for the trial judge is to conduct a hearing to determine whether a conflict exists to the degree that a defendant may be prevented from receiving advice and assistance sufficient to afford him…[the] quality of representation guaranteed. The defendant should be fully advised by the trial court of the facts underlying the potential conflict and be given the opportunity to express his view.

“The mere representation of two or more defendants by a single attorney does not automatically give rise to a constitutional deprivation of counsel. It is settled in…[the Second Circuit] that some specific instance of prejudice resulting from joint representation must be shown to exist.”

The court in Sullivan v. Dalsheim5 noted “the prejudicial conduct of the attorney must be the consequence of a conflict between the interests of the codefendants, and it must be inconsistent with sound trial strategy.” In other words, the conflict must have a causal effect but no false confidence should be taken since “it is possible for an omission by counsel arising out of joint representation to constitute prejudice.” In the context of a conflict the lawyer’s error is more likely to be misconstrued as bad faith and he is less likely to be given the benefit of the doubt that his error was in the zone of reasonable judgment. Where, however, there is no viable defense (or claim for that matter) and no harm results the challenge is not likely to affect the matter’s outcome.6

Joint representation and the potential conflicts that may arise, however, should not be taken lightly and can be the basis of a motion to disqualify counsel. The challenge, however, is not necessarily restricted to former or current clients and can be made by other parties to the litigation. When this occurs, a knowing and intelligent waiver by the clients jointly represented can be required to avert disqualification of counsel. In Burg v. Brunswick Hospital Center7 the court held:

“While courts in the past have accepted written statements from the parties indicating knowing and intelligent consent to joint representation…. The Second Circuit’s recent decision in Oneida, supra indicates that in certain circumstances “other parties to the litigation are entitled to the assurance of an on the record consent sufficient to preclude any subsequent challenge to a judgment…[because of joint representation]…. Since personal counsel for…[one of the two doctor defendants] has already acknowledged that individual liability in this case may exceed the doctor’s policy limits, the Court finds it appropriate to ascertain in open court that both doctors fully appreciate the potential risks of joint representation and that each defendant wishes to proceed in the face of a waiver of their right to object to joint representation.

Joint representation not only presents issues that may lead to an attorney’s disqualification but an inadvertent waiver of one or more of the clients’ attorney-client privileges. Issues that arise also concern the extent of the waiver, whether it is limited to those communications actually shared or to anything dealing with a particular subject matter concerning the group of people jointly represented or constituting a community of common interest. In re: Bruce W. and In re: Terry C.8 addressed the waiver issue in the criminal context and emphasized substance over form with respect to waiver. The court held, following the precedent set by the Court of Appeals…

“Attorneys are under an ethical obligation to disclose to their clients, at the earliest possible time, any conflicting interests that might cloud their representation. Disclosure alone is not enough. The lawyer may not act for his client unless the client has given his informed consent to further representation.”

We hold therefore as a matter of law that when the Legal Aid Society represents alleged coperpetrators of the same criminal transaction, it does so (a) with full knowledge that a prima facie conflict exists; that it must affirmatively rebut the assumption of conflict;…and (c) that failing rebuttal thereof, it is incumbent upon it to show that both alleged coperpetrators were made fully aware of the conflict and exercised informed waivers thereof.

For this reason as observed in Neighborhood Development Collaborative v. Murphy9, “[j]oint representation of clients with potentially adverse interest should be undertaken only when subject to very narrow limits” and “full disclosure of all possible dangers inherent in dual representations” should be made to the clients.

The court in Teleglobe Communications Corp. et al. vs. BCE Inc. et al.10 explained the differences between joint representation of multiple clients, simultaneous representation of co-clients, and a number of lawyers who represent different clients with a community of common interest. The appeal raised “core questions about the proper operation of a corporate family’s centralized in house legal department.” The court explained the subtleties as follows:

While it is permissible for lawyers and clients to limit the scope of representation in a single- client representation,…it is particularly common in co-client situations because of the limited congruence of the clients’ interests….[A] co-client relationship is limited by ‘the extent of the legal matter of common interest’…. While written agreements limiting the scope of a joint representation might be preferable, nothing requires this so long as the parties understand the limitations.

When co-clients and their common attorneys communicate with one another, those communications are “in confidence” for privilege purposes. Hence the privilege protects those communications from compelled disclosure…to persons outside the joint representation. Moreover, waiving the joint-client privilege requires the consent of all joint clients…. A wrinkle here is that a client may unilaterally waive the privilege as to its own communications with a joint attorney, so long as those communications concern only the waiving client; it may not, however, unilaterally waive the privilege as to any of the other joint clients’ communications or as to any of its communications that relate to other joint clients.

[O]ne codefendant could not waive the privilege that attached to the shared information without the consent of all others. Later, courts replaced the joint-defense privilege, which only applied to criminal codefendants, with a broader one that protects all communications shared within a proper “community of interest,” whether the context be criminal or civil. Thus, the community-of-interest privilege allows attorneys representing different clients with similar legal interest to share information without having to disclose it to others. It applies in civil and criminal litigation, and even in purely transactional contexts.

This joint representation occurs where one lawyer represents multiple clients in a matter and while the relationship exists attorney-client privilege applies to communications by and between counsel and is essentially only waived when one client sues or has an adverse claim against the other, where a number of lawyers represent clients with a community of interest the law now has extended the attorney-client privilege to communications related to the common matter the lawyers are representing the clients. This is the joint defense privilege. The third scenario is where one lawyer is representing a number of clients at the same time without necessary relationship of the matters that are the subject of the representation. In those circumstances, the privilege remains in tact unless waived by the individual. Any waiver, whether intentional or inadvertent, applies to only the individual.

The court gave special recognition to the frequently moving target that the above situations can present by observing as follows:

In undertaking a joint representation, the prospective joint attorney must always consider whether she can fulfill her duties to each co-client…. When the co-clients desire to shield information from one another, this inquiry becomes more difficult in light of the prospective joint attorney’s duty of candor to each. …

[W]hen a joint attorney sees the co-clients’ interest diverging to an unacceptable degree, the proper course is to end the joint representation…courts are presented with a difficult problem when a joint attorney fails to do that and instead continues representing both clients…. In this situation, the black-letter law is that when an attorney (improperly) represents two clients whose interests are adverse, the communications are privileged against each other notwithstanding the lawyer’s misconduct.

Three Scenarios

The above three scenarios, i.e., joint representation of multiple clients in a matter, representation of one client in league with other lawyers in a matter, and representation of a number of individual clients at the same time in a matter not necessarily related, present problems on a regular basis for in-house corporate counsel and other attorneys who jointly represent clients in a single matter or co-clients having a community of interest. In-house counsel are particularly susceptible to these conflicts.

A recent case published in the New York Law Journal, May 23, 2008, People v. Hussein, Supreme Court, Kings County, while a criminal case, highlights the risks and responsibilities with respect to joint representation that should be discerned and applied as standards for professional conduct in any civil action or arbitration context. Father and son were charged with burglary, assault and robbery and represented by the same counsel. There was another defendant represented by separate counsel. The case against the son was particularly weak and as a result the significant differences in the “type and quantum” of evidence against each…“suggested different theories and tactics of defense for each” such that “the defendants did not have to demonstrate that the conflict created actual prejudice to their defense or that an alternative defense would likely have produced a more favorable outcome.” The lawyer was inhibited by the father’s position in the case to bring out the weaknesses in the identification and other evidence against the son.

Not only did the opinion criticize counsel for not engaging in an in-depth inquiry or making appropriate disclosures to obtain informed consent to the joint representation, but the prior court was deemed to be remiss.

Counsel as an officer of the court must be fully responsible for the necessary inquiry and disclosure as well as adequately memorializing the client’s informed consent in the event there is a subsequent professional liability issue in the wake of an unfavorable judgment. This eventuality is not remote and attorneys should not take comfort that a showing of proximate cause in a legal malpractice action is exceedingly difficult because of the “case within a case” requirement. The test of causation for breach of fiduciary that implicates more significantly the lawyer’s ethical responsibilities is whether the lawyer’s actions or omissions are a substantial factor in the sequence of causation.11

Waiver of privilege issues relating to joint representation, representing a client pursuant to a joint defense privilege, and representing clients with a community of interest require special sensitivity.

Precautionary Measures

In the undertaking of any representation lawyers should ameliorate if not eliminate conflict issues by obtaining the client’s consent to the representation and the basic strategic approaches, as well as, on an ongoing basis, addressing potential conflicts with the client and obtaining the client’s informed consent as to the actual and possible conflicts as they arise.12

Prudence should also dictate that unless there are compelling economic necessities when representing multiple clients in cases having the same or similar subject matter the individual client or prospective one should be advised to obtain separate counsel and in any event the client should be assisted in making an informed choice if separate counsel is decided to be not preferable.

When working with other counsel on a matter the joint defense privilege should be observed, communications limited to the matter at hand, and the client advised of the risk of adversity developing between clients and the resulting waiver of attorney-client privilege.

When the lawyer represents more than one client and there is a hint of commonality there should be heightened concern so as not to compromise each client’s confidential and privileged information. These prophylactic rules of practice apply in the context of all legal representations.

••••••••••••••••••••••••••••• 1. 627 F.Supp. 155; 1987 U.S. Dist. Lexis 9863 (U.S. Dist. Ct. Delaware 1986) 2. 80 NY2d 396; 605 NE2d 327; 590 NYS2d 84-; 1992 NY Lexis 3906 (Court of Appeals 1992). 3. 727 F2d 734; 1984 US App Lexis 35615 (8th Circuit 1984). 4. 1977 US Dist. Lexis 14280 (SDNY 1977) 5. 1979 US Dist. Lexis 11085 (SDNY 1979) 6. Ohio v. Terry 2007 Ohio 1259; 2007 Ohio App. Lexis 1171 7. 1987 US Dist. Lexis 1987 (EDNY 1987) 8. 114 Misc2d 91; 450 NYS2d 734; 1982 NY Misc. Lexis 3440 (Family Court, Queens County 1982) 9. 233 F.R.D. 436; 2005 US Dist. Lexis 30837 (ND Maryland 2005) 10. 493 F.3d 345, 2007 US app. Lexis 16942 (Third Circuit 2007) 11. Norman B. Arnoff and Sue C. Jacobs, “The Fiduciary Duty Standard of Causation,” April 25, 2000, New York Law Journal p. 3 (Col. 1) 12. New York Law Journal (p. 3, Col. 1), March 2, 2007 Professional Liability Column, Norman B. Arnoff and Sue C. Jacobs, “Informed Consent and Legal Malpractice.”

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HEADLINE: The Lawyer's Fudiciary Duty

BYLINE: By Norman B. Arnoff and Sue C. Jacobs; Norman B. Arnoff is a member of Capuder & Arnoff PC. Sue C. Jacobs, is a member of Goodman & Jacobs and formerly chaired the Insurance Committee of the New York County Lawyers' Association. They are members of its professional liability committee, which Mr. Arnoff formerly chaired. Eniko Bazsa helped prepare this article.

BODY: IT IS THE PUNCTILIO of care, competence and honor. Benjamin Cardozo, Chief Judge of the New York Court of Appeals, beautifully expressed the meaning of fiduciary duty. n1 He articulated both a professional standard of conduct and what members of the bar should always aspire to have their conduct be and to have others perceive it to be when legal services and issues have significance.

n1 Meinhard v. Salman, 249 N.Y. 458, 164 N.E. 545, 62 ALR 1 (1928). The statutes, cases and codes of professional responsibility do not always give precise definition to what must and must not be done; but, because of the importance of the profession, to the rule of law and the welfare of society, attorneys are held strictly to fiduciary standards and must always be motivated to identify and perform their requirements. Whether a review of jurisprudence is historical or involves more recent cases, a lawyer has several basic fiduciary duties. They are preserving the confidentiality of client information, continuing to accord the client access to that information, honesty and fair dealing in the handling of other people's money, entering into only fair and honorable contracts with those served and avoiding both the appearance and the reality of conflicts of interest that diminish the competence and ethics of professional responsibilities and civic obligations.

Duty to Defend Client Privacy A lawyer has a fiduciary obligation not only to treat as confidential information imparted in the course of attorney-client communication but also other information about the client learned from third parties. The obligation extends beyond the attorney-client privilege and gives effect to what Justice Louis Brandeis deemed to be a fundamental right, the right of privacy. The lawyer's necessary and extensive access to client information mandates this obligation if people are to seek legal counsel and have privacy in their affairs. The fiduciary duty to preserve client confidences is a continuing duty extending beyond the termination of the attorney-client relationship. It also entails according the client access to information that the attorney may have and the client does not have regarding the client's affairs. The duty is one of openness and disclosure to the client and an obligation to defend client privacy against an intruding world. In Tekni-Plex Inc. v. Meyner and Landis, n2 the New York Court of Appeals addressed attorney disqualification issues in the context of a corporate merger and arbitration after the merger. The post-merger arbitration was between Page 2 New York Law Journal, April 13, 1999 the predecessor entity and its sole shareholder and the successor entity. The dispute related to indemnification rights regarding environmental compliance issues and the disclosures and representations in the contracts.

n2 Tekni-Plex Inv. V. Meyner and Landis et al., 89 NY2d 123 (1996). An issue was raised whether counsel for the pre-existing entity and former shareholder could represent the latter in the arbitration. The Court held that the attorney must be disqualified. The attorney-client privileged communications were an incident of the sale, and the privilege belonged to the new entity. There was a substantial relationship in the representations. In respect to the merger transaction, the communications were not privileged against the former shareholder. To give the new entity control over these specific attorney-client communications "would thwart, rather than promote, the purposes underlying the privilege." n3 On the duty to protect client confidences, the Court held: Attorneys owe fiduciary duties of both confidentiality and loyalty to their clients... The Code of Professional Responsibility thus imposes a continuing obligation on attorneys to protect their client confidences and secrets. Even after representation has concluded, a lawyer may not reveal information confided by a former client, or use such information to the disadvantage of the former client or the advantage of a third party" An attorney, moreover, "must avoid not only the fact, but even the appearance of representing conflicting interests. n4

n3 Id. at 651. n4 Id. at 651. Assuming the absence of a valid retaining lien, the content of a client file is regarded as the client's information, and access to that information also cannot, as a matter of fiduciary obligation, be denied. In The Matter of Sage Realty Corp. v. Proskauer Rose Goetz & Mendelsohn, n5 the New York Court of Appeals was presented with the issue of the proprietary rights in and attendant access to a law firm's internal legal memoranda, mark-ups, notes and drafts of contracts and other transactional documents. The Court of Appeals astutely held: We can discern no principled basis upon which exclusive property rights to an attorney's work-product in a client's file spring into being in favor of the attorney at the conclusion of a represented matter. Indeed, this case illustrates that often, no unequivocal line can be drawn between pending and completed legal matters; hence, the continued likelihood of useful reference to work product materials in the client's file. n6

n5 Sage Realty Corp. v. Proskauer Rose Goetz & Mendelsohn LLP, 91 NY2d 30 (1997). n6 Id. at 666 NYS2d 988. The Court held that it was not appropriate to place the burden on the client to show specific need, especially where the client may be unaware of the document. The New York Court of Appeals recognized that An attorney's fiduciary relationship with a client may continue even after representation is concluded. Among the duties of an attorney as a fiduciary -- of the client are those of openness and conscientious disclosure. As we remarked in another context, equally applicable here -- [since] the reign of Elizabeth I, the law has as a matter of policy encouraged full disclosure between attorney and client -- [and] that obligation of forthrightness of an attorney toward a client is not furthered by the attorney's ability to cull from the client's file documents generated through fully compensated representation which the attorney unilaterally decides the client has no right to see. n7

n7 Id. at 666 NYS2d 988. There is, however, a qualification with respect to the foregoing duty of disclosure and openness. Duties to third parties and those imposed by law cannot be violated. Further, the obligation to accord open access is not absolute if the document sought serves no useful purpose and was only intended for internal law office facilitation of services and their review.

Page 3 New York Law Journal, April 13, 1999

Strict Duty of Care In handling other people's money, the attorney is like every other citizen, prohibited from deception and misappropriation. The lawyer also must follow a strict standard with respect to the funds and property entrusted to the lawyer's care so that they are only used and given over to those that have the true entitlement. The strict letter of the client's instruction must be followed. In Leon v. Martinez, n8 the New York Court of Appeals addressed issues where a lawyer, on the client's instructions, drafted an agreement giving a percentage of a personal injury recovery to a named third party. Upon recovery, however, the third party was not given any portion of the recovery and brought suit. The Court of Appeals held that the lawyer's fiduciary obligation was to follow the client's instructions: We reject the law firm defendant's argument that compliance with the alleged assignment would have required them to violate their ethical duties to their client... under Code of Professional Responsibility DR9-102. Even if the sole attorney-client relationship that existed... was between... [defendant law firm] and... [the personal injury plaintiff] we conclude that... argument fails for two reasons. First, the cited Disciplinary Rule mandates only that an attorney pay to the client those funds in the possession of the attorney "which the client" is entitled to receive (Code of Professional Responsibility DR9-102 [c][4]) (emphasis added) which is not the case to the extent that the client has conveyed a right to those funds by an enforceable assignment. Second, DR9-102 explicitly creates ethical duties running to third parties as to funds in the possession of the attorney to which those third parties are entitled. Assuming an enforceable assignment -- [the lawyer] was then ethically obligated not only to notify the plaintiff upon his receipt of the funds (DR9-102 [c][1]) but also to pay the funds to plaintiffs as the persons then entitled to receive them (DR9-102 [c][4].) n9

n8 Leon v. Martinez, 84 NY2d 83 (1994). n9 Id. at 614 NYS2d 975. The First Department in an attorney disciplinary proceeding n10 affirmed findings of "violations" [consisting] of specific and obvious failures "to require compliance with the documents." The improper release of the escrowed funds occurred in the context of a fraudulent lending scheme and, therefore, "after his suspicions had been aroused," the lawyer should not have entered into a similar arrangement.

n10 Matter of Elkins, 248 AD2d 20 (1st Dept. 1998). Strict compliance, coupled with due diligence, can only give true comfort that we are performing our fiduciary duties in regard to other people's money. It should be underscored that there is a duty to provide an accounting, irrespective of whether there was irregularity or wrongdoing in the handling of the funds. n11

n11 Adam v. Cutner & Rathkopf, 238 AD2d 234 (1st Dept. 1997).

Honorable Contracts In entering into and performing contracts with clients, the lawyer's fiduciary obligation is to deal fairly and honorably. When the contract is challenged, the lawyer has the burden to prove it is free from fraud. Moreover, in cases where there are ethical or fiduciary breaches, lawyers lose their entitlement to their fees. In Greene v. Greene, n12 plaintiff, a college student, received treatment for mental illness in 1964. In 1965, she executed a trust agreement, surrendering all management and control over her inheritance for her lifetime. Upon her release from the hospital in 1967, plaintiff retained defendant-lawyer and his firm to rescind this agreement. The Court rescinded the agreement, holding there was overreaching by the trustee.

n12 Greene v. Greene, 56 NY2d 86 (1982). Page 4 New York Law Journal, April 13, 1999

In 1968, defendant-lawyer executed a new trust agreement with the power to invest up to $ 100,000 without plaintiff-client's consent and incorporated a provision that the lawyer was entitled to 10 percent of the profit from the sale of trust assets. The agreement also provided authorization to make investments "not of the type customarily made by trustees" and that liability for handling the funds was "limited solely to... willful misconduct or gross neglect." The trust also provided for automatic renewal, unless there was notice of termination. In addition to addressing the allegations relating to the unconscionable terms of the trust, issues of mismanagement and investment in companies in which the lawyer had an interest were also involved in the case. The Court of Appeals on the issue of attorneys' contracting with their own clients articulated the following fiduciary duty principles: An attorney is not prohibited from entering into a contract with a client. He must do so, of course, with respect to his retainer for legal services and, although it is not advisable, an attorney may also contract with a client with respect to matters not involving legal services. Thus a contract between an attorney and his client is not avoidable at the will of the client. However, the relationship between an attorney and his client is a fiduciary one and the attorney cannot take advantage of his superior knowledge and position. The basic rule, as stated -- is that "an attorney who seeks to avail himself of a contract made with his client, is bound to establish affirmatively that it was made by the client with full knowledge of all the material circumstances known to the attorney, and was in every respect free from fraud on his part, or misconception on the part of the client, and that a reasonable use was made by the attorney of the confidence reposed in him." Under this rule it is not necessary for the client to show that the agreement was obtained by fraud or undue influence on the part of the attorney, although, of course, that would make the agreement unenforceable if it were proven. Even in the absence of such misconduct the agreement may be invalid if it appears that the attorney "got the better of the bargain," unless he can show that the client was fully aware of the consequences and that there was no exploitation of the client's confidence in the attorney. n13

n13 Id. at 451 NYS2d 49. The Court held that plaintiff sufficiently stated a breach of fiduciary duty cause of action in drafting a trust with greater than normal fiduciary powers and relief from liability save in circumstances involving fraud or gross neglect. Specifically prohibited are contracts without full disclosure and independent counsel's review that relieve an attorney of liability for legal malpractice, especially in the course of the representation. In Swift v. Choe, n14 allegations were made that the client's severe vision problems prevented him from deciphering the contents of the release at the time it was signed and that the full contents of the release were not explained, especially since the representation had been ongoing.

n14 Swift v. Choe, 242 AD2d 188 (1st Dept. 1998). The First Department held that such circumstances militated against the attorney's meeting the requisite burden and, in fact, construed the language of the release not to include a release of the client's legal malpractice cause of action. The Court said: Nor does... [the client's] execution of the release... warrant dismissal under CPLR 3212... Soliciting a client's execution of a release during the course of representation violates Code of Professional Responsibility DR6-102(A) (22 NYCRR 1200.31[a]). "A lawyer shall not seek, by contract or other means, to limit prospectively the lawyer's individual liability to a client for malpractice, or, without first advising that person that independent representation is appropriate in connection therewith, to settle a claim for such liability with... an unrepresented or former client (see also, EC6-6). While a violation of a disciplinary rule "does not, in itself, generate a cause of action... a release obtained in violation of a disciplinary rule should not serve to shield a lawyer from liability before the facts and circumstances surrounding the execution of the document are fully examined," n15... Mergler v. Crystal Props Assocs. (179 AD2d 177, 181) while upholding the validity of a release entered into following the termination of a lawyer-client relationship, specifically distinguished between such releases and those executed "during the course of the attorney client relationship" n16

Page 5 New York Law Journal, April 13, 1999

n15 Facilitative and Confidential Mediation with a Neutral reviewing the circumstances may be appropriate in this context. n16 Id. at 674 NYS2d 192-193. In determining the validity of a charging lien and, in consequence, the fairness of fees charged and/or received pursuant to a retainer contract, the First Department held that consideration should be given to a number of relevant factors, "among them, the nature of the litigation, the amount of money involved, the results achieved, amounts customarily charged for similar services in the same locality, the certainty of compensation and... professional deportment" and noted breach of ethical and fiduciary duties could entail loss of compensation. n17

n17 Grutman Katz Greene & Humphrey v. Goldman, 673 NYS2d 649, 1998 N.Y. App. Div. Lexis 6377 (N.Y. A.D. 1st Dept. 1998).

Conflicts of Interest In appearance and reality, conflicts of interest invariably undermine the quality of legal representation and the lawyer's performance of fiduciary responsibilities. Disclosure and informed consent can cure some conflicts. Others are irreconcilable and require declining or withdrawing from the representation. The lawyer must give a keen regard to this fiduciary duty. Chief Judge Cooke of the New York Court of Appeals emphasized this important obligation in Greene v. Greene n18: It is a long-standing precept of the legal profession than an attorney is duty bound to pursue this client's interests diligently and vigorously within the limits of the law. For this reason, a lawyer may not undertake representation where his independent professional judgment is likely to be impaired by extraneous considerations. Thus attorneys historically have been strictly forbidden from placing themselves in a position where they must advance or even appear to advance, conflicting interests... This prohibition was designed to safeguard against not only violation of the duty of loyalty owed the client but also against abuse of the adversary system and resulting harm to the public at large.

n18 Greene v. Greene, 47 NY2d 447 (1979). Perhaps the clearest instance of impermissible conflict occurs wen a lawyer represents two adverse parties in a legal proceeding. In such a case, the lawyer owes a duty to each client to advocate the client's interest zealously. Yet to properly represent either one of the parties he must forsake his obligation to the other. Because dual representation is fraught with the potential for irreconcilable conflict, it will rarely be sanctioned even after full disclosure has been made and the consent of the clients obtained... Particularly is this so when the public interest is implicated... or where the conflict extends to the very subject matter of the litigation. n19

n19 Id. at 418 NYS2d 381-82. Another irreconcilable conflict noted by the Court was where the lawyer had a financial interest in the litigation akin to the parties. n20

n20 Id. at 418 NYS2d 382.

Duties to Partners In the culture and framework in which we lawyers practice we must recognize obligations owed to our partners and to those intended to be benefited by the services of other fiduciaries. In Graubard Mollen Dannett & Horowitz v. Moskowitz, n21 the Court of Appeals addressed issues dealing with the withdrawal of a partner, his solicitation of clients prior to withdrawal, and the inconsistency of these activities with a withdrawal and retirement agreement. Chief Judge Kaye, in writing for the Court, defined the lawyer's duty to his partners, appropriately balancing this obligation against the freedom of the client to select counsel. Chief Judge Kaye held: Page 6 New York Law Journal, April 13, 1999

It is unquestionably difficult to draw hard lines defining lawyers' fiduciary duty to partners and their fiduciary duty to clients. That there may be overlap, tension, even conflict between the two spheres is underscored by the spate of literature concerning the current revolving door law firm culture. ... Pre-resignation surreptitious "solicitation" of firm clients for a partner's personal gain... is actionable. Such conduct exceeds what is necessary to protect the important value of client freedom of choice in legal representation, and thoroughly undermines another important value -- the loyalty owed partners (including law partners) which distinguishes partnerships from bazaars. * * * At one end of the spectrum, where an attorney is dissatisfied with the existing association, taking steps to locate alternative space and affiliations would not violate a partner's fiduciary duties... As a matter of ethics, departing partners have been permitted to inform clients with whom they have a prior professional relationship about this impending withdrawal and new practice, and to remind the client of its freedom to retain counsel of its choice. Ideally, such approaches would take place only after notice to the firm of the partner's plans to leave... At the other end of the spectrum, secretly attempting to lure firm clients (even those the partner has brought into the firm and personally represented) to the new association, lying to clients about their rights with respect to the choice of counsel, lying to partners about plans to leave, and abandoning the firm on short notice (taking clients and files) would not be consistent with a partner's fiduciary duties. n22

n21 Graubard Mollen Dannett & Horowitz v. Moskowitz, 86 NY2d 112 (1995). n22 Id. at 629 NYS2d 1013-1014. In the case of In re Clarke's Estate, n23 the attorney for the fiduciary was held by the Court of Appeals also to have a fiduciary duty of undivided loyalty so that the fiduciary would not be prevented from performing his obligation to the beneficiary. As a result of not performing this obligation "the attorney's conduct came within the fixed rule of law denying compensation in cases of divided loyalty of fiduciaries or their attorneys." n24

n23 In re Clarke's Estate, 12 NY2d 183 (1962). n24 Id. at 237 NYS2d 697.

Conclusion Legal malpractice is a violation of the minimally appropriate professional standard that proximately causes harm. Breach of the lawyer's fiduciary duty on the other hand is a deviation from a significantly higher standard of conduct for which the law imposes strict accountability. We, as Judge Cardozo expressed, should always "consciously" strive to maintain and not lower that high standard.

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Monday, January 7, 2008

PROFESSIONAL LIABILITY

The Right and Duty to Defend

Norman Arnoff

Professional liability insurance is essential for the legal as well as other professions in our current world. Professional malpractice in the truest sense is a rare phenomenon, however, lawsuits between lawyers and former clients are not so rare especially when there are fee disputes or between accountants and clients when there is a misleading financial statement and a late filing on a tax return or between customer and broker after the account sustained significant losses in a down market.

The costs of litigation and arbitration are significant and, accordingly, prudence dictates that professional liability insurance be purchased. However, it is especially important to examine what the insurance does cover and whether the claims management of the insurers fairly and honorably meets the needs of the insureds.

Abusive Practices

As a result of the abusive claims practices that this practicing lawyer has experienced in the last year in regard to a number of client insureds, I think it will be helpful to review the essentials of the 'litigation insurance' component of professional liability insurance to more effectively protect not only the client but also your own firm and yourself when coverage disputes arise with the insurer and to assure that the carrier will not overstep and engage in abusive claims practices.

Abusive practices start with initial evaluation of the claim and extend through the claims handling process even when the insurer provides a defense. To walk away from defense obligations insurers employ 'the complaint taken as a whole' subter- fuge, i.e., while the insured had the professional relationship covered by the policy, the insured was really serving another role and, according to the insurer, any professional services were incidental. Further exclusions in the policy not only expressly deny indemnity by virtue of the specific products or services but any 'allegation' or any activity 'related to' the product or service is excluded

so the insurer disclaims defense coverage even when the insured denies being involved in such activity. This is specious since insurers are to defend even when the claims are false, fraudulent and groundless.

Defense coverage where there is a reservation of rights and the insurer is obligated to respect the insured's choice of counsel and pay its reasonable fees is di- luted when the insurer attempts to limit the insured counsel's hourly rate to the minimal rate set for panel counsel who defend when the insurer assumes the liability risks. Further, paying expert consultants and witnesses is often partially or wholly avoided with the contention that notwithstanding counsel's tactical choice to engage the expert as a consultant and/or testifying witness, the expert is not needed and is not allowed for by the insurer's 'budget.'

In one recent securities arbitration, this author experienced a claims person de- claring the carrier would only pay for the expert's time on the witness stand and not for preparation or attending the hearing so that he could render an opinion on the record as a whole.

The foregoing, as will be demonstrated in this article, is bad faith and should be remedied by the industry and professional associations as well as the regulators because it defeats the purpose of 'litigation insurance' paid for by substantial premiums.

Settled Principles

In professional liability insurance, the insurance covers both the risks of litigation and liability. [FN1] It is a combination of litigation insurance and liability insurance that additionally provides indemnification for the insured in the event of an adverse award or judgment and/or settlement. [FN2] Most policies indicate also that the insurer has both the right and duty to defend. When the insurer accepts the insured's risks of liability it has no conflict and is entitled to control the defense, i.e., has the right to defend. However, when the insurer disclaims the risk of liability the insurer still must provide the defense for which it received premiums although the insured controls the defense by selecting his own counsel at the insurer's reasonable expense. [FN3]

If a reading of the policy in conjunction with the pleadings merely suggests the possibility of a covered claim or even if it does not, but the facts outside of the pleadings suggest a covered claim, the insurer must defend. [FN4] It is the insurer's burden to establish, as a matter of law, that the allegations of the complaint unambiguously 'cast the pleading solely and entirely within the policy exception.' [FN5] This is the settled law that is so deeply rooted that the insurer's disregard more often than not has to be conscious and willful and a mandate for the court to swiftly remedy. [FN6]

Further, if one claim in a multiple claim complaint potentially falls within the indemnity coverage provided for in the policy, the insurer must defend the entire

action. [FN7] The cases also stand for the proposition that even if the pleadings do not trigger the duty to defend there is such a duty when extrinsic facts outside of the complaint trigger the obligation. [FN8] Moreover the cases also stand for the proposition that the insurer may not rely on outside facts to negate the obligation. [FN9]

All jurisdictions including New York adhere to the above-stated propositions. In 1974, the Court of Appeals addressed a case where plaintiff sought to recover from its insurer the legal fees and disbursements incurred in defending an action brought by an employee in which damages were sought for personal injuries by reason of plaintiffs' alleged negligence. The insurer disclaimed liability and refused to defend the negligence action. The plaintiff was required to retain counsel to represent it in the underlying litigation that resulted in a dismissal of the action. The Court in International Paper Company v. Continental Casualty Co., in determining the insurer breached its duty of defense held:

It is manifestly clear that the negligence complaint did not allege facts sufficient to find on its face, that it was subject to...[the] policy exclusions, and...if the insurer is to be relieved of a duty to defend it is obligated to demonstrate that the allegations of the complaint cast that pleading solely and entirely within the policy exclusions, and, further, that the allegations, in total are subject to no other interpretation. As a consequence, even if the complaint fails to articulate adequately an action grounded solely in negligence, the insurer is required to defend. An insured's right to be accorded legal representation is a contractual right and consideration upon which his premium is in part predicated, and this right exists even if debatable theories are alleged in the pleading against the insured. (Emphasis added)

The Court further held, as would be true in every case a policy is purchased for litigation insurance:

In plain and concise language, and without equivocation, the defendant obligated itself to defend any action brought against the ...insured whenever alleged a cause of action in negligence covered by the policy regardless of the ultimate factual determination of the occurrence...

***

An insurer's obligation to furnish its insured with a defense is heavy indeed, and of course, broader than its duty to pay. The rule to be followed is clearly set out in Goldberg v. Lumber Mut. Cas. Ins. Co. of New York (297 N.Y. 148, 154), wherein this Court wrote: 'Indeed even in cases where the policies do not render the allegations by the injured party controlling,' it has been said, the distinction between liability and coverage must be kept in mind. So far as concerns the obligation of the insurer to defend the question is not whether the injured party can maintain a cause of action against the insured, but whether he can state facts

which bring the injury within coverage. If he states such facts the policy requires the insurer to defend irrespective of the insured's ultimately liability...

***

The insurer is cloaked with the burden of proving that the incident and claim thereunder came within the exclusions of the policy... (Emphasis added)

Clearly the duty to defend is broader than the duty to indemnify. [FN10]

In Public Service Insurance Co. v. Goldfarb, the Court held that the determination of an insurer's duty of indemnification comes after a finding of the facts and a special jury verdict is returned by the jury. Before that point the insurer 'must...defend...in the pending lawsuit because a claim within the stated coverage has been made' and '[m]oreover, inasmuch as the insurer's interest in defending the lawsuit is in conflict with the defendants' interest -- the insurer being liable only upon some of the grounds for recovery asserted and not upon others...[the insured] is entitled to defense by an attorney of...[the insured's] own choosing, whose reasonable fee is to be paid by the insurer.' [FN11]

Litigation Insurance

In regard to litigation insurance the Court of Appeals said:

An insurer must defend whenever the four corners of the complaint suggest -- or the insurer has actual knowledge of facts establishing a reasonable possibility of coverage...the duty is broader than the insurer's obligation to indemnify: [t]hough policy coverage is often denominated as 'liability insurance,' where the insurer has made promises to defend 'it is clear that the [coverage] is, in fact, 'litigation insurance' as well.' (Emphasis added)

Moreover, it is the insurer's burden to 'establish as a matter of law that there is no possible factual or legal basis on which it might eventually be obligated to indemnify its insured under any policy provision' (emphasis added). If the complaint in the underlying action merely suggests a malpractice or breach of fiduciary claim by a professional, the action is squarely within the ambit of coverage and presents a burden that cannot be met by the defendant insurer. [FN12]

In fact, any review of the cases demonstrates it is a virtual impossibility to preclude coverage if the insured is acting in the context to which the insurance applies. In Steadfast Insurance Company v. Stroock & Stroock & Lavan LLP, [FN13] a lawyer liability case, the Court held:

An insurer may escape its duty to defend only if the insurer demonstrates that the allegations of the complaint cast the pleadings wholly within...[the] exclusion, that the exclusion is subject to no other reasonable interpretation and that there isno possible factual or legal basis upon which the insurer may eventually

be held obligated to indemnify the insured under any policy provision. If any of the claims against the insured arguably arise from covered events, the insurer is required to defend the entire action. (Emphasis added).

*** If the universe of claims against the insured requires proof of conduct that is excluded from coverage then the insurer has no duty to indemnify or defend its insured...

***

The insurer bears the burden of proving that the exclusions apply in a particular case...'this burden is heavy, especially when the insurer is seeking to avoid the duty to defend.'.... Exclusionary clauses are strictly construed to give the interpretation most beneficial to the insured...a construction favorable to the insurer will be sustained only if it is the only construction which may fairly be placed on the [words used]. (Emphasis added)

Insurer Avoiding Obligation

An insurer can only avoid its obligation to defend if it can show as a matter of law no such duty. [FN14] This can almost never be shown so it is incomprehensible there are as many coverage disputes relating to the duty to defend as occur today. Further, there is no prejudice to the insurer defending as observed in Steadfast Insurance Company v. Stroock & Stroock & Lavan since the insurer can issue a reservation of rights that precludes the insurer from waiving its coverage defense.

Almost 30 years from the date the New York Court of Appeals articulated the breadth of the duty of defense and the standards for its interpretation and application the U.S. District for the Southern District of New York in Admiral In- surance Company v. Weitz & Luxenberg, et al. [FN15] articulated and applied the same rooted principles to make a determination in regard to the insurer's duty of defense. The case was also a lawyer liability action.

The Court held:

Courts in New York have held that an insurer's duty to defend and to pay defense costs under liability insurance policies must be construed broadly in favor of the policyholder. Further, it is broader than the duty to indemnify.

***

an insurer's duty to defend arises whenever the allegations in a complaint state a cause of action that gives rise to a reasonable possibility of recovery under the policy.... If the allegations of the complaint are even potentially within the language of the insurance policy, there is a duty to defend... If any of the claims against [an] insured arguably arise from covered events, the insurer is re-

quired to defend the entire action.... Indeed, 'the duty to defend arises whenever the allegations in the complaint against the insured fall within the scope of the risks undertaken by the insurer...[and it is immaterial] that the complaint against the insured asserts additional claims which fall outside the policy's general coverage or within its exclusionary provisions'...the merits of the complaint are irrelevant. (Emphasis added)

If any segment of the complaint implicates a covered risk, then there is defense coverage. In Admiral Insurance Co. v. Weitz and Luxenberg PC, et al., the Court further observed that if the insurer has a duty to defend 'it has a duty to defend against the entire complaint.' Further, the Court in the case held '[a] policyholder may recover attorney's fees incurred in successfully defending itself against an insurer's attempt to free itself form its obligations under an insurance policy.' There should be no distinction between the insurer bringing an action to deny coverage and its stonewalling its obligations to provide a defense forcing its insured to bring an action for declaratory judgment. In the context the insured is in as much of a defensive posture after a disclaimer as the insured being required to defend against the insurer bringing a declaratory judgment action to deny coverage. In fact, an insured having to defend against liability and personally incur substantial litigation expenses after paying ever-increasing premiums on a yearly basis is clearly in a defensive posture.

In Napoli Kaiser & Bern LLP v. Westport Insurance Corp., [FN16] the Court addressed an equivocal breach of fiduciary claim asserted against a law firm as follows:

A breach of fiduciary duty claim can be based on negligence and the complaints carefully do not allege that the breach was intentional.... The Claimant Firms, in addition to the primary allegations of fraud, have alleged that ...[the Claimant Firm] breached its fiduciary duty in obtaining low settlements for the referred clients. It is entirely possible that Claimant Firms will be unable to prove a scheme by...[Claimant Firm] to distort settlements, but that they will be able to show that.... [Claimant Firm] negligently represented the referred clients. Such a 'reasonable possibility' of coverage is sufficient to trigger the duty to defend ...(Emphasis added)

As a result of the foregoing, insurers should better monitor their claims personnel and coverage counsel to make sure the insurer honors its duty to defend. Bar associations, professional organizations and insurance regulators should also be attentive to this issue.

Bad Faith

In Smith v. American Family Mutual Ins. Co., [FN17] the court addressed the sufficiency of allegations against an insurer for breach of the implied covenant of good faith and fair dealing holding that such a cause of action can be sustained

where the insurer objectively acts without justification. Further, neither the breach of the covenant of good faith and fair dealing, nor the claim of bad faith and fraudulent marketing and claims practices is limited to the duty of indemnification. In Hugo Boss Fashions Inc., et al v. Federal Insurance Co., [FN18] the U.S. Court of Appeals held: '...an insurance company could perfectly reasonably disclaim indemnify coverage, and yet be in bad faith in refusing to defend until the scope of coverage was determined.' To be entitled to attorney's fees and costs for securing coverage and a punitive damage award there must be 'a gross disregard for its policy obligations' by the insurer.

Citing New York case law the Court held:

...[t]here remains a strong presumption in New York against a finding of bad faith liability by an insurer.... 'It is...well-settled that an insured cannot recover his legal expenses in a controversy with a carrier over coverage, even though the carrier losses the controversy, and is held responsible for the risk.' The presumption against bad faith liability can be rebutted only by evidence establishing that the insurer's refusal to defend was based on 'more than an arguable difference of opinion' and exhibited 'a gross disregard for its policy obligations.' (Emphasis added)

In the case cited above the bad faith issue was decided by the Court after a jury trial. The policyholder did not adduce sufficient evidence 'as a matter of law, to overcome the presumption.' The court drawing a similar conclusion to a cited New York State case held ''the record shows merely an arguable case in which the carrier was held wrong...[and] (t)hat is not enough to impose a liability beyond the terms of the contract.'' Where the policy language and pleadings clearly indicate the possibility of a covered claim there is not nor can there be any reasonable difference on the issue of the duty to defend, i.e., what is written cannot be ignored. As noted in Pavia v. State Farm Mutual Automobile Insurance Co., [FN19] when the facts show 'an extraordinary... disingenuous or dishonest failure to carry out the insurance contract,' bad faith is demonstrated. Bad faith is more apt to be shown by the comparison of the language in the policy and the pleadings and therefore a breach of the duty to defend can more easily fit in the bad faith category than other acts or omissions of insurers.

Nor is the cause of action for breach of the duty of good faith and for fair dealing duplicative of plaintiffs' cause of action for bad faith and fraudulent marketing and claims practices. The insurer's breach of its obligations under its insuring agreement with the individual plaintiffs when there is serious misconduct also constitutes 'acts or practices' that 'must...[and does] have a broad impact on consumers at large.' [FN20] It is not strictly a matter of private contract.

Claims for breach of the covenant of good faith and fair dealing distinctly permit insureds to recover defense costs in the underlying action and the bad faith and fraudulent marketing and claims practice claims encompass recovery for the at-

torney's fees and costs in securing defense coverage and do justify the courts upon the evidence to submit a special verdict form to the jury as to whether punitive damages should be awarded. The cause of action based on bad faith and fraud is also based on facts relating to the marketing and claims practices that predate the particular claims made policy in issue because the insurer continues to offer 'litigation insurance' and collects significant premiums with apparently no intent to honor its defense obligation under the policy when circumstances would trigger that obligation. Such conduct breaches duties independent of the specific insuring agreement and relates to ongoing and continuous acts and omissions of the insurer to collect premiums based upon publicly stated commitments it has no intent to honor.

The bad faith and fraudulent marketing and claims practices are not merely limited to a breach of a specific contract or a private wrong. Recovery for such deceptive marketing and claims practices are also permissible under General Business Law (GBL) §349. [FN21] Over the years when insureds purchase and renew their lawyer's professional liability policy and pay significant yearly premiums, and the insurers repeatedly represent and promise that the policy will be providing 'litigation insurance,' with no intent to perform; there should be no doubt that a case is made out for bad faith. Such a wrong is consumer-related and adversely affects the public interest.

The insurer should not be entitled to avoid liability for the insured's attorney's fees and costs in bringing the coverage action by itself and not bringing the action to settle coverage issues, because the insured, by virtue of having to defend an underlying action without the defense coverage provided by the policy, is truly in a defensive posture created by the insurer's unjustified disclaimer. Even if New England Mutual Life Insurance Co. v. Johnson [FN22] and Mighty Mid- gets Inc. v. Centinental Insurance Co., [FN23] are given restrictive scope, the insurer, by virtue of its bad faith denial of coverage, should be estopped from such a defense. [FN24] In any event §349 of the GBL allows for such recovery. [FN25]

A bad faith denial of defense coverage is also appropriate for punitive damages. In Walker v. Sheldon [FN26] the Court held:

Punitive or exemplary damages have been allowed in cases where the wrong complained of is morally culpable or is actuated by evil and reprehensible motives, not only to punish the defendant but to deter him, as well as others who might otherwise be so prompted from indulging in similar conduct in the future.

*** Although they have been refused in [an] 'ordinary' fraud deceit case...we are persuaded that on the basis of analogy, reason and principle there may be exemplary damages in fraud and deceit actions where the fraud, aimed at the public generally is gross and involves high moral culpability.

It is unlawful in New York to engage in '[d]eceptive acts or practices on the conduct of any business trade or commerce.' [FN27] Any person injured by such violation of the deceptive acts or practices prohibition is entitled to bring an action in his own name to recover his damages not to exceed one thousand dollars. The court may award a prevailing plaintiff attorney's fees. Id. In order to plead a claim under Gen Bus. Law §349, it must be shown the unlawful conduct is consumer-oriented, that it is deceptive and has injured the plaintiff. [FN28] Conduct is considered deceptive if it is likely to mislead a reasonable consumer acting reasonably under the circumstances. [FN29] In order for conduct to be consumer- oriented, it does not need to be repetitive or recurring but...must have a broad impact on consumers at large....' [FN30] Denying wrongfully an essential feature of professional liability insurance that is the prime reason for insureds buying the insurance is a wrong that, when it occurs, has to be a consumer-oriented wrong fitting within the General Business Law's prohibitions, as well as an independent wrong actionable under the common law of torts.

Conclusion

To maximize one's professional liability insurance coverage and to effectively resist a wrongful denial of coverage one merely has to start with the proposition that when the policy language read in conjunction with one specific allegation in the pleading indicates there is the mere possibility of at least one covered claim, the insurer cannot squirm out of its obligations.

When a reservation-of-rights letter is issued indicating there is a conflict between the insurer and insured, the insurer thus has given up its right to control the defense although it still may have a clear duty to defend for which it will be held strictly responsible. In such instances the insurer should pay the reasonable fees of the insured's counsel and other litigation costs that it cannot 'skimp on,' as exceeding its guidelines, because it no longer controls or should control the defense.

Professional liability insurance is very important today. The underwriting process, if done right, can lead to sound risk management and avoidance. Professional insureds will be protected against catastrophic economic injuries but most significantly the ever-increasing economic burdens of litigation will be ameliorated for the individual and small firm professional.

Justice Louis Brandeis once observed, 'Sunlight is the best disinfectant.'

This is why the claims practices relating to 'litigation insurance' need to receive the 'sunlight' of our attention, so that bad and fraudulent practices can be eliminated and both the insurers and the professional insureds can and shall engage in best practices.

Norman B. Arnoff practices law in New York City.

FN1. Inter. Paper Co. v. Continental Cas. Co., 35 N.Y.2d 322, 325, 361 N.Y.S.2d 873 (1974).

FN2. Hugo Boss Fashions, Inc. v. Federal Ins. Co., 252 F.3d 608, 615 (2d Cir. 2001) citing Hanover Ins. Co. v. Cowan, 172 A.D.2d 490, 568 N.Y.S.2d 115, 116 (2d Dept. 1991).

FN3. Public Service Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392, 401, 442 N.Y.S.2d 422 (1981).

FN4. Continental Cas. Co. v. Rapid Am. Corp., 80 N.Y.2d 640, 648, 593 N.Y.S.2d 966 (1993).

FN5. Inter. Paper Co., 35 N.Y.2d at 325, 361 N.Y.S.2d 873 accord Allstate Ins. Co. v. Riggio, 125 A.D.2d 515, 509 N.Y.S.2d 594 (2d Dept 1986).

FN6. See also the following cases that hold that as long as the allegations of the complaint give rise to the possibility of recovery on a covered claim there is a duty to defend: Continental Cas. Co. v. Rapid-American Corp., 80 N.Y.2d 640, 593 N.Y.S.2d 966 (1993); Lusalon, Inc. v. Hartford Acc. & Indem. Co., 400 Mass. 767, 511 N.E.2d 595 (1987).

FN7. See, e.g., Public Service Mut. Ins. Co. v. Glodfarb, 53 N.Y.2d 392, 401, 442 N.Y.S.2d 422 (1981); Ruder & Finn., Inc. v. Seabord Sur. Co., 52 N.Y.2d 663, 439 N.Y.S.2d 858 (1981).

FN8. See, e.g., Fitzpatrick v. American Honda Motor Co., 78 N.Y.2d 61, 571 N.Y.S.2d 672 (199); United States Fidelity & Guar. Co. v. United States Under- writes Ins. Co., 194 A.D.2d 1028, 599 N.Y.S.2d 654 (3d Dept. 1993).

FN9. See, e.g., Fitzpatrick v. American Honda Motor Co., 78 N.Y.2d 61, 571 N.Y.S.2d 672 (1991); Petr-All Petroleum Corp. v. Fireman's Ins. Co., 188 A.D.2d 139, 593 N.Y.S.2d 693 (4th Dept. 1993) (same).

FN10. See Emery v. Capital Mut. Ins. Co., 151 A.D.2d 854, 542 N.Y.S.2d 289 (3d Dept. 1989); Colon v. Aetna Life & Cas. Ins. Co., 66 N.Y.2d 6, 494 N.Y.S.2d 688 (1985).

FN11. See also, 225 East 57th Street Owners Inc. v. Greater New York Mutual Insur- ance, 187 AD 2d, 589 NYS 2d 481 (First Dept. 1992).

FN12. See also the following cases holding that the duty to defend which is essentially 'litigation insurance' requires the insurer even to defend 'groundless, false or fraudulent claims.' See Monroe County Water Auth v. Travelers Ins. Co., 195 A.D.2d 1043, 600 N.Y.S.2d 862 (4th Dep't 1993); Trizec Properties Inc. v. Biltmore Constr. Co., 767 F.2d 810 (11th Cir. 1985).

FN13. 227 F.Supp.2d 245 (SDNY 2003),

FN14. The following cases stand for this proposition: New York v. Blank, 745 F.Supp. 841 (N.D.N.Y. 1990), aff'd in part, vacated in part, 27 F.3d 783 (2d Cir. 1994); Nancie D. v. New York Cent. Ut. Fire Ins. Co., 195 A.D.2d 535, 600 N.Y.S.2d 472 (2d Dept. 1993).

FN15. 2002 U.S. Dist. Lexis 20306 (SDNY 2002)

FN16. 293 F.Supp. 2335, 2003 U.S. Dist. Lexis 22497 (SDNY 2003).

FN17. 294 NW 2d 751 (N.D. 1980).

FN18. 252 F3d 608; 2001 US App. Lexis 12080; 59 U.S.P.Q.2d (DNA) 1161 (2d Cir. 2001).

FN19. 82 NY2d 445, 626 NE2d 24 (Court of Appeals 1993).

FN20. Rosenberg & Estes P.C., et al v. Chicago Insurance Co., 2003 WL 21665680 (N.Y. Supp.), 2003 NY Slip Op. 51085 (U) and Binder v. National Life of Vermont, 2003 WL 21180417 (SDNY 2003).

FN21. Zawaher v. Berkshire Life Ins. Co., 22AD 3d 841, 804 NYS2d 405 (2d Dept. 2005).

FN22. 155 Misc.2d 680, 589 NYS 2d 736 NY Supp. 1992 (Sup. Ct. NY Co. 1992).

FN23. 47 N.Y.2d 12, 389 NE2d 1080, 416 NYS2d 559 (1979).

FN24. Harradine v. The Board of Supervisors of Orleans County, 73 A.D.2d 118, 425 N.Y.S.2d 182 (4th Dept 1980); United Pickle Co., Inc. v. Omanoff, 63 A.D.2d 892, 892, 405 N.Y.S.2d 727, 728 (1st Dept. 1978).

FN25. See Gaidon v. Guardian Life Insurance Co. of America, 94 NY 2d 330, 704 NYS 2d 177 (1999).

FN26. 10 NY2d 401, 405, 223 NYS2d 488, 179 NE2d 497 (N.Y. Court of Appeals).

FN27. Gen. Bus. Law §349(a).

FN28. New York University v. Continental Ins. Co., 87N.Y.2d 308, 318, 639 N.Y.S.2d 283, 289 (1995); Gaidon v. Guardian Life Insurance Co. of America, 94 N.Y.2d 330, 334, 704, NYS 2d 177, 183 (1999).

FN29. Gaidon 94 N.Y.2d at 344, 704, N.Y.S.2d at 183.

FN30. 87 N.Y.S.2d at 320, 639, N.Y.S.2d at 290.

1/7/2008 NYLJ 3, (col. 1)

END OF DOCUMENT

by Sue C. Jacobs and Norman B. Arnoff

Reliance on the advice of counsel is a recognized and frequently asserted defense in criminal fraud prosecutions and regulatory proceedings as it effectively negates bad faith and intent when they are elements of the charges. The point from which this defense is viewed is that of the client or former client. Upon reflection, however, the elements or better yet, their absence establish a most effective defense to a legal malpractice cause of action. From the view point of the lawyer sued by the former client, if the former client cannot establish the elements there is not a viable legal malpractice claim. Proximate causation, a necessary element of legal malpractice, cannot be established without satisfying the requirements of the defense of reliance on counsel.

Therefore, this must be the starting point of analysis if reliance on counsel is to be placed in the framework of addressing legal malpractice.

CORE ELEMENTS

In the case, In re: G-I Holdings Inc.,i a Debtor was challenged by the IRS on the sale of property i.e., the sale failed to qualify as a non taxable contribution and, in fact, the transaction was a disguised sale of taxable property. The Court held:

“When a party cites legal representation as an affirmative defense to a claim, however, the party puts that advice ‘at issue’ and waives the attorney-client privilege...\There is] a three part test for finding (at issue) waiver: ‘(1) assertion of the privilege was a result of some affirmative act, such as filing suit, by the asserting party; (2) through this affirmative act, the asserting party put the protected information at issue by making it relevant to the case, and (3) application of the privilege would have denied the opposing party information vital to his defense”

−1− ... Courts have found that by placing the advice in issue, the client has opened up to examination facts relating to that advice...The advice of counsel is placed in issue where the client asserts a claim or defense by disclosing or describing the attorney client communication” . In referring to a Court that upheld waiver under such circumstances, the Court observed,

”The Court there rationalized that the party defending against a ‘reliance-on-counsel’ claim must be able to test what information was conveyed by the client, whether counsel was provided with all material facts in rendering advice and whether that advice was relied upon by client” (emphasis added).

In Schilling v. Farmers Bank & Capital Trust ii a judgment notwithstanding the verdict was granted to the bank in a suit by the bondholders that claimed the bank as an indenture trustee for bonds issued to finance the conversion of a school into a nursing home improperly permitted the project manager to continue after a series of defaults on the bonds. The bank claimed reliance on counsel in accepting the assurances of the nursing home that the payments would be made. The Court held:

“It is well settled that the defense of reliance on the advice of counsel is an absolute defense that may be defeated only by showing bad faith on the part of the party claiming the defense or by showing that the advice of counsel was unreasonable and that the client knew or should have known that the client knew or should have known that it could not rely on the advice.”

The bank presented proof that it consulted counsel on the available remedies.

The bank could not have replaced the project’s management because it did not have this power. It had the burden of going forward, but once it presented its proof the burden shifted to the bondholders. In accepting the reliance on counsel defense the Court held:

−2− “...\W]e need not address the question of causation as even if the bondholders proved that the bank’s actions proximately caused their losses, the defense of advice counsel protects the bank from liability.”

In US v. Wegneriii the defendant published a newsletter and had a syndicated radio program. The investors were not informed the recommended companies paid compensation to defendant for touting the stock. Defendants were convicted of criminal violations of Section 17(a) of the Securities Act of 1933 (“Securities Act”) and Section

10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) for unlawfully publicizing a stock for consideration from an issuer, underwriter or dealer without disclosing the fact and amount of the payments and illegally selling short penny stock. In respect to the reliance on counsel defense, the Court held:

“Good faith reliance on counsel, however, is not a complete defense, but is merely one factor a jury may consider when determining whether a defendant acted willfully... \T]o establish a good faith reliance on counsel defense, the defendant must show ‘(1) a request for advice of counsel on the legality of a proposed action (2) full disclosure of the relevant facts to counsel, (3) receipt of advice from counsel that the action to be taken will be legal and (4) reliance in good faith on counsel’s advice.’” . The Court of Appeals affirmed the conviction and admitted prior bad acts to negate the defense of reliance on counsel.

In SEC v. Scottiv the SEC brought an action seeking to enjoin the C.E.O. of a reinsurance corporation and securities analyst who was a limited partner of a broker-dealer that was an underwriter in a stock offering. The SEC alleged the prospectus was misleading in that it represented the proceeds of the offering would be invested primarily in liquid fixed income securities; the reinsurance company would

−3− manage its own portfolio; and the issuer would enter the reinsurance business. There was also material non-disclosure that the proceeds of the offering would not be in speculative securities. Instead, the investments were in Canadian real estate ventures and the reinsurance corporation’s president had been convicted previously of fraud which adversely affected the company’s license in the Cayman Islands.

Further, during the offering proceeds of $1.6 million were invested in equity and not fixed income securities. These securities had been underwritten by the broker-dealer that underwrote the reinsurance offering. Notwithstanding the representations about how the proceeds were to be invested, “(i)t soon became clear... that a sizeable portion of the proceeds was destined not for conservative investments but for purchasers of ‘new issues underwritten by [the broker-dealer].’”

Counsel advised that if the proceeds were invested in this manner they would withdraw their legal opinion. The Board ratified the investments and counsel concluded because the amount of the equity investments were reduced, the registration statement did not need to be amended and the prospectus stickered. Counsel’s concerns were apparently resolved in that a Form SR was filed indicating the use of the proceeds complied with applicable law and the stated disclosures. A certificate signed by the issuer’s officers were prepared so that there were no material adverse changes except those set forth in the prospectus and its amendments. The broker-dealer collapsed and the reinsurance company’s portfolio was exposed to be equity securities underwritten by the broker-dealer and the offering proceeds were misapplied.

The securities analyst could not raise a defense of reliance on counsel since as the

Court held “his failure to prove that he asked for, received and acted on the advice of

−4− counsel regarding the purchases... \of the securities] precludes the defense of reliance on counsel.” The Court further held:

“The Courts have recognized the defense of reliance on counsel has required proof that the defendant (1) made a complete disclosure to counsel, (2) requested counsel’s advice as to the legality of the contemplated action and (3) relied in good faith on that advice...Moreover, the fact that a defendant justifiably relied on advice of counsel in taking the unlawful action has not been viewed as an automatic defense to liability but rather has been regarded as only one factor considered in determining the propriety of injunctive relief.”

In the case, even though counsel may ultimately have gone along with the transaction no request was made for the informed opinion of counsel regarding how the proceeds were to be invested in equities as opposed to fixed income securities. The

Court observed:

“The reliance-on-counsel defense, however, does not mean that one can totally abdicate responsibility by consulting counsel... \T]he reliance-on-counsel defense requires more than such a complacent attitude. A defendant must establish that he actively sought and relied on advice of counsel, a showing that cannot be made on this record...” (Emphasis added).

Waiver of the Attorney Client Privilege

The assertion of the defense of reliance on advice of counsel as is the institution of a legal malpractice claim by the client is an implied waiver of the attorney-client privilege.

In re: Broadcom Corp. Securities Litigationv addresses and explains the waiver issue.

The case involved false press information and market manipulation alleged in a securities class action. The issue was whether the defense had been asserted. The Court held:

“The defense of reliance on counsel is an implied waiver of the attorney client privilege...Once the privilege is waived all

−5− communications relating to the same subject matter are discoverable. While waiver extends to all communications on the same subject matter, it should be no broader than needed to ensure the fairness of the proceedings...the purpose of the waiver is to allow the opposing party to respond to the reliance on counsel defense. Here, since the purported reliance on counsel extends only to the issue of the defendant’s knowledge of the legality and accuracy of...\the corporation’s] public statements, ‘the waiver should be deemed to extend only to those communications relating to the public statements at issue.’”

The defendants were corporate officers and had authority to waive the corporations’ privilege and attorney work-product was included in the waiver. Since defendants’ state of mind and knowledge were relevant, “fairness principles underlying waiver” was a key consideration and the privilege was deemed waived as to the subject matter of the litigation.

Such a result precludes selective waiver in respect to the subject matter over which the legal advice is in issue. In SEC v. Forma vi the Court observed:

“\I]t is well established that a defendant cannot claim that the assurances of counsel protect him from liability and at the same time preclude discovery of attorney-client communications related to that advice. In such circumstances, the defendant is deemed to have impliedly waived the privilege.

Nevertheless, parties are entitled to plead in the alternative...Because the reliance on counsel defense will result in the disclosure of privileged communications, defendants should first be permitted to test the validity of other defenses.”

Before the “self-defense” exception to the attorney client privilege is invoked, the client has to definitively put in issue the attorney’s advice. In SEC v. Fieldsvii where SEC staff were seeking the lawyer’s testimony as an alleged aider and abettor, the Court

−6− observed:

“...There must...\exist] some objective factual basis for the allegation. Otherwise, the SEC could elicit testimony from lawyers incriminating their clients merely by charging the attorneys, without foundation, as aiders and abettors...\T]he attorney client privilege is too important to be breached by innocent but wrong headed...actions that cause a vulnerable attorney to disclose confidential communications...”

More often than not before the attorney-client privilege is waived and the advice becomes an issue, the client or former client has to testify. viii In the case of In re:

Buspirone Antitrust Litigationix the issue was whether work product of outside counsel should be disclosed where their opinion may have conflicted with inside counsel. The

United States Magistrate Judge described the “at issue” waiver doctrine and its rationale as follows:

“...The attorney-client privilege is waived when the party places otherwise privileged communications ‘at issue’ in the litigation... Communications are ‘at issue’ when the party makes an assertion ‘that in fairness requires examination of protected communications.’”

Other Courts have expressed “the privilege may not simultaneously be used as a shield and a sword; where a defendant opens the door by waiving the attorney-client privilege...the defendant cannot open the door only to the information he would like to admit.”x

Other Predicates and Limitations

When the defense of reliance on counsel is asserted it has to be anticipated the advice giver will have to testify and be disqualified.xi Furthermore, the defense of reliance on counsel has to be asserted on a timely basis Amquip Corp v. Admiral Insurance Co.12 was a declaratory judgment action against the insurer seeking to order the insurer it had a

−7− duty to defend and declare bad faith on the insurer’s part if it did not defend. There was what appeared to be intentional failure to assert a reliance on counsel defense and timely amend the pleadings to add the defense. The Court held Rule 15 of the Federal Rules of

Civil Procedure (“FRCP”) permits amendment freely and “delay does not preclude amendment.” Although there was no undue prejudice the delay was held to be inexcusable in this case. What is most critical is that the advice in issue must be legal advice; not business, psychological, investment or other types of advice. Where there is not an outstanding legal issue that will affect a future course of conduct the defense cannot be asserted. Rodriguez v. Ortegon13 was an action for conversion of corporate stock by minority stockholders. The Court held the legal defense of reliance on corporate counsel could not be asserted in respect to the refusal to transfer stock as authorized by the stockholders when no legal justification for refusal existed. The Court held:

“The defense of good faith is not available to a party to excuse his actions in a conversion suit...’The requisite intent is only one to assert a right in the property, and a wrongful intent is not required’...Therefore, good faith could not have been asserted by the appellant to legally excuse his unreasonable refusal to transfer the stock.”

The Court further observed “...\a] party may not assert the legal defense of reliance on corporate counsel when no legal justification for the refusal exists.” In Texas, the

Court also noted there was a statutory requirement that the defense of reliance on counsel could only be asserted where there was a written opinion. This makes eminent good sense in a commercial or property transaction.

In certain contexts, both the defense and a legal malpractice claim to be asserted must have as a threshold a supportive expert opnion. In Hatfield v. Herz14 plaintiff was

−8− sued in state court in his capacity of a board member of a co-op. A judgment was entered against defendant and an appeal was not timely perfected. Plaintiff did not submit an expert affidavit. Plaintiff offered only general and not specific allegations and summary judgment was granted. The Court held an attorney is not held liable because the former client has “‘dissatisfaction with strategic choices’” and performance was not “optimal.”

The malpractice alleged in part was the failure to call the co-op’s counsel in the underlying case who plaintiff claimed had been relied on in handling a sublease issue. The defense argued reliance on counsel was not viable because the questionable conduct occurred before the co-op counsel was retained and because plaintiff “continued to direct the sublease negotiations without consulting...\counsel]”. There was no suggestion that when the underlying case was being litigated the lawyer’s testimony was required for the defense. The issue was then “squarely before the Court” and should have been raised at that point in time. Further “evidentiary proof” was not presented that “a proper defense would have altered the result.”

Advice of Corporate Counsel

Another key consideration in today’s context is that where attorneys advise and represent corporations they indirectly advise and represent corporate directors, officers, and employees. The advice can have significant personal consequences.

In Howard v. SEC15, the SEC instituted an administrative proceeding against a broker/director for his approval and participation in two “partial or none offerings” which were violative of applicable law and regulatory requirements. The Court of Appeals reversed the imposition of sanctions because the broker/director was held to have acted in good faith and with due care because inside and outside counsel communicated their

−9− approval of the transactions to the organization and its officers and directors.

The Court, in upholding the defense, negating the SEC’s claims of willfulness, recklessness, and intent, expounded:

“The ALJ made the...finding: Howard believed that...higher management...and outside counsel had approved actions that violated the anti-fraud provisions and Rule 10(b)-9...Matcovsky who headed...the corporate finance department and had been a lawyer with the SEC’s Division of Market Regulation called Howard...to solicit his vote. Matcovsky was also a member of...\the] board...Only after Matcovsky reported that the board had voted in favor of the transaction and that Rogers & Wells had approved it did Howard add his approval. (The partner in charge of Rogers & Wells specialized in securities law and had more than 20 years of experience.)...As with the first offering, Howard played no role in drafting...documents, again relying on the expertise of outside counsel and...\the] corporate finance department. The SEC dismissed this and other such evidence on the ground that ‘Howard had an ongoing obligation to familiarize himself with pertinent legal requirements in order to protect investors from illegality’. This entirely misses the significance of the evidence... In this case, rather than red flags, Howard encountered green ones, as outside and inside counsel approved...\the] transactions...”

The Court also significantly held that the defense of reliance on counsel was not defeated because officers and directors subordinate to the higher ups did not directly communicate with counsel. The Court further explained:

“Suppose a company president communicates directly with competent outside counsel, makes full disclosure, is advised incorrectly - that the proposed transaction is entirely lawful; tells junior officers in the company of the legal advice; and instructs them to consummate the transaction. Under the SEC’s theory, the president could avoid charges of fraudulent conduct by using the attorney’s advice to prove his lack of scienter while those working under him could not. That is illogical and makes no sense whatsoever.”

Where corporate counsel specifically knows lower level corporate management and

−10− employees will rely on his advice, there is a risk of malpractice exposure to this group.

The Absence of Reliance on Counsel Defense

The defense creates a viable framework for determining the viability of a legal malpractice cause of action. Legal malpractice occurs where there is an attorney-client relationship, the lawyer breaches the appropriate standard of care, and as a result

“proximately causes” actual damages. If the malpractice is bad advice, the former client to assert a viable claim has to seek legal (and not business, psychological, or investment) advice, disclose all relevant facts to the lawyer and show reliance on that specific advice for the course of action taken. If the former client cannot establish these elements, lawyers and their firms have a very viable defense that can be easily articulated and applied to the facts.

−11− End Notes

1. In re: G-I Holdings Inc.,218 FRD 428, 92 AFTR2d 2003-6451, 2004-1 USTC P 50, 154

(D. NJ2003).

2. Schilling v. Farmers Bank & Capital Trust, 2002 WL 328 33 433 (KY App.2002).

3. US v. Wegner, 427 F.3d 840, Fed. Sec. L. Rep. P 93, 542, 68 Fed.R.Evid. Serv 805,

10th Cir. (Utah 2005).

4. SEC v. Scott, 565 F.Supp. 1513, Fed.Sec.L.Rep. P 99, 236 (S.D.N.Y. 1983).

5. In re Broadcam Securities Litigation, 2005 WL1403513, (C.D.Calif.2005).

6. SEC v. Forma, 117 F.R.D. 516, 9 Fed. R. Serv.3d 943, 24 Fed.R.Evid. Serv. 300

(S.D.N.Y. 1987).

7. US v. Fields, 592 F.2d 638, 647 (2d. Cir. 1978).

8. US v. Lindo 18 F.3d 353, Fed. Sec.L.Rep. P 98, 114, 1994 Fed App. 0079P (6th Cir.

1994).

9. In re: Buspirone Antitrust Litigation, 208 F.R.D. 516, 2002-1 Trade Cases P73, 742

(S.D.N.Y. 2002).

10. US v. Locascio 357 F.Supp.2d 536 (E.D.N.Y. 2004) and In re: ML-Lee Acquisition Fund

II, L.P. 859 F.Supp. 765 (D.Del. 1994).

11. US v. Gouaz, 2003 WL 2862653 (S.D.N.Y. 2003).

12. 231 F.R.O.197 (E.D. PA 2005)

13. 616 S.W.2d 946 (Texas Civ. App.Ct. 1981)

14. 109 F.Supp.2d 174 (S.D.N.Y. 2000).

15. 376 F.3d 1136, 363 US App. D.C. 100, 100 Fed. Sec. L. Rep. P 92, 891 (D.C. Cir.

2004).

−12− The authors wish to thank Russell Farbiarz, an Editor of the Roger Williams University Law

Review and summer associate at Wexler & Burkhart, for his assistance in the preparation of this article.

steph\wordperf\norman\articles\reliance on the advice of counsel

−13−

Vol. 2011 • No.2

SLAs 2011 | 07-12 • Published 11/11 The Sentinels, Madoff And Dodd-Frank Reform By Norman B. Arnoff, Esq.*

Introduction & Generally, the courts have addressed auditor the crowbar. Of course, Congress did Statement of Purpose liability, with respect to the hedge funds that not mean that any mistake of law or This article in respect to Madoff’s fraud is invested their client funds through Madoff by misstatement of fact should subject an not intended as a criticism of the SEC, the declining to extend auditor’s responsibility attorney or an accountant to criminal legal or accounting profession, or those beyond the feeder fund financial statements, liability simply because more skillful who invested and traded through private i.e., no liability for transactions by and practitioners would not have made equity and hedge funds. Nor is it the between the feeder fund and third parties them. But Congress equally could not author’s intention to ascribe responsibility (e.g., custody arrangements). have intended that …{persons} holding for the fiasco to one group or organization themselves out as members of these as opposed to others. The purpose is Adherence to the privity rule, which restricts ancient professions should be able to to achieve through an analysis a fair liability to only those who were engaged by escape criminal liability on pleas of perspective of the systemic problems in contract, avoids subjecting the accounting ignorance when they have shut their our law and practices which allowed the professional to indeterminate liability to eyes to what was plainly to be seen or Madoff Ponzi scheme to continue for the an indeterminate group. Functional privity have represented a knowledge they extraordinary length of time that it did. or “near privity” improves protection for knew they did not possess.1 (Emphasis Hopefully in this manner we can take and those who depend on the accountants and Added) continue to take such remedial steps as their work and services, if the accountant will avert such devastating frauds in the knows who will be relying on the financial In light of what transpired in respect to future. statements in respect to specific transactions. Madoff and the lessons learned, as well If, however, the authoritative literature as the legislative, organizational, and Reform on Wall Street cannot come about prescribes certain audit procedures that are professional reforms that are being put by demonstrations, but by careful analysis not followed, and it is apparent that investors in place, it is hoped and expected that the of systemic problems and the vigilant will be harmed thereby, then there should professions, the regulators and the courts, responsibility it hopes to achieve. Lawyers be liability. The law is still developing will no longer “shut their eyes to what … and accountants serve as our sentinels to and certainly Dodd-Frank will impact that {is} plainly to be seen.” preserve the integrity and transparency development. of our capital markets and ultimately the In reviewing a series of cases involving protection of public investors. In virtually The Accountant’s Role the fraud perpetrated by Bernard Madoff, every high profile and complex securities Judge Henry J. Friendly, commenting using a series of feeder funds in order proceeding, whether in the civil litigation on the role of the legal and accounting to pass investors’ funds into the fictitious or regulatory contexts; professional professions, wrote: accounts of his colossal Ponzi scheme, it is responsibility and liability is an issue. clear, in this author’s view, that most of our The role of the auditor as a sentinel in our In our complex society the accountants’ courts have not placed the responsibility they financial markets is an important piece certificate and the lawyer’s opinion can cont’d on page 2 of the whole and will be the focus of this be instruments for inflicting pecuniary article. loss more potent than the chisel or TABLE OF CONTENTS

* Norman B. Arnoff is a lawyer practicing in New York City. His practice consists of Feature Article 1 representing brokers, broker-dealers, investment advisers, and adviser representatives before the SEC and other regulators and in securities arbitration and litigation Case Summaries 10 (primarily defense) disputes. Legal and accounting malpractice litigation and insurance defense and coverage work are also specialties. The Author wishes to thank Table of Cases 64 Lynne Potter, a financial services and IT professional, for her helpful assistance. 1 Securities Litigation Commentator Vol. 2011 • No.2 FEATURE ARTICLE cont’d from page 1 should upon the auditors and accountants accountants’ professional liability risk in our accountant watchdogs and other for the feeder funds. In consequence, this commercial lending and private securities gatekeepers cannot any longer avoid their has dramatically diminished the ability of transactions, when defined and relatively responsibilities. investors to pursue a viable recovery source. limited groups are dependent and/or rely upon the accountants’ services and work The Madoff This systemic weakness in the law of product. Such assessments are not and Accounting Litigation professional liability, especially as it will not be a fair and effective way for The Madoff accountants’ liability should apply in our capital markets and the law to establish what the accountants’ litigation that has taken place in our state to the financial services industry, lets professional liability risk should be in and federal courts in the last three years the insurance carriers off the hook in not other contexts, such as what occurred should be given important consideration in merely having to compensate investor in regard to the Madoff fraud. When the now setting the parameters of professional loss but also virtually eliminates a level public interest is so important a factor, liability risk. Baker v Andover Associates of effective self-regulation through the there has to be a different basis for Management Corp. et al [2] is, and it insurer’s underwriting practices. Where determining liability. describes, the prototypical Madoff - there is no recognizable risk of liability, Accountants’ case as follows: there is no need of insurance and the Auditors of public issuers, broker-dealers, underwriting by the insurers that can and investment advisors are integral to the The action seeks to address losses achieve loss prevention. integrity of the markets. It is the premise sustained by an investor as a result of the of this article that more progress in the law Ponzi scheme run by Bernard L. Madoff. The law is moving away from “privity” has to be achieved through the recognition Here, plaintiff-investor seeks to recover and “near privity” to known reliance that self-imposed professional standards her losses from the investment group to on an accountant’s work and services are the best way to resolve professional whom she entrusted her money and from in establishing liability. Assessing the liability issues. In that regard, the Dodd- the group’s auditors. The investment accountant’s awareness of who is relying Frank Wall Street Reform And Consumer group served was one of the funds which upon the financial statement may be Protection Act (‘the Dodd-Frank Act”) fed investors’ money to Madoff and the a prudent and fair means to define the has made significant advances to assure entities he controlled. against audit failures and make it clear cont’d on page 3 BOARD OF CONTRIBUTING LEGAL EDITORS

Richard P. Ryder, Editor-in-Chief SENIOR CONTRIBUTING EDITORS Sarah G. Anderson Jack D. Ballard Paul J. Dubow Attorney at Law Ballard & Littlefild, LLP Arbitrator • Mediator Charleston, SC Houston, TX San Francisco, CA

David C. Franceski, Jr. Pete S. Michaels William D. Nelson Stradley Ronon Stevens & Young, LLP Michaels, Ward & Rabinovitz, LLP Rothgerber Johnson & Lyons, LLP Philadelphia, PA Boston, MA Denver, CO

CONTRIBUTING EDITORS Carlton R. Asher, Jr. Philip J. Hoblin, Jr. James L. Komie Greenberg Freeman, LLP Attorney at Law Schuyler Roche & Crisham, P.C. New York, NY White Plains, NY Chicago, IL

Noah D. Sorkin Burton W. Wiand AIG Advisor Group Wiand Guerra King PL New York, NY Tampa, FL

securities litigation commentator is a semi-quarterly publication of Securities Litigation Commentator, Inc., P.O. Box 112, Maplewood, NJ 07040. Business Office: 93 Riggs Place, South Orange, NJ 07079. Tel: 973-761-5880. FAX: 973-761-1504. E-Mail: help@ sacarbitration.com. WebSite: www.sacarbitration.com. Copyright © 2011 Securities Litigation Commentator, Inc. No part of this publication may be reproduced in any manner without the written permission of the publisher. subscription information: Regular Subscription (semi-quarterly newsletter only): $350/year, regular rate. Preferred Subscription (semi-quarterly newsletter and weekly email Alert): $695/year, regular rate. 2 Securities Litigation Commentator Vol. 2011 • No.2

FEATURE ARTICLE cont’d from page 2

Privity and Near Privity limitation of new channels of liability… was the proximate cause of the loss The accounting firm in Baker responded Foreseeability alone does not define duty of Andover’s investment. (Emphasis to Plaintiffs’ allegations that they were - it merely determines the scope of the Added) not engaged by Plaintiff and that she duty once it is determined to exist. The could not be a third-party beneficiary of injured party must show that a defendant Analysis of the two cases shows that the their engagement between the accountant owed not merely a general duty to progress in the law will be better achieved and the feeder fund. Plaintiff did not society but a specific duty to him or her, by moving away from the formalities make any allegations that she reviewed for without a duty running directly to the of a contractual or quasi-contractual or relied upon the financial statements for injured person there can be no liability in relationship as a way of defining the which the accountants were responsible damages, however careless the conduct accountants’ professional liability risk to and certainly there was no awareness of or foreseeable harm. (Emphasis Added) the more rooted and definitive standards or acknowledgment by the accountants established by the accounting profession of such reliance. Accordingly, the The broad formulation stated above itself. Court held Plaintiff did not satisfy “the goes beyond the narrow criteria of elements necessary to plead a near privity “privity” or “near privity” and therefore Other cases also show the limitations relationship with the accountants.” is helpful. There is little precision to the of not paying sufficient attention to Court’s analysis, however; and it is easy professional standards to define the The Court adopted the accounting firm to see in the context of today’s financial parameters of the accountant’s liability defendants’ argument. In the absence of marketplace that the necessary guidance risk. Illustrative of the foregoing a formal client relationship, the plaintiff to determine the accountants’ professional proposition is In re Tremont Securities had to establish that the accountants were liability risk is not provided. Professional Law, State Law and Insurance Litigation aware that the plaintiff, or a defined group standards have to and should be looked 4]. There, the Court held, merely “alleging in which the plaintiff was a member, to in making a correct analysis of the a shoddy audit in violation of GAAS would be relying upon the financial accountants’ liability exposure, both in does not establish the intent to defraud statements that they audited or reviewed respect to professional malpractice, but required to maintain a claim for securities in connection with a particular transaction. fraud claims as well. This method can fraud.” Further, as to the negligence and fairly define risk, justly compensate loss, negligent misrepresentation claims, the The Court dismissed Plaintiff’s com- and deter negligence and misconduct. It Court rejected the “plaintiffs’ proposed plaint in Baker for negligence and is the balance that needs to and can be inference that the auditors did not comply negligent misrepresentation on traditional achieved. with GAAS because they ignored the ‘red privity grounds. flag’ warnings and… {thereby} failed to The Court in Hecht held: uncover the Ponzi Scheme.” In Hecht v Andover Associates Manage- Accounting malpractice contemplates ment Corp et al 3] a derivative action was a failure to exercise due care and proof According to the Court’s flawed logic, brought on behalf of a limited partnership of a material deviation from recognized the better explanation “as to why that was the conduit to place the and accepted professional standards for Madoff’s fraud went undetected for two investors’ funds with Madoff. In this case, accountants and auditors. Plaintiff must decades was his proficiency in covering however, the negligence and negligent establish that defendant departed from up his scheme and eluding the SEC and misrepresentation causes of action generally accepted accounting principles other financial professionals.” This is were not dismissed. Clearly the limited and the departure was the proximate troublesome, because our capital markets partnership was within the parameter of cause of plaintiffs’ injury… Giving are not wastelands with the regulators and professional liability risk, if it and not the plaintiff the benefit of every possible self-regulators being the only responsible investors brought the case. The Court’s inference, the Court must assume parties to prevent fraud and other forms analysis was as follows: that an audit of Andover Associates’ of financial wrongdoing. It is precisely the investments conducted pursuant to professional’s standards of care, adopted The threshold question in any negligence generally accepted auditing procedures reflectively, that anticipate the risks that action is whether defendant owes a would have uncovered Madoff’s fraud. must be avoided; those standards, if legally recognized duty of care to the Although …{the accounting firm} disregarded, should serve as a basis for a plaintiff… The duty is defined “by was retained after plaintiff invested in fair liability. balancing several factors, including the Andover Associates, the Court must reasonable expectations of the parties assume that a proper audit would have The Court in Tremont also went on and society generally, the proliferation provided Andover with the opportunity to restrict liability on formal contract to liquidate its investment… Thus, principles, as follows: of claims, the likelihood of unlimited or insurer like liability, disproportionate plaintiff has sufficiently alleged that.. But most critically, the auditors were risk and reparation allocation, and public {the accounting firm’s} departure from never engaged to audit Madoff’s policies affecting the expansion or generally accepted auditing procedures cont’d on page 4 3 Securities Litigation Commentator Vol. 2011 • No.2 FEATURE ARTICLE cont’d from page 3

businesses or to issue an opinion on the as a ‘qualified immunity,” because it auditor had actual knowledge of and/ financial statements of BMIS [Bernard is obvious the Attorney General does or consciously disregarded red flags L. Madoff Securities LLC]. The not have the resources to pursue civil have been found to be sufficient to plead auditor’s only role is that they audited recoveries for public investors on a “scienter” (Emphasis Added). Besides the financial statements of the… Funds... broad basis sustaining loss by reason of the GAAS and GAAP violations, there The notion that a firm hired to audit non-intentional fraud and/or professional must be “’additional facts showing that the financial statements of one client… malpractice in connection with securities there were numerous red flags that… [the] must conduct audit procedures on a third transactions. [auditor-defendant] must have been aware party…that is not an audit client…on of, if it were conducting any kind of audit’ whose financial statement the audit firm Violation of Professional sufficient to create… [a] strong inference expresses no opinion has no basis. To Standards and Red Flags of reckless behavior.” A plain disregard impose liability on the auditors would Insulation from professional malpractice of clear professional standards, however, expand their limited circumscribed duty liability in this context relies upon a even on one occasion, is intentional or impermissibly… (Emphasis Added). combination of the following legal certainly reckless conduct. conclusions: (1) “red flags” as to possible This aspect of the holding is also flawed, violations of professional standards and a Since the complaint did not allege because an audit of the feeder funds is not disregard of the profession’s authoritative “whether or how … {the accounting firm} being extended to an audit of Madoff’s texts, in and of themselves, do not acquired knowledge of most of these red broker-dealer and/or investment advisor, establish “scienter” or recklessness; and flags,” the complaint was dismissed. only to the investment transactions and (2) in any event, no duty exists upon the custodial arrangements between the part of the feeder fund auditors to verify Policy Considerations entities that materially impact the financial whether in fact Madoff was actually for Liability Exposure statements the accountant is being called making legitimate investments and Fairfield Retirement Programs et al v upon to audit. Looking at the accountants’ whether the performances being reported NEPC, LLC et al, 8] correctly articulated professional standards, however, would were truthful. 6] the policy of what must be considered not be an impermissible expansion but in setting the parameters of professional the fairest and most appropriate means Stephenson v Citco Group Ltd. et al 7] liability risk and, in so doing, did not to define the scope of the professional’s addresses the issue of GAAS and GAAP dismiss the plaintiff, investor-limited responsibility and liability. violations. The Court held that failure “to partners’ complaint. The case does adequately investigate does not satisfy the hold the auditor did have a specific and Statutory Preemption of scienter element of plaintiff’s fraud claim” independent duty to the limited partner- Professional Malpractice and even “in the accounting context ‘failure investors, because the audit reports were Claims to identify problems with the… {client} specifically addressed and sent to the In New York it is also settled law that company’s internal controls and accounting investors directly. However, the fortuity professional malpractice and constructive practices does not constitute recklessness’ of this holding is not really an indication fraud securities law claims are subject …” However “GAAP violations and that the law is meaningfully moving in to Martin Act Preemption pursuant to investigatory failures … can when the right direction, because, absent the N.Y. Gen. Bus. Law 352-c(1), i.e., the combined with allegations that the auditor auditor’s communication to the limited New York Attorney General has “sole ignored red flags” be legally sufficient. This partners, the complaint may have been authority to prosecute state law claims is problematic because of the uncertainty of dismissed. involving securities and sounding in when the threshold is met. securities fraud that does not require In respect to the policy considerations proof of intent to defraud or “scienter” The bar is also too high in Stephenson. concerned, the Court in Fairfield 5}. In essence, preemption operates Only “complaints alleging that an cont’d on page 5

OBAMA ADMINISTRATION JOINS IN REQUEST FOR CERTIORARI IN SECURITIES FRAUD CASE. The U.S. Government has filed an amicus curiae brief urging the U.S Supreme Court to accept an appeal from the U.S. Court of Appeals for the Fifth Circuit in a securities fraud class action against Halliburton Company. In the case, plaintiffs alleged that Halliburton misled investors about its financial condition, asserting their reliance on a fraud- on-the-markets theory. The Circuit Court held that plaintiffs must prove loss causation to win class certification under that theory. In their petition for writ of certiorari, plaintiffs argued that loss causation was an issue for the merits stage of the proceeding, not class certification, and the U.S. agreed. Subsequently, the U.S. Supreme Court not only issued a writ of certirori, but reversed the Court of Appeal’s ruling in a decision we covered in 2011-04. (Source: “US Urges High Court To Overturn Securities Fraud Ruling,” by Hilary Russ, www.law360 (4/25/11) 4 Securities Litigation Commentator Vol. 2011 • No.2 FEATURE ARTICLE cont’d from page 4

Retirement Programs explained: complexity of both securities instruments the Madoff fraud have made a material Duty is not sacrosanct in itself, but is and securities transactions has increased. difference in judging the accountant’s only an expression of the sum total of As was noted by the Second Circuit, in liability exposure in the context of the those considerations of policy which an era long before the Madoff Ponzi: ‘In Madoff fraud? In addressing these issues, lead the law to say that the plaintiff is our complex society the accountants’ we can determine how sweeping is the entitled to protection… The problem for certificate and the lawyers’ opinion can recently enacted reform legislation. As the law is to limit the legal consequences be instruments for inflicting pecuniary far as accountant’s liability in relation of wrongs to a controlled degree. The loss more potent than the chisel or the to the market activity of hedge funds final step in the duty inquiry, then, is to crowbar.’ (Emphasis Added) and private equity funds that represent a make a determination of the fundamental significant percentage of the trading in our policy, as to whether the defendants’ Criticism And markets, the Dodd-Frank Act should have responsibility should extend to such Further Analysis a positive and material impact. results. (Emphasis Added) The cases and the analysis that they represent are in a dynamic and now In view of the lessons from such systemic The Court held: uncertain tension. The law legitimately failures as Madoff’s fraud the mandate …{T}he test for the existence of a legal should eliminate the professionals’ is for more certain and better protection duty of care entails (1) a determination liability risk of an indeterminate nature for the ultimate investors and as a result of whether an ordinary person in the to unidentified groups for an extended the Dodd-Frank Act has taken significant defendant’s position, knowing what series of transactions. However, defining steps to protect the investing public. the defendant knew or should have the scope of the accountants’ liability Progress should not stop because the known, would anticipate that harm of by the formality of “privity” and “near costs to public investors of frauds of that general nature suffered was likely privity” is too narrow and not realistic in serious magnitude such as Madoff’s and to result, and (2) a determination, on terms of what we expect and face in our the damage to the perceptions everyone the basis of a public policy analysis, of capital markets and from the financial must share, with respect to the integrity whether the defendant’s responsibility services industry that serves it. Even of the capital markets and the regulatory for its negligent conduct should extend to making known reliance as the ultimate framework, are too great. the particular consequences or particular test will not be fully effectual, unless plaintiff in the case…The first part of the the courts recognize that implicit in the The AICPA Audit and test invokes the question of foreseeability professional’s standards is not merely Accounting Guide for and the second part invokes the question of what procedures the professional has to Investment Companies policy… [W]e are not required to address follow, but who will be harmed if there is By assuming a private equity or hedge the first prong … if we determine, based a breach. fund is an investment company but for on the public policy prong, that no duty the exemptions under sections 3(c)(1) or of care existed. Nor does creating statutory preemptions 3(c)(7) of the Investment Company Act of that foreclose certain private causes of 1940 (“40 Act”), one can look to the Audit The Court’s decision did alight upon the action and conferring standing only upon and Accounting Guide for Investment important policy considerations in judging the regulators and prosecutors make sense Companies developed by the AICPA professional liability in today’s financial in view of the limitations of resources of Investment Companies Guide Task Force marketplace that hopefully will and government and regulatory authorities. as a useful source for GAAS and GAAP. should push the law in the right direction. This author believes that the accountants’ The AICPA Audit and Accounting Guide What the courts should consider in more and auditors’ authoritative and textual (“Audit Guide” or “AAG”) describes depth is that the best source of duty and professional standards will provide better “operating conditions and auditing the liability that ensues is the accountants’ answers for both the accounting profession procedures unique to the investment own self-imposed standards of care. and society to define the parameters of industry and illustrates the form and professional liability. content of investment company financial The Court in Fairfield Retirement Programs statements and related disclosures. addressed the most important consideration Two questions to be addressed arising (Emphasis Added) of market integrity as follows: out of the Madoff accounting liability litigation involving his feeder funds are: Chapter 2: Investment Accounts, …In the wake of the Madoff morass, (1) did the courts correctly apply and Investment Objectives and Policies, many fortunes were ventured and lost… should they have applied the “privity” Section 2.02, provides in pertinent part: Retirement funds previously believed and “near privity” standard to define the An investment company discloses the to be conservatively invested were built accountants’ liability exposure; and (2) investment objectives adopted by its upon sand, not rock. The role of the would the Dodd-Frank Wall Street Reform management and the strategies adopted to accounting profession has increased and Consumer Protection Act (the “Dodd- achieve them in its charter or partnership in importance as the number and Frank Act”) if its enactment predated cont’d on page 6 5 Securities Litigation Commentator Vol. 2011 • No.2 FEATURE ARTICLE cont’d from page 5 agreement and in the documents such as held in safekeeping, either by a registered f. Lack of segregation of duties between registration statements, prospectuses, or investment company or an affiliated bank portfolio management and trading, or offering circulars. Restrictions, statutory as a custodian to be inspected at various absence of independent review of trading or otherwise, are also disclosed. Those times by the registered investment executions; for example, unexpected restrictions may include specific company’s independent auditor. The concentrations of trading with limitations or outright prohibition of deposited securities are required to be counterparties, poor trade executions, transactions… [O]ther restrictions physically segregated and subject to or higher-than-normal commissions may include limitations on investing withdrawal only by duly authorized indicate existence of collusion between in unregistered securities, making persons under specified conditions. portfolio personnel and counterparties. short sales of securities, underwriting (Emphasis Added). (Emphasis Added). securities of other issues, acquiring securities of other investment companies, Pre-audit the auditor must acquire an Sections 2.248 and 2.152 indicate the or using leveraging techniques, such understanding of the entity and its auditor should consider identifiable as margin accounts, bank borrowing, environment and assess the risks of “events or conditions that indicate and transactions in options and futures. material misstatement, whether due to incentives or pressures, or both to (Emphasis Added) mistake or fraud, “and … design the perpetuate fraud, opportunities to justify nature, timing and extent of further a fraudulent action” which are referred There are other “specific limitations” audit procedures.” (Emphasis Added). to as “fraud risk factors.” In Madoff’s and underlying records that will also be Consideration of the possibility of case it was clearly and ostensibly the subject to audit and testing of whether the fraud in the financial statement audit is custodial arrangements with the third “specific limitations” are being observed. essential to the “auditors in fulfilling their parties that constituted the prime fraud Section 31 of the ‘40 Act and the rules responsibility to plan and perform the risk for the feeder fund auditor to under that section require the following audit to obtain reasonable assurance about consider. records be kept and be subject to audit: “(1) whether the financial statements are free journals or other records of original entry of material misstatement, whether caused Section 2.155 states that one of the showing all securities purchases, sales, by error or fraud…” The Audit Guide risk factors related to fair valuation of receipts and deliveries, and collections requires professional skepticism and the investments “arises from the fact that and payments of cash for securities auditors have to consider the possibility significant amounts of investments transactions; (2) a record showing the of misstatement due to fraud. Two of are valued by management, either unit, quantity, price, and aggregate costs the areas requiring skepticism are (a) judgmentally or through valuation … for each position and each transaction, “significant investments for which readily models, … [and] presents a number of as of the trade date…[and] (3) a record for available market quotes are not available risks that need to be addressed by the all orders for purchase or sale by or on and inadequate procedures for estimating auditor.” Item ‘g’ notes one of the risks behalf of the investment company...” these “values” and (b) “unusual and to be “lack of evidence for fair valuation considerable influence of the portfolio decisions made.” There can be no question that the auditor manager over pricing sources and fair should consider reviewing the partnership valuation methodology used to value Section 2.156 addresses inter alia “(a)… and charter documents as well as the securities” (Emphasis Added). [the] use of a pricing service with disclosure documents to ascertain the inadequate capabilities or controls” investment objectives, restrictions, A mandatory risk assessment is to be made and “(b)…[the] ability of the portfolio organization structure and by necessity the by the auditor of the “susceptibility of management… to override prices.” quantity and type of investor class (i.e., assets to misappropriation… Inadequate members, limited partners, or shareholders). internal control over assets may increase Section 2.193 states the principal audit the susceptibility of misappropriation objectives of a registered investment Further, and especially significant to the of those assets” and is a result of the company audit (and logically the audit of Madoff fraud is Section 2.06, Custody following: a private equity or hedge fund as well), of Securities, that in pertinent part states, is “to provide reasonable assurance that “[t]he … ‘40 Act and the related rules a. Access to funds and securities and the investment company has ownership require that securities held in custody by a the accounting for them is directly of and accounting control over all of member of a national securities exchange be controlled by the adviser, with inadequate its portfolio investments” and “income inspected at various times by the registered segregation of duties (or no direct from investments and … [that] realized investment company’s auditors and that the communication between custodian and gains and losses from transactions are auditor issue a report thereon to the SEC…” accounting personnel) ... accounted for properly”. Further, Section 2.08 provides: c. Infrequent and incomplete recon- Section 2.195 states the second standard …The…[‘40 Act] and the related rules ciliation of securities holdings with the of field work to be that “the auditor must require all securities determined to be custodian.... cont’d on page 7 6 Securities Litigation Commentator Vol. 2011 • No.2

FEATURE ARTICLE cont’d from page 6 obtain a sufficient understanding of the illustrative report on internal control and Others, Section 401, (a)(29) states entity and its environment, including the required by the SEC under Form N-SAR. “[t]he term ‘private fund’ means an issuer entity’s internal control to assess the risk Specifically “[t]he instructions to Form that would be an investment company, of material misstatement of the financial N-SAR further note that the internal control as defined in Section 3 of the…[40 Act] statements due to error and/or fraud, and report is to be based on review, study, but for section 3(c)(1) or 3(c)(7) of that to design the nature, timing, and extent and evaluation of the financial reporting, Act and Section 403 most significantly of further audit procedures.” (Emphasis including control activities for safeguarding eliminates by amendment the private Added). securities.” (Emphasis Added) adviser exemption (i.e. no registration required for advisers with 15 or fewer Applying these principles to feeder The illustrative opinion and/or report clients). Section 404(2) of the Dodd-Frank funds is revealing. If the feeder fund states: “we considered the Company’s Act, Treatment of Records, provides “… was dependent on Madoff, what controls internal controls over financial reporting [t]he records and reports of any private existed in reference to what material risks? including controls over safeguarding fund shall be deemed to be the records This consideration had to have and should securities, as a basis for designing our and reports of the investment adviser.” have been evidenced in the accountant’s auditing procedures for the purpose of work papers or it can safely be concluded expressing our opinion on the financial Section 404(3) provides that “[t]he records there was only a pretense of an audit and statements.” (Emphasis Added). and reports required to be maintained arguably then there would be auditor by an investment adviser and subject to accounting fraud in which the accountant Key to any audit are the company’s inspection by the Commission under this would be complicit. Certainly if these audit internal controls because “[a] company’s subsection shall include investment: a procedures are recklessly disregarded and internal control over financial reporting is description of “(A) the amount of assets not applied this has to be the case. a process designed to provide reasonable under management and use of leverage assurance regarding the reliability of including off balance-sheet leverage; (B) The controls that have to be considered financial reporting” and “includes those counterparty credit risk exposure; (C) are those (1) “covering the receipt of policies and procedures that (1) pertain trading and investment positions; (D) and payment for securities, delivery of to the maintenance of records that, in valuation policies and practices of the securities, and control over cash received; reasonable detail accurately and fairly fund; (E) types of assets held; (F) side (2) “for physically segregating and reflect the transaction and disposition of arrangements or side letters, whereby satisfactorily safeguarding the company’s the assets of the company; (2) provide certain investors in a fund obtain more securities., in the custodian’s vaults; (3) reasonable assurance that transactions are favorable rights or entitlements than physical counts of securities and other recorded as necessary to permit preparation other investors; (G) trading practices; procedures performed by the custodian’s of financial statements in accordance with and (H) such other information as internal auditors; (4) … over securities GAAP … and (3) provide reasonable the Commission, in consultation with held in central depositories and (5) over assurance regarding prevention or timely the …(Financial Oversight Council), receipts of cash including dividend and detection of unauthorized acquisition, determines is necessary and appropriate interest payments”. use or disposition of a company’s assets … for the protection of investors or for that could have a material effect on the the assessment of systemic risk…” Section 2.197 provides “[i]f the custodian financial statements.” (Emphasis Added). has engaged a service auditor to examine Sections 404(4), Maintenance of Records, the custodian’s description of controls If the standards set forth above pre- and 404(5), Filing of Records, requires over custodial functions, the fund’s existed the Dodd-Frank Act, it is counter- maintenance of records by the investment auditor should consider obtaining a copy intuitive to conclude the feeder fund adviser of the private fund as provided of the service auditor’s report” and Section and/or investment advisor auditor could for by SEC rules and filing with the SEC 2.198 provides that “[t]he auditor should not have discovered Madoff’s fraud. In “… reports containing such information obtain an understanding of the extent any event, the Dodd-Frank Act does not as the Commission deems necessary of inter-custodial responsibilities and merely rest upon the auditing profession’s and appropriate” for the protection rights under sub custodial agreements”. self-imposed standards but establishes of investors or for the assessment of (Emphasis Added). What this signifies is requirements so that the audits of the systematic risk.” i.e. the auditor of feeder that the feeder fund auditor must satisfy feeder funds, investment advisors, and funds and their advisors will be subject himself of the bona fides of the audit of broker-dealers will give greater assurance to pro-active rule making. The Dodd- the custodian; these standards predated to the most important constituency, i.e., Frank Statute’s pertinent sections do not Dodd-Frank. the public investors. change what should be audited but only enhance and require further procedures Section 11.25 contains an illustration of The Dodd-Frank Act making the audit more effective. This what the auditor must report on in respect In respect to Dodd-Frank, Title II, fact coupled with the elimination of the to internal control. The section has an Regulation of Advisers to Hedge Funds cont’d on page 8 7 Securities Litigation Commentator Vol. 2011 • No.2 FEATURE ARTICLE cont’d from page 7 private adviser exemption creates far incongruity of what Madoff recorded and Violations of professional auditing greater transparency. reported and the real transaction detail standards without more, do not should have been easily discoverable “in constitute strong circumstantial Any Kind Of Audit any kind of audit.” evidence of conscious recklessness…’ The fact patterns presented by the See: Novak v Kasaka,216 F.3d at 309. Madoff-accountant’s liability litigation In reality the transactions were not just ‘[A}llegations of GAAP violations or show an actionable basis for investors in between the feeder fund and Madoff, accounting irregularities, standing alone, the feeder funds to sue the feeder fund but the feeder fund with Madoff as a are insufficient to state a securities fraud auditors for accounting malpractice and conduit and, third party securities traders claim. Only where such allegations are fraud (whether it is securities fraud in and custodians. This is the case whether coupled with evidence of corresponding connection with the initial purchase or Madoff was acting as an investment fraudulent intent might they be sufficient. subsequently for withholding information adviser and/or broker-dealer. At a ’In re: Tremont Se.Law,State & Ins. that should have been disclosed to the minimum there was reckless disregard, Litg. ,703 F.Supp 2d 362,371 (S.D.N.Y, fund’s board and would have caused the because “any kind of audit” would have 2010) … ([A]lleging a shoddy audit in investors to liquidate their investments). discovered the fraud. violation of GAAS does not establish the This is true whether the events predate or intent to defraud required to maintain a postdate Dodd-Frank. The Privity Concept, An Anachronism claim for securities fraud’). On whether there is a sufficiently alleged The pertinent portions of the professional accounting malpractice cause of action Based on the detail and clarity of the audit standards quoted above demonstrate there that can be maintained by the feeder fund standards, the fraud allegations should were definitive audit procedures with investors, the “privity” or “near privity” have been sufficient. Coupled with “red respect to (a) custodial arrangements, threshold is easily satisfied. Certainly flags” warnings, “a strong inference of (b) specific buy and sell transactions and “near privity” exists if White v. Guarente conscious recklessness” should have been then pricing; (c) internal controls; and the 9] applies. permitted. Violations of clear professional possibility of fraud and misappropriation standards that do not allow for discretion risk for funds and securities. The fact that The case holds that the test is whether in their application should establish at the auditors in advance had to design “plaintiff seeks redress, not as a mere a minimum a refutable presumption of audit procedures with respect to the risks member of the public but as one of a actual knowledge or reckless disregard. and those procedures addressed a not settled and particularized class.” The For any professional to deny that a insignificant quantity of specific detail case held that the limited partners of a breach of such standards does not create a demonstrates there were and still are tax shelter limited partnerships which foreseeable risk of harm to an investor or duties to examine the transactions between was a hedge fund had standing to sue the lender is to turn reality into fiction. entities, the pricing and the location of the auditors who prepared and transmitted funds and securities and who had custody. materially inaccurate K-I’s. There was The Court, citing White v. Guarante, did The supporting documentation compels “near privity,” because there was known not find there was intention upon the part the conclusion that if these procedures reliance upon the financial statements and of the auditor that a specific and known were not applied to Madoff in reality there financial information by persons within party was to rely on the financial reports. was a mere pretense of an audit. “Any a defined and limited group. There was However, where there was reliance upon kind of audit” would have discovered not uncontrolled risk in respect to an the financial statements in connection the fraud, and that should have been the indeterminate class. with particular transactions by a known case even prior to the enactment of Dodd- group of investors that was held to be Frank. In fact the limited partnership agreement sufficient. The Court held: should have been one of the first Madoff’s pricing and account values documents the auditor looked at in …The ‘known’ parties’ prong of the presumptively did not correlate with the planning the engagement. In respect to Credit Alliance test does not require an true market values. Either there was an feeder funds most likely they are limited auditor know a ‘particular’ third party absence of the requisite documentation partnerships or limited liability companies by name. Rather it recognizes that, while with the necessary detail and/or there so the classes of investors suing are from an accountant does not owe a duty to would not be any match with what Madoff a defined group evident to the auditor in members of an ‘indeterminate class…, reported as the pricing and values that had the charter documents. If proper audit an accountant owes a duty to ‘[members] to come to the auditor’s attention if an procedures are not followed, the privity of a settled and particularized class audit was performed. concept should not preclude liability. among the members of which the report In Anwar v. Fairfield Greenwich Ltd. could be circulated’… In respect to the proposition that mere red 10] while the Court dismissed the flags and GAAS and GAAP violations do fraud allegations against the auditors, it Thus, implicit in the procedures of what not satisfy the scienter element (i.e. actual followed precedent that held: the auditor is required to do is definitely knowledge or reckless disregard), the total cont’d on page 9 8 Securities Litigation Commentator Vol. 2011 • No.2 FEATURE ARTICLE cont’d from page 8 who may be harmed. When the public unreasonable for the profession to assume plainly to be seen” and will now lead to interest is so significantly involved as it as it is implicit in the profession’s own the reform necessary for the protection of was in the Madoff context and, because standards. public investors. of the extent of the trading of hedge and private equity funds in our markets, the Dodd-Frank Reform End Notes fair standard for judging liability and In another respect the Dodd-Frank Act 1. United States v.Benjamin, 328 F.2d its extent is the content and clarity of facilitates investor actions. The private 854(2dCir1964) professional standards. fund’s records are now explicitly deemed 2. 2009 NY Slip Op. 52788U, 30 Misc. 3d to be the records of the hedge fund and/ 1218A; 2009 N.Y. Misc. Lexes 6587. (S. Ct. In respect to the issue of whether the or private equity fund advisers who now Westchester Co. 2009) Dodd-Frank Act facilitates or impedes cannot rely upon the private advisor 3. 2010 NY Slip. Op. 50528U; 27 Misc. 3d investor actions against feeder fund exemption from regulation and therefore 1202A; 910 N.Y. S. 2d 405; 2010 N.Y. Misc. Lexis 638; 242 N.Y. L. J. 61 (S. Ct. Nassau Co. auditors by reason of the privity rule, are subject to audit and SEC inspections. 2010). See also: Sacher v Beacon Associates most likely the investment vehicles will Prior to the enactment of Dodd-Frank the Management Corp. et. al. 2010 NY Slip Op be limited partnerships or limited liability adviser as an agent and by contract had 508 26 U: 27 Misc. 3d 1221 A: 910 NYS 2d companies, so the class of investors to make available its records to the feeder 765; 2010 NY Misc Lexis 992 (S. Ct. Nassau suing would be from a defined group and fund auditor. Now the feeder fund’s Co. 2010) the charter documents would be audit records are deemed to be the adviser’s 4. 703 F Supp. 2d 362; 2010 U.S. Dist. Lexis 3 evidence of this fact. From this standpoint records and within the category of SEC 2216; Fed Sec. L. Rep. (CCH) P95, 666 SDNY the statute is neutral. required records. The records clearly are 2010); See Also: In re: Beacon Associates subject to both audit and SEC inspection. Litigation 745 F. Supp. 2d 386; 2010 U.S. Dist. “Near privity” is a hybrid of contract and Lexis 106355; Fed. Sec. L. Rep. (CCH) P95, tort liability. The auditor’s duties arise Additionally, section 404(2) by including 929 (S.D.N.Y 2010) 5. Anwar v Fairfield Greenwich Ltd. 2010 U.S. out of its contract of engagement and the the records of the private fund as the Dist. Lexis 96606. (SDNY 2010) Meridian audit and accounting standards that are adviser’s and Section 404(3) that details Horizon Fund L.P. et al. v Tremont Group both explicit and implicit promises of the “required information” assures that the Holdings Inc., 2010 U.S. Dist. Lexis 32215 engagement contract. The tort component auditor and/or SEC examiner will be able (SDNY 2010); CRT Investments Ltd. et al. v comes from what is considered to test the transactions and the fund and/or Merkin et. al. 2010 NY Slip OP 51868U: 29 “reasonably foreseeable”. Based upon securities deposits the adviser has with a Misc. 3d 1218 A; 918 NYS 2d 397, 2010 N.Y. pre-existing standards as well as the counterparty, whether the counterparty is Misc Lexis 5282 (S. Ct. NY Co. 2010) Dodd-Frank Act, if a feeder fund auditor a securities trader or custodian. 6. Saltz v First Frontier L.P. 2010 U.S. Dist. does not perform the audit as required ,it Lexis 136140 (S. D. NY 2010) certainly should be reasonably foreseeable In the last analysis, in respect to the Madoff 7. 700 F Supp. 2d 599; 2010 U.S. Dist. Lexis that at a minimum the limited partners or type fraud, Dodd-Frank does advance the 32321 (S.D. N.Y 2010) 8. Fairfield Retirement Program For Employers LLC members can sustain economic loss public interest and make it less likely to NEPC LLC 2011Conn. Super Lexis 527 and are within the defined group entitled occur. Further, a better appreciation and 9. 43 NY 2d. 356, 401 N.Y.S. 2d 474,372 NE. to sue. Further the professional standards application of the accounting profession’s 2d 315, 320 (1977) that the auditor undertakes to comply with own standards coupled with the coverage 10. 728 F. Supp 2d 372 (SDNY 2010) should create no doubt as to the auditor’s provided by the statute will not allow the liability risk. This risk is neither unfair nor sentinels “to shut their eyes to what…is

DON’T HAVE TOO MUCH CONFIDENCE IN CONFIDENTIAL SOURCES. Securities plaintiffs’ counsel sometimes find themselves relying on confidential sources to assert the specific allegations of scienter needed to maintain a claim under the heightened pleading standards of the Private Securities Litigation Reform Act. If one does so, however, it is advisable to confirm the accuracy of the source through counsel’s due diligence, as one law firm found to its chagrin. Early this year, the U.S. District Court for the Northern District of Illinois dismissed a securities fraud class action after plaintiffs’ confidential source denied making the statements or having the knowledge attributed to him. It turned out that plaintiffs’ counsel relied entirely on their own investigator’s notes of her interview with the source. The Court found that the purported information was “at best unreliable and at worst fraudulent,” no matter whether it was the source or the investigator who lied, and noted that the problem “could have been avoided by reasonable inquiry on the part of plaintiffs’ counsel,” before the filing of the amended complaint that relied on the statements. (Source: “Check Your Sources,” by Steve Koh, Kathleen M. O’Sullivan and Jeremy L. Ross, www.law360.com (4/5/11))

9 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12 Case Summaries from Securities Litigation Alerts SLAs 2011-07 through 2011-12

Editor’s Disclaimer: The decisions summarized in these pages are often slip opinions when we review them and may never be approved for publication. They may also be amended by the issuing court or, subsequently changed on reconsideration, appeal, or review en banc. Readers are, therefore, cautioned to review local rules and to “shephardize” these decisions before citing them or relying upon them in an actual litigation or arbitration. While our effort is to deliver current material and to record it in ways that will assist lawyers and others in their legal research, no reliance should be placed upon us to report when a decision has been disapproved for publication, overturned, amended, vacated, or otherwise changed. In our view, this is a professional responsibility that can only be adequately discharged at the time the decision is cited as precedent. Moreover, all synopses, commentaries and “tactical tips” should be viewed as general remarks and reportage and not as the rendering of legal advice. Any recommendations expressed here are made without an attempt to assay all relevant facts of either the case at hand or any other.

Absolute Activist Value billions of essentially illiquid shares of penny stocks were registered with the Master Fund Ltd. v. Homm, these companies that were incorporated SEC, their shares were not traded on a No. 09 Civ. 08862 (GBD), 2010 U.S. Dist. in the United States and whose shares domestic exchange. Rather, the fraudulent LEXIS 137150 (S.D. N.Y., 12/22/10). were quoted on the OTC Bulletin Board scheme alleged involved PIPE transactions Derivative/Vicarious Liability (Con- or by the Pink OTC Markets, Inc. The in which the plaintiff funds were caused spiracy) * FRCP (Rule 12(b)(1) “Subject- shares were not sold on an exchange, but to purchase the illiquid shares directly Matter Jurisdiction”, Rule 12(b)(2) rather were purchased directly from the from the companies through private “Personal Jurisdiction”) * Fiduciary issuers pursuant to private placements. placements. The entire “market” alleged Standards (Hedge Fund Managers) * The alleged scheme of manipulating and was the trading between the plaintiff funds Jurisdictional Issues (Extraterritorial) artificially inflating the price of the penny based in the Cayman Islands and managed * Market Manipulation (Dominion & stocks was accomplished, in part, by in Europe. Accordingly, the “transaction Control; Pre-Arranged Trading/Wash trading and re-trading the stocks many test” established by Morrison precludes Sales (PIPE Transactions); “Pump and times between the funds. The scheme this action: there was no sale of a security Dump”) * Misrepresentations/Omis- allegedly served to generate bogus listed on an American exchange, as the sions * Pleading Requirements/Issues commissions for defendants, including PIPE transactions involved penny stocks * 1934 Act (§10 Rule 10b-5). Under Hunter, a California FINRA-registered that were purchased directly from the Morrison v. National Australia Bank’s broker-dealer, and to artificially inflate the company, and no transaction occurred in “transactional test,” “F-Cubed” cases stock price to the point at which defendants the United States. Permitting this case to (i.e., foreign investors suing foreign (and were free to sell previously untradable move forward on the theory that any trade American) defendants for misconduct shares and exercise certain warrants, routed through the United States meets the relating to securities purchased on a which defendants then sold to the funds Morrison standard would be the functional foreign exchange) may now be swiftly at a profit. Defendants moved to dismiss antithesis of Morrison’s directive. dispatched with for lack of subject matter the amended complaint, which asserted (C. Asher.) (SLC Ref. No. 2011-07-09) jurisdiction, even where there is some 10b-5 and other claims for, among other connection to the United States. grounds, lack of personal jurisdiction Akamai Technologies, Inc. Plaintiffs Cayman Island hedge funds that and failure to state a claim. Based on the v. Deutsche Bank AG, invested on behalf of investors located Supreme Court’s subsequent decision No. 10-10254-JLT (D. Mass., 2/15/11). around the world, including the United in Morrison v. National Australia Bank Product/Sales Practice Issues (Auction States, sued Hunter World Markets, (130 S. Ct. 2869), the Court determines, Rate Securities) * 1934 Act (Rule 10b- Inc. (“Hunter”) and other primarily sua sponte as a threshold matter, that it 5) * Fiduciary Standards * Damages foreign defendants who allegedly caused lacks federal subject matter jurisdiction Calculations (Economic Loss) * plaintiffs, in connection with a pump-andover the claims; as such, it refrains from Control Person Liability * State Law dump scheme, to purchase nearly valueless opining on the various other grounds upon Interpreted (Mass. G.L., ch 110A) * penny stocks issued by companies that which defendants have moved to dismiss, PSLRA (Applicability) * Pleading were registered with the SEC. Defendants and dismisses the complaint in its entirety. Requirements (Scienter) * FRCP (Rule caused plaintiff funds to purchase Although the companies that issued the 9(b)). cont’d on page 11 “This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.” —from the Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations. 10 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Any distinction between omissions and not need to identify statements made by Class Action”) * Timeliness Issues misrepresentations is illusory, where the specific DBS employees in an omission (Statute of Limitations). broker-dealer owes a fiduciary duty to the case and that, in analyzing a motion to Although the absence of loss causation client. dismiss, it was reasonable to assume that is an affirmative defense to a Section 11 Defendant’s Motion to Dismiss Plaintiffs’ any misstatements that might have been claim under the 1933 Act, a complaint federal fraud claims, pursuant to Federal made were made by the DBS employees may be dismissed pursuant to Rule 12(b) Rules of Civil Procedure 12(b)(6) and responsible for Akamai’s account. Notably, (6) if the loss causation defect is apparent 9(b), are denied. Plaintiffs, Akamai the Court also holds that “Defendant’s from the face of the pleading. Technologies, Inc. and Akamai Securities contention that it owed Plaintiffs no duty Plaintiff Dominic F. Amorosa and his Corporation (collectively “Akamai”), to disclose material facts does not excuse counsel, Christopher J. Gray, appeal, allege that Deutsche Bank Securities, Inc. it, as Defendant in fact owed Plaintiffs a respectively, from the final judgment (“DBS”), the wholly-owned subsidiary broad fiduciary duty.” With regard to the granting defendant Ernst & Young’s of Defendant Deutsche Bank AG second element, the Court holds that, (“E&Y”) motion to dismiss securities law [“Defendant”], wrongfully invested $217 under section 20(a), the [Private Securities and other claims arising from allegedly million in “toxic” auction-rate securities Litigation Reform Act of 1995’s] fraudulent accounting practices at AOL (“ARS”). According to Akamai, DBS, heightened “strong inference” pleading and then newly-merged company AOL- acting as Akamai’s investment advisor standard for scienter is inapplicable.” Time Warner (“AOLTW”) and the District and broker, recommended and invested Under F.R.C.P. 9(b), Akamai is simply Court’s grant of E&Y’s motion for Akamai’s money in ARS, despite DBS’s required to “set forth specific facts to make sanctions under Rule 11. In its Summary knowledge that the illiquid nature of the it reasonable to believe that defendants Order, the Second Circuit affirms the investment ran contrary to Akamai’s stated knew that a statement was fraudulent or judgment and the imposition of sanctions objectives. Moreover, DBS allegedly misleading.” The Court briefly addresses in all respects. In the first instance, plaintiff failed to disclose its role in secretly the sufficiency of Akamai’s pleading failed to meet his burden of pleading loss supporting ARS auctions, failed to disclose with regard to the third and fourth causation for purposes of his 14(a) and the illiquid nature of the investments and elements. With regard to the fifth and 10(b) claims under the 1934 Act. The secretly worked to keep ARS interest rates sixth elements, Akamai’s allegation that, District Court correctly noted that plaintiff artificially low. Akamai asserted claims “but for Defendant’s misconduct, Akamai had not alleged any corrective disclosure against Defendant under section 20(a) of would not have owned ARS when the regarding E&Y’s June 1999 audit opinion; the Securities and Exchange Act of 1934 ARS market froze,” sufficiently addresses none of the events identified as corrective and Massachusetts General Laws chapter the economic loss and causation pleading disclosures by plaintiff in his complaint 110A, section 410(b). DBS moved to requirements. Finally, the Court finds that addresses AOL’s accounting practices dismiss these claims, arguing that Akamai the question of Defendant’s actual control or in any way implicates E&Y’s audit failed to plead the elements of its fraud of DBS is, by law, a question of fact, not opinion. Thus, plaintiff cannot establish claims, failed to plead its fraud claims with appropriate for analysis in a motion to that any misstatement or omission in specificity, and failed to properly allege dismiss. Accordingly, the Court denies E&Y’s audit opinion was revealed to Defendant’s status as the controlling entity Defendant’s motion to dismiss. the market, resulting in a diminution in of DBS. In order for Akamai to state a (P. Michaels) (SLC Ref. No. 2011-11- the value of the securities. Moreover, claim under section 20(a) of the Exchange 10) because plaintiff’s complaint fails to Act, it must “plead (1) an underlying identify specifically any misstatements violation of the same chapter of the Amorosa v. or omissions during the relevant time securities laws by the controlled entity and AOL Time Warner Inc., period to the auditor itself and, in turn, the (2) control of the primary violator by the No. 09-5270-cv (L), 2011 U.S. App. risk that was thereby concealed, plaintiff defendant with culpable participation.” LEXIS 2149 (2nd Cir., 2/2/11). has failed to establish loss causation on The underlying violation alleged by Attorney Fees * Class Actions (Effects a “materialization of the risk” theory. plaintiffs was a violation of section of) * Derivative/Vicarious Liability Regarding his Section 11 claim under the 10(b) of the Exchange Act. The elements (Aiding & Abetting; Holder Action) * 1933 Act, his claim is either time-barred of such a claim are: “(1) a material FRCP (Rule 11 “Sanctions” Rule 12(b) or fails for lack of loss causation. The first misrepresentation or omission by the (6) “Claim for Relief”) * Loss Causation/ disclosure - actual or constructive - reveals defendant; (2) scienter; (3) a connection Proximate Cause * Misrepresentations/ E&Y’s alleged fraud on January 12, 2001. between the misrepresentation or omission Omissions * Pleading Requirements/ Plaintiff did not file suit until May 29, and the purchase or sale of a security; Issues * Preemption, Federal * PSLRA 2003. Plaintiff argues that the statute of (4) reliance upon the misrepresentation (Pleading Requirements) * Sanction limitations was not triggered until the or omission; (5) economic loss; and (6) Powers (Judicial) * 1933 Act (§11) Washington Post published a series of loss causation.” With regard to the first * 1934 Act (§10 “Rule 10b-5”, §14 articles in July 2002 that revealed AOL’s element, the Court finds that Akamai did “Tender Offer”) * SLUSA (“Covered questionable accounting practices. If the cont’d on page 12 11 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Court, however, were to accept plaintiff’s costs and to indemnify defendants pursuant not the duty to advance defense costs. The contention, the Section 11 claim still to the terms of a professional liability exclusionary provisions did not absolve fails for lack of loss causation. Because policy plaintiffs issued to defendants. A plaintiffs of their duty to advance defense AOLTW’s share price went up between the question of plaintiffs’ duties to advance costs. The Court also rejects plaintiffs’ date of the Washington Post’s articles and defense costs and indemnify arose from argument that advancing defense costs the date plaintiff filed suit, E&Y’s alleged four class actions and two arbitration was within their sole discretion. The misstatement could not have resulted in proceedings brought against defendants advancement of defense costs is mandatory any losses. Regarding plaintiff’s “holder” by various holders of self-directed IRA provided that defendants submitted a claim under the federal securities law, accounts that were invested with Madoff’s written request. It is undisputed that the courts continue to reject this theory failed and insolvent brokerage firm, defendants timely notified plaintiffs of the since Blue Chip Stamps. Furthermore, Bernard L. Madoff Investment Securities. underlying actions. for substantially the reasons set forth Plaintiffs denied defendants’ request to (W. Nelson) (SLC Ref. No. 2011-07-05) by the District Court, SLUSA preempts advance defense costs arising from the plaintiff’s state law claims as his suit is a underlying actions, pursuant to certain Badger v. Southern Farm “covered class action” within the meaning exclusions in the policy. Those exclusions Bureau Life Ins. Co., of the statute. After reviewing the District provide, in pertinent part, that plaintiffs No. 09-12999, 2010 U.S. App. LEXIS Court’s decision, no abuse of discretion shall not be liable to reimburse defendants 15895 (11th Cir., 7/30/10). in the imposition of sanctions has been for damages in connection with any claim Evidentiary Standards (Jury identified and, thus, no reason is found to “arising out of or alleging any criminal, Instructions) * Misrepresentations/ disturb the decision on appeal. malicious, dishonest or fraudulent act, Omissions * Liability Issues (C. Asher.) (SLC Ref. No. 2011-10-06) error or omissions of any Insured or any (Corporation-Shareholders) * other person for whose actions the Insured Disclosure Issues (Duty to Disclose) * Aspen Insurance UK, Ltd. is legally responsible. . .” or “arising Waiver. v. Fiserv, Inc., out of the bankruptcy of, or suspension In an arms-length securities transaction, No. 09-CV-02770 (D. Colo., 12/9/10). of payment by, any broker or dealer in the seller may have disclosure duties to the Insurance Issues (Exclusions) * securities or commodities. . ..” Regarding purchasing corporation, but that duty does Indemnification/Contribution (Defense defense costs, the policy provided that not extend to the purchasing corporation’s Costs) * Contract Issues/Interpretation plaintiffs “shall advance, at the written shareholders. * Sales Practice/Product Issues (Madoff; request of [defendants], Defense Costs This case is an appeal to the U.S. Court of Ponzi Schemes) * Liability Issues. prior to the final disposition of the Claim. Appeals for the 11th Circuit from a jury Exclusionary clauses designed to except Such advance payment by the [plaintiffs] verdict against Southern Farm Bureau particular conduct or situations from shall be repaid to the [plaintiffs] by the in a case brought by the shareholders of insurance coverage provisions must be [defendants]. . .in the event and to the a corporation that owned a debenture drafted in clear and specific language; to extent that the [defendants] shall not be issued by Southern Farm Bureau. The benefit from an exclusionary clause, an entitled under the terms and conditions Plaintiffs alleged that, in connection with insurer must establish that the exclusion of this policy to payment of such Loss.” the purchase by Southern Farm Bureau applies and is not subject to any other In granting defendants’ cross-motion for of the debenture from the corporation, the reasonable interpretation. summary judgment, the Court concludes shareholders had not been provided with This declaratory judgment action concerns that the exclusionary provision in the accurate information. They claimed that, plaintiffs’ obligations to advance defense policy only concerns the duty to indemnify, during the negotiations, Southern Farm cont’d on page 13

A REPORT ON THE FINANCIAL CRISIS. Phil Angelides, chair of the Financial Crisis Inquiry Commission, appeared before the U.S. Senate Banking Committee this past May to testify on what the Commission discovered about the causes of the recent financial meltdown and how to avoid it in the future. He urged full implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act as necessary to prevent a recurrence, but faulted the Act for not doing enough to regulate ratings agencies. Angelides testified that the aggressive push for home ownership contributed to reckless speculation in home mortgages, but denied that Fannie Mae or Freddie Mac was a leading cause of the crisis. He did sharply criticize Federal Reserve Board Chairman Ben Bernanke, Ex-U.S. Secretary of the Treasury Henry Paulson and his successor, Timothy Geithner (then head of the Federal Reserve Bank of New York) for failing to predict and stop the crisis from happening. (Scource: “Financial Crisis Study Reveals Systemwide Breakdown,” by Ian Thoms, www.law360.com (5/10/11))

12 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Bureau had proposed a “fair price” for the Bank of America Corp. security by the plaintiff. Here, BAS posted debenture and the shareholders alleged ARS Marketing Litigation, on its website that “in connection with any this proposal was a misrepresentation. In Re: Bondar v. BOA, particular auction, BAS is permitted but is The jury returned a verdict in favor of No. 09-md-02014 JSW, 2011 US Dist not obligated to submit orders for its own the Plaintiffs and awarded them $31.7 LEXIS 18208 (N.D. Cal., 2/24/11). account, either as a bidder or a seller, and million. This appeal was primarily based Class Actions, Effects of * Product/Sales routinely does so in its sole discretion, on the form of the jury instructions. Practice Issues (ARS: Auction Rate even after obtaining knowledge of some Southern Farm Bureau argues that the jury Securities) * Market Manipulation * or all of the orders submitted through it.” instructions in the case were inappropriate Disclosure Issues. BAS also disclosed that its bids might be for two reasons: First, the instructions A cause of action for market manipulation designed to prevent auction failures or advised the jury that they could find will fail if it is shown that the defendant to prevent an auction from clearing at a liability if Southern Farm Bureau had disclosed the allegedly manipulative rate that BAS believed was not a market failed to disclose material information conduct prior to the purchase of the rate. Consequently, the Court finds that about the transaction to the shareholders, security. there was no deception in connection without including an instruction that the Plaintiffs brought a class action against with BAS’s practice of entering support jury must find that there was a duty owed Banc of America Securities (“BAS”) bids in general. But the Court does not by Southern Farm Bureau, an arms-length and Bank of America Corp. (“BAC”), find persuasive BAS’s argument that it purchaser in the transaction, to make a alleging that BAS violated Section 10(b) fully disclosed its conduct with respect disclosure. Second, Southern Farm Bureau by manipulating the prices of auction rate to rate cap waivers. The website did not challenged the jury instructions, arguing securities (“ARS”). BAC’s liability is disclose the triggering of the rate caps that, even if a duty existed, there could be based on its status as BAS’ control person. and the need for BAS to obtain the rate no liability for failing to make disclosures Plaintiffs allege that BAS systematically cap waivers. However, plaintiffs failed to the shareholders of the company that intervened in auctions in order to set the to allege that any of the specific ARS that owned the debenture, as opposed to failing clearing rate for auctions that would have they purchased contained interest rate to disclose information to the company failed but for its support bids. Plaintiffs caps and did not set forth dates on which itself. With respect to the first of these further allege that, in August 2007, the BAS obtained rate cap waivers. Rather, arguments, the Court finds that a proper market for BAS ARS came under increased plaintiffs made vague and conclusory instruction should have advised the jury stress, because of the deteriorating credit allegations that “sometime in the fall of that they must find a duty of Southern Farm environment and that, therefore, BAS 2007” BAS “colluded” with unspecified Bureau before they could find liability. began to place support bids in such a issuers to obtain the rate caps. The Court However, since the attorneys for Southern manner as to increase the clearing rates therefore grants defendants’ motion, Farm Bureau had not raised any objection for BAS ARS in order to prevent auction but also grants plaintiffs leave to amend on this ground to the jury instructions, failure. Many ARS contained rate caps only in connection with transactions that the Court does not reverse the verdict on and BAS’s actions increased the interest occurred subsequent to August 2007 when this ground. With respect to the second rates to the point of approaching the rate the practice of obtaining rate cap waivers argument, the Court of Appeals finds that caps. Investors in BAS ARS were unaware began. an attorney of the corporation that owned that, if the rate caps were triggered, the (P. Dubow) (SLC Ref. No. 2011-11-05) the debentures had been provided with the interest rates on many BAS ARS would information that the shareholders claimed be reset automatically to levels well below Bernard L. Madoff Investment was not disclosed to them. Finding this to market rates for comparable securities. In Services, LLC, In Re: Picard be the case and also determining that the order to forestall this event, BAS obtained v. Cohmad Securities Corp., law does not require any disclosure to the rate cap waivers from the ARS issuers. No. 09-1305 (BRL) (S.D. N.Y., 2/3/11). shareholders of a corporation, as opposed By December 2007, BAS made plans to Settlement Issues * Injunctive Relief * to the corporation itself, the Court finds exit the ARS market and unload its ARS Judicial Authority, Scope of * Standing/ merit on this argument of Southern Farm inventory. On February 13, 2008, BAS Privity Issues * Jurisdiction Issues Bureau and reverses the judgment of the and other major broker-dealers refused to (Enforcement of Settlement). District Court. The Court of Appeals also support the ARS auctions and the market If a party requires enforcement of a notes that a representation by one party for ARS collapsed, causing plaintiffs’ loss. provision in a settlement agreement, any to an arms-length negotiation, that in its Defendants move to dismiss on the ground stipulation of dismissal in connection with opinion a particular amount was a “fair” that plaintiffs failed to state a cause of that settlement must either specifically price, is not something that could be action for market manipulation. The Court reserve enforcement authority to the court considered as a misrepresentation in an begins by stating that a claim for market or the order must incorporate the relevant action under the federal securities laws or manipulation fails where the defendant terms of the settlement. in an action for fraud. discloses the allegedly manipulative On December 7, 2010, the SIPC Trustee in (B. Wiand) (SLC Ref. No. 2010-40-07) conduct prior to the purchase of the the Madoff case entered into a settlement cont’d on page 14 13 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

agreement with the “family of Carl J. the Jaffe defendants from the Cohmad situated to perform. The Court of Appeals Shapiro,” in which the Trustee recovered adversary proceeding. The Stipulation is agrees. The district court has procedures $550 million for the BLMIS estate. a separate document from the Settlement available to it relating to the scope of the Petitioner Robert M. Jaffe, a son-in-law of Agreement and the former constitutes an record and the determination of the facts, Carl and Ruth Shapiro, was included in that order of the Court while the latter does not. which are not available at the appellate settlement and the settlement agreement Even if the Court were to rule on the merits, level. In addition, because appellees specifically allocated $38 million to the though, it would still deny the petition. As indicated that they planned to bring further resolution of an adversary proceeding the Trustee has asserted that the settlement dispositive motions, such motions would brought against Cohmad Securities and served to recover all customer property be within the province of the district court. others, in which Mr. Jaffe was named as one from the Jaffe Defendants that the BLMIS (W. Nelson) (SLC Ref. No. 2010-39-10) who had allegedly engaged in fraudulent estate was due, none of the judgments transfers, preferences, turnovers, and state obtained in the third-party actions would Billitteri v. law fraudulent conveyances and acted as have any effect on the BLMIS SIPA Securities America, Inc., transferees of funds in the Madoff Ponzi Liquidation. Thus, there is no basis for No. 3:09-01568 (N.D. Tex., 2/18/11). scheme. The Court approved the settlement injunctive relief. (SLC Ref. No. 2011-09- Class Actions, Effects of (Settlement in a December 21, 2010 order and, 05) Approvals) * Settlement Issues * pursuant to that approval, the Trustee filed Simultaneous Proceedings * Injunctive a Stipulation of Dismissal with Prejudice, Betz v. Relief (Arbitration Stays) * Federal dismissing the Trustee’s Amended Trainer Wortham & Co., Statutes Interpreted (All Writs Act). Complaint in the adversary proceeding, No. 05-17054, 2010 U.S. App. LEXIS The All Writs Act permits a federal court to as it applied to the Jaffe Defendants. Mr. 13821 (9th Cir., 7/6/10). enjoin pending arbitration proceedings, at Jaffe claims in this proceeding that the Timeliness Issues (Statutes of least for TRO purposes, that might threaten Court’s Order also barred the prosecution Limitation) * Federal Statutes approval of a class action settlement. of several actions brought by third-parties Interpreted (28 U.S.C. § 1658(b)) * This Court must deal with the against Mr. Jaffe and he asks the Court to Duty of Inquiry (inquiry Notice) * administration of a class action lawsuit enforce its Settlement Order in that regard. Jurisdiction Issue (Appellate Remand). involving broker-dealer defendants who The Trustee weighed in and opposed the A remand to the district court is warranted are engaged in defending hundreds of Motion, arguing that the Jaffe Defendants in situations where the district court has arbitration proceedings, while defending are no longer defendants in any proceeding procedures available to it relating to the the allegations in this case. The central before the Court and, thus, have no scope of the record and the determination problem is that the arbitrations concern standing to invoke the Court’s jurisdiction. of the facts not available to the court of the same defunct issuers, Medical Capital Under existing precedent, a federal court appeals. Holdings and Provident Royalties LLC, as has jurisdiction to enforce a settlement We previously summarized three earlier the class action and allege similar conduct agreement “only if the dismissal order decisions in this case (SLA 2007-25 (2x) by the brokerage firms that sold the specifically reserves such authority or & 2008-17). In an earlier appeal, the securities in private placement offerings the order incorporates the terms of the Court held that there was a genuine issue (Reg D offerings). The Court has obtained settlement.” Otherwise, enforcement of a of material fact whether Betz’s securities notice from settling parties that they have settlement agreement is a matter for the fraud claim against Trainer Wortham is reached resolutions that could end the state courts. The Settlement Agreement in time-barred under 28 U.S.C. § 1658(b). class action and result in payments to the Shapiro matter contains an exclusive Trainer Wortham sought review of the the class investors, but the parties have jurisdiction clause, which reserves all Court of Appeals’ decision though a also sounded alarms about the ongoing disputes regarding the Agreement for the petition for writ of certiorari filed with arbitration proceedings. In a previous Bankruptcy Court, but the Stipulation the United States Supreme Court. After decision (SLA 2011-06), the Court agreed does not retain jurisdiction over the terms deciding the related case of Merck v. to stay a score of arbitration proceedings, of the Settlement Agreement, no does it Reynolds (130 S.Ct. 1784), in which the while it considered a proposed settlement incorporate any of the Settlement’s terms. Supreme Court construed the statute of between the class Plaintiffs and CFS, one A dismissal with prejudice has the effect limitations in 28 U.S.C. § 1658(b) for of the named broker-dealers that sold of removing jurisdiction from the court the first time, the Supreme Court granted MedCap and Prudential investments. and “the district court cannot adjudicate the certiorari petition, vacated the prior Believing that other broker-dealers might disputes arising out of the settlement that opinion and remanded with instructions to be ready to settle, the Court later suspended led to the dismissal merely by stating it reconsider the appeal in light of the Merck the class action proceedings, in a separate is retaining jurisdiction.” The Stipulation decision. Appellees then filed a motion to Order, while it considered the adequacy here fails even to reference the Settlement remand to the district court, arguing that of CFS’s offer (SLA 2011-06). In this and that leaves little doubt that the Court the Merck analysis of the facts of the case decision, the Court weighs Plaintiffs’ lost jurisdiction with the dismissal of is an analysis that the district court is best request for a TRO staying three named cont’d on page 15 14 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 arbitrations against Securities America, $4.8 million in compensatory damages.) be timely; (2) the applicants must have as those arbitrations are approaching (SLC Ref. No. 2011-09-01) in interest [sic] relating to the property an initial hearing date and Securities or transaction which is the subject of America has submitted a settlement offer Billitteri v. the action; (3) the applicants must be so that Plaintiffs have accepted. Plaintiffs Securities America, Inc., situated that the disposition of the action maintain that allowing the arbitrations No. 3:09-cv-01568-F (N.D. Tex., 3/7/11). may, as a practical matter, impair or to proceed will permit the dissipation Class Actions, Effects of (Settlement impede their ability to protect that interest; of assets, through the expenditure of Objections) * Settlement Issues and (4) the applicants’ interest must be defense costs and payment of possible (Intervenors) * Liability Issues inadequately represented by the existing monetary awards to the arbitrating class (Co-Tortfeasors) * Contribution/ parties to the suit.” The bank trustees members, that would otherwise have been Indemnification * FRCP (Rule 24 meet all of these requirements, the Court available to all class members as part of “Intervention”). finds, and it, therefore, grants the motion the settlement. To prevent the dilution of Intervenors who wish to object to a class to intervene. the settlement proceeds, the parties seek action settlement must be unrepresented (ed: The Court scheduled a hearing to a preliminary injunction maintaining in the action and, yet, have an interest in entertain objections to the settlement the status quo pending the Court’s final the property or subject of the action that and to its stay of related proceedings settlement approval determination, and will be impeded or impaired by the Court’s (SLA 2011-06 & -09) in late March. The enjoining all other parallel proceedings approval of the settlement. settlement ultimately went forward, but in the courts or arbitration. The All Writs The Bank of New York Mellon and Wells not before Ameriprise and Securities Act permits a federal court to exercise its Fargo move to intervene in this class America reached a global settlement with discretion and use its injunctive powers in action, in which they are not parties or more than 95% of the 600-plus abitrations aid of its jurisdictions and other courts have necessarily related to parties in the action. its faced and not before the two brokerage exercised that authority to stay proceedings They are, however, in positions, given firms upped the settlement for the class to elsewhere and bind non-parties when their their status as Trustees of instruments $70 million from about $45 million.) (SLC actions, though not wrongful conduct, (Medical Capital Holdings, now defunct) Ref. No. 2011-11-06) threaten the implementation of a court sold by the defendant broker-dealers, to order “or the proper administration of pursue contribution claims against the Bilyeu v. justice.” The Court grants the TRO, Defendants. The impetus to intervene Johanson Berenson LLP, ruling that it is necessary to restrain the arises from a proposed settlement that No. 1:08-cv-02006 (W.D. La., 9/27/10). individual arbitration proceedings “to the Court is considering, which Securities FRCP: Federal Rules of Civil ensure the conditions for reaching a America has negotiated with the class Procedure (Rule 12(b)(6)) * FAA (§3 Settlement Agreement remain in place Plaintiffs, that, if accepted, will release all “Stay of Litigation”) * Appealability as the Court considers the Motion for claims against Securities America relating (Final Dismissal) * Scope of Agreement Preliminary Approval.” The injunction is to, among other things, sales of Medical (Arbitration) * Breadth of Agreement temporary and will give the Court time to Capital Holdings interests to the Plaintiffs. (Non-Signatories). decide if it has the authority to enjoin an The interests, called notes, were issued The preferred method of petitioning arbitration proceeding when the parties to in series and each series of notes was for enforcement of an agreement to that arbitration have agreed to resolve their associated with assets that were held in arbitrate is to move pursuant to the dispute by means of arbitration. There is trust for the noteholders. The Trustees of Federal Arbitration Act, rather than to divided authority on this question and the those MedCap entities were the proposed seek dismissal of all claims under the Eighth Circuit in In re Piper Funds, Inc., bank intervenors. The bank Trustees Federal Rules; dismissal, as opposed to a 71 F.3d 298 (1995), has ruled against such face potential liability for their actions stay of litigation under Section 3, is only authority. as trustees, just as Securities America appropriate in special circumstances. (ed: *A preliminary injunction would cover faces liability in this and other actions In this dispute involving as Defendants a a wide swath: all persons who “invested for its actions as the seller of the MedCap group known as the Johanson Defendants through Securities America, Inc. in (1) securities. As intervenors believe the and Wachovia Securities LLC, the Court a series of shale gas ventures sponsored proposed settlement will release claims of explores the difference between a motion by Provident Royalties, LLC between contribution or indemnity they may have to dismiss under FRCP 12 for failure to September 2006 and January 2009; and against Securities America, they seek the state a claim for relief and a motion to stay (2) a series of notes sponsored by Medical Court’s permission to intervene as of right, litigation pending arbitration, pursuant Capital Holdings, Inc. between November pursuant to FRCP 24, and object to the to Section 3 of the Federal Arbitration 2003 and July 2008.” **According to proposed settlement. Four criteria govern Act. The question is squarely before the news reports, SAI’s contribution to the intervention as a matter of right, according Court because both sets of Defendants settlement pot will be $21 million. The to Fifth Circuit precedent, the Court recites: claim rights under arbitration agreements three stayed arbitrations seek a total of “(1) the application for intervention must between them and the Plaintiffs and the cont’d on page 16 15 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Johanson Defendants have asked the “[d]ismissal now would obviously and the agent to enter into agreements that Court to dismiss the claims against them needlessly complicate this process.” For will expedite that investment manager’s pending arbitration, while Wachovia these reasons, the motion to dismiss is performance. has made a more traditional Section 3 denied “and the parties requested, if they This decision of the Eleventh Circuit motion. Addressing only the Johanson wish to reurge the issue of compelling Court of Appeals reviews a previously Defendants’ request in this decision, arbitration, to seek a stay rather than reported decision (SLA 2009-30) of the Court explains that Plaintiffs have dismissal of these proceedings.” the United States District Court for the objected to arbitration based both upon (ed: Among the consequences of imposing Southern District of Florida that denied a the scope of the proffered arbitration a dismissal pending arbitration would be motion to compel arbitration of Citigroup agreement and its enforceability as against a right by Plaintiffs to appeal immediately Global Markets, Inc. The case arises some non-signatory parties. The Johanson if the Court were to grant arbitration. Just from a consulting agreement between Defendants urge the Court to follow the why Defendants were so set on a Rule 12 Citigroup and the Police and Firefighters’ Fifth Circuit’s decision in Alford v. Dean dismissal in lieu of a Section 3 motion was Pension Fund of Delray Beach, pursuant Witter Reynolds, 975 F.2d 1161 (1992), not made plain in the Opinion.) (SLC Ref. to which Citigroup provided performance where the Court held that, in the “proper No. 2010-42-02) evaluation, consulting and other services circumstances,” a court might dismissal for the pension fund’s investments. The a case pending arbitration. Perhaps so, Board of Trustees of the pension fund was dissatisfied with its the Court responds, but such “proper City of Delray Beach Police performance and brought an action against circumstances” are “uncommon,” as Alford and Firefighters Retirement Citigroup. The agreement for consulting presented a straightforward dispute, with a System v. Citigroup Global services between the pension fund and well-developed record, and assertions by Markets Inc., f.k.a. Salomon Citigroup did not contain an arbitration Plaintiff that were sufficiently frivolous Smith Barney, agreement. Thereafter, Citigroup to allow the Fifth Circuit “to discern prior No. 09-13451, 2010 U.S. App. LEXIS suggested the appointment of a specific to the commencement of proceedings on 20880 (11th Cir., 10/8/10). manager for a portion of the pension the merits that all of the issues among all Agreement to Arbitrate (Arbitrability) funds assets. The Board of the pension of the parties were subject to arbitration.” * Contractual Issues (Implied Actual fund approved this action and authorized In other words, Alford occurred in a Authority; Apparent Authority) * its Chairman to enter into the agreement situation where “retaining jurisdiction… Competing Agreements * Agreement, with the money manager. As a part of [would] serve no purpose.” In the instant Scope of (Other Accounts) * Fiduciary entering into this agreement, the Chairman case, on the other hand, the record is Standards (Pension Consultant; Self- also executed brokerage agreements with not exceptionally well-developed, the Dealing) * Disclosure Issues (Conflicts Citigroup where the accounts managed facts are in dispute, and the agreement is of Interest) * State Statutes Interpreted by the new manager would be held. contested. Moreover, neither in Alford, nor (Fla. Stats. §§ 175 & 185; Florida Those brokerage firm agreements did in two other cases Defendants were able to Sunshine Law) * Breadth of Agreement contain broad arbitration agreements. find, did the courts develop why dismissal (Principal-Agent). Before the District Court, the pension was appropriate in the particular settings. *A brokerage account agreement fund had argued that its Chairman was Finally, dismissal, even in the “proper to arbitrate disputes under “other not given specific authority to enter into circumstances,” is optional, “specifically agreements between us” extends to other brokerage agreements and, since he was when a court may determine a priori related roles that a broker may play, e.g., not specifically authorized to do so, any that ‘the entire matter is encompassed as pension consultant. **A governing agreement to arbitrate was invalid. Both by the arbitration clause.’” Here, the board that authorizes its agent to complete Florida State law requiring authorization Court believes that it may be necessary an agreement for investment management of pension fund actions by the Board and for the parties to return to the Court and services also, by implication, authorizes the language of the consulting agreement cont’d on page 17

INVESTORS IN MADOFF SCHEME PRESS PICARD TO PRODUCE REPORT. Irving Picard, liquidating trustee of Bernard L. Madoff Investment Services, LLC, the defunct firm and namesake of the notorious broker who used it to perpetrate the largest Ponzi scheme in U.S. history, faces demands from more than 1,200 of Madoff’s victims to produce a report on his investigation of Madoff’s fraud. The investors assert that the Securities Investor Protection Act requires Picard to produce a report containing information they alleged the trustee has already turned over to the Securities Investor Protection Corporation. The investors seek details on the findings and conclusions of the investigation, evidence in support of those findings and a description of how the fraud operated. Source: “Madoff Investors Demand Report on Ponzi Probe,” by Carolina Bolado, www.law360.com (4/26/11))

16 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

(indicating that it could not be changed (Employment Arbitration Procedures) be evaluated in resolving the question of without a duly authorized action of the * Forum Costs * Green Tree Interpreted whether Ms. Brady was financially able Board) supported this view. The Court * Enforceability (Vindication of Rights; to share the arbitration costs. The U.S. of Appeals first finds that, contrary to the Public Policy) * Contractual Issues Supreme Court’s decision in Green Tree decision of the District Court, general (Severability of Arbitration Clause). v. Randolph, 531 U.S. 79 (2000) did not principles of administrative law govern When a petitioner’s statutory rights are set forth the factors, but it did prescribe the actions of the Board and those general imperiled by the costs of arbitration, a a process. The Court reviews post-Green principles permit the delegation of actions court must determine whether to enforce Tree decisions by the Fourth and Sixth by the Board. Because no Florida law the arbitration agreement and sever any Circuits and finds in that wisdom the prohibits the sort of delegation at issue fee-sharing provision or, in the alternative, following: the question of financial ability (i.e., the execution of contracts) the Board give the petitioner the right to remain in must be decided on a case-by-case basis could delegate its authority. The Court court or pay the contracted-for costs and and should weigh: “(1) whether the litigant rejects the assertion that, since the specific stay in arbitration. can pay the arbitration fees and costs; delegation of authority to execute the We have followed this case from the (2) what is the expected cost differential contacts was not published according to trial court (SLA 2007-38), through the between arbitration and litigation in court; the Florida Sunshine Law that such action Appellate Division (SLA 2009-23) to the and (3) whether the cost differential is could not be valid. A Florida governmental Top Court in New York. Appeal to the so substantial as to deter the bringing of agency cannot utilize its own violation New York Court of Appeals was based claims in the arbitral forum.” On remand, of the Sunshine Law as a defense to upon a 3-2 dissent in the First Department the trial court should apply these tests obligations that were created through decision. The Appellant in this appeal and, if it determines that the “equal share” its own wrongdoing. The execution of is Williams Capital Group, the former provision is unenforceable, it must then the brokerage agreements was merely employer of Lorraine C. Brady, whom decide whether to order arbitration and incidental to the authorized actions of WCG terminated as a fixed income sever the fee provision or to allow Ms. retaining the money manager. The express salesperson in February 2005. Ms. Brady Brady the choice of proceeding in court or authority to hire the named investment was out of work for 18 months and during accepting the “equal share” provision and manager implied the authority to open that period commenced AAA Arbitration continuing in arbitration. an account through which the manager under the forum’s Model Employment (ed: *The Brady decision has broad can perform the only job it was hired to Arbitration Procedures and in accordance implications, taken to its logical limits. perform. The Chairman of the pension with her employment agreement with Recall that the Green Tree case concerned board acted on behalf of the Board and WCG. She sued for race and/or gender neither a statutory discrimination claim, the pension fund was bound by the plain discrimination under three statutes, but nor an employee-employer dispute. Thus, meaning of the agreement entered into the issue that has forestalled arbitration statutory rights of all kinds can, in theory, with Citigroup, including the arbitration during the past five years and that has trigger the “means” issue and a Green clause. The decision of the District Court concerned these various courts has been Tree proceeding (we checked; it does not was reversed and the case remanded with the question of fees. The WCG pre-dispute appear there will be one on remand in the instructions that the District Court arbitration agreement Ms. Williams signed this case). **An important question, not grant the motion of Citigroup to compel indicated that the parties would split the addressed in the Court’s decision, but arbitration. cost of the arbitrator, but AAA Rules answered by inference in the Appellate (B. Wiand: One interesting comment of provide for the firm to pay those costs. Division’s Opinion, relates to the timing the Court in this decision relates to the The First Department agreed with WCG of the “means” analysis. If the court federal presumption of arbitrability. The that the PDAA trumped the AAA’s Rules, fixes on the arbitration filing date, while Court notes that, prior to the finding but reversed on public policy grounds. the employee remains unemployed, it that an arbitration agreement existed, no An employee cannot be made to pay cuts one way. If the analysis fixes on the such presumption exists, as “arbitration arbitration costs that effectively deter the date that the court conducts the Green is a matter of consent, not coercion.” vindication of her statutory rights. On Tree proceeding, the employee may have However, once the arbitration agreement that basis, the First Department ordered become re-employed and a quite different is found, then the federal presumption WCG to front the costs of the arbitration, outcome could obtain. ***Tactical tip: favoring arbitration applies in full force.) with a right to request an allocation of Counsel wishing to avoid arbitration (SLC Ref. No. 2010-42-01) costs by the Arbitrator at the conclusion should consider these prospects: the of the arbitration proceedings. The Court availability of a statutory claim, the Brady v. Williams Capital of Appeals agrees with the analysis, but practicality of filing in court first, and, Group, LP & AAA, faults both the trial court and the First when in court, responding to a motion to No. 36 (N.Y., 3/25/10). Department for skipping the required arbitrate with a request for a Green Tree Employment Discrimination * Green Tree analysis. Neither court analysis.) (SLC Ref. No. 2010-40-01) Competing Agreements * AAA Rules considered all of the factors that must cont’d on page 18 17 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Braintree Laboratories v. an arbitration, but, focusing upon the **How did Braintree have the broker’s Citigroup Global Markets, Inc., mandatory, as opposed to prohibitory, “testimony available to support its case No. 09-2540 (1st Cir., 10/12/10). nature of the injunctive request, it also for injunctive relief?” The Court cites a Appealability (Pendant Jurisdiction; emphasizes that “the exigencies of the deposition in a “related state action.” In Final Order) * Injunctive Relief situation [must] demand such relief.” The this way, state regulators are able to aid (Mandatory vs. Prohibitory) * District Court relied upon the principle that the causes of state citizens. ***Of note, the Products/Sales Practice Issues (ARS: prejudgment interest, upon success on the three-judge Panel included ex-Associate Auction-Rate Securities) * Remedies merits, is designed to compensate victims Justice of the U.S. Supreme Court David (Consequential Damages; Prejudgment for the loss of use of money. Braintree H. Souter, sitting by designation.) (SLC Interest) * Expert Testimony/Opinions argued the inappropriateness of an interest Ref. No. 2010-39-01) * Jurisdiction Issues (Remand; Stay factor, as it might be difficult to determine of Arbitration) * FAA (§16) * Judicial retrospectively the magnitude of what CFTC v. Bolze, Authority, Scope of (Pre-Arbitration was lost in terms of missed opportunities. No. 3:09 Civ. 088 (E.D. Tenn., 3/2/11). Relief) * Parallel Proceedings The Appellate Court responds: “A need Enforcement Practice/Procedures (Discovery). for liquidity is not irreparable harm . * Collection Issues (“Monitor”) * If a trial court had meant to provide relief An asserted injury so ubiquitous cannot Privileges/Immunities (Court Agent) * other than what was requested in the serve as the basis for the issuance of a Criminal Issues. motion at bar, the presumption on appeal preliminary injunction.” A “substantial Bankruptcy does not insulate fraudsters is that the court would have said so; thus, evidentiary showing”would be needed; from responsibility to pay restitution a court granting arbitration intended here, Braintree’s CFO testified to the and civil penalties that flow from their to stay the litigation, not dismiss it (thus need for the funds, but no expert analysis fraudulent activities. thwarting an immediate appeal). or specific proof backed the essentially In July, the Court declared the Defendants In response to Plaintiff’s claim that CGMI conclusory evidence. Jurisdiction over the in default and granted judgment as to the misrepresented the nature of the Auction- appeal of an arbitration-compelling order liability of each defendant and entered Rate Securities (ARS) it purchased in mid- drives the discussion in the remainder of injunctions against them. This decision, 2008, CGMI made a motion to compel the Court’s Opinion. FAA §16 does not responding to the CFTC’s motion to arbitration and a stay of the litigation. permit an immediate appeal generally, enter judgment, enters the injunctive Braintree opposed that motion and but Braintree argues that the District orders and issues the requested relief. countered with a motion for preliminary Court intended a “final” order, not an Dennis R. Bolze, one of the Defendants, relief in the form of an order requiring interlocutory one. The Court agrees that pled guilty to charges of wire fraud and CGMI to rescind the transaction and the trial court controls the appealability money laundering, was sentenced to jail refund the purchase price pendente lite. issue, as it “chooses to stay litigation and ordered to pay restitution exceeding To await a final adjudication, Braintree pending arbitration or instead to dismiss $13 million to customers he defrauded. argued, would choke the lifeblood of its the case entirely.” This District Court The indictment in the criminal action business and deprive it of critical research was silent on the issue, but, to decide the alleged that Bolze masterminded a and development funds. As proof of the point, the First Circuit relies upon CGMI’s scheme to defraud investors of monies likelihood of success, it argued the post- request for a stay. The District Court placed with his companies Centurion ARS-freeze timing of the transaction and would not have been silent on the issue, Asset Management, Inc. (“CAM”) testimony of the CGMI broker that he if it meant to deny the requested relief, the and Advanced Trading Services, Inc. knew the top priority his client placed Court reasons. Finally, the Court rejects (“ATS”). He was convicted of soliciting on liquidity, that he had sold the ARS as Braintree’s pendent jurisdiction argument. millions of dollars in funds under false a “money market alternative,” and that It clearly had appellate jurisdiction over pretenses, failing to invest investors’ he had not even mentioned ARS during the injunctive issue, but to extend its funds as promised, and misappropriating the sales conversation. Braintree had jurisdiction to the arbitration question and converting investors’ funds to his been purchasing ARS since 2001, but its would require the issues be (1) inextricably own benefit without the knowledge or claims in this lawsuit related to a series intertwined or (2) necessarily decided authorization of the investors. Mr. Bolze of transactions, totaling $41 million, together to “ensure meaningful judicial declared bankruptcy, but the bankruptcy made during June to August 2008. The review.” Neither is the case in this matter. court waived discharge of those debts. trial court granted arbitration, but denied (ed: *Did Braintree assert the injunctive Thus, the Court observes, the monetary the preliminary injunction requested request, at least in part, to buttress an relief it grants in this enforcement action by Braintree. Braintree appealed both argument for an immediate appeal? That will not be subject to discharge either. orders. On appeal, the First Circuit affirms it waited until CGMI made its arbitration In addition to the $13 million restitution the denial of injunctive relief. It agrees motion suggests that possibility. Had it figure, which the Court also assesses, Mr. that the District Court had the power been granted, the order would have had Bolze is charged a civil penalty of $37 to issue injunctive relief in advance of a powerful influence on the Arbitrators. million. The National Futures Association cont’d on page 19 18 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 is appointed “Monitor,” in order to oversee as the controlling person of Crossfire Enforcement Practices/Procedures the restitution payments. As Monitor, NFA fraudulently solicited over $40 million * CEA: Commodity Exchange Act will act as an arm of the Court and will from individuals for the purpose of trading (Commodities Fraud, Reparations be immune from suit for any negligent commodity futures in a commodity pool. Proceedings) * Appealability * acts. It will be in charge of gathering the Hays misrepresented to prospective and Remedies (“Rising Tide” Distribution) payments from Defendants and deciding actual customers that Crossfire operated * Receivership/Trust/Estate. an equitable distribution method for a commodity pool that day-traded stock A party that wishes to appeal an order satisfying customer entitlements. The index and crude oil futures on behalf approving a method of distribution from injunctions prevent the Defendants from of pool participants and that the pool a common fund can ask the trial court to transferring assets to family or others for earned a 3% monthly return. Hays never stay the order pending appeal or to set the purpose of concealing assets from the registered with the CFTC in any capacity. aside a reserve to enable its claim to be regulators or creditors. Hays provided pool participants with false paid if it prevails on appeal. (SLC Ref. No. 2011-12-09) account statements showing that Crossfire After entering default judgment against had a commodities account with Dorman defendants in this civil action by CFTC v. Hays, Trading, although it never had such an the CFTC, the Court enters an order No. 09-259, 2011 U.S. Dist. LEXIS 9243 account. Summary judgment is proper if approving the receiver’s proposal to (D. Minn., 1/27/11). there are no disputed issues of material distribute recovered assets to defrauded CEA (Commodities Fraud; CPO/ fact and the moving party is entitled to commodity-pool investors under the so- CTA Registration Issues) * Remedies judgment as a matter of law and is designed called Rising Tide methodology. This (Disgorgement) * Judicial Authority, to secure just, speedy and inexpensive order was entered over the objection Scope of * Enforcement Practice/ determination of every action. A party of certain investors, who argued that Procedure * Sales Practice/Product opposing summary judgment may not rest the distribution should be made under Issues (Ponzi Scheme). on mere allegations or denials, but must a different methodology. One of those District courts have the power to order set forth specific facts showing that there objecting investors, GAMAG Black & disgorgement as a remedy for violations is a genuine issue for trial. Defendants White, Ltd. (“GAMAG”), filed an appeal. of the Commodities Exchange Act for the failed to oppose CFTCs allegations that GAMAG did not, however, ask the purpose of depriving the wrongdoer of his they violated §§ 4b, 4o(1), 4m(l), 4k(2) trial court to stay the distribution order ill-gotten gains and determining violations and 13(b) of the CEA, nor did they oppose pending its appeal or to create a reserve of the law. CFTCs request for injunctive relief as to from the distribution. Thus, the receiver This matter is before the Court on a Motion Crossfire, which is granted. Hays argues distributed the recovered assets to the for Summary Judgment brought by CFTC that a permanent injunction against him investors pursuant to the Court’s order. in a case arising from a day-trading Ponzi is overly broad, but the Court disagrees, Now before the Court are motions by the scheme orchestrated by Hays through finding that Hays conduct over the last receiver to make additional distributions Crossfire Trading, LLC. On February 8 years, resulting in over $20 million in to certain parties based either on 4, 2009, a criminal complaint and later losses, shows what little regard Hays had a calculation error by the receiver a Criminal Information was filed against for the futures market. Because restitution or clarification regarding transfers Hays, who entered into a plea agreement was ordered in the criminal case, there is between certain family members. The and pled guilty. Counts charged in the no need to order the same in the civil case, additional distributions are to be made Information include mail fraud in violation although the Court awards disgorgement from a $1,000,000 fund set aside by the of 18 U.S.C. § 1341; wire fraud in violation of $19+ million. District courts have the receiver for payment of professional of § 1343 and structuring in violation of §§ power to order disgorgement as a remedy fees. GAMAG objects to the receiver’s 5324(a)(3) and (d)(2). Hays was sentenced for violations of the Act for the purpose of motion, asking that consideration of the to 117 months in prison, with three years depriving the wrongdoer of his ill-gotten motion be deferred until after its appeal, supervised release, together with a special gains and determining violations of the because otherwise there might not be assessment of $300 and restitution of law. Section 6c(d)(1) of the Act allows sufficient funds to make an additional $21,601,065.87. CFTC filed a five-count the CFTC to seek a civil penalty for each distribution to GAMAG should it prevail civil complaint against Hays and Crossfire violation of the Act, which it does in the on its appeal. The Court refuses to stay seeking injunctive and other equitable amount of $64+ million, even though the consideration of the receiver’s motion. relief. The Court enters an ex parte Court regards this as largely academic. If GAMAG wanted protection of this Statutory Restraining Order, pursuant to (S. Anderson) (SLC Ref. No. 2011-08-07) nature, it should have moved the court to § 6c of the CEA and a consent order for create a reserve (as another appellant did) preliminary injunction. Defendants have CFTC v. Lake Shore Asset or to stay distribution pending its appeal. not filed an answer to CFTC’s complaint, Management, Ltd., It did neither. Therefore, GAMAG is although they submitted an opposition to No. 07 CV 3598, 2010 U.S. Dist. not entitled to relief now that would the Motion for Summary Judgment. Hays LEXIS 65370 (N.D. Ill., 6/30/10). effectively subordinate the claims of cont’d on page 20 19 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

other investors to its claim. 2009-31. Appellant argued that it was prejudice if details of those lawsuits are (J. Komie) (SLC Ref. No. 2010-39-07) twice removed, but the Court’s rationale presented to the jury. The circumstances remained the same.) (SLC Ref. No. 2010- of other lawsuits would be confusing for CFTC v. Perkins, 39-06) the jury, possibly resulting in prejudice No. 09-2507, 2010 U.S. App. LEXIS with respect to evidence relating to the 13593 (3rd Cir., 7/1/10). Chapple v. attempted withdrawal of the executive’s CEA: Commodity Exchange Act Fahnestock & Company, Inc., attorney in the other litigation. The Court (Commodities Fraud; Registration No. 03-4989 (E.D. N.Y., 8/5/10). believes that any such evidence would Requirements) * Statutory Definitions Employment Disputes (Gender inevitably become the subject of wild (“Commodity Pool Operator”). Discrimination; Sexual Harassment) speculation since evidence relating to the The purpose of the CEA would be * Parallel Proceedings * Evidentiary specific reasons for the withdrawal would undermined if one entity could escape Standards (Motion in Limine; Hostile probably be subject to the attorney/client regulation merely by having another entity Work Environment). While evidence of privilege. Evidence merely of the request execute its trades. a hostile work environment can extend for withdrawal by counsel would be of This case is on appeal from the U.S. to incidents not necessarily involving the little probative value. Weighing all of these District Court for the District of New plaintiff, evidence of other lawsuits filed factors, the Court grants the defendants’ Jersey in which the court held that against the defendants making similar Motion in Limine. Appellant, a manager of an investment harassment allegations are likely to be (B. Wiand) (SLC Ref. No. 2010-41-03) firm that did not execute futures trades more prejudicial and speculative than and instead forwarded investment funds probative. Charles Schwab Corp. to an entity, Equity Financial, that in turn This decision is a ruling by Tucker L. Securities Litigation, In Re, forwarded the funds to the ultimate trader, Melancon, United States District Judge No. 08-cv-01510 (N.D. Cal., 9/13/10). was a “commodity pool operator” (CPO) for the Eastern District of New York. The Sales Practice/Product Issues (YieldPlus for purposes of the Commodity Exchange case involves claims of sexual harassment Mutual Funds) * Class Actions, Effects Act (SLA 2009-15). The manager appeals against a Fahnestock executive. The of * Scope of Class (Intermediary to the Third Circuit. In a prior case, the Plaintiffs had indicated in pre-trial Accountholders) * Notice Requirements Court determined that the absence of a disclosures that they intended to present (Pendency; Settlement). Notice of the trading requirement is consistent with evidence in the trial that three state court pendency of a class action, as well as the purposes of the CEA, in that, when cases had been filed against the corporate the settlement terms proposed between Congress defined the CPO term, it sought executive involving sexual harassment the parties, must be provided to all class to regulate the solicitation of funds and that his attorneys in those cases had members, so that they have a reasonable from customers and potential customers sought to withdraw. The executive and opportunity to opt out of the class or and it intended to protect them from Fahnestock filed a Motion in Limine to object to the settlement before a release of fraudulent solicitation. The statute would exclude this evidence. The Court indicates claims is imposed upon them in exchange be undermined if one entity could escape that, in a sexual harassment case involving for settlement payments. regulation merely by having another a hostile work environment, a plaintiff This is a brief Court decision, most execute its trades. Allowing an investment may present evidence on the nature of notable as an update on the settlement manager to circumvent regulation merely the workplace environment as a whole of this class action proceeding and the by transferring funds from one account to and that instances of hostility need not parties’ agreement to expand the scope another does not comport with Congress’ be directed at the plaintiff in order to of the class (as well as increasing the size aim of protecting investors. The conflicting support her claim. Thus, the Court rules of the settlement pot by approximately language of certain CFTC regulations that the Plaintiff in this case will be $2.8 million) to include additional does not change the Court’s conclusion allowed to call as witnesses other women accountholders. “Intermediary Accounts” that Congress intended broad definitions to testify that they had been subjected to that held YieldPlus Fund shares at broker- of “commodity pool” and “CPO.” The harassment by the executive. However, dealer intermediaries other than Charles proximity to trading is not an important the Court finds merit in the arguments Schwab were not notified of the settlement factor. If the pool is established with the that evidence of other lawsuits or that of the class action, even though some of purpose of trading in commodity futures, the executive’s lawyers had sought to those accountholders held YieldPlus Fund then the pool is a commodity pool for CEA withdraw from those lawsuits should be Shares during the class period from May purposes. excluded. The focus of the case before 31, 2006 to March 17, 2008. A notice (S. Anderson). (EIC: In an earlier decision, the Court should be on the facts of that now needs to be sent to all broker-dealer the Third Circuit upheld the District case, not on the litigation history of other intermediaries directing them to provide Court’s finding that Equity Financial, the lawsuits. There is little probative value to names, addresses and “all YieldPlus Fund middle “man” between Appellant and the the fact that other lawsuits have been filed transaction data, so that the appropriate trader, met the definition of a CPO. SLA and there is a significant danger of unfair notices can be sent to the customers, cont’d on page 21 20 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 along with proof of claim forms. Where one that could be made in most cases and, the outcome absent any basis for liability transaction data becomes available to the if not properly limited, this type of attack under any of Nopuente’s causes of action. Settlement Administrator, proof of claim could swallow the rule that arbitration (P. Dubow) (SLC Ref. No. 2011-10-03) forms will not be needed. Intermediary Awards are generally not reviewable Account holders shall have at least 45 on the merits. To address this concern, Citigroup Smith Barney v. days from the date of notice in which to courts have required parties making Henderson, (1) provide notice of opt-out, (2) submit such contentions to show at the outset a No. A139707, 2011 Ore. App. LEXIS 180 any objections to the settlement, or (3) likelihood of prejudice to the outcome. In (Ore. App., 2/23/11). if warranted, submit a proof of claim. the typical arbitration, an arbitrator must Arbitration Agreement * Breath The $2.8 million additional payment is make numerous decisions about admission of Agreement (Non-Signatory) * designed to provide the same pro rata of evidence and in doing so may exclude Enforceability (Waiver) * Equitable recovery to Intermediary Accounts as the material evidence. No doubt there will Doctrine (Estoppel) * FAA (Generally) other class members are due to receive. often be aggrieved parties who believe that * State Law, Applicability of (Fed v. A hearing to consider any objections to they have been substantially prejudiced. State) * Account Administration * the settlement is scheduled for December If the trial court must routinely review Liability Issues (Interpleader). *A non- 2010. (SLC Ref. No. 2010-42-07) the arbitrator’s decision on materiality signatory to a contract with an arbitration before reaching the issue of substantial clause will be required to arbitrate a Choy v. Nopuente, prejudice, the legislative goal of arbitral dispute arising from the contract, if No. A126779, 2011 Cal. App. Unpub. finality will be unattainable. Instead of the non signatory enjoys the benefit of LEXIS 727 (Cal. App., 1Dist., 1/28/11). saving time and money, the arbitration will the contract. **A New York court will Award Challenge * Confirmation be supplemented by lengthy and costly determine whether a right to arbitrate of Award * Arbitrator Misconduct judicial second-guessing of the arbitrator. has been waived only if the underlying (Material & Pertinent Evidence) Section 1286.2(a)(5) is a safety valve in contract provides that it will be enforced * Prejudice to Party * Damages private arbitration that permits a court to pursuant to New York law. ***Under the Calculations * Evidentiary Issues intercede when an arbitrator has prevented FAA, if an agreement is silent on whether a (Admissibility; Materiality). a party from fairly presenting its case. court or an arbitrator will decide the issue A motion to vacate an award on the ground The reviewing court should generally of waiver, then the default position is that that the arbitrator(s) failed to admit focus first on prejudice, not materiality. the issue will be decided by the arbitrator. material evidence will only be granted To find substantial prejudice, the court After client Lyle Henderson died, Citigroup upon a showing of substantial prejudice. must accept, for purposes of analysis, attempted to disburse the proceeds of Isabelita Nopuente appeals from a lower the arbitrator’s legal theory and conclude his IRA account. But it discovered that court decision denying her motion to that the arbitrator might well have made it had two conflicting forms designating vacate an arbitration Award (FINRA ID a different award had the evidence been the beneficiary under the plan. One form, #04-00772 (S.F., 4/16/09)) in favor of allowed. In the present case, regardless which was dated, provided that the funds Tony Choy and H.D. Vest Securities. of whether the Panel erred in refusing to would pass to Madge Henderson, his Nopuente, the claimant in the underlying accept the proffered evidence, Nopuente second wife. The other form, which was FINRA arbitration, asserts that the Award has failed to show how it might have not dated, provided that the funds would should be vacated, pursuant to California changed the outcome had the panel pass to his children by his first wife. Since Code of Civil Procedure 1286.2(a)(5), considered the excluded evidence. Citigroup could not determine which which permits vacatur “if the rights of the Her clearest argument on prejudice is beneficiary designation form was Mr. party were substantially prejudiced by the that, because it decided not to receive Henderson’s last wish, it wrote to the two refusal of the arbitrator(s) to hear evidence Nopuente’s proffered evidence about groups urging them to resolve the problem material to the controversy.” Nopuente the transactions, the Panel was unable to and stating that it would file an interpleader argues that she was prejudiced by the calculate how much money she gave to if the dispute could not be resolved. The failure of the Arbitrators to admit two H.D. Vest and Choy and how much she heirs failed to resolve the issue and so documents showing that she refinanced recovered so that it could award her the Citigroup filed its interpleader, requesting real estate that she owned. These deficiency. However, that argument fails that the funds be deposited in court and documents were purportedly material, to acknowledge that the Panel found no that it be dismissed from liability. Both because she invested the proceeds into basis for a monetary award to Nopuente in sets of heirs filed counterclaims asserting her securities account and thus, after any amount. If the Panel had found a basis a breach of contract, because Citigroup subtracting the monies that she withdrew for an award to Nopuente, the proffered could not honor the designation form that from the account, this evidence would evidence might have been relevant in each favored and so they opposed the have established her loss. The Court of determining the proper amount of the request for dismissal. Citigroup then filed Appeal affirms. The contention that an award, but Nopuente fails to explain how a motion to compel arbitration. All the arbitrator excluded material evidence is the excluded evidence might have affected heirs opposed the motion on the ground cont’d on page 22 21 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

that Citigroup had waived arbitration by issues will be decided by the arbitrator. signed with Legg Mason were assigned filing the interpleader. The children also Since the court below decided the issue to CGMI. That the two companies merged opposed the motion on the ground that of waiver, not the arbitrator, its decision is is sufficient proof that the contracts they were not bound to arbitrate, because reversed. transferred to CGMI, the Court finds; an they had not entered into any arbitration (P. Dubow) (EIC: This is an Oregon court actual assignment is not necessary. Several agreement with Citigroup. The trial court interpreting New York law -- and it looks to responses greet the unclean hands defense denied the motion. Citigroup appeals. The us as though the Court got it right. Query, proffered by Defendants. The brokers Court quickly disposes of the children’s though, how likely is it an arbitrator assert that the customer information they argument that they were not bound by the will send this case back to court? What took when they left CGMI duplicated arbitration agreement. That argument runs happens now, anyway? Will the trial court their conduct when they left earlier counter to the well-established principle hold onto the interpleader side of the employment and transferred their records that a party who accepts a benefit from a case, stay it and send the counterclaims and business to Legg Mason. The Court’s contract cannot avoid an arbitration clause, to arbitration? Will FINRA accept the first response is that two wrongs do not even when the party is a non-signatory to deposit of interpleader assets, if the lower make a right: “In essence, Defendants ask the contract. With respect to the waiver court dismisses the interpleader action? the Court to accept the cutthroat business issue, the heirs argue that the contract The Appellate Court does not specify a practices as routine for the industry provided that it “shall be governed and result.) (SLC Ref. No. 2011-12-02) and put the law aside because inequity construed in accordance with New York is inherent in the brokerage business.” law,” that New York law provides that the Citigroup Global Markets, Inc. That other courts have accepted this in issue of waiver shall be decided by the v. Potter, pari delicto approach is rejected here, court, and that the trial court had ruled that No. 6:07-cv-00163-JA-JGG 9 (M.D. Fla., because there are distinctions. The defense Citigroup waived arbitration. The Court 2/14/07). requires proof that Plaintiff’s wrongdoing holds that this argument does not account Unfair Competition (Raiding/ concerned the Defendants; that is not the for the distinction in New York law Recruiting) * Standing/Privity Issues case here. Stifel Nicolaus was not injured between the construction of provisions (Merger, Effect of) * Equitable by the earlier transfers and, in any case, in an agreement and the enforcement of Doctrine (In Pari Delicto) * SRO they occurred with regard to Legg Mason those provisions. The New York Court of Rules (NASD Rule 10335) * Injunctive and before the merger. Defendants have Appeals has held that a provision requiring Relief (Likelihood of Success; Industry not even shown that the client files they that a contract “shall be governed” Practice) * Misappropriation/ brought to Legg Mason were the same by New York law did not express an Conversion (Customer Accounts; Trade 1,400 accounts they took when they left agreement to have New York law govern Secrets). CGMI. Testimony indicates there may the agreement’s enforcement. Waiver is Both Florida and Maryland law recognize only be a 40% overlap. Defendants also an enforcement issue, not a construction that customer lists can constitute trade assert the “industry practice” argument issue. Only a provision selecting New secrets. with respect to the “likelihood of success” York law to govern both “the agreement Stifel Nicolaus and six brokers were test that courts must weigh in considering and its enforcement” would require a named by Citigroup Global in this raiding injunctive relief. They charge that court to decide the threshold issue of dispute. CGMI sought injunctive relief arbitrators understand industry practice whether Citigroup waived arbitration. from the Court, prefatory to proceeding and will not award damages or injunctive The text of the agreement herein does not in arbitration under the expedited relief on the basis of the conduct alleged include the critical language pertaining procedures of NASD Rule 10335. CGMI here. Maybe, the Court replies, but it will to enforcement. The agreement does stated in its filing papers that it had filed not “set aside legal judgment and surmise contain the additional language that it simultaneously with NASD, as the Rule as to what an arbitration panel of industry shall be “construed” in accordance with requires, but in fact there was a week’s representatives might do with these facts.” New York law, but “construed” does not interval. Defendants oppose the motion Defendant-brokers executed non-compete mean “enforced.” Hence, the agreement is for injunctive relief on numerous grounds, and non-solicitation agreements when silent on the question of whether a court one of which is CGMI’s incomplete they joined Legg Mason. The agreements or an arbitrator shall decide the issue of adherence to Rule 10335. The Court, are reasonable in scope and CGMI has the waiver or any other enforcement issue. though, rules that a simultaneous filing right to enforce them. Injunctive relief will Both sides agree that the dispute involves is not a “condition precedent” to its issue for a period of 45 days or until the interstate commerce and thus is covered jurisdiction. Defendants also challenge arbitration panel issues its own Order. by the Federal Arbitration Act. Where standing, on the premise that the six (ed: We did not get to see if the Stifel an arbitration agreement is silent on broker Defendants were first Legg Mason Defendants guessed right about what the whether the court or an arbitrator should employees, who were “acquired” in the Arbitrators would do, because the matter decide issues of waiver, the FAA supplies merger with Citigroup/Smith Barney, and settled with an agreement to have the Panel a default rule. It is presumed that waiver there is no proof that the contracts they impose a stipulated injunctive Order. ID cont’d on page 23 22 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

#07-00423 (Orlando, 12/27/07).) (SLC failure to disclose certain facts was a Clayton v. Ref. No. 2010-39-03) result of wrongful intent, or scienter, even Heartland Resources, Inc. assuming defendants knew of” the facts No. 1:08CV-94, 2010 U.S. Dist. LEXIS City of Dearborn Heights Act at issue. The Court limits its review to 123654 (W.D. Ky, 11/16/10). 345 Police & Fire Ret. Sys. the question of scienter, which it defines 1934 Act (§10 and Rule 10b-5) * Loss v. Waters Corp., as a “mental state embracing intent to Causation/Proximate Cause * Reliance/ No. 10-1514, 2011 U.S. App. LEXIS 1065 deceive, manipulate, or defraud.” Plaintiff Transaction Causation * State Statutes (1st Cir. (Mass.), 1/20/11). could show scienter by demonstrating Interpreted (Kentucky Blue Sky Laws) 1934 Act (10(b) and Rule 10b-5) * Class that defendants intentionally or recklessly * Statutory Definitions (“Offer or Sell;” Actions, Effect of * PSLRA (Pleading controlled or artificially affected the “Agent;” “Trade or Commerce”) * Requirements) * Materiality * Culp- price of a security. However, under the Liability Issue (Aiding and Abetting) * ability Standards (Scienter; Actual recklessness standard, the defendant must Consumer Protection Act (Tennessee) * Knowledge) * Misrepresentations/ make a “highly unreasonable omission, Representation Issues. Omission * Insider Trading. involving not merely simple, or even Whether attendance at investor meetings Motion to Dismiss class action against inexcusable, negligence, but an extreme and answering investors’ legal questions defendant for fraudulent omission granted departure” from ordinary care, about a fact constituted an attempt to effect the sale due to lack of scienter. of which they had actual or constructive of securities by an attorney, the content of Waters Corp. manufactured knowledge. Under the PSLRA, “plaintiffs the attorney’s answers and not simply the chromatography equipment, which it must state with particularity facts act of answering the questions is the key sold around the world. Japanese sales giving rise to a strong inference that the factor. and revenue made up 10% of its business defendant acted” with scienter. That Heartland Resources (“Heartland”) is practice. In the 2000s, the Japanese strong inference must be as likely or an oil and gas exploration company that government enacted laws that strictly more likely than any other explanation issued working interests and partnership regulated the testing of drinking water. for the statement or omission. Although interests in a number of offerings sold to These regulations led to a significant defendants may have known about the plaintiffs. Durham, a securities lawyer, increase in sales and revenue from Japan, change in Japanese regulations, the fact drafted and reviewed private placement as consumers purchased Waters Corp. that Japanese sales were only moderately memorandums and made himself available products to perform the tests required by affected and that overall international sales to speak with prospective investors. the new regulations. In 2006 the Japanese continued to grow, made it reasonable Plaintiffs filed this action alleging that government eased the regulations related to for defendants to omit disclosure of this Durham’s preparation of various PPMs drinking water. In the third quarter of 2007, information in early 2007. It was not replete with material misrepresentations after reporting slight underperformance, until later in the year, when the company and omissions, his inclusion of a statement Waters Corp.’s publicly traded stock lost admitted to diminishing per share revenue, that he was available to discuss the offers almost 20% of its value. Shareholders that the regulations became a concern. with prospective investors, and his actions brought this class action suit, alleging that Furthermore, the Court determines that in actually speaking to two investors Waters Corp. and, in particular, two of one officer’s sale of 4% of the shares he on the telephone made him part of the its officers knew or should have known owned was insufficient to show scienter. solicitation and sales process in violation about the easing of Japanese drinking While the second officer’s sale of more of the federal and Kentucky securities water regulations, should have known than 20% of the shares he owned during laws, the Tennessee Consumer Protection that it would significantly decrease the the relevant time period may have hinted Act and common law. The Court denies value of Waters Corp. shares, and should at scienter, without some allegation that plaintiffs’ motion for partial summary have disclosed this information in early such a sale was out of the ordinary for judgment. Regarding the §10(b) claim, 2007. As evidence of this knowledge, the that officer, no strong inference of scienter the Court finds the existence of a genuine plaintiff shareholders referenced certain could be drawn. Moreover, the value of the issue of material fact regarding plaintiffs’ language in Waters Corp.’s fourth quarter stock significantly recovered shortly after reliance. When a plaintiff alleges fraud disclosures and certain sales of shares the period complained of by the plaintiffs. based on omissions, reliance is presumed. by officers of the company prior to its Accordingly, the Court finds that the However, when a plaintiff alleges disclosure. Plaintiffs’ claim was brought plaintiffs fail to make a strong inference affirmative misrepresentations, there is under the Private Securities Litigation that the defendants had the necessary no such presumption and reliance must Reform Act of 1995 (“PSLRA”). The scienter under the PSLRA and affirms the be proved. When plaintiffs allege both trial court dismissed the claim for failure trial court’s dismissal of plaintiff’s fraud misrepresentations and omissions, the to properly plead the requisite scienter claims. Court must engage in a context-specific under the PSLRA. The Appellate Court (P. Michaels) (SLC Ref. No. 2011-08-03) determination of whether the offenses addresses the question of “whether there alleged are characterized as omissions or is a strong inference that the defendants’ cont’d on page 24 23 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

misrepresentations in order to determine * Waiver (Knowing & Voluntary) * as a condition precedent to receiving a unitary burden of proof on the reliance Compensation Issues (Severance Pay). severance runs counter to public policy: issue. Here, the Court concludes that Defendant’s motion to dismiss Plaintiff- waivers of rights under federal and state the allegations should be characterized employee’s breach of contract claims is anti-discrimination laws are enforceable if primarily as misrepresentations. Plaintiffs granted, where Plaintiff failed to execute knowing and voluntary. At the same time, failed to produce any evidence that a post-termination release, but denied, after finding that Plaintiff’s allegation they relied on the misrepresentations. where Plaintiff has adequately pled that he was terminated in retaliation Regarding the Kentucky Securities Act employment discrimination claims. for criticizing management’s business claim, the Court rules that plaintiffs failed Before the Court is Defendant’s motion strategies in violation of Defendant’s own to demonstrate the absence of a genuine to dismiss Plaintiff Cloke-Browne’s anti-retaliation policies, the Court denies issue of material fact as to Durham’s complaint pursuant to Federal Rule of Defendant’s motion to dismiss the breach participation in the solicitation of the sale Civil Procedure 12(b)(6). Plaintiff’s suit of implied contract claim. Additionally, of securities. The term “offer or sale” is grew out of his employment by Defendant the Court grants Defendant’s motion to not so broad as to include professionals, in 2006 as Senior Vice President of dismiss Plaintiff’s fraudulent inducement such as attorneys or accountants, whose Defendant’s Portfolio Management and fraudulent concealment claims, participation is confined to providing Division for the Americas. Following finding that Plaintiff failed to satisfy the professional services. To impose liability, Plaintiff’s professed struggles to complete heightened pleading requirements of an attorney must do something more than financial transaction deals on Defendant’s Federal Rule of Civil Procedure 9(b): act as legal counsel. He or she must have behalf, Plaintiff was terminated in 2009, Plaintiff proffered no specification of the actively assisted in offering securities for due to a purported “staff reduction.” time and place that Defendant allegedly sale, solicited offers to buy or actually Importantly, Plaintiff refused to execute a made fraudulent statements upon which perform the sale. Where an attorney drafted release and waiver requested by Defendant Plaintiff relied in accepting employment the PPM intended to solicit investors and and covering, among other points, any with Defendant. Finally, the Court denies then attended certain client meetings to racial discrimination claims that Plaintiff Defendant’s motions to dismiss Plaintiff’s answer legal questions, the content of the might have against Defendant’s firm. discrimination claims, finding (as against attorney’s answers and not simply the act When Plaintiff failed to execute the the corporate Defendant) that Plaintiff of answering questions is the key factor release, Defendant withheld certain has sufficiently pled facts giving rise to in determining whether the attorney has monies which otherwise would have been discrimination under applicable federal attempted to effect the sale of securities. due Plaintiff in the form of severance. and state statutes. Here, Durham’s preparation of the PPMs Shortly after his termination, Plaintiff (N. Sorkin) (SLC Ref. No. 2011-12-03) falls squarely within the category of filed suit, alleging a host of contractual, providing legal services, which does not employment and discrimination-related Credit Suisse Securities (USA) constitute an attempt to effect the sale of violations, including breach of contract, LLC v. West Coast Opportunity securities. Likewise, his offer to speak fraudulent inducement and concealment, Fund, LLC, with investors fails to demonstrate that and violations of federal and New York No. 4380-VCN, 2010 Del. Ch. LEXIS 209 he actively assisted in offering securities state labor and civil rights acts. The Court (Del. Chancery, 10/11/10). for sale. Plaintiffs failed to produce any now reviews Defendant’s motion to Collection/Debtor Issues (“Lock-up evidence of the content of the specific dismiss as it relates to each of the various Agreements”) * Declaratory Judgment conversations that Durham had with counts asserted by Plaintiff, granting * Margin Violations/Liquidations * investors. As to the Tennessee Consumer Defendant’s motion as to some counts, Account Administration (Securities Protection Act claim, the Court concludes while denying it as to others. Accordingly, Transfers) * Remedies * Judicial that the practice of law does not constitute the Court grants Defendant’s motion Authority, Scope of * Settlement Issues trade or commerce under the TCPA. to dismiss the cause of action asserting (Law of the Case). (W. Nelson) (SLC Ref. No. 2011-08-08) breach of express contract: noting that the Under Delaware Chancery Court Rule express terms of Plaintiff’s employment 60(b), where exceptional circumstances Cloke-Browne v. Bank of provided for severance payments only have deprived the parties of appellate Tokyo-Mitsubishi UFJ, LTD, upon Plaintiff’s execution of Defendant’s review, the court may vacate a prior No. 10 Civ. 2249, 2011 U.S. Dist. LEXIS release. As the Court stresses, a corporate ruling, even after the case is settled. 14116 (S.D. N.Y., 2/9/11). officer forfeits his right to severance pay This action for declaratory relief presented Employment: Breach of Contract by not executing a release required by his the question whether plaintiff, Credit * Fraudulent Concealment and employment agreement. Moreover, the Suisse, had the right to liquidate shares Inducement * Employment Court rejects Plaintiff’s arguments that, pledged to it in violation of a lock-up Discrimination (Racial) * FRCP: Fed as the release would preclude Plaintiff agreement between the owner of the shares R Civ. Pro. (9(b) & 12(b)(6)) * Release, from asserting racial discrimination and defendant, West Coast. On motions Effect of (Title VII; Public Policy) claims, the requirement that it be executed for partial judgment on the pleadings, cont’d on page 25 24 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 the court found in favor of Credit Suisse to avoid the possible collateral estoppel fraud claim must allege with particularity on the lock-up issue, a ruling that West effects of a judgment that was, perhaps, not the circumstances constituting fraud. Coast initially appealed, but then settled. well-founded. Thus, the Court concludes, Plaintiff’s pleading stated claims for Following the settlement, defendant this is “one of those very few, unusual fraudulent misrepresentation and fraud in moved to vacate the judgment. As the cases where vacatur is appropriate.” the inducement by alleging Defendants Court notes, under Court of Chancery (D. Franceski: While the ultimate intentionally misrepresented that: (1) they Rule 60(b), vacatur may be granted to outcome is cloaked in Delaware Chancery were licensed to provide securities advice prevent an unappealable judgment from Court procedure, it seems more a matter and services; (2) $500,000 withdrawn obtaining “precedential or preclusive res of the Court having realized, with some from Plaintiff’s account had purchased judicata effect.” Where, however, the guidance on remand, that its interpretation certain securities when in fact the money parties voluntarily surrender their right of the lock-up agreement was not legally or had been paid to Defendant Karl; and to such review through settlement, the equitably sound, and may have ultimately (3) investments in certain securities were Court should do so only in exceptional absolved the real wrongdoer of a fraud.) exempt under the Securities Act of 1933 circumstances and the right to relief (SLC Ref. No. 2010-42-10) when they were not. As for Plaintiff’s should be narrowly construed. During claims that Defendants violated the the pendency of the underlying action, Davis v. Karl, LUTPA, which prohibits “unfair methods two things had happened: (1) plaintiff No. 10-875, 2010 U.S. Dist. LEXIS 85318 of competition and unfair deception or had obtained a FINRA arbitration award (E.D. La., 8/19/10). deceptive acts or practices in the conduct for compensatory and punitive damages FRCP: Federal Rules of Civil Procedure of any trade or commerce,” the Court holds against the owner of the shares (and (Rule 12(b)(6) and Rule (9(b)) * 1933 Act that Plaintiff has sufficiently asserted the counterparty to West Coast in the lock-up (§ 12(a)(2)) * State Statutes Interpreted elements of “fraudulent misrepresentation, agreement) for losses occasioned in the (Louisiana Unfair Trade Practices deception or other unethical conduct” that margin account with plaintiff; and (2) the Act) * Private Right of Action (Civil amount to unfair trade practices under Appellate Court had remanded the matter Conspiracy) * Fiduciary Standards the LUTPA, based upon adequately pled for consideration by the Chancery Court (Broker) * Timeliness Issues (Statute of claims for fraudulent misrepresentation of two issues not considered by the Court Limitations; Peremptive Periods). Civil and fraudulent inducement. Furthermore, which, no matter how they were eventually conspiracy claims must plead all elements because Plaintiff asserted that the decided, effectively would have precluded of the underlying tort in which defendants Defendants committed various torts appellate review of the adverse judgment. conspired; statutory rights of action under throughout the course of their relationship, Here, for those and other reasons, the the Securities Act of 1933 do not permit a the allegations could rise to a continuing Court concludes the case presents such conspiracy claim. violation of the LUPTA, which would toll exceptional circumstances. First, the Plaintiff sufficiently pled claims for fraud, the LUTPA’s one-year peremptive period. parties had not sought to vindicate harm violations of the Louisiana Unfair Trade As for Plaintiff’s conspiracy claims, caused by the other, but only to protect Practices Act (“LUTPA”), conspiracy the Court holds that, while Plaintiff has legitimate business interests from harm to violate LUTPA, and conspiracy to sufficiently alleged a conscious agreement caused by a third party (in the case of commit fraud, but claims for conspiracy among the Defendants, only the conspiracy plaintiff, its right to margin collateral, and to violate §12(a)(2) of the 1933 Securities claims for violations of the LUTPA and in the case of defendant, its lock-up rights) Act and conspiracy to commit breach of conversion are sufficiently pled. Because and plaintiff had been compensated for fiduciary duty were dismissed, because there is no federal cause of action for that harm through the arbitration award. there is no federal cause of action for a conspiracy to commit a violation of § 12(a) To establish harmful precedent against conspiracy to violate §12(a)(2) and the (2) of the 1933 Securities Act, Plaintiff’s either on the lock-up issue would not claim for conspiracy to commit breach of claim for conspiracy to commit a violation seem just, especially since West Coast was fiduciary duty lacked an essential element of that statute fails. Finally, the Court still pursuing issues related to the lock- of the underlying tort. Unbeknownst to holds that Plaintiff’s claim for conspiracy up agreement against the owner of the Plaintiff, Defendants were not licensed to to breach a fiduciary duty should be shares. Second, the questions on remand provide security advice. Defendants filed dismissed, because, under Louisiana law, from the Appellate Court suggested a motion to dismiss pursuant to Rules 9(b) a breach of fiduciary duty arises only in that the Appellate Court may have and 12(b)(6) of the Federal Rules of Civil contract; Plaintiff’s claim for conspiracy affirmed or reversed on entirely different Procedure, alleging plaintiff failed to state to breach a fiduciary duty therefore lacks grounds, leaving the Chancery Court’s a claim for fraud, civil conspiracy, and an essential element of conspiracy, the holding effectively unreviewable. And unfair trade practices. Defendants also underlying tort. third, subsequent discovery and a more contended Plaintiff’s LUTPA claims were (J. Ballard) (SLC Ref. No. 2010-38-08) developed record suggested a different untimely under the LUPTA peremptive result on the underlying contract question, period. The Court holds that Plaintiff Detroit General Retirement a good reason according to the Court satisfied Rule 9(b)’s requirement that a System v. Medtronic, Inc., cont’d on page 26 25 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

No. 09-2518, 2010 U.S. App. LEXIS Medtronic responded with its 12b(6) 00912 (Boston, 10/27/09). Instead, this 19379 (8th Cir., 9/16/10). motion to dismiss for failure to state a claim post-Award dispute concerns, as the Court Class Actions, Effects of * PSLRA: and relied upon the heightened pleading broadly puts it, “the legality of a permanent Private Securities Litigation Reform requirements for securities fraud in the confidentiality provision in an award made Act of 1995 (Pleading Requirements) * Private Securities Litigation Reform Act by an arbitrator.” That confidentiality FRCP: Federal Rules of Civil Procedure (“PSLRA”). Plaintiffs argued that the letter order from the Panel is described as (Rule 12(b)(6) “Claim for Relief”) * to doctors “falsely reassured” investors follows in the Award: “During the hearing, 1934 Act (§10 “Rule 10b-5”). Plaintiffs’ that the failures were due to implantation [Respondent] Dever requested that certain securities fraud class action lawsuit was errors. However, the Court finds it difficult documents be de-classified as confidential. dismissed for failure to state a claim, to see how a letter disclosing a possible [Respondent] Dever’s request for de- where plaintiffs’ pleadings did not satisfy problem and announcing an investigation classification of documents ruled by the the heightened pleading requirements into that problem was materially Panel as confidential is denied. Further, for securities fraud and there was no misleading. Additionally, the plaintiffs the testimonies, hearing transcripts, and indication that statements were false when had no evidence that the statements in the the arbitration proceedings (including made or that they were made with the letter were false when made. Although the confidential documents) are ruled as requisite scienter. company was in the process of collecting confidential and are to remain so.” The Plaintiff investors in medical device and examining data that eventually led to Panel also issued a “gag order” during the manufacturer Medtronic brought securities the recall, there was no evidence that any proceedings, “…prohibiting the parties and fraud claims after sales of a popular conclusion was drawn prior to the date the their counsel from discussing the case with medical device were suspended. The recall was issued. Finally, the company the press or anyone else,” but that order plaintiffs alleged that the company misled and the FDA both agreed that the available was lifted by the Panel in issuing its Award. investors regarding the seriousness of statistics did not require such action. Mr. Dever seeks a ruling from the Court problems with the device. The suspended Because the plaintiffs failed to offer modifying the Award and invalidating the device was a wire that connected an evidence of a material misrepresentation, confidentiality order, charging that it will internally implanted defibrillator to a their causes of action are dismissed. prevent him from defending himself in patient’s heart and delivered a shock if (J. Ballard) (SLC Ref. No. 2010-42-06) the “court of public opinion” and inhibit needed. In February of 2007, a doctor who his efforts to maintain a clean “public had been implanting the device in heart Dever v. rating with the Central Registration patients informed the company that he Oppenheimer & Co., Inc., Depository system.” Oppenheimer asserts intended to stop using the devices after a No. 09-5051 (Mass. Super. Ct., Suffolk the privacy of arbitration proceedings and study he conducted showed an increased Cty., 6/28/10). seeks continuation of the order, to restrict failure rate because of a tendency to Award Challenge * Modification of disclosure of “embarrassing personal fracture. In March of 2007, Medtronic sent Award (Partial Vacatur) * Exceeding matters” The Court weighs the requests a letter to physicians informing them that Powers * Arbitrator Misconduct * under the State’s Uniform Arbitration Act, some clinics reported higher than normal Discovery Issues (Confidentiality) M.G.L. c. 251 and reviews the grounds fracture rates, that it was investigating * State Law, Applicability of * upon which it may vacate or modify an the reports, and that variables within Constitutional Issues (Freedom of arbitration Award. Among other things, the implant procedures may have been Speech) * State Statute Interpreted it states that public policy violations may significant contributors to the failures. (Mass. UAA, M.G.L. c. 251) * Public warrant judicial intervention and that errors Medtronic proceeded to examine the lead Policy * Injunctive Relief (Permanent by arbitrators may be corrected, but only if analysis studies and its own database of Arbitral Relief) * Authority, Scope of they fall outside the limits of the arbitrators’ patient information. In May of the same (Arbitrator) * Scope of Agreement * powers. Certainly, confidentiality may be year, Medtronic filed an application with Statutory Definitions (“State Action”). expected as part of the discovery process the FDA to modify the design of the lead in Enforcement of a confidentiality order and, in this case, the parties actually question. Finally, in October, the company contained in an arbitration Award invokes protected certain disclosed documents announced that it was suspending sales the Court’s enforcement powers and, with a confidentiality agreement. Here, of the leads, and stated that, although therefore, represents “state action;” though, the Arbitrators made that relief the increased failure rate due to fractures endorsing such an order when it broadly permanent and did so very broadly in a was not statistically significant, it had and without sufficient justification restricts “blanket order.” FINRA itself has warned the potential to become significant over conduct, and possibly speech, offends arbitrators against imposing broad orders time. The stock price dropped over 11% public policy. and asks that such orders be narrowly in the following days. Plaintiffs instituted Neither side in this action for vacatur fashioned. FINRA has also cautioned their securities fraud suit, claiming that challenges the substance of the underlying firms against entering into confidentiality Medtronic misled investors as to the FINRA Award, styled Oppenheimer & agreements that have the effect of seriousness of the problem with the leads. Co. v. Jesup & Lamont Securities, ID #08- impeding investigations or enforcement cont’d on page 27 26 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 actions. This order offends public policy, privilege, or, if made public, would invade names, and other customer information because of its sweeping and permanent the privacy of an individual. from numerous documents that would not restrictions; no evidence establishes, for In a prior decision (SLA 2011-07), this be impounded on grounds of customer instance, that the order does not cover oral Court modified this FINRA Award (#08- privacy. Documents relating to charges of expressions, but only prohibits document 00912), at the request of Mr. Dever, to employee misconduct and Oppenheimer’s disclosures. The Court invokes freedom delete an arbitral direction preventing the investigations of such claims are released, of speech at this juncture and supports parties from revealing information about as the investigations are complete and that overlay with the observation that, the arbitration proceedings. The language a “fair picture of the allegations” can be upon confirmation, this Award “would excised from the Award upon the order of shown. “This may cause embarrassment to then become enforceable as any other the Court, stated: “Further the testimonies, certain individuals, but embarrassment,” judgment.” It concludes: “I am satisfied hearing transcripts and the arbitration the Court observes, “is no grounds for that the confidentiality provision in this proceedings (including confidential impoundment.” case violates public policy, is contrary to documents) are ruled as confidential and (ed: Impoundment, the Court writes in a legal and constitutional mandates, and are to remain so.” In order to preserve the footnote, should not be viewed as a broad exceeds the powers accorded to this panel. integrity of the Arbitrators’ order, while order of confidentiality, such as the Panel The offensive language is excised and the the Court was considering its legitimacy, imposed. “An impoundment order is Award is otherwise confirmed. the Court impounded all documents directed to the clerk of the court not to the (ed: *While lifting the Panel’s submitted by the parties. After the Court parties. Oppenheimer was not authorized confidentiality order, the Court maintains essentially vacated that order as overbroad by this court to seek to restrain the an impoundment order that the parties and beyond the Arbitrators’ authority, communications of plaintiff Dever….” ** entered into at the outset of the court Oppenheimer sought to invoke the Court’s The Court agreed to only a 24-hour hold on proceedings for 45 days “to give the powers to preserve confidentiality of the the released documents before disclosure, parties an opportunity to bring further documents. It submitted to the Court, in noting that the Boston Globe had signaled motions to impound specific documents addition to that which was already filed interest, even asking for open hearings before the session judge, or to seek and impounded during the proceedings, on the impoundment proceedings. “[T]he appellate remedies.” Oppenheimer did, in “two hefty binders containing 1651 pages public interest in the matter is high, and fact, seek specific protection for some of of proprietary and customer/employee- the public ought not be further delayed.” the impounded documents, which led to the related documents produced during the ***The Globe, indeed, was interested. We decision covered below. **The arbitration discovery phase of the FINRA arbitration.” found a long news article reviewing the proceedings also favored Mr. Dever, as the In this way, Oppenheimer sought to make 1600+ released documents on the paper’s Arbitrators granted a monetary award on the documents part of the Court’s record WebSite (1/18/11: “Opco fight…,” by Beth a counterclaim of $74,939 and pre-Award and obtain impoundment of “this much Healy.)) (SLC Ref. No. 2011-07-04) interest of $11,830.24. Stuart D. Meissner, larger universe of documents….” The a New York attorney, represented Mr. Court, acting, as it says, as a “Special Dronsejko v. Grant Thornton, Dever in the underlying arbitration Master, spent seven hours with the parties Nos. 09-4222 & 10-4074, 2011 U.S. App. and fought the battle for relief from the reviewing virtually every page of the LEXIS 1052 (10th Cir., 1/20/11). confidentiality order.) (SLC Ref. No. “universe” in a closed hearing, “so that PSLRA: Private Securities Litigation 2011-07-03) counsel could argue freely and a complete Reform Act of 1995 (Pleading and comprehensible transcript of the Requirements) * 1934 Act (§10 and Dever v. proceedings could be made for appellate Rule 10b-5) * FRCP: Federal Rules of Oppenheimer & Co., Inc., review.” In this decision, the Court rules Civil Procedure (Rule 60b) * Pleading No. 09-5051 (Mass. Super. Ct., Suffolk what documents will be impounded Requirements/Issues * Culpability Cty., 12/22/10). following this review and explains its basis Standards (Scienter). Award Challenge * Modification of for ordering impoundment. The bases for Claims of accounting irregularities or Award (Partial Vacatur) Injunctive impoundment are the proprietary nature violations of GAAP support a claim of Relief (Document Impoundment) * of the documents, their privileged nature scienter only when coupled with evidence Discovery Issues (Confidentiality; (either as attorney-client communications that the violations or irregularities are the Reg S-P) * Judicial Authority, Scope or communications with regulators), result of the defendant’s fraudulent intent of * Privileges/Immunities (Attorney- or regard for the privacy of customers to mislead investors. Client; Regulatory). or employees. The Court impounded a In these consolidated appeals, plaintiffs Impoundment of documents is the courts’ score or more proprietary documents, but challenged the district court’s dismissal way of protecting documents produced rejected impoundment of documents based of the second amended complaint for in litigation from becoming publicly upon claims of attorney-client or regulatory failure to properly plead scienter under available, where the documents are privilege. It also redacted account the PSLRA and from the district court’s proprietary in nature, are covered by a numbers, social security numbers, client denial of a Rule 60(b) motion in which cont’d on page 28 27 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

plaintiff sought the opportunity to file a the existing PSLRA heightened pleading Attorney General, agreeing to pay a fine of new amended complaint to incorporate requirements.) (SLC Ref. No. 2011-07-08) approximately $22.5 million and agreeing newly-discovered evidence. Regarding to buy back approximately $1 billion the former, under the PSLRA, the Farber v. in unmarketable ARS from customers complaint must state with particularity Goldman Sachs Group, who purchased their ARS directly from facts giving rise to a strong inference that No. 10 Civ. 873, 2011 U.S. Dist. LEXIS defendants. The settlement did not cover the defendant acted with the requisite state 16673 (S.D. N.Y., 2/16/11). any amounts from purchasers who bought of mind. Here, although Grant Thornton’s Collateral Estoppel/Res Judicata from other broker-dealers. Plaintiff filed a interpretation of an AICPA rule concerning (Arbitration) * Product/Sales Practice Statement of Claim with FINRA against revenue recognition may have been Issues (ARS: AuctionRate Securities) * Goldman Sachs & Co. and E*Trade under incorrect or even negligent, the complaint FRCP: Federal Rules of Civil Procedure § 10(b) of the 1934 Act, § 36b-29(a)(2) of does not establish that Grant Thornton’s (Rule 12(b)(6) “Claim for Relief”) * the Connecticut Uniform Securities Act, conduct was an extreme departure from Pleading Requirements * 1934 Act (§ for breach of fiduciary duty, and for aiding the standards of ordinary care. Claims of 10 “Rule 10b-5”/ § 20(a) “Control”) and abetting a breach of fiduciary duty. accounting irregularities or violations of * SRO Rules (FINRA Rule12504). Goldman Sachs moved to dismiss pursuant GAAP support a claim of scienter only In a Rule 12(b)(6) motion to dismiss, to FINRA Rule 12504(a)(6)(E), which when coupled with evidence that the plaintiff’s obligation is to provide proof provides for dismissal where the moving violations or irregularities are the result of his entitlement to relief, which requires party had no contact with the accounts, of the defendant’s fraudulent intent to more than labels and conclusions and a securities or conduct at issue. The FINRA mislead investors. Regarding the latter, the formulaic recitation of the elements of a panel dismissed all of plaintiff’s claims newly-discovered evidence consisted of cause of action. on the grounds that Goldman was not two orders entered by the Public Company Plaintiff asserts six claims against connected to the account at issue and that Accounting Oversight Board, which defendants in relation to an auction rate plaintiff did not purchase the securities imposed sanctions on two representatives security (“ARS”) it purchased from non- from defendants. Plaintiff then filed this of Grant Thornton for their role in the party E*Trade Securities. Defendants move action, asserting the previous four claims underlying audit at issue on appeal. The to dismiss pursuant to FRCP Rule 12(b) and § 20(a) of the 1934 Act, and added Court of Appeals affirms the district court’s (6) on the basis that a FINRA arbitration Goldman Sachs Group as a defendant but denial of the Rule 60(b) motion for relief Panel previously dismissed these same did not name E*Trade. Defendants move from the dismissal, noting that the PCAOB claims. ARS are debt instruments with to dismiss under Rule 12(b)(6), pursuant orders were of dubious weight, because long-term nominal maturity for which to which plaintiff must assert enough respondents stipulated to the allegations the interest rate is regularly reset through facts to state a claim that is plausible on and did not contest the resulting sanctions. Dutch auctions. According to plaintiff, its face. Issues of collateral estoppel and Moreover, plaintiffs failed to establish that defendants were one of the principal res judicata may be decided on a motion they met the requirements of Rule 60(b), developers of the multi-billion dollar ARS to dismiss. Res judicata applies in federal specifically why they could not have market. Beginning in 2005, institutional courts to bar the assertion of claims that discovered the evidence earlier had they purchasers, who were the backbone of the were adjudicated or could have been acted with proper diligence. ARS market, began to leave the market. raised in a previous proceeding, where the (W. Nelson: Regarding scienter, the10th According to plaintiff, defendants falsely parties or those in privity with them were Circuit acknowledged that other circuits marketed ARS as cash equivalents and involved in the proceeding. The FINRA have developed a recklessness standard recruited thousands of new retail purchasers Panel ruling is entitled to preclusive effect specifically for §10(b) claims against to replace the institutional purchasers who under collateral estoppel, which prevents outside auditors. Under that standard, were fleeing the market. In 2007, plaintiff a party from re-litigating an issue that outside auditors act recklessly only when was approached by an E*Trade salesman has been previously decided against him accounting practices were so deficient that who solicited a $1 million purchase of in a proceeding in which he had a fair the audit amounted to no audit at all, or to the Mass. Health & Education Facilities opportunity to fully litigate the point. an egregious refusal to see the obvious or Authority ARS, which he did, relying on That the arbitration panel did not include investigate the doubtful or that accounting prior oral and written misrepresentations a detailed examination of each element judgments which were made were such of defendants regarding the value of all of plaintiff’s claims does not mean the that no reasonable accountant would have ARS. Only after defendants and other decision was not on the merits, where made the same decision presented with major broker-dealers stopped supporting a ground for the panel’s decision can be the same facts. The Court concludes that the market for ARS did defendants admit inferred from the facts of the case. Nothing it need not decide whether to adopt an that ARS were not cash equivalents and in the Panel’s order indicates that its scope auditor-specific standard for recklessness that there is no guarantee that there will is limited to the procedural question of under §10(b) claims, because the second be liquidity. In August of 2008, defendants whether plaintiff’s case was arbitrable. amended complaint was deficient under entered into a settlement with the N.Y. Although Goldman Sachs Group was not cont’d on page 29 28 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 a party to the FINRA arbitration, it is in plus reimbursement of litigation-related with SEC rules and regulations, damages privity with its wholly-owned subsidiary, expenses of $211,596.69. Class Counsel and scienter. The risk of dismissal and, Goldman Sachs & Co. Plaintiff’s two new diligently litigated plaintiffs’ claims for hence, non-recovery was a very possible claims were or could have been raised in seven and one-half years and prevailed on outcome under the PSLRA’s heightened the FINRA arbitration and are barred by defendants’ motion to dismiss the amended pleading standards. The litigation risk res judicata. class action complaint and on both motions supports a 1/3 fee award on a contingent (S. Anderson) (EIC: The finality of the for class certification. Class Counsel fee basis. The quality of representation is Panel’s Order and its dispositive nature, conducted substantial merits discovery beyond reproach and the requested fee is fully dismissing Goldman from the and obtained expert opinions regarding reasonable in relation to the settlement. arbitration, makes this Order an “Award” the issues of loss causation and damages. Counsel may be entitled to a ‘multiplier” in our view. Yet, FINRA will not make that In addition, Class Counsel defended the of their lodestar rate to compensate them Order public, because it is not, in FINRA’s four lead plaintiffs at their depositions, as for the risk assumed by them, the quality view, an “Award.” As a consequence, well as plaintiffs’ loss causation expert. of their work and the result achieved for if the Farber claim against E*Trade Class Counsel accrued $4.3 million in the class. The lodestar rate here is almost settled, as it appears it has, FINRA will legal fees, exclusive of costs. This lodestar twice the amount of fees requested. Thus, not list this Order on the Arbitrators’ figure represents 64.4% of the Settlement the lodestar “cross-check” unquestionably disclosure sheet and future parties will Fund. If Class Counsel receives a fee- supports a percentage fee award of 1/3. not be advised by FINRA that Goldman award of 1/3 of the Settlement Fund, it will (S. Anderson) (SLC Ref. No. 2011-12-06) won a Panel dismissal in the underlying only recover 51.6% of the accumulated arbitration. ARBchek searches will reflect lodestar expended on this litigation. Full Value Advisors, LLC this “Award.” A copy may be viewed in the Counsel’s request for a fee award of 1/3 v. SEC, ARBchek Award Library, www.ARBchek. was disclosed in the Notice of Pendency No. 10-1053, 2011 U.S. App. LEXIS 3167 com, under FINRA ID #09-02371.) (SLC of Settlement sent to prospective class (D.C. Cir., 2/4/11). Ref. No. 2011-10-02) members and no objections were received. 1934 Act: Securities Exchange Act of Courts have two methods used to calculate 1934 (§ 13(f)) * Notice Requirements Foragazzo v. Lehman Bros., fees: the percentage method and the * Enforcement Practices/Procedures No. 03 Civ. 5194 (S.D. N.Y., 2/23/11). lodestar method. Under the percentage * Constitutional Issues (Freedom of Class Actions, Effects of (Settlement method, the court awards counsel a Speech; Uncompensated Taking) * Approval) * Attorney Fees (“Common reasonable percentage of the recovery Enforcement Practice/Procedure * Fund Doctrine”) * PSLRA (Fee as a fee. The lodestar method requires Standing Issues (Case/Controversy) * Determinations) * Judicial Authority, the court to scrutinize the fee petition to U.S. Statutes Interpreted (15 U.S.C. § Scope of * Damages Calculations ascertain the number of hours reasonably 78m (f)). (“Lodestar” Method; “Percentage” billed, then multiply that figure by an The SEC reporting requirements Method). appropriate hourly rate. The trend in this applicable to institutional investment In a class action, any percentage award Circuit is toward the percentage method, managers under § 13(f) of the 1934 Act of attorneys’ fees will be assessed for with the lodestar method serving as a regarding proprietary securities positions reasonableness using the Goldberger “cross-check” for the percentage method. do not compel speech in violation of the criteria, which include the time and labor Any percentage award will be assessed First Amendment; nor do they constitute expended by counsel, the magnitude and for reasonableness using the Goldberger an uncompensated taking in violation of complexities of the litigation, the risk of the criteria, which include a number of the Fifth Amendment. litigation, the quality of representation, the factors. In this Circuit, courts have held Full Value, a hedge fund and institutional requested fee in relation to the settlement that the level of risk is often the “most investment manager under the 1934 Act, and public policy considerations. important” factor. Where the total award appeals from the SEC’s denial of its Lead plaintiffs brought this securities class computed under the percentage method is requests for a permanent exemption from, action on behalf of a class consisting of significantly less than the lodestar figure, a or temporary confidential treatment of, its all who purchased or otherwise acquired higher percentage may be warranted. Class § 13(f) quarterly reporting requirements RSL Communications, Inc. common stock Counsel expended 10,989.60 hours in this under the Act, 15 U.S.C. § 78 (f) (1). Full between April 30, 1999 and December litigation. Plaintiffs alleged that, during the Value sought relief from the reporting 29, 2000. Lead plaintiffs and defendants Class Period, the price of RSL’s common requirements, which otherwise would Morgan Stanley & Co. and Goldman Sachs stock was artificially inflated as a result of make public certain of its securities & Co. have agreed to a cash settlement in the untrue or materially misleading statements holdings, on the ground that such public amount of $6,750,000. Class Counsel now and omissions made by defendants in disclosure would drive up stock prices, moves, pursuant to PSLRA, for an award their equity research reports. Thus arose thereby making it more difficult to pursue of attorneys’ fees of $2,250,000, which is substantial and complex issues of loss proxy contests or effect other management 1/3 of the $6.75 million settlement fund, causation, defendants’ non-compliance changes in the companies it held. The cont’d on page 30 29 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

SEC had denied Full Value’s requests on Genworth Financial Genworth database. Regarding irreparable the ground that it had not yet made a good v. McMullan, harm, a rebuttable presumption of faith request for confidential treatment No. 09-CV-1521 (D. Conn., 6/10/10). irreparable harm is warranted in cases under § 13(f)(3), denial of which was a Federal Statutes Interpreted (Computer where there is a danger that, unless prerequisite for an exemption under § Fraud and Abuse Act) * Unfair enjoined, a misappropriator of trade secrets 13(f)(2), because it refused to support Competition (Raiding/Recruiting will disseminate those secrets to a wider the request with sufficient investment “Protocol for Broker Recruiting”) * audience. Where a misappropriator seeks information from which the Commission Injunctive Relief (Irreparable Harm) only to use those secrets without further might make an informed decision. Full * Misappropriation/Conversion (Trade dissemination or impairment of value in Value refused to do so because, had the Secrets). * pursuit of profit, no such presumption is Commission denied Full Value’s requests, Misappropriation of trade secrets by a warranted because an award of damages it would have been required by law to competitor is not necessarily irreparable will provide an adequate remedy. Here, publicly disclose the information which harm, because the misappropriator is however, Genworth introduced evidence Full Value sought to keep confidential. likely motivated to protect the secret to showing that defendants not only used On appeal, Full Value attempts to avoid serve its own purposes. **Injunctive the information to establish TJT Capital, this “catch-22” by asserting that the Act’s relief may be warranted in cases where but they also used information regarding disclosure requirements (1) compel speech there is a danger that, unless enjoined, Genworth’s operations and relationship in violation of the First Amendment, and a misappropriator of trade secrets will with Brinker to discredit the utility of (2) constitute an uncompensated taking disseminate those secrets to a wider those services. In addition, defendants of its trade secret, proprietary trading audience or otherwise irreparably impair disseminated the confidential information and investment strategies in violation the value of those secrets. to counsel for a class action pending of the Fifth Amendment both as to the Defendants were employees of Genworth against Genworth. The Court finds that ultimate disclosures to the public and in its private client group serving high the information “pervades the class action as to its preliminary disclosures to the net worth investors. Genworth’s private complaint,” demonstrating that defendants Commission in support of its exemption client group provided investment were motivated to impair the value of and confidential treatment requests. The strategies based upon asset allocation Genworth’s reputation and the exclusivity Court rejects both constitutional challenges models from Brinker. Genworth filed of the information in question. and affirms the Commission’s order. As this action for injunctive relief against (W. Nelson) (SLC Ref. No. 2010-41-02) to public disclosure, the Court concludes the individual defendants, alleging that, that the constitutional issues are not yet prior to making staggered departures from Gonchar v. SEC. ripe, because the Commission “may yet Genworth, defendants copied Genworth’s No. 09-4215, 2010 U.S. App. LEXIS grant Full Value an exemption,” if Full database which contained client names, 25763 (2nd Cir., 12/17/10). Value submits the requisite information phone numbers, contact information, Administrative Law (Judicial Review) to support confidential treatment or portfolio management history and client * Abuse of Discretion * Enforcement an exemption in the future. And as to notes. Genworth further alleged that the Practice/Procedure * Sanction Powers preliminary disclosure to the Commission, defendants formed TJT Capital and used (Regulatory). the Court concludes, with respect to confidential client data to solicit and divert SEC disciplinary proceedings are the First Amendment, that the statutory Genworth clients to the newly formed governed by a preponderance-of-the- requirements are a “rational means” of the entity. After an evidentiary hearing, evidence standard even when they seek to Commission fulfilling its goals, similar the Court enters an injunction against punish violations of anti-fraud provisions to other disclosure obligations to the defendants, finding that Genworth has of the federal securities laws. government, such as income tax filings, demonstrated a likelihood of success on Petitioners sought judicial review of a and with respect to the Fifth Amendment, the merits. The information at issue was SEC order sustaining sanctions imposed that the regulations requiring disclosure do not generally known outside of Genworth’s on them by the NASD for violations of not go “too far,” even assuming Full Value business and Genworth took reasonable §10(b) of the Securities Exchange Act. The has a protectable proprietary interest in its steps to maintain its confidentiality, sanctions imposed barred petitioners from investment positions. Finally, with respect including the use of restricted access and associating with any NASD member and to Full Value’s concern that denial of its password protection to the databases. The fined each of them $114,022. In denying requests would lead to mandatory public information had high economic value. the petition for review, the Court holds that disclosure, the Court notes that Full Value The Court rejects defendants’ explanation the SEC properly applied a preponderance will be able to seek judicial review of the that the customer lists were created from of evidence standard in finding them Commission’s decision before its filings memory by noting that the typographical guilty of fraudulent conduct. The Court become public. errors in those lists were direct matches rejects petitioners’ argument that NASD (D. Franceski) (SLC Ref. No. 2011-11-07) to typographical errors found in the was required to prove the charges under cont’d on page 31 30 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 a clear and convincing evidence standard, with respect to all after-market purchases clause. In 2008, Securities America, Inc. applying Steadman v. SEC (450 U.S. and plaintiff dismissed with prejudice (“Securities America”) acquired 100% 91). It also rejects petitioners’ argument its claims concerning shares purchased of BYA’s shares. In connection with the that they were improperly denied the in the IPO. The Court of Appeals acquisition, BYA allegedly assigned all of use of subpoenas in the original NASD affirmed and the Supreme Court granted its assets, accounts and contractual rights proceeding and that the SEC erred in plaintiff’s petition for review. The issue and obligations to Securities America. In finding that they were not harmed by any before the Court was whether the third 2010, Plaintiff filed suit against Houser error committed. Petitioners failed to show amended complaint sufficiently alleged and Securities America, alleging breach of that their inability to obtain testimony from participation in the sale of the after-market contract and tort claims relating to a 2009 two witnesses harmed their defense in the shares. Plaintiff argued that, because investment that was allegedly mishandled underlying case. Finally, the Court rejects defendants induced the purchase of the by Houser. Defendants filed a motion to petitioners’ argument that the sanctions after-market shares, they must also have compel arbitration, arguing that Securities were excessive, finding that the SEC’s participated in the sale. The Supreme Court America could enforce the arbitration conclusion was that the misconduct was disagrees. While one may simultaneously agreement in the New Account Form as egregious and that conclusion was well- induce and participate in an illegal sale, BYA’s assignee. Defendants also argued supported by the evidence. participation and inducement involve that equitable estoppel prevented Plaintiff (W. Nelson) (SLC Ref. No. 2011-12-08) separate factors. If all inducers were also from denying that he was bound by the automatically participants, the use of the arbitration agreement. The Court first Grand v. Nacchio, No. CV-09- term “induces” in the Arizona statute determines that the Federal Arbitration 0317-PR, 2010 Arizona LEXIS 35 (Ariz., would be unnecessary. Here, the conduct Act applies to the matter and that state law 8/5/10). State Statutes Interpreted alleged in the third amended complaint applies to the determination of whether (A.R.S. §§ 44-1991(A); 44-201(A) & 44- does not describe participation in the a party is bound by or can enforce an 2003(A)) * Private Cause of Action * illegal sales. Rather, the complaint alleges arbitration agreement. The Court rejects Statutory Interpretation * Fraudulent that, through their acts and omissions, the Securities America’s argument that it Inducement * Statutory Definitions defendants encouraged plaintiff to buy is entitled to enforce the arbitration (“Participated in” the Sale; “control stock from others in the after-market. This agreement based on the BYA assignment, person”). One may simultaneously is classic inducement. Plaintiff also fails finding that Securities America failed induce and participate in an illegal to make a claim for secondary liability to provide sufficient evidence of the securities sale;however, participation and as a control person, because KPNQ, the contractual assignment. Specifically, inducement involve separate factors and controlled entity, did not participate in any the Court determines that Securities are not coterminous. of the allegedly illegal after-market stock America’s generic affidavit claiming Nacchio and McAllister, both officers purchases. that BYA assigned all of its contracts, of Qwest Communications, were also (W. Nelson) (SLC Ref. No. 2010-40-08) without documentary evidence of such the Chairman of the Board and CEO, a transaction, was insufficient proof of respectively, of a Qwest joint venture, Grant v. Houser, the alleged assignment. The Court also KPNQ. Plaintiff purchased 30,000 shares No 10-1919 (E.D. La., 1/10/11). rejects Securities America’s argument of KPNQ stock on the IPO and an additional Agreement to Arbitrate * Arbitrability that arbitration was required under the 255,000 shares in the after-market. After * Equitable Doctrine (Estoppel) * principle of equitable estoppel, finding KPNQ failed, plaintiff commenced this Contractual Issues (Assignment) * that the Plaintiff’s claims for fraud and action alleging common law claims and Breadth of Agreement (Non-Signatory). unfair trade practices against Securities violations of state and federal securities Court denying brokerage firm’s motion America were separable from the claims laws. As a result of motions practice to compel arbitration of customer claims that were arbitrable under the contractual and after remand, plaintiff filed a third based on firm’s failure to supply sufficient language in the New Account Form. amended complaint, which alleged only evidence of assignment of arbitration (J. Ballard) (SLC Ref. No. 2011-09-02) state securities law claims and sought agreement and upon a determination only rescissionary damages. In response that equitable estoppels did not apply to Great Florida Bank, v. to defendants’ motions to dismiss, plaintiff compel arbitration. Countrywide Home Loans, Inc., acknowledged that the third amended In 2004 Plaintiff opened a brokerage Countrywide Securities Corp., complaint abandoned any claims that account with Brecek & Young Advisors, Inc. and BAC Home Loans Servicing, defendants had induced the after-market (“BYA”). BYA’s registered representative, LP (F/K/A Countrywide Home purchases and instead relied entirely on Kevin Houser (“Houser”), was in charge Loans Servicing, LP), the theory that the defendants were liable of Plaintiff’s account. In connection No. 10-22124-CIV-Huck/O’Sullivan under A.R.S. § 44-2003(a) because they with the opening of the account at BYA, (S.D. Fla., 2/3/11). had participated in the stock sales. The Plaintiff signed a New Account Form Product/Sales Practice Issues trial court granted the motions to dismiss containing a broadly worded arbitration (ABS: Asset-Backed Securities) * cont’d on page 32 31 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Underwriting Issues (Due Diligence) Second, the Court focuses sua sponte and non-debtor insureds alike, leaving * Pleading Requirements (“Shotgun on the allegations that the two agents claimants with a fractional distribution Pleading”) * Liability Issues (Principal- of Countrywide Securities Corp. were of less than 25% on their claims. Both Agent) * FRCP (Rules 9 “Particularity” agents of Countrywide Home Loans, Inc. the SEC and Securities Claimants in the & 15 “Leave to Amend”). Even though the Defendants in the case bankruptcy whose claims against non- “Shotgun pleading,” or the practice of did not object to the characterization, the debtors would have been barred opposed naming numerous defendants and then Court rules that it is necessary to allege the motion. Based on its conclusion that making allegations of misconduct that underlying facts to establish that agency; the settlement would not be fair and are attributable to all of them without he also dismisses this case on those equitable, the Court denies the motion and distinction, is not an appropriate form of grounds. Finally, the Court focuses on the refuses to approve the settlement. Though pleading, especially when the particularity allegations that are based on “information the settlement provides the debtor’s estate requirements of FRCP Rule 9(b) are and belief.” Many of these allegations with the maximum recovery remaining involved. relate to the knowledge of the two agents under the policy, and also avoids the This case arises from a claim brought in of Countrywide Securities Corporation further exhaustion of policy proceeds the United States District Court for the that the underwriting of the securities had in defense costs, the bar order deprives Southern District of Florida by Great not been properly performed. The Court claimants of any additional recovery Florida Bank, seeking damages based upon indicates that, under FRCP 9(b), the general outside the bankruptcy against non- losses incurred by Great Florida Bank due pleading of knowledge on information and debtors. Thus, the Liquidating Agent is to the purchase of securities backed by belief without any specific facts to show settling claims that are not those of the non-conforming loans. Great Florida Bank that these agents actually had knowledge liquidating estate. According to the Court, alleged that Countrywide Home Loans, of these facts is improper. Having reached the true beneficiaries of the settlement Inc. and its affiliates failed to disclose these conclusions, Judge Huck dismisses would not be the Securities Claimants, that they did not perform appropriate the plaintiff’s Complaint for a third time, but the numerous individuals accused of underwriting of the securities and that two but does say without prejudice; this allows unauthorized trading, churning, fraud and agents of Countrywide Securities failed the plaintiff’s to amend their Complaint, to unsuitability, who caused claimants’ losses to provide or give access to appropriate add specificity and remove the “shotgun” and bankrupted GunnAllen. At the same information so that the loan portfolio pleadings if they so desire. He indicates time, it adds little value beyond distributing could be evaluated. The Complaint of that a Fourth Amended Complaint will in some orderly fashion the settlement Great Florida Bank had been dismissed be the Plaintiff’s last opportunity to plead proceeds. That decision, however, belongs two times previously and, in this decision, their case. to the Securities Claimants. And though the Court considers the Third Amended (B. Wiand) (SLC Ref. No. 2011-11-09) the insurer’s offer does satisfy its duty to Complaint. It focuses on three aspects of try to settle as many claims as possible the Defendant’s Motion to Dismiss: first, GunnAllen Financial, Inc, within policy limits, and therefore protects that the Complaint is deficient because it In Re.: GunnAllen v. it from a bad faith claim, it is not fair and constitutes “shotgun pleading;” second, U.S. Specialty Ins. Co., equitable to the claimants and will not be the failure of the Complaint to properly No. 8-10-cv-2855, 2011 Bankr. Lexis 334 imposed over their objection. allege agency of the two agents of (M.D. Fla., 2/3/11). (D. Franceski) (SLC Ref. No. 2011-10- Countrywide Securities Corporation to act Bankruptcy/Insolvency Issues * 05) as agents of Countrywide Home Loans, Insurance Issues * Settlement Issues Inc.; and, finally, that the Complaint (Fairness Approval). Settlement of the Haase v. makes numerous allegations on the Liquidating Trustee’s claims against one of GunnAllen Financial, Inc., basis of “information and belief.” First, Debtor’s liability carriers for the balance No. 2:08-cv-10927, 2011 U.S. Dist. with respect to “shotgun” pleadings, of policy limits, on condition of a bar order LEXIS 19454 (E.D. Mich., 2/28/11). Judge Huck notes that the Eleventh which extends to claims against non- Class Actions, Effects of * 1933 Act Circuit has on numerous occasions debtors as well, is not fair and equitable (§15 “Control”) * 1934 Act (§20(a) indicated that such “shotgun” pleading to claimants and will not be approved over “Control”) * Common Law Interpreted is inappropriate. He points out that in their objections. * Derivative/Vicarious Liability this case it is particularly inappropriate, The Liquidating Agent for defunct broker- (Aiding & Abetting) * FRCP (Rule 9b because the Plaintiffs aggregate all of dealer GunnAllen sought approval of a “Particularity” “Group Pleading”) the Defendants as “Countrywide” and settlement with one of the Debtor’s pre- (Rule 12(b)(6) “Claim for Relief”) * it is impossible to tell in the Complaint petition liability insurers. The insurer Pleading Requirement/Issues * PSLRA what entity or person is responsible for offered to contribute to the debtor’s estate (Pleading Requirements) * State what actions. Thus, the Court directs that the entire $1.7 million balance of the policy Statutes Interpreted (Mich. Comp. the Complaint be dismissed, because of limits in exchange for a bar order that Laws §451.2509, §451.2509) * Statutory the inappropriate method of pleading. would cover claims against both debtor Definitions (“Control Person”). cont’d on page 33 32 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Claims based on control person liability for the accounts which were non-discretionary proposed neutral arbitrator would be able an underlying primary violation of fraud cannot give rise to a fiduciary duty or to be impartial.” FINRA forms prompted must satisfy the pleading particularity breach and plaintiffs’ unjust enrichment disclosure, if the Arbitrator or “any requirements of Rule 9(b) and the PSLRA; claims do not pass muster under Iqbal and member of [his] immediate family, close conclusory allegations of participation Twombly. social or business associate, [was] involved as a “control person” or seller will not (D. Franceski) (SLC Ref. No. 2011-12- in the last five years in a dispute involving suffice to state claims for relief under the 05) the same subject matter” as the assigned 1933 Act, 1934 Act or state statutory or case. As to one lawsuit, the Court labels common law. Hagman v. “not the same” an “elder abuse action” in In this putative class action for losses Citigroup Global Markets, which the Arbitrator, in his capacity as a incurred in this alleged Ponzi scheme Inc., trustee, was a party. The other, though, involving the sale of interests in phony No. BS128800 (Cal. Super. Ct., Los did “involve the same subject matter” telecommunications companies, Angeles Cty., 2/9/11). and should have been disclosed. Both defendant Questar Capital, one of several Award Challenge * Evident Partiality matters involved breach of fiduciary duty brokerage firms with which the alleged * State Law, Applicability of * Waiver claims regarding a person with expertise Ponzi schemer had been associated as a (Due Diligence) * Vacatur of Award * and mismanagement of the investment registered representative, moved to dismiss Arbitrator Misconduct (Postponement, involved. The investments were different, on these grounds: (1) that plaintiffs’ Refusal of; Material & Pertinent as was the nature of the mismanagement federal securities fraud claims had not Evidence) * State Statutes Interpreted alleged, but the earlier action, in which the been pled with sufficient particularity; (2) (Cal. CCP §§ 1281 &1286.5 “Impression Arbitrator was a plaintiff, was not “remote that plaintiffs’ state securities law claims of Possible Bias”) * Disclosure Issues in time” (two years prior) and generally for sale of unregistered securities failed (Arbitrator). involved similar allegations. This was a adequately to allege that Questar was a An arbitrator who fails to disclose his case, in the Court’s view, where disclosure seller; and (3) that plaintiffs’ state common involvement in litigation that pertains was required. That Citigroup might have law claims fail for various similar reasons. to subject matter similar in nature to the discovered the existence of the prior The Court agrees and grants the motion. assigned dispute provides grounds under litigation from the public records does With respect to each of plaintiffs’ claims California law for vacatur on evident not dissuade the Court. The burden lies rooted in control person responsibility for partiality grounds. with the Arbitrator. The need to disclose the broker’s fraud, the Court concludes This Award (FINRA ID #09-03251 (Los is paramount in that balance and “the that, because Questar’s 1934 Act liability Angeles, 10/6/10)) garnered considerable proper salve for this particular societal ill is contingent on an underlying primary media attention when it first issued -- is to encourage complete disclosure before violation of fraud, the heightened pleading including a New York Times exclusive -- the matter is heard…” With disclosure, requirements of Rule 9(b) and the PSLRA not only because of the size of the amount “would-be-after-the-fact attackers” will be apply to the element of control as well. awarded ($11.5 million), but also because forced to object or waive before the matter The same goes for control person liability of the famous Claimant (Dallas’ Larry is heard. The Court gives full consideration under the 1933 Act in this case, because Hagman). The punitive-damage award to the misconduct charge as well, because the 1933 Act claims are grounded in fraud. of $10 million was also unique, because the witness in question was allegedly In the Court’s view, plaintiffs have not it directed Citigroup (CGMI) to make the one of Hagman’s “personal financial pled with any particularity facts sufficient payment to a charity of Mr. Hagman’s advisors” and her inability to testify was to demonstrate that the broker was in choice. It appears that CGMI did some simply a scheduling problem. Ultimately, Questar’s employ when he made the extra homework after the Award issued though, CGMI was permitted to question misleading statements. Similarly, plaintiffs and discovered that one of the Arbitrators the advisor for a full day, albeit after the do not identify any specific Questar on the Panel, in fact, the Chair of the record was first closed. That allowance conduct that amounts to an “urging” of a Panel, was engaged in two undisclosed eliminated “substantial prejudice,” in the sale under Michigan law. Undistinguished lawsuits within the past five years that Court’s view, even assuming an abuse of group pleading of the issue will not suffice. CGMI alleged “involve(s) the same discretion in the original ruling. Thus, the Further, Questar cannot have vicarious subject matter.” CGMI also charged that Court grants vacatur on one ground only. or aiding and abetting liability under the the Panel as a whole improperly refused (ed: An appeal was taken by actior section of the Michigan Securities Act a postponement of testimony, so that a Larry Hagman, challenging the vacatur on which plaintiffs rely. Finally, though material witness could testify. Citing decision On the legal side, we are plaintiffs’ common law fraud, breach California law and FINRA disclosure interested in the waiver question, which of fiduciary duty and unjust enrichment standards, the Court examines the items the Court addressed in its Opinion, and claims are not preempted by Michigan that were not disclosed and weighs the question of whether FAA vacatur statutory law, those claims rooted in fraud whether disclosure “could cause a person standards should apply, which it did not fail under Rule 9(b) pleading standards; … to reasonably entertain a doubt that the address.) (SLC Ref. No. 2011-07-02) cont’d on page 34 33 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Hansalik v. agreed to constructive notice, such waiver or expectancy of a relationship, tortious Wells Fargo Advisors, LLC, is ineffective, as the agreement’s terms interference with a business relationship No. BS128947 (Cal. Super. Ct., LA Cty., were not complied with, i.e., service via cannot be proved. 2/7/11). notice “at his residence or office by the This case from the Court of Appeals of Award Challenge * Notice Director.” Mr. Hansalik claims not to Michigan arises from an action filed by Requirements * Vacatur of Award * have had notice of the proceedings at all the Hantz Group, Inc., against Joseph Competing Agreements * SRO Rules until November 2010, six months after the Haney, Paul Mattes and Sterling Agency, (Form U4) * Constitutional Issues (Due Award issued. Respondent claims actual Inc. The Hantz Group is an insurance and Process) * State Statutes Interpreted notice may have occurred earlier, as it financial services company that owns (Cal. CCP §1282) * Waiver * Exceeding sent e-mails and a FedEx package that a professional soccer team, the Detroit Powers * Arbitrability (Notice Issues) * were not returned, but the Court sides with Ignition. Defendants Sterling Agency is Timeliness Issues (Notice of Award) * Petitioner. Absent proof of actual notice or a property and casualty insurance agency Tolling Principles. notice in accordance with the agreement and is a competitor of the Hantz Group. The law disfavors default judgments and or statute, other attempts at notice are Defendants Mattes and Haney are officers that principle requires strict interpretation not persuasive. Any determination by the of Sterling. The Defendants were members of notice requirements, even in arbitration Arbitrator that notice was adequate may of Our Lady Star of the Sea, a Catholic settings; inadequate notice leads to be disregarded, as arbitrators may not parish and school located in Grosse Pointe vacatur of this Award. issue Awards without notice. Woods, Michigan. In October of 2007 the The Court issues its decision to vacate (ed: *The Court is impressed with the Detroit Ignition attended “Harvest Night,” a FINRA Award, ID #09-04860 (Los quickness with which Mr. Hansalik a fund-raising event sponsored by the Angeles, 4/28/10), under a tentative, reacted to the initial collection efforts parish and school. As part of the Detroit written “Notice of Ruling,” calling the by Wells Fargo and that fact influences Ignition’s participation in Harvest Night, Award set-aside something it is “inclined” the conclusion that actual notice of the they passed out questionnaires and made to do. The Award is subject to being claim and the hearing did not occur until arrangements for members of the parish set aside, the Court writes, because of November. It also appears to influence the to be solicited for financial services by inadequate service, both under California Court’s evident allowance of some form the Hantz Group. Members of the Hantz arbitration law and under constitutional of equitable tolling, relative to the time to Group also called the night receptionist requirements of due process. According move for vacatur, but that is not discussed for the parish and arranged to participate to the Court, California Code of Civil directly in the Opinion. **Courts generally at future events and give financial Procedure §1282.2 calls for notice to all disfavor default judgments in litigation; seminars for students at the school and parties to the arbitration either personally this Court’s attitude toward this default also provide financial information at other or by certified mail, absent a waiver of such Award is evident in its disregard for the church functions. When Mattes and Haney notice “in their arbitration agreement.” many attempts that were made to notify learned that the Hantz Group was using The agreement before the Court indicates Petitioner during the proceeding and the soccer team to sell financial products that notice will be given at the party’s also by its final observation, analogizing and had made arrangements with the residence or place of work. Notice was this case to a default in a civil case: “… parish to engage in marketing activities not given to Mr. Hansalik of Wells Fargo’s although a default can enter in a civil with the parishioners, they wrote letters claim against him for $1.24 million on a case when notice is properly served in a to the parish priest advising him that the note case that proceeded under the default manner reasonably calculated to provide Hantz Group was a high-pressure outfit procedures of Section 13801 at his actual notice, that default can be set aside by a that had been brought up on charges a few residence, but at his last known residence. defendant who establishes service did not times and that Sterling had caught agents In fact, he had moved to Switzerland before result in actual notice.”) (SLC Ref. No. of Hantz on occasions impersonating that notice was sent to his last known 2011-10-04) customers in order to attempt to get residence. Wells Fargo’s counsel did serve personal financial information. The letters notice of the claim at Mr. Hansalik’s place Hantz Group, Inc. v. stated that they had been brought up on of work, but the statute states that “the Haney, Mattes and Sterling charges for fraud and fined $750,000 arbitrator” is to serve notice, not one of the Agency, Inc., by the NASD. Upon learning of this parties. Thus, service is ineffective under No. 292954, 2010 Mich. App. LEXIS letter, Hantz demanded a retraction and both the arbitration agreement and the 2288 (Mich. App., 11/30/10). Defamation the Sterling Group forwarded a letter California statute. Furthermore, the Court (Business Competitors) * Motion to the parish priest, indicating that they writes, an arbitration Award that issues Practice (Summary Judgment) * had only been expressing their opinions without proper notice and an opportunity Pleading Requirements * Damages and that their statement that the Hantz to be heard violates due process and is Calculations * Tortious Interference. Financial Group had been brought up void. Petitioner did not waive this right In the absence of a well-founded, on charges was based upon an NASD to notice and, to the extent he may have legally sound or binding relationship, release indicating that Hantz Financial cont’d on page 35 34 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Group and its CEO had been in total fined Law Claims (Fraudulent Inducement; in doing so, the District Court applied the $700,000 for fraud and misrepresentation Induced Forbearance) * Fiduciary correct legal standard.” That the District relating to undisclosed revenue sharing Standards (Non-Discretionary Court dismissed the fiduciary duty claim arrangements. The Defendants moved Accounts) * Loss Causation/Proximate for reasons other than lack of proof of for summary judgment, arguing that Cause * Holder Actions. proximate cause does not change the the allegations had not been made with That the District Court dismissed claims result. Proximate cause remains a required particularity and that the information on a basis that was incorrect in the final element of that cause of action and this stated was substantially true and that analysis does not preclude an affirmance, Court “may affirm the judgment of the damages claims were too speculative. The if the Appellate Court finds the claims District Court on any basis supported by trial court granted summary judgment, invalid on other grounds. the record, including grounds upon which because it believed that the information In an effort to decide whether the District the District Court did not rely.” conveyed was substantially true and that Court’s dismissal of this Individual (ed: Undeterred by this four-year detour opinion was not actionable. The Michigan Action (SLA 2006-40) by a large holder from pursuit of its claims, Plaintiff Court of Appeals reviews the decision of shares in WorldCom was proper, the petitioned in September 2010 for upon the appeal of the Hantz Group and Second Circuit certified several questions certiorari to the U.S. Supreme Court, Dkt. concludes that, indeed, the allegations regarding Georgia law to that State’s No. 10-409. The Petition was denied on had not been made with particularity, Supreme Court (SLA 2009-41). The December 6, 2010.) (SLC Ref. No. 2010- as they failed to state precisely to whom Georgia Supreme Court responded in 41-10) defamatory statements had been made or early 2010 (SLA 2010-10) with answers, how damages were incurred. The claim for agreeing with the District Court that Huffington v. tortious interference fails, since any hoped- Georgia law requires that proof of a T.C. Group, LLC, for business the Hantz Group desired to misrepresentation includes a showing No. 10-1405 (1st Cir., 2/25/11). acquire from its promotional activities at of proximate cause, i.e., that the truth Motion to Dismiss * Forum Selection the parish was speculative. Moreover, the concealed by the defendant entered the Clause * Venue Issues * Statutory only person who had agreed to allow the marketplace and precipitated a drop in the Definitions (“With Respect To”) * Scope future seminars to take place was the night price of the security. On the other hand, the of Agreement (Subscription Agreement) receptionist. She had no authority to enter state court also held that Georgia common * State Statutes Interpreted (Mass. Blue into a contract and, thus, there was no law recognizes fraud claims based on Sky Law). business relationship to be interfered with. forbearance from selling securities and Court affirms district court order Finally, based upon the NASD documents, a fiduciary duty on the part of brokers to dismissing Plaintiff’s claims under the statements about the company were the holder of a non-discretionary account. Fed.R.Civ.P. 12(b)(6), concluding that substantially true. Thus, the Michigan Those latter two holdings differed from the forum selection clause in Plaintiff’s Court of Appeals affirms the trial court’s the District Court’s ruling. Still, the Court subscription agreement encompasses his decision granting summary judgment. affirms the judgment below. The lower claims and requires that they be brought (B. Wiand) (SLC Ref. No. 2011-11-04) court was right about proximate cause, in Delaware and not Massachusetts. even though it missed on the other two Plaintiff Michael Huffington, a Holmes v. Grubman & Citigroup issues, and, in the Court’s view, proximate Massachusetts resident, made a $20 million Global Markets, Inc., cause is an essential element of claims of investment in a fund raised by The Carlyle No. 06-5246-cv, 2010 U.S. App. LEXIS fraud, negligence, and breach of fiduciary Group, a global investment management 12863 (2nd Cir., 6/23/10). duty. These are the claims dismissed by the firm. The aim of the fund was to invest Conflicts of Interest (Research Analyst) District Court, “because plaintiffs failed to in fixed-income securities, primarily * Account Administration * Trading plead adequately proximate cause, and the residential mortgage-backed securities Issues (Order Execution) * Common Supreme Court of Georgia confirmed that, issued by Fannie Mae and Freddie Mac. cont’d on page 36

SECURITIES SUITS RISE IN THE FIRST QUARTER OF 2011. A new study of securities cases filed in the first three months of 2011 indicates that, if the remainder of the year keeps the same pace, the number of cases filed in 2011 will rise by 12% over 2010. During the quarter analyzed, securities fraud cases, including enforcement actions, led all categories, accounting for a full 35% of all securities cases. Breach of fiduciary duty suits closely followed, at 33%. Financial services firms were the largest industry section targeted, defending in 34% of the cases, while information technology companies comprised another 17% and health care and consumer discretionary companies, 12%. Settlements averaged $21.2 million overall, but class actions averaged $54.6 million. (Source: “2011 Securities Suits On Track To Set Record: Report,” by Megan Stride, www.law360.com (4/19/11))

35 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Plaintiff alleged that, prior to his making the agreement. The forum selection clause maintain ABP accounts with ING after the his investment, one of the founders and satisfies the grounds for enforceability as brokers had left ING did not violate them. managing directors of The Carlyle Group articulated by the U.S. Supreme Court After a hearing, the Court agrees. In so traveled to Plaintiff’s home in Boston and in The Bremen v. Zapata Off-Shore Co., concluding, the Court accepts defendants’ represented the fund as a conservative, 407 U.S. 1 (1972), particularly in that it position that, as fiduciaries, defendants lower risk investment vehicle that would does not contravene Massachusetts public were obliged to discuss and consider the suit Plaintiff’s investment philosophy. policy. According to the First Circuit, whole of their clients’ assets, including Plaintiff then executed a subscription the Massachusetts Blue Sky Law simply the ABP accounts at ING. Merely being agreement and committed to purchasing creates a cause of action making liable in contact with former clients, especially shares of the fund for $20 million. The – for any material misrepresentation where the fiduciarymust be in contact with subscription agreement contained a causing loss – a person who offers or those clients to perform other investment forum selection clause which provided: sells a security in Massachusetts, without duties, does not constitute solicitation. “The courts of the State of Delaware requiring that such action be brought in The fact that over 200 clients withdrew shall have exclusive jurisdiction over any Massachusetts. Accordingly, the First from the ING plan within a short time of action, suit or proceeding with respect Circuit affirms the dismissal of Plaintiff’s defendants’ leaving ING does not alone to this Subscription Agreement…” In claims, holding that the forum selection persuade the Court otherwise. Because March 2008, the fund, which was heavily clause is enforceable and that Plaintiff’s plaintiffs have failed to demonstrate a leveraged (despite representations to claims can only be brought in Delaware. likelihood of success on the merits, and Plaintiff that its investment strategy (P. Michaels) (SLC Ref. No. 2011-12- because the relief requested, which would avoided “overleverage”), defaulted on 10) have restricted defendants from “taking its loans and went into liquidation. On any action to effectuate the sale or transfer July 13, 2009, Plaintiff brought suit in ING Life Insurance and of assets” is overbroad, the Court denies Massachusetts state court, alleging claims Annuity Co. v. Gitterman, plaintiff’s motion for injunctive relief and for (1) violation of the Massachusetts No. 10-4076, 2010 WL 3283526 (D. N.J., dissolves the TRO. Blue Sky law; (2) misrepresentation; 8/18/10). (D. Franceski) (SLC Ref. No. 2010-39- and (3) a violation of the Massachusetts Injunctive Relief * Evidentiary Issues/ 04) consumer protection act. The Defendants Standards * Unfair Competition (Non- removed the case to federal court and Compete; Non-Solicitation) * Raiding/ Iowa Public Employees’ moved to dismiss all claims based on the Recruiting Issues * Fiduciary Standards Retirement System v. forum selection clause in the subscription (Financial Adviser). MF Global, Ltd., agreement. The district court granted A financial advisor whose fiduciary duty No. 09-3919-cv, 2010 U.S. App. LEXIS the motion and dismissed all claims requires consideration of the whole of a 19138 (2nd Cir., 9/14/10). without prejudice. On appeal, Plaintiff client’s assets does not violate a written Bespeaks Caution Defense * Capital argues that his claims are not “with non-solicitation agreement by contacting Formation Issues (IPO) * Class Action, respect to” the subscription agreement former clients about assets which Effects of * Supervision Issues (Risk – and therefore not subject to the forum include those still managed by the former Management Systems) * Conversion/ selection clause – because he advances no employer. Misappropriation * Derivative/ contract claim and his stated statutory and Plaintiff ING obtained a temporary order Vicarious Liability (Control Person) common law tort claims rest on alleged restraining a group of departing brokers * FRCP (Rule 9(b) “Particularity,” misrepresentations that occurred before from soliciting customers for whom the Rule 12b)(6) “Claim for Relief”) * he signed the subscription agreement. defendant brokers provided a host of Loss Causation/Proximate Cause The First Circuit notes that Plaintiff’s financial advisory services, both before * Materiality/Relevance Issues * position “would wear well if the clause and after their affiliation with ING. The Misrepresentations/Omissions * encompassed only claims ‘to enforce or services included life and disability Pleading Requirements/Issues * 1933 for breach of’ this agreement;” however, insurance, long term care planning, college Act (§§ 11 “Registration Statement”, the clause “by its terms reaches any claim savings plans, 401(k)s and New Jersey 12(a)(2) “Prospectus”, 15 “Control”) ‘with respect to’ the agreement and easily Alternative Benefit Program Plan (“ABP”) * Standard of Review * Transaction invites a broader application.” Further, the accounts. Following a hearing nine days Causation/Reliance. misrepresentations at issue are actionable later, the Court denies the request for A statement of confidence in a firm’s only because they caused Plaintiff to enter injunctive relief as unlikely to succeed on operations may be forward-looking – into an agreement whereby he made an the merits and dissolves the TRO. Though and thus insulated by the “bespeaks unfavorable purchase. Each cause of action defendants were subject to an agreement caution” doctrine – even while statements asserted has as a prerequisite the loss that with ING that contained non-solicitation or omissions as to the operations in flowed from the subscription agreement. clauses, they claimed that their on-going place (and present intentions as to future Thus, the claims arise “with respect to” contact with clients who continued to operations) are not. cont’d on page 37 36 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Plaintiffs appeal from the judgment However, bespeaks caution does not the McDonnell Douglas burden-shifting dismissing their class action complaint apply insofar as those characterizations framework, whereby a prima facie for failure to state a claim arising from communicate present or historical fact as showing by plaintiff of discrimination alleged misstatements and omissions in to the measures taken. Neither the rogue or retaliatory discharge establishes a defendant MF Global Ltd.’s prospectus trading incident nor subsequent events presumptive violation, which then shifts and registration statement in violation revealed to the public that anyone with the the burden to the defendant to articulate of §§ 11, 12(a)(2) and 15 of the 1933 password could access client accounts and a legitimate reason for termination, Act. Following the announcement that trade at will therein, as plaintiffs alleged. which in turn shifts the ultimate burden MF Global was responsible for settling This allegation concerns a security risk of of persuasion of discrimination or trades, in which it absorbed $141.5 client fund misappropriation -- not the sort retaliation back to plaintiff. On the pay million in losses speculating in wheat of risk made plain by and after the rogue discrimination claim, the Court concludes futures due to its rogue trader, Evan trader’s losses. It is therefore apparent on that plaintiff failed to establish that she Dooley, MF Global stock price severely the face of the complaint that the stock price was “similarly situated” to the others with dropped resulting in a two-day market decline (and plaintiffs’ resulting losses) which she compared herself, and therefore capitalization loss exceeding $1.1 billion. cannot be attributed to the prospectus’s failed in her prima facie case. According Plaintiffs asserted, among other things, failure to disclose that alleged fact and the to the Court, there was “a clear qualitative that the firm’s prospectus misrepresented allegation was properly dismissed. difference” between the sales, compliance, and failed to disclose material facts (C. Asher.) (SLC Ref. No. 2010-42-05) and operational responsibilities assumed relevant to the strengths and weaknesses by plaintiff and those performed by others. of its risk-management system and that the Kearney v. ABN Amro, Inc., On the sex and age discrimination claims, prospectus failed to disclose that the traders No. 04 CV 6885, 2010 U.S. Dist. the Court finds that, while plaintiff stated did not have limits when trading for clients Lexis 100419 (S.D. N.Y., 9/15/10). a prima facie case, the termination of and that, with the proper password, anyone Employment Discrimination * 168 employees to eliminate redundancies could access client accounts and trade in Evidentiary Issues/Standards * Federal following a related acquisition, and the them at any time. The Court affirms the Employment Statutes (Retaliatory opposition to termination voiced by the judgment in part and vacates it in part and Discharge; Title VII) * U.S. Statutes very supervisor who ultimately had to remands the case for further proceedings. Interpreted (Civil Rights Act of 1964, terminate her, shifts the burden back to As to the claim that the prospectus and 42 U.S.C. § 2000e) * Culpability plaintiff to demonstrate discriminatory registration statement exaggerated risk- Standards (Discriminatory Animus). animus, a burden which she has not met. management measures, the dismissal *While the duties and responsibilities of Finally, as to the retaliatory discharge should be vacated because the district court similarly situated employees need not be claim, the Court concludes that plaintiff erroneously applied the bespeaks-caution identical in order for a Title VII plaintiff to failed to adduce any evidence that, prior to doctrine. As to the remaining claim that demonstrate discrimination or disparate her termination, plaintiff had complained the prospectus and registration statement treatment, they must be similar in all of age, sex, or pay discrimination in a way failed to disclose deficiencies in the firm’s material respects. **Stray comments by that would have constituted “protected controls of client accounts, the dismissal the very individual who took steps to activity” under Title VII. for lack of causation should be affirmed protect plaintiff’s job are not sufficient, in (D. Franceski) (SLC Ref. No. 2010-40- in part, vacated in part and remanded. the context of the totality of the evidence, 03) Plaintiffs alleged that the prospectus failed to demonstrate discriminatory animus. to disclose the material fact that the firm’s Plaintiff, who joined defendant ABN Kirschner v. KPMG LLP, risk management system protocols and Amro as a secretary, worked her way Nos. 151 & 152, 2010 N.Y. LEXIS 2959 procedures did not apply to its employees up over the course of the next 11 years (N.Y., 10/21/10). when trading their own accounts. That to Director of Financial Operations and Liability Issues (Secondary Actors) * allegation specifies an omission of present Chief Compliance Officer and Chief Standing/Privity Issues (Bankruptcy fact, to which bespeaks caution does not Administrative Officer of an affiliated Trustee) * Bankruptcy/Insolvency apply. The applicability of the firm’s risk- joint venture. When she was terminated Issues (Wagoner Rule) * Estates/Trusts/ management system to employee accounts in the course of a reduction in personnel, Receiverships (Powers) * Pleading was ascertainable when the challenged she sued under Title VII for pay, gender Requirements * Principal & Agency statements were made. It was therefore and age discrimination, and retaliatory (Imputation of Knowledge; Adverse error for the district court to rely on the discharge. On defendant’s motion for Interest) * Equitable Defenses (In Pari “bespeaks caution” doctrine to dismiss that summary judgment, the Court dismisses Delicto; Public Policy) * Culpability claim. Characterization of the firm’s risk- the federal statutory claims and declines Standards (State of Mind). management system -- that the system was to exercise its supplemental jurisdiction The adverse interest exception, blocking “robust,” for example -- invite the inference over the remaining state law claims. Each imputation of knowledge of fraud from that the system will reduce the firm’s risk. of plaintiff’s Title VII claims is subject to controlling corporate officers to the cont’d on page 38 37 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

corporation (thus preventing application interest and queried the New York Court the Pennsylvania Supreme Court earlier of the in pari delicto defense), applies of Appeals. The New York Court responds this year (Official Comm. of Unsecured narrowly to the circumstance where the to the certification inquiry by exploring Creditors of Allegheny Health Educ. and corporation is actually a victim of the the roots of the in pari delicto doctrine Research Fund v. PricewaterhouseCoopers insiders’ wrongdoings. and finding its underpinnings grounded LLP, 989 A2d 313 [Pa 2010] [AHERF])…. We covered the federal court decisions in public policy considerations. The Our sister states fashioned carve-outs in this case, where the District Court principle applies most forcefully where the from traditional agency law in cases of dismissed this bankruptcy trustee action wrongdoer seeks damages from a negligent corporate fraud so as to deny the in pari (SLA 2009-26) and the Second Circuit, party, but it also protects defendants where delicto defense to negligent or otherwise on appeal of that ruling, certified a pivotal both parties engaged acted willfully. culpable outside auditors (New Jersey) question of state law to the New York “Indeed,” the Court emphasizes, “the and collusive outside professionals Court of Appeals (SLA 2010-37). The principle that a wrongdoer should not (Pennsylvania). Thus, the adverse interest Trustee in this case is dismantling Refco, profit from his own misconduct is so strong exception, while not abolished, is again Inc., a commodities futures commission in New York that we have said the defense rendered beside the point.” ***The dissent merchant that succumbed to fraud applies even in difficult cases and should best summarizes the Court’s holding, albeit engineered by its own controlling-officer- not be ‘weakened by exceptions’….” It pejoratively: “these simplistic agency shareholders – Bennett, Grant, Trosten becomes unfair to extend this principle, principles as applied by the majority and Maggio. According to the Trustee’s however, to the instance where the errant serve to effectively immunize auditors and Complaint, these individuals conspired to employee is acting entirely for his own or other outside professionals from liability falsely represent Refco’s performance, so another’s purposes and has abandoned his wherever any corporate insider engages as to sell their shareholdings at an inflated principal’s best interests. This “adverse in fraud.” Judge Ciparick disagrees price. In addition to the four company interest” exception operates where the with nuances of the majority’s analysis officers, the Refco Trustee also named corporation is actually the victim of the in a number of respects, but, ultimately, numerous third-party advisors, including employee’s bad acts. The exception has she dissents on the belief that important Credit Suisse Securities, Banc of America been interpreted narrowly in New York, public policy concerns militate against Securities, Deutsche Bank Securities, and because principals are best positioned to immunizing outside professionals from various others. Both sides agree that, if monitor the conduct of their agents and liability; they play a critical “gatekeeper” the Wagoner Rule applies (See, Shearson public policy encourages principals to role and investors rely heavily upon Lehman Hutton v Wagoner, 944 F2d 114, select their agents with care. In the cases the information they provide. “Strict 118 [2d Cir 1991] [bankruptcy trustee presented, the adverse interest exception imputation rules” merely encourage such does not possess standing to seek recovery would not apply. gatekeepers to neglect their protective from third parties alleged to have joined (ed: Justifying its position further, the roles -- see our feature article (Arnoff) on with the debtor corporation in defrauding majority notes that, from a liability this issue.) (SLC Ref. No. 2010-42-04) creditors]), the Trustee will lack standing standpoint, “outside professionals -- to pursue the stated claims. However, underwriters, law firms and especially Levin v. Alms & Assoc., Inc., Plaintiff clings to the narrow “adverse accounting firms -- already are at risk No. 10-1896, 2011 U.S. App. LEXIS interest” exception. That exception for large settlements and judgments in 2494 (4th Cir., 2/10/11). Agreement to operates when the rogue officer, purporting the litigation that inevitably follows the Arbitrate * Arbitration Agreement to represent the corporation, nevertheless, collapse of an Enron, or a Worldcom or (SRO Requirement) * Appealability is acting in his/her own self-interest to a a Refco or an AIG-type scandal. Indeed, (Frivolousness) * Arbitrability * Stay degree that his/her actions are not properly in the Refco securities fraud litigation, the Pending Appeal * FAA (§16) * Scope of attributed to the corporation. In this case, IPO’s underwriters, including the three Agreement (Integration). though, the District Court concluded, the underwriter-defendants in this action, An appeal of arbitrability automatically Complaint was “saturated by allegations have agreed to settlements totaling $53 divests the district court of jurisdiction that Refco received substantial benefits” million (www.refcosecuritieslitigation. over the underlying claims and requires from the alleged wrongdoing. The insiders’ com).” **Thus, the in pari delicto defense a stay of the action unless the district subjective intent was not the measure; remains strong in New York. Indeed, the court certifies the appeal as frivolous or rather, the effect on Refco was. And the Court points out that the doctrine is less forfeited. fraud was not a product of embezzlement strong in the adjoining states of New This action arises from the district court’s or theft of assets from Refco, but, instead Jersey and Pennsylvania: “Alternatively, holding that certain disputes between Alms a fraud upon new shareholders of Refco the Litigation Trustee urges us to take the and Levin were not subject to mandatory securities. On appeal to the Second approach to in pari delicto and imputation arbitration. Following the filing of this Circuit, that Appellate Court recognized adopted by the New Jersey Supreme Court appeal, Appellants asked this Court to the closeness of the question regarding in 2006 (NCP Litig. Trust v. KPMG LLP, stay the district court proceedings on the intent as a factor in determining adverse 187 NJ 353, 901 A.2d 871 [NJ 2006])… or underlying claims pending resolution of the cont’d on page 39 38 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 appeal. This Court issued an interim one- stay of the action during the pendency on its total assets under management; and judge order staying proceedings pending of this appeal was required. The Court (2) a performance fee of 20% of the profits resolution of the motion. Beginning in of Appeals reviews the district court’s generated from the capital it invests on 2004, Alms provided financial services findings concerning arbitrability de novo. behalf of its limited partners. Under certain to Levin and the parties entered into CFO Whether a party has agreed to arbitrate is circumstances, when investments perform Advisory Agreements, which governed the a matter of contract interpretation. Due poorly, Blackstone may be subject to a relationship and payment of fees. Levin to the heavy presumption of arbitrability, claw-back of already-paid performance asserts that the relationship was plagued by when the scope of the arbitration clause is fees. Plaintiffs allege that, at the time of irregularities, including investments in two open to question, a court must decide the the IPO, two units of Blackstone were real estate entities for which Alms failed question in favor of arbitration. Here, the experiencing problems, that Blackstone to disclose that they were paid consultants. integration arbitration clauses may easily was aware of this, and that these problems Alms also allegedly failed to disclose be read together to state that the agreement subjected it to a claw-back of performance that the entities were having financial encompasses and embodies all terms, fees, thereby materially affecting its troubles as early as 2005. In 2009, Levin understandings and agreements between future revenues. In 2003, a consortium filed suit against Alms for negligence, the parties and that any dispute shall be of investors, including Blackstone, negligent misrepresentation, violation of submitted to arbitration, which would purchased an 88% interest in FGIC Corp., the Investment Advisors Act of 1940 and include disputes prior to 2007 when the a monoline financial guarantor, from breach of contract. Alms moved to dismiss 2007 CFO Agreement was entered into. GE for $1.86 billion. FGIC is the parent the action or to stay the proceedings (S. Anderson) (SLC Ref. No. 2011-11-01) of Financial Guaranty, which primarily pending arbitration. The district court provides insurance for bonds. In the ruled that the arbitration agreement did Litwin v. Blackstone Group, LP, years leading up to the IPO, FGIC began not cover claims prior to 2007, but ordered No. 09-4426-cv, 2011 U.S. App. LEXIS writing insurance on collateralized debt the parties to arbitrate claims after the 2641 (2nd Cir., 2/10/11). Class Actions obligations (“CDOs”), including CDOs date of the CFO Advisory Agreements. * FRCP (Rule 8 “General Rules of backed by sub-prime mortgages to higher- Alms then appealed. The FAA authorizes Pleading;” Rule 12(b)(6) “Claim risk borrowers. By 2007, FGIC was an appeal from a district court’s denial for Relief”) * Disclosure Issues * exposed to billions of dollars in non-prime of a petition to stay an action pending Materiality * Misrepresentations/ mortgages. In 2006, Blackstone invested arbitration under § 3 of the Act. Alms’ Omissions * Negligence, Actionable * $3.1 billion in Freescale Semiconductor, motion asks the court to decide whether 1933 Act (§§ 11, 12 & 15 “Control”)) Inc., which lost an exclusive agreement the general rule applies in an appeal * Public Offering Issues * Pleading to manufacture wireless 3G chipsets for under § 16(a)(1)(A) to divest the district Requirements/Issues. its largest customer, Motorola. Plaintiffs court of jurisdiction over the proceedings It is only when there is both materiality and allege that Blackstone was required to relating to the underlying claims. The a duty to disclose that a company may be disclose this material adverse development Third, Seventh, Tenth and Eleventh held liable for omitting information from a in its Registration Statement. Plaintiffs Circuits have held that an appeal regarding registration statement or prospectus. also allege that the Registration Statement arbitrability does divest the district court Plaintiffs appeal from a judgment of made material misrepresentations of jurisdiction over those claims, as long the District Court, dismissing a putative concerning trends in the real estate as the appeal is not frivolous. The Second class action complaint, pursuant to FRCP market, it violated GAAP and materially and Ninth Circuits have held that no such 12(b)(6), for failure to state a claim. overstated the value of Blackstone’s real divestiture occurs. This Court decides to The Court concludes that the District estate investments. Notably, the complaint join the majority of the circuits. The core Court erred in dismissing the complaint, does not allege fraud, but rather alleges subject of an arbitrability appeal is the because plaintiffs plausibly allege that negligence in preparing the Registration challenged continuation of proceedings material information was omitted from or Statement; as such, it is not subject to before the district court on the underlying misstated in defendants’ IPO registration the heightened pleading requirements claims. Permitting discovery to proceed is statement and prospectus, in violation of of § 9(b). Plaintiffs need only satisfy one of those aspects of the case involved §§ 11, 12(a)(2) and 15 of the 1933 Act. the basic notice pleading requirements in the appeal of which the district court Blackstone is a leading global alternative of Rule 8 and so long as they plausibly lacks jurisdiction. The Court holds that asset manager and provider of financial allege that Blackstone omitted material an appeal of arbitrability automatically advisory services and one of the largest information it was required to disclose divests the district court of jurisdiction independent alternative asset managers in or made material misrepresentations in over the underlying claims and requires a the world. In 2007, just prior to the IPO, its offering documents, they meet the stay of the action, unless the district court Blackstone was formed as a Delaware relatively minimal burden of stating certifies the appeal as frivolous or forfeited. Limited Partnership. Blackstone receives a claim pursuant to §§ 11 and 12(a), Given that the district court specifically a substantial portion of its revenues from under which Blackstone’s liability as held that the appeal was not frivolous, a two sources: (1) a 1.5% management fee an issuer is absolute. Case law does not cont’d on page 40 39 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

support the sweeping proposition that an allege the critical element of scienter Sales Practice/Product Issues issuer of securities is never required to and affirms the district court judgment. (Commodities Futures) * Venue Issues disclose publicly available information. Hoping to create a plausible inference of (Forum Non Conveniens) * Forum The relevant question under Item 303 is scienter from allegations of motive and Selection Clause. whether Blackstone reasonably expects opportunity, plaintiffs based their claims A court case will be stayed under the the impact to be material. Materiality is against E&Y on (1) E&Y’s use of stale doctrine of forum non conveniens if satisfied when plaintiff alleges a statement and incorrect data, (2) numerous alleged there is a suitable alternate court and the or omission that a reasonable investor “red flags” that should have placed E&Y private interests of the parties and the would have considered significant in “on notice of financial improprieties” and public interests in litigating the case are making an investment decision and (3) E&Y’s alleged expectation of higher preserved. The fact that the law of another that would have altered the total mix of fees if the acquisition they were auditing forum is less favorable to a litigant is of information made available. A reasonable was completed. Under Tellabs, in order to no weight. investor would almost certainly want to survive a motion to dismiss, the inference Between 2003 and 2005, plaintiffs opened know information related to that segment of scienter must be “cogent and at least as securities accounts with Michael Chen. that Blackstone reasonably expects will compelling as any opposing inference.” They accepted Chen’s recommendation have a material adverse effect on its future Though the district court made reference that they invest 20% of their funds in revenues. The motion to dismiss should to a more demanding standard—that commodities. Because Chen could have been denied. the inference of scienter be the “most not execute commodities transactions (S. Anderson) (SLC Ref. No. 2011-12-04) plausible” inference—the Appellate Court directly on an exchange, he opened characterizes that as dictum, concludes the accounts with defendant FCStone LLC, Louisiana School Employees’ lower court actually applied the Tellabs an Illinois corporation whose only Retirement System, et al. v. standard, and finds that the facts alleged office was in Chicago. Plaintiffs signed Ernst & Young, LLP, here fall short of that standard. As the account agreements with FCStone, No. 08-6194, 2010 U.S. App. Lexis Court notes, scienter requires more than which provided that any disputes would 19636 (6th Cir., 9/22/10). 1934 Act a misapplication of accounting principles. be litigated or arbitrated in Illinois. In (§10 “Rule 10b-5”) * FRCP (Rule 9b Unfortunately for plaintiffs, both PWC 2008, Chen committed suicide after some “Particularity”) * Class Actions, Effects and Deloitte issued unqualified audit of the plaintiffs attempted to withdraw of * Misrepresentations/Omissions * opinions during the same general period their funds. Plaintiffs then discovered Pleading Requirements/Issues * PSLRA of time in which neither found evidence that Chen had invested all of their funds * Representation Issues (Professional of an inadequate allowance for doubtful with FCStone, then withdrew the monies, Malpractice) * Standard of Review accounts. Similarly, the “red flags” alleged forged plaintiffs’ endorsements, and * Culpability Standards (Scienter) * by plaintiffs were not obvious or egregious, deposited the monies into his own bank Liability Issues (Secondary Actors) * but rather conclusory and devoid of fact, account. The FCStone accounts were Tellabs Interpreted. * and the magnitude of the alleged fraud, by entirely depleted. Plaintiffs thereupon In order for red flags to create a strong itself, cannot establish scienter; otherwise sued FCStone and others in California, inference of scienter in securities fraud the well-established principle that scienter alleging securities fraud. The defendants claims against outside auditors, they must cannot be based on accounting errors moved to dismiss or stay the lawsuit on the be in the nature of an egregious refusal alone would be eviscerated. With respect ground of forum non conveniens, citing to see the obvious or to investigate the to plaintiffs’ allegation of motive, the the account agreements’ forum selection doubtful. **Accounting errors alone promise of future business, without more, clause. The court stayed the lawsuit and cannot support a plausible inference of from a client whose fees were not alleged plaintiffs appeal. The Court of Appeal scienter under Tellabs. to be more significant than others, cannot affirms. A court ruling on a motion to This appellate decision addresses whether support a plausible inference of scienter. stay or dismiss an action on forum non the dismissal of a putative class action Finally, because plaintiffs failed, beyond conveniens grounds engages in a two-step against defendant Ernst & Young (“E&Y”) mention of the request in supporting briefs, analysis. First, the court must determine for securities fraud, decided under the to formally move to amend, the Appellate whether there is a suitable alternative Sixth Circuit’s more stringent pre-Tellabs Court affirms the lower court’s dismissal forum. A forum other than California is pleading standard, should stand under without leave to replead. suitable if and only if the defendant is Tellabs. Though E&Y had also been sued (D. Franceski) (SLC Ref. No. 2010-41- subject to jurisdiction in that forum, the for accounting malpractice by its client, and 05) statute of limitations in that forum would though the company’s stock had dropped not bar the action, and the action would be 44% in one day when the understated Lu Yu v. adjudicated by an independent judiciary allowance for doubtful accounts was first Global Merchant Center, Inc., respecting the due process of law. The reported, the Appellate Court concludes No. B218388, 2010 Cal. App. Unpub. fact that the law of another forum is that the complaint does not adequately LEXIS 9825 (Cal. App., 2Dist., 12/14/10). disadvantageous to the plaintiff or that the cont’d on page 41 40 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 forum does not provide a remedy available of * Contractual Issues (Waivers) * 1934 Act (Securities Fraud) * Collateral in California does not make such a forum Remedies (Rescission). A contractual Estoppel/Res Judicata (Claim unsuitable. The second step is to consider promise to provide AAA-rated securities Preclusion) * Re-Litigation Issues (Full the private interests of the parties and the to an investor is not a promise of credit Faith and Credit Act) * Release, Effect public interests in litigating the case in quality; it is merely a promise to provide of. California. The private interest factors are securities that have an AAA rating. Objecting to a class action settlement does those that make trial and the enforceability In the case below, the trial court dismissed not prevent it from having a preclusive of the ensuing judgment expeditious and four of five counts against the Merrill effect, once approved, upon the objector’s relatively inexpensive, such as the ease Lynch Defendants. On appeal, the Court ability to re-litigate the issue in another of access to sources of proof, the cost of examines all five causes, affirms the forum. obtaining attendance of witnesses, and decision as to the four dismissals, and The Third Circuit Court of Appeals affirms the availability of compulsory process modifies the judgment to dismiss the fifth. the dismissal of federal securities fraud for attendance of unwilling witnesses. The fraud-related claim was properly claims brought by plaintiff stockholders, The public interest factors include dismissed, as the Plaintiffs’ pleadings did holding that plaintiffs, as members avoidance of overburdening local courts not overcome the specific disclaimers in of a class in a state court class action with congested calendars, protecting the the contract between the parties. Plaintiff concerning the same operative facts, interests of potential jurors so that they are was a sophisticated investor and the were bound by a state court judgment not called upon to decide cases in which allegedly omitted information was not approving a settlement and release in that the local community has little concern, beyond its reach. The contention that it action. Plaintiffs were owners of seats on and weighing the competing interests of would have been impractical to conduct the Philadelphia Stock Exchange, which, California and the alternate jurisdiction the investigation necessary to reveal until recently, was a mutual organization. in the litigation. Here, Illinois is a suitable the undisclosed information does not In 2003, the Exchange proposed a alternative forum. Plaintiffs’ action satisfy the requirements of the “peculiar demutualization plan, which was approved will be adjudicated by an independent knowledge” exception, i.e., that disclosure by its members. Under the plan, the judiciary, which will indisputably respect was necessary as Defendants held Plaintiffs received 100 shares of Exchange the due process of law. Further, the exclusive knowledge of the facts. The common stock for each seat they had private interests of the parties and the breach of contract claims are based on two previously owned. Later, the Exchange public interest in litigating in California premises: one, that the promise to provide entered into separate transactions with do not require invalidation of the forum subordination protection was breached so-called Strategic Investors; as a result selection clause. The sources of proof and, two, that the promise to provide AAA- of the transactions, the Strategic Investors and the witnesses are in Illinois, where rated securities was breached. The former – Citadel Derivatives Group, Citigroup, the offices of the defendants are located promise does not appear in the contract Credit Suisse First Boston, Merrill Lynch, and the transactions took place because and the latter promise, while present in the Morgan Stanley and UBS Securities – plaintiffs’ claims against defendants are contract, was not breached. The securities obtained 45% of the outstanding stock based upon the looting of their accounts may have been deficient in quality, but in the Exchange, a figure that was later by Chen and his fraudulent endorsement they were AAA-rated. The contract does increased to 89.4%. In the end, Plaintiffs of their redemption checks, actions which not promise credit quality. Plaintiffs also were left with approximately 10% of the took place in Illinois. Finally, the plaintiffs alleged a breach of the implied covenant Exchange’s common stock and a smaller freely agreed to the forum selection clause of good faith and fair dealing. Here, the amount of the Exchange’s equity per share in the contracts signed in an arm’s length Court is cryptic, but it appears to hold that than they had prior to demutualization. transaction. Public policy alone does the implied breach is based on the same In June of 2006, a different, named not justify denying enforcement to the conduct as the claimed contract breach plaintiff initiated a state court action in FCStone forum selection clause, nor does complains of and, thus, the damages from the Delaware Court of Chancery, asserting the additional expense or inconvenience of one or the other breach are tied together. state law fiduciary claims against the requiring plaintiffs to litigate their claims The remedy of rescission, requested by Exchange, its Board, and the Strategic against defendants in Illinois. Plaintiffs, cannot be properly claimed, Investors. The Delaware court eventually (P. Dubow) (SLC Ref. No. 2011-07-10) until it is established that compensatory certified a class of “all Class A common damages cannot remedy the loss. (SLC stockholders” of the Exchange, a group MBIA Insurance Corp. Ref. No. 2011-09-10) which included Plaintiffs. Shortly after v. Merrill Lynch the state court action was filed, Plaintiffs International, McGowan Investors, LP filed suit in the District Court for the No. 4163 (N.Y. App., 1Dept., 2/1/11). v. Frucher, Eastern District of Pennsylvania against Fraudulent Inducement (Disclaimers) No. 07-3980, 2010 U.S. App. LEXIS the Exchange’s Board, two Exchange * Reliance/Transaction Causation 16908 (3rd Cir., 8/12/10). officers and the Strategic Investors for (Justifiable) * Sophistication, Effect Class Actions, Effects of (Opt-Out) * their involvement in the demutualization cont’d on page 42 41 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

of the Exchange. Plaintiffs asserted claims Rate Securities) * Motion to Dismiss (2) Defendant continued to aggressively arising under SEC Rule 10b-5, including * 1934 Act (Rule 10b-5) * Reliance/ market and sell the ARS to Plaintiff; and an allegation that “demutualization and Transaction Causation (Justifiable) (3) Defendant issued internal research the investment by the Strategic Investors * Misrepresentations/Omissions * reports several months prior to the ARS decreased the value of [Plaintiffs’] Fiduciary Standards (Holders Actions) market failure, stating that the ARS ownership interests” in the Exchange. On * Good Faith and Fair Dealing * failures were rare. The Court rules that the eve of the Delaware state court trial, Investment Banking Issues (Private Plaintiff’s bare allegations are insufficient the parties to that case settled. In exchange Placement) * Trading Issues (Auction to demonstrate that its reliance on for compensation, the settlement class Freeze) * Pleading Requirements. Defendant’s statements and internal report – which included Plaintiffs – agreed to a Court granted Defendant’s Motion was reasonable. The disclosures in both broad release that covered all claims arising to Dismiss, ruling that Plaintiff’s the presentation and the private placement out of or relating to, among other things, complaint did not sufficiently allege any memorandum fully covered the omissions demutualization. The trial court approved misrepresentations or omissions and that and misrepresentations contained in the settlement over the objection of several it failed to adequately plead scienter. Plaintiff’s complaint. The Court also finds class members, including Plaintiffs. The Plaintiff bank filed suit against Defendant these statements to be mere puffery and not Delaware Supreme Court affirmed the trial brokerage firm for violations of federal actionable. Even if Defendant made the court’s approval of the settlement. Prior securities laws and a variety of state law alleged omissions and misrepresentations, to the state court settlement, the District claims. The claims arose out of Plaintiff’s Plaintiff failed to adequately plead scienter. Court dismissed the federal case, on purchase of auction rate securities Therefore, Plaintiff’s complaint relating other grounds, for failure to state a claim. (“ARS”) in a private placement offered by to the post-purchase misrepresentations Plaintiffs appealed. The appeal focuses Defendant. Plaintiff alleged that Defendant must be dismissed. The Court also on a single, narrow issue: whether the violated Section 10(b) of the Securities dismisses Plaintiff’s state law claims for state court settlement and release bars the and Exchange Act and SEC Rule 10b- misrepresentation, breach of fiduciary claims asserted in the federal action. The 5 for both pre-purchase omissions and duty, and breach of good faith and fair Third Circuit holds that it did, finding it to post-purchase misrepresentations. As dealing. No fiduciary duty exists between be “indisputable” that the demutualization for the pre-purchase omissions, Plaintiff a broker and its client under Kentucky state claims arose “out of the common nucleus alleged Defendant did not disclose: (1) law. The Court also finds no existence of a of operative facts asserted in the [state Defendant’s bidding practices and the contract between Plaintiff and Defendant court] complaint.” The Third Circuit ability of Defendant to submit support and, because of its absence, no duty of agrees with the assessment of the Delaware bids or affect the clearing rate, (2) the good faith and fair dealing exists under Supreme Court, which had opined that liquidity risks in the ARS market, and (3) Kentucky state law. Plaintiff’s complaint “demutualization was not a transaction the various potential conflicts of interest. in its entirety does not contain sufficient that was ‘unrelated’ or ‘tangential’ to or The Court finds that the complaint does factual matter, which if accepted as true, ‘remote’ from the conduct that form[ed] not point to any misrepresentations or would state a claim for relief that is the basis for the specific claims for relief omissions prior to the purchase of the plausible on its face. Therefore, the Court asserted” in the state court action; rather, it ARS. In any case, a presentation made grants Defendant’s Motion to Dismiss. was at their core. Plaintiffs were members by Defendant to Plaintiff adequately (P. Michaels) (SLC Ref. No. 2011-10-07) of the state court class and “all members disclosed these alleged omissions. The of the class” were bound by the settlement, presentation disclosed that: (1) Defendant Morales v. the release and the ensuing state court may submit bids to support the auction to UBS Trust Co. of Puerto Rico, judgment. Further, the Full Faith and ensure it is successful, while it was under No. 09-2205 (D. P.R.. 1/20/11). Credit Act applies to the federal action, no obligation to do so; (2) there is a risk FRCP: Fed. R. Civ. P. 19 (Joinder; and, there being no applicable exception of illiquidity if there are more sellers of Indispensable Party) * FAA: Federal to that Act, Plaintiffs were precluded from the ARS than buyers; and (3) there was Arbitration Act * Arbitrability * bringing the federal action. a potential for a conflict of interest by Trust/Estate/Receivership * Fiduciary (P. Michaels) (SLC Ref. No. 2010-39-02) Defendant, as the market structure of Standards (Trust; Conflicts of Interest * the ARS made it apparent. Therefore, Breadth of Agreement (Non-Signatory) Merrill Lynch Auction Plaintiff’s complaint relating to the pre- * Equitable Doctrines (Equitable Rate Securities Ltgn., In Re: purchase omissions was dismissed. Estoppel). Anschutz Corp. v. Plaintiff also alleged that Defendant made A party moving to compel arbitration must Merrill Lynch & Co., Inc., several post-purchase misrepresentations, show that the other party is bound by the No. 09 MD 2030, 2011 U.S. Dist. LEXIS which induced Plaintiff to remain invested arbitration clause at issue. 7337 (S.D. N.Y., 2/9/11). in the ARS. Specifically, Plaintiff alleged Plaintiff, as beneficiary of the Leonardo Class Actions, Effects of * Product/ that: (1) Defendant represented that the Cabrera Trust (the “Trust”), brought an Sales Practice Issues (ARS: Auction ARS were liquid and suitable for Plaintiff; action against Defendant UBS Trust cont’d on page 43 42 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Company of Puerto Rico (“Defendant”) executed solely by others. Defendant Southern District of New York in this for breach of fiduciary duty and duty of argues that, pursuant to InterGen N.V. action is the next segment of a nine-year loyalty, in violation of Puerto Rico tort and v. Grina, 344 F.3d 134 (1st Cir. 2003), a legal battle consisting of three separate contract law, 31 L.P.R.A. §§ 3052, 5141- party may be estopped from asserting cases involving identical facts and claims 5142. Defendant moved to dismiss for that the lack of his signature on a written asserted against Morgan Stanley. By way of failure to join an indispensable party and, contract precludes enforcement of the background, in 1999, several hedge funds in the alternative, to compel arbitration. On contract’s arbitration clause when he run by Conrad Seghers opened accounts or about June 16, 2005, Plaintiff’s brother has consistently maintained that other at Morgan Stanley. In 2001, Seghers created the Trust, naming Defendant as provisions of the same contract should accused Morgan Stanley of committing Trustee and Plaintiff as beneficiary. The be enforced to benefit him. InterGen, serious errors related to how activity in the Trust stated that the investment of the 344 F.3d at 145. In addition, a third-party funds’ accounts was reflected on account assets would be handled through UBS beneficiary of a contract containing an statements and blamed these errors Financial Services, Inc. of Puerto Rico arbitration clause can be subject to that for large losses in the funds’ value. An (“UBS Financial”) or any other securities clause and compelled to arbitrate on the investor in Seghers’ hedge funds then sued broker that the founders of the Trust demand of a signatory. Id. at 146. The him, his business partners, and the funds in indicated in writing. Defendant executed Court holds that neither the passive benefit Texas state court for fraud. Several of the an agreement (the “Agreement”) with UBS Plaintiff derived from the Agreement, nor funds proceeded to sue Morgan Stanley Financial establishing a brokerage account his indirect attempts to enforce it, amounts in a separate suit in Texas state court and for managing the investment of the Trust’s to “exploitation” necessary to trigger that suit was compelled to arbitration. In assets. The Agreement contained an equitable estoppel. Similarly, the Court 2006, Seghers sued Morgan Stanley in the agreement to arbitrate any dispute arising rules that Defendant failed to establish Southern District of New York, alleging out of the Agreement. Plaintiff alleged that Plaintiff is entitled to sue under the fraud arising out of the same alleged that Defendant directed UBS Financial Agreement. Plaintiff’s relationship to the errors and misrepresentations in the to invest all of the Trust’s assets in Bank Agreement was different from that of a account statements. Morgan Stanley was of America Corp. Plaintiff further alleged third-party beneficiary. The difference is successful on a motion to dismiss, asserting that the value of the Trust, which at its peak clear from the fact that Plaintiff’s ability that Seghers’ claims were time-barred reached $300,000, eventually dwindled to to enforce the terms of the Trust and by the four-year statute of limitations for approximately $75,000 as a result of the agreements related to it are governed fraud claims. In 2007, Integral Hedging risky investment in Bank of America. by trust law, which limits Plaintiff’s Offshore, Ltd., one of Seghers’ funds Plaintiff instructed Defendant to initiate relationship beyond ordinary contract whose assets had been traded at Morgan legal proceedings against UBS Financial. principles. Therefore, Defendant’s motion Stanley, filed an arbitration against Plaintiff claimed that Defendant’s refusal to compel arbitration is denied. Morgan Stanley based on the same facts to do so constituted a breach of its fiduciary (P. Michaels) (SLC Ref. No. 2011-09-03) as the 2006 Southern District of New duty and duty of loyalty. Defendant argued York action. Morgan Stanley successfully that UBS Financial was a required party Morgan Stanley & Co., Inc. petitioned the New York Supreme Court to under Fed. R. Civ. P. 19(a). However, v. Seghers, stay and dismiss this arbitration. In 2010, Defendant maintained that joinder was No. 10 Civ. 5378, 2010 U.S. Dist. 107686 Seghers commenced a FINRA arbitration, not feasible, because UBS Financial was (S.D. N.Y. 10/8/10). alleging facts identical to those asserted likely to successfully compel arbitration of Injunctive Relief (Stay of Arbitration; in the 2006 Southern District of New any claims, which Defendant maintained Irreparable Harm) * Statute of York action and the Integral Hedging was a winning objection to venue under Limitations * Waiver * Res Judicata/ Offshore, Ltd. arbitration. Morgan Stanley Fed. R. Civ. P. 19(a)(3). The Court notes Collateral Estoppel (Claim Preclusion) proceeded to file the complaint in the that Plaintiff did not seek to enforce the * Pre-Hearing Adjudications present action with the Southern District of Agreement or claim any right to enforce (Arbitration) * SRO Rules (FINRA New York, seeking a declaratory judgment it. Since Plaintiff’s claims center around Rule 12504 “Dispositive Motions”) that Seghers waived any right to arbitrate Defendant’s conduct as Trustee, and * Simultaneous Proceedings * his claims by litigating them in an earlier not around UBS Financial’s investment Enforceability (Waiver). lawsuit and that Seghers’ claims were conduct, UBS Financial does not have Broker-Dealer is successful on a motion barred by the doctrine of claim preclusion. any interest in the suit. Therefore, the for a preliminary injunction, enjoining Morgan Stanley also sought an injunction Court holds that UBS is not a required customer from proceeding with FINRA enjoining Seghers from pursuing the party under Rule 19(a)(1). In support of its arbitration where customer had filed 2010 arbitration. The Court finds that motion to compel arbitration, Defendant several previous suits arising out of the Morgan Stanley meets all of the factors for argues that, under the doctrine of equitable same set of facts. issuance of injunctive relief. First, Morgan estoppel, a nonsignatory can be bound Morgan Stanley & Co., Inc.’s motion for Stanley can show likelihood of success on by an arbitration provision in a contract a preliminary injunction filed with the the merits of its claim that Seghers waived cont’d on page 44 43 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

any right to arbitrate his claims by filing Practice/Product Issues (Subprime reliance on allegations concerning the 2006 Southern District of New York Mortgages “MBS”). the originators, service providers and action, which proceeded to final judgment That a suit may be a class action adds rating agencies and the alleged falsity of and which was filed four years prior to the nothing to the question of standing, for prospectus and supplement disclosures 2010 arbitration. Second, Morgan Stanley even named plaintiffs who represent a class precludes its argument that it can can show that it will suffer irreparable must allege and show that they personally demonstrate standing to sue on behalf harm if injunctive relief does not issue. As have been injured, not that injury has been of the holders of trust certificates of FINRA does not allow motions to dismiss, suffered by other, unidentified members of which WVIMB was not a purchaser. The Morgan Stanley would be unable to show the class to which they belong and whom timeliness allegation of the complaint is the finality of the 2006 action. Third, the they purport to represent. plainly insufficient to address the requisite balance of hardships and public interest Defendants Morgan Stanley & Co., issue of time and circumstances. It is tip in favor of Morgan Stanley because Incorporated and individual and other equally plain that, unless the claims first Morgan Stanley would have to expend affiliates moved to dismiss the consolidated asserted in WVIMB’s original complaint time and resources in an arbitration that amended complaint by Public Employees’ can be deemed to relate back to PERS’ it could not move to dismiss. The Court Retirement System of Mississippi original filing date, any amendment of the grants Morgan Stanley’s motion for a (“PERS”) and West Virginia Investment timeliness allegations as to the WVIMB preliminary injunction. Management Board (“WVIMB”), claims would be futile. (P. Michaels) (EIC: This is the first case asserting Sections 11, 12(a)(2) and 15 of (C. Asher.) (SLC Ref. No. 2010-41-08) we can identify in which a respondent in the 1933 Act, on behalf of purchasers, arbitration has successfully resorted to for false and misleading statements, in Municipal Derivatives court action in the face of an inability connection with the marketing and sale Antitrust Ltgn., to seek relief from the arbitrators, as a of mortgage-backed security pass-through In Re: Hinds County, MS v. consequence of the new rules restricting certificates issued by Morgan Stanley Wachovia Bank, NA, pre-hearing motions to dismiss. It Capital I Incorporated and several Morgan No. 08 Civ. 2516, 08 MDL 1950 (S.D. occurs in circumstances where parties Stanley Mortgage Loan Trusts. PERS had N.Y., 3/1/11). have traditionally turned to the courts purchased certificates from one such trust, Class Actions, Effects of (Regulatory) * -- to manage conflicting proceedings – 2006-14SL, and WVIMB purchased trust Settlement Issues * Parallel Proceedings but the Court’s analysis of the need for certificates from 2007-11AR. The trust * Enforcement Practice/Procedure injunctive relief is aided here by the certificates for 2006-14SL and 2007-11AR * Sales Practice/Product Issues impossibility of obtaining relief from the were related in that they shared a common (Municipal Securities). arbitration panel.) (SLC Ref. No. 2010- shelf registration statement. WVIMB Class actions seeking damages and 42-03) filed the complaint concerning these two regulatory settlements seeking restitution certificates, although the complaint only may conflict, requiring judicial Morgan Stanley Mortgage identifies WVIMB as a named plaintiff. intervention to weigh the public interest in Pass-Through Certificates The Court adopts defendants’ argument allowing one or both to go forward. Litigation, In Re, that plaintiffs lack standing to prosecute Bank of America (BofA) is one of the No. 09 Civ. 2137 (LTS)(MHD), 2010 U.S. claims concerning trust certificates they Defendant banks in this multi-district Dist. LEXIS 84146 (S.D. N.Y., 8/17/10). did not own and that the Court therefore litigation on behalf of purchasers of Capital Formation Issues (Structured lacks subject matter jurisdiction of those municipal derivatives. Plaintiffs allege Finance/CDO) * Class Action, Effects additional claims. It also rules that the that, between January 1, 1992 and of * Derivative/Vicarious Liability complaint fails to state claims upon which the present, Defendants engaged in a (Control Person) * Duty of Inquiry relief may be granted, because WVIMB’s widespread price-fixing and bid-rigging * FRCP (Rules 12(b)(1) “Subject- claims are untimely and because the conspiracy in the multi-billion dollar Matter Jurisdiction”, 12(b)(6) “Claim complaint is legally and factually municipal derivatives industry. BofA has for Relief”, 15 “Relation Back”) * insufficient. Accordingly, the Court also been the subject of investigations by Jurisdiction Issues/Federal Question) denies, with prejudice, WVIMB’s claims DOJ, SEC and many of the nation’s state * Misrepresentations/Omissions relating to the 2007-11AR trust; denies, attorneys general concerning the same * Pleading Requirements/Issues * without prejudice to renewal, PERS’ conduct. Bank of America has entered PSLRA (Generally) * 1933 Act (§§ claims relating to the 2006-14SL trust; into a settlement agreement with many 11 “Registration Statement”, 12(a)(2) and grants leave to plaintiffs to amend of the investigating regulators, which “Prospectus, Oral Communication”, 13 the complaint to demonstrate PERS’ provides for partial restitution (“the State “Limitations”, 15 “Control”) * Standing standing with respect to claims that have Agreement”). If the municipalities opt Issues (Case/Controversy) * Timeliness been dismissed pursuant to 12(b)(1), and in to the State Agreement, lead plaintiffs Issues (Statute of Limitations) * to augment and clarify the pleading of the complain, it could threaten the class Transaction Causation/Reliance * Sales complaint asserted by PERS. WVIMB’s action litigation and it might extinguish cont’d on page 45 44 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 the claims of a portion of prospective FRCP (Rule 23) * Misrepresentation/ class treatment is not superior. As a result, class members, at least those lodged Omissions. plaintiffs’ motion fails under Rule 23 (b). against BofA. According to Plaintiffs, Class Plaintiffs’ Section 11, 12(a)(2) and (D. Franceski) (SLC Ref. No. 2011-08- notice packets regarding the State 15 1933 Act claims for misrepresentations 04) Agreement have been prepared and are about loan origination guideline ready to be sent to eligible plaintiffs, compliance in the offering materials Newman & Register v. First which will require accepting entities to of mortgage-backed securities fail Montauk Financial Corp., release BofA from liability on claims the class certification requirements of No. 7:08-CV-116-D, 2010 U.S. Dist. that could include those involved in the predominance and superiority under Rule LEXIS 74695 (E.D. N.C., 7/23/10). instant action. Plaintiffs ask the Court 23(b). Agreement to Arbitrate * Arbitration to (1) enjoin BofA from proceeding Having survived motions to dismiss Agreement (SRO Requirement) with these “opt in” offers; (2) supervise (see SLA 2010-16), plaintiffs in these * Contribution/Indemnification * the communications with putative class putative class actions against issuers of Remedies (Bifurcation of Claims) * members regarding the State Agreement; mortgage-backed securities now seek SRO Rules (FINRA Rule 13200) * Tax- (3) subject the State Agreement to fairness class certification for their 1933 Act, Related Issues (Tax-Free Exchange, 26 proceedings; and (4) require the Settling Section 11, 12(a)(2) and 15 claims. USC. §1031). States to join the class action litigation Plaintiffs based their claims on allegedly Possible inefficiency may occur due to as necessary parties. The Court chooses misleading statements in offering referral of a claim to arbitration, because to do the “minimum necessary” at this documents about whether the residential the relevant federal law requires piecemeal juncture to protect its jurisdiction and the mortgages underlying the securities resolution when necessary to give effect to interests of the putative class members, followed proper loan underwriting an arbitration agreement. which entails BofA submitting the notice guidelines. Though satisfied that plaintiffs Newman and Register sued First Montauk packets or other communications with meet the requirements of Rule 23(a), the and certain individuals, alleging violation putative class members for the Court’s Court ultimately denies class certification, of North Carolina law arising from a failed approval. The Court also directs BofA because plaintiffs fail to prove either investment in Parcel Leasehold Interests in to affirm that it has not been threatened predominance or superiority under Rule a Texas shopping center. The defendants or coerced by the Settling States to enter 23(b). Though plaintiffs did not identify and third-party plaintiffs sued certain the State Agreement. It wants to assure numbers of proposed class members by attorneys, McLamb and Edward Jones for that adequate information is provided to tranche, neither that, nor the sophistication indemnity or contribution. McLamb and claimants in “clear, concise and neutral and resources of the class, overcomes Edward Jones moved to compel arbitration terms” that presents the remedies available the presumption of numerosity, issues and to dismiss or stay the proceedings to them and the consequences of electing of commonality and adequacy of class against them. The offering memorandum to opt in to the State Agreement. The representative are easily satisfied, and for investors in the private placement in the Court promises to render its conclusions the typicality prong of Rule 23(a) “is not Texas mall required that the sales be made on such submissions in a future decision. demanding.” Therefore, Plaintiffs satisfy by a registered broker-dealer and required (ed: News reports indicate that the the requirements of Rule 23(a). Turning that the purchaser of a parcel leasehold regulatory settlement involves a total to Rule 23 (b) and the predominance interest sign a questionnaire stating that of $137 million, with $60 million set requirement, the Court concludes that, the interest is a suitable investment for aside for individual claimants. These because many putative class members are the purchaser. McLamb contacted First territorial disputes between class actions sophisticated, and because, over time it Montauk about the investment and was and receivers, regulators and individual became known among certain purchasers allegedly told that it was the best product litigants and arbitration claimants are that loan originators were loosening on the market, which he conveyed to becoming more common.) (SLC Ref. No. standards, leading to different levels plaintiffs. Plaintiffs sold their property for 2011-10-08) of knowledge among class members, $2+ million and invested $2 million in the individualized issues of knowledge private placement, purchasing 64 parcel- New Jersey Carpenters Health predominate. Similarly, with respect to leasehold-interest units and assuming Fund v. Residential Capital, superiority, where, as here, the proposed $1+ million in mortgage debt. Plaintiffs LLC,; New Jersey Carpenters class consists of large, institutional allege that First Montauk had a conflict Vacation Fund v. The Royal and other sophisticated investors with of interest with the sponsor of the private Bank of Scotland Group, PLC, substantial financial resources and placement and that First Montauk made Nos. 08 CV 8781, 08 CV 5093, 2011 Dist. incentives to pursue their own claims, and misrepresentations in connection with Lexis 4343 (S.D. N.Y., 1/18/11). where significant individualized evidence the sale to plaintiffs. Defendants filed a 1933 Act (§§ 11, 12, 15 “Control”) * Class on, among other things, each purchaser’s third-party complaint and McLamb and Actions, Effects of (Class Certification; knowledge and damages, some with Edward Jones filed a motion to compel Lead Plaintiff/Lead Counsel) * competing interests, will be required, arbitration and either to dismiss the claims cont’d on page 46 45 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

against them or stay the proceedings 16706 (9th Cir., 8/12/10). Federal Statutes strongly suggests that Congress intended pending arbitration. FINRA Rule 13200 Interpreted (Sudan Accountability to preclude other methods of enforcement. provides that a dispute must be arbitrated and Divestment Act) * ICA (§13 “Safe Moreover, it is evident from the text of the under the Code, if the dispute arises out Harbor”) * Private Right of Action. Investment Company Act that Congress of the business activities of a member The fact that the Sudan Accountability knew how to create a private right of action or associated person and is between or and Divestment Act of 2007, which was to enforce a particular section of the Act among members; members and associated codified in part as Section 13(c) of the when it wished to do so. In Section 30(f) persons or associated persons. The Investment Company Act, gave investment of the original Act, Congress expressly FINRA manual constitutes an agreement companies a safe harbor from lawsuits authorized private suits for damages in writing under the FAA, which binds arising from the divesture of Sudanese against insiders of closed-end investment third-party plaintiffs, McLamb and related investments, does not mean that companies who make short-swing profits. Edward Jones, as FINRA members or there is an implied private right of action Congress created a second express private associated persons, to submit an eligible under Section 13(a) of the Investment right of action in 1970 when it added dispute to arbitration. Although the Fourth Company Act. Section 36(b), which allows shareholders Circuit has not expressly interpreted an In this case, the Ninth Circuit reverses the to sue an investment company’s advisor arbitration provision including the phrase, District Court and rules that there is no for breach of certain fiduciary duties “arises out of the business activities of a private right of action under Section 13(a) relating to management fees. The District member or associated person,” as used of the Investment Company Act of 1940. Court had found it significant that Section in FINRA Rule 13200, this Circuit has Section 13(a) prohibits an investment 13(c) referred to actions that a “person” consistently interpreted similar language company from deviating from its policy in could file and reasoned that Congress’ in favor of arbitration. Accordingly, the respect of concentration in any particular use of the word “person” in Section 13(c) Court considers Rule 13200 a broad industry or group of industries as recited must have meant that private persons, arbitration clause and applies the Fourth in its registration statements, where the and not just the SEC, were authorized to Circuit’s “significant relationship” test. In policy is changeable only if authorized bring an action for violation of Section opposition to the arbitration request, third- by shareholder vote. The District Court’s 13(a). But the Ninth Circuit counters that party plaintiffs contend that their claims opinion was based on language in the this argument would only have validity if do not arise out of Edward Jones’ and Sudan Accountability and Divestment the Sudanese bar in Section 13(c) applied McLamb’s business activities and urge the Act of 2007 (“SADA”). That statute was only to causes of action to enforce the Court to narrowly construe the arbitration enacted in reaction to atrocities committed other provisions of Section 13, including clause. They cite a California case holding by the Sudan government in Darfur Section 13(c). But the bar is not so limited. that disputes must arise out of the business and barred United States citizens from The bar extends to any civil, criminal, activities of an individual as an associated doing business with certain Sudanese or administrative action brought under person to fall within the scope of Rule companies. It contained a safe harbor, any state or federal law. Thus, Congress 13200’s arbitration clause; however, the found in Section 13(c) of the Investment intended the term “person” to include Court holds that the claims do not relate to Company Act, which provided that, a wide range of potential plaintiffs. side business, but to the business activities “notwithstanding any other provision of Congress meant to bar all such potential of member firms and their associated federal or state law, no person may bring plaintiffs from remedies for divestment. It persons. Nor is there an exchange- any civil, criminal, or administrative did not limit the Sudanese bar to plaintiffs relatedness requirement, because FINRA action against any registered investment under Section 13(a). has a broader regulatory mandate than company….solely upon the investment (P. Dubow) (SLC Ref. No. 2010-39-09) NASD and NYSE before it. The third- company…divesting from…investments party claims are significantly related to the in business operations in Sudan..” The Pendergest-Holt v. parties’ roles as members and associated District Court reasoned that this language Certain Underwriters at persons and the claims fall within a valid would have been unnecessary if there were Lloyd’s of London, arbitration agreement, requiring the no private right of action under Section No. 09-3712, 2010 U.S. Dist. LEXIS Court to grant a stay pending arbitration. 13(a), but the Ninth Circuit disagrees. The 86393 (S.D. Tex., 8/23/10). Possible inefficiency may occur because structure of the Investment Company Act Evidentiary Issues/Standards (Motions the relevant federal law requires piecemeal does not indicate that Congress intended In Limine; Hearsay Rules) * Expert resolution when necessary to give effect to to create an implied private right of action Testimony/Opinions * FRE: Federal an arbitration agreement. to enforce the individual provisions of the Rules of Evidence (Rules 803, 804 & (S. Anderson) (SLC Ref. No. 2010-41-01) Act. Congress expressly authorized the 807) * Insurance Issues (Advancing SEC to enforce all provisions of the Act by Defense Costs) * Indemnificiation/ Northstar Financial Advisors, granting the Commission broad authority Contribution. Inc. v. Schwab Investments, to investigate suspected violations. This Court denying motion in limine seeking No. 09-16347, 2010 U.S. App. LEXIS thorough delegation of authority to the SEC to preclude (i) use of plea agreement and cont’d on page 47 46 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 transcript of guilty plea proceeding of analysis were prepared after months of the Award does not prevent the Court former CFO of Stanford Financial Group extensive, complex and expensive work, from confirming the Award.” In fact, Company, and (ii) use of declarations and and included information from “highly CPLR 7511 provides only four grounds affidavits prepared by forensic accountant reliable sources,” the Court finds that on which an application to confirm an hired by Receiver for Stanford Financial the reports meet the factors required for Award may be denied (fraud; partiality; Group, based on findings that such items admission under F.R.E. 807. Namely, the exceeding powers; and “a failure to met hearsay exceptions and that no unfair reports and analysis had “circumstantial follow the procedures of CPLR Article 75. prejudice would result from the admission. guarantees of trustworthiness” and were Respondent does not allege any facts that Laura Pendergest-Holt and other former more probative than other evidence that fall with the four grounds…,” meaning the Stanford executives (“Respondents”) filed could be procured through reasonable application must be granted. a motion in limine seeking to preclude efforts, plus their admission would serve (ed: The sole Arbitrator’s Award in this certain evidence at a scheduled hearing the interests of justice. Finally, the Court matter provides more detail regarding on the issue of whether Underwriters at finds that the Respondents failed to show the nature of the dispute and the reasons Lloyd’s of London and Arch Specialty that they would suffer unfair prejudice why a direction to redeem was necessary. Insurance Co. (the “Underwriters”) would from admission of the Davis plea matters Pine Street evidently sought redemption be required to pay the Respondents’ or the accountant’s reports, but reserves in October 2008 (two months before the defense costs. The Respondents sought the right to entertain further argument and Madoff blow-up) and Southridge did to preclude Underwriters from using at analysis as to admission of particular items not respond formally until March 2009. the injunction hearing the plea agreement during the hearing, or in post-hearing Refusal to redeem immediately was based and transcript of the guilty plea proceeding briefing. upon contractual provisions and a claim of James Davis, a former Stanford CFO, (J. Ballard) (SLC Ref. No. 2010-41- of extraordinary circumstances pursuant or any of 22 declarations and affidavits 04) to the limited partnership Agreement. prepared by a forensic accountant and The Arbitrator found that “Respondents fraud examiner hired by the Receiver of the Pine Street Associates, LP v. failed to establish a credible evidentiary Stanford assets. The Court acknowledges Southridge Partners, LP, basis for the existence of those defined that Davis’s statements are hearsay, but No. 652109/2010 (N.Y. Sup. Ct., NY Cty., circumstances, or the reasonableness of admits the information that is against 3/3/11). their exercising discretion,” and ordered Davis’s penal and other interests under Award Challenge * Confirmation of full redemption, with pre-Award interest, the hearsay exception in Federal Rules of Award * Exceeding Powers * Standing/ 40% in 30 days and the remainder within Evidence (“F.R.E.”) 804(b)(3). However, Privity Issues (Mootness) * Timeliness 90 days, together with an accounting statements made by Davis that inculpate Issues. within 45 days “of Claimant’s interest and others are not admitted under the 804(b) That the directives of an arbitration position in Southridge….” The Award is (3) exception. The Court also finds that Award have been complied with and part of SAC’s Award Database and can be Davis’s sworn factual statements about performed does not constitute a defense to viewed at www.ARBchek.com, using the conduct in which he personally engaged confirmation of that Award. Award ID number.) (SLC Ref. No. 2011- satisfies the factors for admission under This is a short Opinion, ending in 11-03) the residual hearsay exception, F.R.E. confirmation of an AAA arbitration 807, because the plea-related factual Award (AAA ID #13-148-01042-09) for Popkave v. John Hancock statements had “circumstantial guarantees the redemption of a hedge fund interest Distributors LLC, of trustworthiness,” the statements were worth about $8 million. The Award was No. 10-3680, 2011 WL 382713 (E.D. Pa., more probative than any other evidence issued in January 2010 and Pine Street 2/7/11). then currently available through reasonable applied for confirmation in November Award Challenge (Nationality/Rational efforts, and the admission of the statements 2010, pursuant to CPLR 7510 and 7514. Basis) * Common Law Interpreted * would serve the interests of justice. The Respondents objected that the Award had Confirmation of Award * Derivative/ Court finds that the declarations, affidavits been performed and that the application Vicarious Liability * Exceeding Powers and exhibits prepared by the Receiver’s for confirmation was untimely. The * FAA (§10) * Liability Issues (Successor forensic accountant are admissible under Court does not explain the basis for the Liability) * Manifest Disregard of Law F.R.E. 807 to the extent that they contain untimeliness challenge, explaining only * Standard of Review. objective findings or other conclusions that New York’s CPLR 7510 allows one An arbitration Award, which is at least based on documents or other reliable year from delivery of the Award to file “barely colorable” based on the facts information. However, the Court does not for confirmation and this application was and the law, the result of confusion and admit reports of the forensic accountant filed within ten months. With respect uncertainty on the part of the arbitrators that include findings on ultimate facts to the objection to confirmation based as to the applicable law, but not completely potentially at issue in the litigation. Noting upon performance, the Court responds: irrational, does not exceed powers and is that the forensic accountant’s reports and “Respondents’ full compliance with not in manifest disregard of the law. cont’d on page 48 47 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

In response to petitioner’s request for vacated. According to the Court, though rated the securities, for losses resulting confirmation of an arbitration panel’s respondent challenged petitioner’s right from purchases of mortgage pass-through Award (FINRA ID #09-03616) of over to proceed against it, in each instance the Certificates, a form of collateralized $579,000, respondent John Hancock record indicates respondent’s emphasis debt obligation issued by the Goldman Distributors, LLC (“JH Distributors”) of facts rather than law, confusion and Sachs defendants in February and March moved to vacate on the ground that, uncertainty on the part of the arbitrators, 2006. The complaint alleged as to the in allowing the petitioner/claimant to and a governing legal standard that was Goldman Sachs defendants that the proceed against JH Distributors, an not at all apparent. Furthermore, the party offering documents mischaracterized affiliate of John Hancock Life Insurance to the original contract (JH Mutual) had the accuracy and reliability of the loan Company (“JH Life”), the arbitrators ceased to exist and the remaining potential underwriting behind the mortgage loans either (1) exceeded their powers or (2) respondents were corporate affiliates. securitized by the Certificates, and, as to acted in manifest disregard of the law. JH Though the arbitrators may have made the Rating Agency defendants, that the Distributors claimed that, unlike JH Life, factual or legal errors, in the absence of ratings did not accurately portray the risk the non-FINRA entity which mishandled clarity about the law, they could not have associated with the assets which secured the petitioner trustee’s request to reallocate manifestly disregarded it. The arbitrators’ the Certificates. Defendants moved to an annuity’s assets to the annuity’s money Award must therefore be confirmed. dismiss on pleading, standing and statute market account, or JH Life’s predecessor, (D. Franceski: Perhaps as interesting of limitation grounds. Turning first to John Hancock Mutual, which sold the as the lengths to which the Court goes the Rating Agency Defendants, the Court annuity to petitioners, it had nothing to to confirm the Award is the petitioner’s concludes that, though they may have do with petitioners or the annuity. While tactical decision to proceed against an played a significant role in the ability JH Mutual, the predecessor to JH Life and affiliate with no apparent role in the of the other defendants to market the the company that actually sold the annuity, matter, albeit the only JH affiliate over Certificates, under current law (which had been a FINRA member, its successor which FINRA had jurisdiction.) (SLC Ref. the Court hints it might not necessarily JH Life was not. JH Distributors, which No. 2011-12-01) agree with) they are neither underwriters underwrote annuities as an affiliate of JH nor participants in the underwriting and, Life but not the annuity at issue, is a FINRA Public Employees’ Retirement therefore, must be dismissed from any member. Petitioner apparently brought System of Mississippi 1933 Act claims. As to the Goldman Sachs the claim against JH Distributors in order (“MISSPers”) v. defendants, however, the Court concludes to invoke FINRA jurisdiction. Without Goldman Sachs Group, Inc., otherwise. Though the Court agrees that deciding whether manifest disregard is No. 09 CV 1110, 2011 WL 135821 (S.D. plaintiffs lack standing to pursue claims a viable ground for vacatur under the N.Y., 1/12/11). related to any trust from which they did FAA, the Court denies respondent’s 1933 Act (§§ 11, 12, 15 “Control”) * not actually purchase Certificates, they request on both grounds and confirms the Class Actions, Effects of * Culpability have adequately pled both Section 11 and Award. As the Court notes, review of an Standards * Duty of Inquiry * FRCP Section 12(a)(2) claims for those from arbitral Award is limited and deferential. (Rule 12(b) (6)) * Misrepresentations/ which they did. The decline in value of the As long as there is a “barely colorable” Omissions * Negligence, Actionable Certificates, even in a privately negotiated justification for the arbitrators’ decision, it * Pleading Requirements/Issues * transaction, establishes loss, and the failure must be upheld. Turning first to whether SEC Regulation AB, Section 1111 * to disclose in offering documents that the the arbitrators exceeded their powers, the Statutory Definitions (“Control Person” loan originators systematically disregarded Court concludes that, because respondent “Underwriter”) * Timeliness Issues loan origination underwriting standards did not dispute that petitioner could have (Statute of Limitations) * Standing/ in order to increase loan volume could arbitrated with respondents’ affiliates, it Privity Issues. be the basis of the “virtually absolute” was not “completely irrational” for the Plaintiffs’ 1933 Act claims that the liability imposed by section 11, and also arbitrators to conclude that JH Distributors registration statement and prospectus be sufficiently negligent to satisfy Section was a proper party. Moving on to manifest failed to accurately disclose that 12(a)(2) requirements. In so holding, the disregard, the Court finds that, because loan originators failed to follow loan Court also rejects the Goldman defendants’ (1) respondent did not adequately underwriting standards survive the contention that, because plaintiffs present the law regarding the legal dismissal motions of the Underwriting fail to allege that defendants actually distinction between, or successor liability defendants, but not the motions of the knew the loan origination guidelines of, respondent and its affiliate, (2) the Rating Agency defendants. were being disregarded, they satisfied arbitrators did not independently recognize Plaintiff MISSPers brought this putative their disclosure duties under Section the law, (3) the law was otherwise not class action under Sections 11, 12(a) 1111 of SEC Regulation AB regarding obvious, and (4) there were justifications (2) and 15 of the Securities Act of 1933 disclosure requirements for mortgage- in the record for the Award that are at least against defendant Goldman Sachs, its backed securities. Because defendants are barely colorable, the Award will not be affiliates and the Rating Agencies who alleged to have affirmatively misstated cont’d on page 49 48 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 the loan origination process, under the occasion, attempted to remove the case to County to dismiss the action. 1933 Act their actual knowledge is federal court and pursuant to the provisions (B. Wiand) (SLC Ref. No. 2011-08-05) immaterial. Nor are the 1933 Act claims of SLUSA to have the case dismissed. untimely. That similar Certificates were These tactics were unsuccessful and the Regions Morgan Keegan performing poorly or that publicly federal court remanded the case to state Securities, Derivative, and available documents had begun to report court, because there was not a sufficient ERISA Litigation, In Re: issues with loan underwriting guidelines number of plaintiffs involved in the case. Landers v. Morgan Asset in the subprime market, without a more Thereafter, the defendants moved to have Management, Inc., direct link to the Certificates and loans at the case dismissed, arguing that the state No. MDL 2009 08-2260, 2010 U.S. Dist. issue here, is not enough at this stage to court lacked jurisdiction since the claims LEXIS 101987 (W.D. Tenn., 9/24/10). conclude that Plaintiffs were on inquiry that were made were essentially claims Class Actions, Effects of (Derivative notice and obliged to investigate further. of a derivative nature and the plaintiffs Actions; Demand Futility) * Liability Finally the Court allows the Section 15 had not complied with Rule 23.1 of the Issues (Business Judgment) * control person claims to proceed against Alabama Rules of Civil Procedure. Those Product/Sales Practice Issues (CDOs: the Goldman defendants as well. Rules require that a demand be made Collateralized Debt Obligations). (D. Franceski) (SLC Ref. No. 2011-07- upon directors or comparable authority Under Maryland law, when a plaintiff 06) of the RMK funds prior to initiating a simultaneously argues that they have derivative action. The defendants in this made a demand on the board of directors Regions Financial Corporation, case sought an order of mandamus from and that demand is excused, the plaintiff’s Morgan Asset Management, the Supreme Court of Alabama, directing arguments that demand would be futile are Inc. and Kelsoe, Ex Parte: Rice that the action be dismissed for failing to mooted. v. RFC, In Re, comply with the demand requirement. The Plaintiff investors filed a derivative suit No. 1090425, 2010 Ala. LEXIS 183 (Ala. Alabama Supreme Court goes through an against Defendants for Defendants’ Sup. Ct., 9/30/10). exhaustive analysis with respect to what investments in collateralized debt Class Actions, Effect of (Derivative kind of claims can be brought directly obligations (“CDOs”). Plaintiffs argued Action) * Damages Calculations * and what kinds of claims must be brought that Defendants caused the firm to make Notice Requirement (Demand Futility). derivatively. In this regard, the Court finds investments in CDOs, in several of the An independent wrong and damages that, where the damage alleged by the firm’s funds, which exceeded the limits separate and apart from the damage plaintiffs is dependent upon damage to the of the funds’ prospectuses. Plaintiffs done to the issuer corporation must corporation and there is no independent made a demand on the previous board be demonstrated to avoid having the harm to the plaintiffs, the claim must be of directors, but a new board of directors class action dismissed as an improperly brought derivatively. The Court notes was appointed prior to the filing of the instituted derivative action. that, in certain circumstances, where complaint. Plaintiffs argued that it made a This decision arises from the appeal of a breach of fiduciary duty by directors demand upon the new board of directors the Jefferson County, Alabama Circuit was alleged and there was a direct duty and also, in the alternative, that demand Court denying the motion of Regions to the shareholders, that a direct action upon the new board of directors is futile. Financial Corporation (“RFC”), Morgan might proceed. However, in this case, Defendants filed a motion to dismiss or, Asset Management, Inc. (“MAM”), and the wrongful actions alleged were the in the alternative, a motion to stay the employee James Kelsoe (“Kelsoe”) to mismanagement of the funds by MAM action until the board of directors could dismiss an action brought by a number and the only possible method to bring investigate Plaintiffs’ claims. The Court of individuals based upon the collapse of an action against them was through a denies Defendants’ motion to dismiss, six Regions Morgan Keegan investment derivative action and not a direct action. but grants their motion to stay the action funds. The individuals had invested in Having made the determination that the pending the response of the board of these mutual funds and, due to the over action was one that had to be brought directors to Plaintiffs’ complaint. The concentration of the funds’ investments derivatively, the Court notes that Rule pivotal issue in the case is the effect of in sub-prime mortgage-based securities, 23.1 states that, in order to maintain a Plaintiffs’ having pled that they made a the underlying investments in the funds derivative action, the plaintiff must allege demand on the new board of directors. became valueless and the funds collapsed. with particularity the efforts, if any, made The Court finds that under Maryland The plaintiffs lost almost their entire by the plaintiff to obtain the action the corporate law, a party is prohibited from investments. They alleged that these plaintiff desires from the directors or simultaneously pleading that demand damages were due to mismanagement comparable authority. In light of the fact was made and also that it is excused. The of the funds, the improper valuation that there was no evidence, either alleged Court states that demand is an either/or of the funds, and various other acts of or presented of any such efforts, the Court proposition, and a derivative plaintiff may misconduct of MAM, Kelsoe, and RFC. grants the requested order of mandamus not stand neutral by making a demand and Initially, the defendants, on more than one directing the Circuit Court for Jefferson continuing to argue that demand is futile. cont’d on page 50 49 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Plaintiffs admitted that the new board from 1996 through 2005 to have engaged September 25, 2002, the civil fine that was of directors is qualified to exercise its in an ongoing scheme involving bribing ordered against him was appropriate. With business judgment about whether the suit the State Treasurer of New Mexico in respect to the disgorgement, that sanction should go forward based upon Plaintiffs’ order to secure brokerage business from was not a “fine, penalty, or forfeiture,” affirmative decision to argue that demand the state. The evidence submitted during as described in the statue of limitations was made. Under Maryland corporate law, the administrative proceeding included and thus was not barred by that statute. the new board of directors is required to lengthy testimony from the former New Similarly the cease-and-desist order and affirmatively state its position on Plaintiffs’ Mexico Treasurer, Michael Montoya, who other sanctions ordered against Riordan suit, after an investigation, regardless of in the interim had pled guilty to federal were not fines, penalties, or forfeitures whether Plaintiffs made demand on it. criminal violations. Montoya described and no time limitation bars the imposition Thus, Plaintiffs’ argument that demand is regular and repeated kickbacks paid by of those sanctions. The Court of Appeals futile is moot if the Plaintiff also argues Riordan in order to secure the brokerage affirms the Commission’s order. that it made a demand upon the board of business. The Court of Appeals had little (B. Wiand) (SLC Ref. No. 2011-09-07) directors. The Court orders a stay of the problem in finding that the Commission’s action until the board of directors responds evidence presented at trial was RK Company v. See, to Plaintiffs’ complaint within the time overwhelming. Riordan also claimed that No. 07-3894, 2010 U.S. Dist. LEXIS period prescribed by the Court. he had been prohibited from presenting 19666 (7th Cir., 9/22/10). (P. Michaels) (SLC Ref. No. 2010-40-04) certain evidence relating to the fact that Attorney Fees * FRCP: FRCP: Federal he had himself reported the misconduct Rules of Civil Procedure (Rule 17(a)) Riordan v. SEC, of Montoya and that Montoya’s testimony * Liability Issues (SEC Filings) * No. 10-1034, 2010 U.S. App. LEXIS against him should not be believed, Misrepresentations/Omissions * 26277 (D.C. Cir., 12/28/10). because it was in retaliation for Riordan Remedies (Prejudgment Interest) * Enforcement Procedures/Practice having blown the whistle. The Court of Standing Issues * Reliance/Transaction * Evidentiary Standards (Burden Appeals in reviewing the record finds that Causation * Waiver. of Proof) * Sanctions (Regulatory) there is no evidence that Montoya had A party that successfully prosecutes a * Timeliness Issues (Statutes of known that Riordan turned him in and, claim under federal law is presumptively Limitations) * Sales Practice/Product thus, that evidence would not support entitled to prejudgment interest. Issues (Municipal Securities; Pay to any retaliatory action by Montoya. In Defendant See was the founder of a Play) * Federal Statute Interpreted (28 addition, the Court of Appeals notes that in pharmaceutical company that was U.S.C. §2462). administrative proceedings, the “harmless developing products to treat sexual The applicable statute of limitations for error” rule applies and that, in light of the dysfunction. The company issued various fines, penalties and forfeitures that may overwhelming evidence against Riordan, press releases concerning the progress result from regulatory actions does not failing to allow this evidence was harmless of developing these products, as well as apply to the remedies of disgorgement or error. Finally, Riordan complained that filing forms with the SEC that mentioned cease-and-desist orders. much of the conduct for which he was the same. The press releases and SEC This decision of the United States Court being sanctioned occurred outside the filings contained misstatements of facts. of Appeals for the District of Columbia five-year statute of limitation that applies Nevertheless, See signed the SEC filings reviews a decision of the Securities to SEC actions. The Court notes that the and approved the press releases. Plaintiff and Exchange Commission (“SEC” or action was filed on September 25, 2007 RK Company, described as the “investment “Commission”), upholding the ruling and that the conduct of Riordan occurred vehicle” for an individual named Robert of an administrative law judge barring both before and after that date. The statue Krilich, purchased $500,000 worth of Guy P. Riordan (“Riordan”) from being of limitations that applies is 28 U.S.C. stock in See’s company. Krilich reviewed associated with a broker/dealer, entering §2462, which states that “an action, the false SEC filings and press releases a cease-and-desist order against him, and suit or proceeding for the enforcement before making the investment. The FDA entering monetary sanctions, including of any civil fine, penalty or forfeiture, eventually began investigating See and disgorgement and civil penalties. pecuniary or otherwise, shall not be his company, leading to the company’s Riordan’s appeal from the decision of entertained unless commenced within five bankruptcy and demise. Plaintiff RK the Commission was substantially based years from the date when the claim first filed suit against See personally, alleging upon his claim that, in the administrative accrued.” Riordan argued that much of the claims under federal and state securities proceeding, the Commission had not disgorgement that he was ordered to pay laws, state deceptive practices law and presented sufficient evidence to support related to transactions that occurred prior to common law fraud. After a bench trial, some of its claims and sanctions and that September 25, 2002 and that he was being the district court entered judgment in certain of the sanctions were applied to fined for acts that occurred before that favor of plaintiff, including prejudgment conduct that had occurred outside the date. However, the Court of Appeals finds interest and attorneys’ fees. See challenges statute of limitations. Riordan was alleged that, because his conduct continued after the judgment on appeal on a variety of cont’d on page 51 50 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 grounds, but the Seventh Circuit affirms reflects more than 100 Awards in which Mr. retroactive application is impermissible. the district court’s judgment in all respects. Sacks is named as a party representative; Statutes are applied retroactively only in See argues that plaintiff “RK Company” almost half of those Awards issued since circumstances where Congress has been was not the real party in interest, since it 2000 and, in 2010. Mr. Sacks is listed in express in that intention and retroactive was not a formal legal entity but rather three Awards. Thus, he has maintained application is disfavored. Here, Mr. Sacks Robert Krilich doing business as RK this NAR “practice” both before and after was barred from the industry, yet his bar Company. While the law requires suits FINRA adopted restrictions that, if applied stated nothing regarding his capacity as a to be prosecuted by the real party in to Mr. Sacks, would have prevented him NAR in securities arbitrations. Thereafter, interest, See waived that argument by not from operating in the FINRA arbitration this new FINRA rule purported to bar raising it until trial. See’s challenge to forum. FINRA does not oppose non- him from a further activity that he had the judgment as not being supported by attorney representation per se, unless state previously been permitted to pursue. sufficient evidence likewise is rejected. restrictions would prevent NARs from Thus, retroactive application is apparent Plaintiff presented credible evidence that practicing, but, in April 2007, FINRA and, in these circumstances, it is also See approved the press releases, that he proposed a rule change that the SEC impermissible. “We hold that the rule here had knowledge of the information in approved, which, as the Ninth Circuit put cannot be applied retroactively.”(SLC Ref. the SEC filings and that his signature it in this decision, “prohibits non-attorneys No. 2011-10-10) accompanied the SEC filings. In contrast, who have been banned from the securities See’s testimony, such as his statement industry from representing parties in SEC v. Earthly Mineral that he read and approved the first and securities-related arbitration.” During the Solutions, Inc., third paragraphs of a press release, but public comment period, Mr. Sacks wrote No. 2:07-CV-1057, 2010 U.S. Dist. LEXIS missed the second paragraph entirely, was to the SEC, objecting that the FINRA rule 1019872 (D. Nev., 9/24/10). not credible. As for See’s challenge to change would be impermissibly applied Criminal Issues (Plea, Effect of) * the district court’s award of prejudgment retroactively, were he to be barred from Enforcement Practices/Procedures interest and attorney’s fees, those are practice in the forum. According to the * Collateral Estoppel/Res Judicata rejected as well. A party who successfully Ninth Circuit, which is responding to (Default Judgment) * Statutory prosecutes a claim under federal law is Petitioner Sacks’ request for review, “the Definitions (“Actually Litigated”) presumptively entitled to prejudgment SEC’s Division of Market Regulation * Parallel Proceedings * Standing/ interest. The award of attorney’s fees rejected Sacks’ protest” and approved Privity Issues (Offensive, Non-Mutual here was also proper, particularly since the rule change. The SEC makes the Collateral Estoppel). See failed to specify his objections to jurisdictional objection that Petitioner Guilty pleas in a criminal action suffice defendant’s fee petition. has not exhausted his administrative to support the application of collateral (J. Komie) (SLC Ref. No. 2010-41-11) remedies. The Administrative Procedures in a civil enforcement action; active Act requires those challenging rules and participation in a related civil proceeding Sacks v. SEC, procedures of governmental agencies to also suffices, even if the case ends in a No. 07-74647 (9th Cir., 2/22/11). exhaust administrative remedies before default judgment, so long as the defendant Jurisdiction Issues (Rulemaking moving in court for review. In this case, a actively participated in defense of the Review) * Standing/Privity Issues special statutory review scheme has been claims. * Remedies (Exhaustion of) * adopted by Congress (15 USC §78y) that Three defendants, all accused of securities Federal Statutes Interpreted (APA: governs review of rules proposed by SROs fraud in connection with a Ponzi scheme, Administrative Procedures Act; and this makes the APA inapplicable are faced in this decision with the 15 U.S.C. §78y; 17 CFR 201.430) * to these circumstances. The exhaustion prospect of partial summary judgment, Constitutional Issues (Retroactive requirement in 75y(c)(1) allows circuit as a consequence of parallel proceedings. Application) * Representation Issues court review only after the objection has The charges against the trio are that they (Non-Attorney Representatives) * been “urged before the Commission or defrauded investors in Earthly Mineral Statutory Definitions (“Urged”). there was reasonable grounds for failure to Solutions and Natural Minerals Processing A non-attorney representative is exempt do so.” The D.C. Circuit has held that an Company into investing approximately from forum restrictions upon NAR objection to the rule during the rulemaking $20 million and that, in connection appearances in FINRA arbitrations, process satisfies the “urged” predicate for with those sales, engaged in securities where the restrictions were adopted after judicial review to ensue. Here, Mr. Sacks registration and broker registration he was engaged in active representation. objected during the comment process violations. The SEC seeks summary Richard Sacks is subject to a bar from and the SEC responded to his objection judgment only in connection with the association with a broker-dealer. Mr. Sacks in its approval order. Nothing more is Section 17 (1933 Act) and Section 10 has also represented parties in FINRA jurisdictionally required to place the issue (1934 Act) fraud charges and does so and other SRO arbitration proceedings before this Court. Reaching the merits on the basis of criminal convictions of for many years. SAC’s Award Database of Sacks’ petition, the Court agrees that Defendants Schwartz and Higgs and a cont’d on page 52 51 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

civil judgment against Defendant Lawton. unless there is a just reason to grant SEC v. Payne, The issue before the Court is the reach the motion. No. 1:00 cv 1265, 2010 U.S. Dist. of collateral estoppel in resolving the The SEC brought suit against four LEXIS 136105. (S.D. Ind., 12/23/10). contested elements of the alleged fraud defendants---Loomis, Hagener, Loomis Collateral Estoppel/Res Judicata * violations. To apply collateral estoppel Wealth Services (“LWS”), and Lismar Parallel Proceedings * Criminal Issues based on the criminal convictions, the Financial Services LLC (“Lismar”). * Enforcement Practice/Procedure Court must find: (1) a substantial overlap Loomis and Hagener answered the * Injunctive Relief * Sales Practice/ in the evidence or issues; (2) the same complaint. LWS and Lismar, which are Product Issue (Money Laundering) * applicable rule of law; (3) overlap in corporations controlled, respectively, by Waiver. pretrial preparation and discovery; and Loomis and Hagener, did not. The SEC Collateral estoppel may be applied in civil (4) closeness in the relationship between moves for default judgments against cases to issues previously determined in a the claims. The two actions stem from LWS and Lismar. The Court denies the criminal conviction; a criminal conviction the same set of underlying facts and both motion without prejudice. With respect based on a guilty plea conclusively charge federal securities act violations. to multi-defendant cases, FRCP 54(b) establishes for purposes of subsequent While the criminal action was settled by provides that “the court may direct entry civil proceedings that the defendant guilty pleas, the admissions by Messrs. of a final judgment as to one or more, but engaged in the criminal act for which he Schwartz and Higgs satisfy all elements fewer than all, claims or parties only if was convicted. of the civil fraud charges and, thus, there the court expressly determines that there The SEC filed this civil action against is no need to re-litigate those issues. The is no just reason for delay.” Here, there is Payne one month before he was indicted civil matter involving Defendant Lawton “no just reason for delay,” such that entry for mail fraud and 20 counts of money as a defendant did not involve the SEC, of judgment against LWS and Lismar laundering. Payne later pled guilty to but under the doctrine of offensive non- prior to the adjudication of the claims five counts of mail fraud and to one mutual collateral estoppel, the SEC can against the remaining defendants would count of money laundering. The SEC assert the preclusive effect of the first be appropriate. As to plaintiff’s first, moved for summary judgment in the action. Moreover, that may even be the second, third, and sixth claims for relief, civil case, arguing that, because Payne case where the first action resulted in a which are asserted against all defendants, pled guilty to the underlying allegations, default judgment, as long as the defaulted LWS and Lismar are similarly situated. he was collaterally estopped from re- party actively participated in the litigation The same is true for Hagener and Lismar litigating those issues. The Court agrees. or had a reasonable opportunity to defend, with respect to plaintiff’s fourth and fifth Federal preclusion law determines the but declined to do so. The earlier case claims. As to each of these claims, plaintiff preclusive effect of a federal criminal ended with a default judgment based upon has alleged liability as to a non-responding proceeding. Collateral estoppel may be non-cooperation of defendants and failure defendant that overlaps with the alleged applied in civil cases to issues previously to comply with discovery requirements. liability of a defendant who has appeared determined in a criminal conviction. A Despite Defendant Lawton’s claim that and intends to defend himself. To the criminal conviction based on a guilty the charges against him were, therefore, extent that claims are ultimately resolved plea conclusively establishes for purposes not “actually litigated” in the prior suit, in favor of Loomis or Hagener, there is of subsequent civil proceedings that the the record shows that Mr. Lawton filed a not insignificant risk of incongruous or defendant engaged in the criminal act for over thirty pleadings and that the case inconsistent judgments were the Court which he was convicted. The SEC alleged proceeded for two years. The requested to determine at this relatively early stage that the facts underlying Payne’s criminal judgment is, therefore, granted. (SLC Ref. of the proceedings that LWS and Lismar convictions conclusively established the No. 2010-39-08) are liable for the same violations of the elements of the counts in the civil action. securities laws that are alleged against In responding to the SEC’s motion, SEC v. Loomis, Loomis and Hagener. Plaintiff may very Payne was required to identify potentially No. 2:10-cv-00458, 2010 U.S. Dist. well have valid claims against LWS and determinative facts and support them LEXIS 87021(E.D. Cal., 8/24/10). Lismar that are ultimately appropriate for with admissible evidence or the SEC’s Motion Practice (Default Judgment) entry of default judgment. However, given supported facts would be admitted to * Remedies * Enforcement Practices/ the overlapping nature of the claims as to exist without controversy. Pro se litigants Procedures * FRCP (Rule 54). different defendants and the current stage are subject to the same waiver rules as In a multi-defendant case, where of the proceedings, there is just reason for represented parties. Because Payne failed claims against all defendants overlap delay in entering default judgment against to identify any specific material fact in and where some of the defendants fail the two non-responding defendants. Thus, dispute, the factual basis underlying his to answer the complaint, a motion the motion is denied without prejudice, guilty plea established the elements of the for default judgment against the non- subject to re-filing the motion at a more counts in the civil action. responding defendants will not be appropriate time. (W. Nelson) (SLC Ref. No. 2011-08- granted prior to trial of the matter, (P. Dubow) (SLC Ref. No. 2010-42-09) 06) cont’d on page 53 52 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

SEC v. Payne (Danker), (Disgorgement) * Enforcement Prac- fraud. It is also irrelevant whether Salyer or No. 1:00 cv 1265, 2010 U.S. Dist. LEXIS tice/Procedure * Account Administra- one of his companies actually took control 136108 (S.D. Ind., 12/23/10). tion (Forgery) * Selling Away. The of the funds, because Salyer had admitted Collateral Estoppel/Res Judicata * purpose of disgorgement of profits that he controlled those entities. The Court Enforcement Practice/Procedure * acquired through securities fraud is to assesses the full amount requested by the Injunctive Relief . force a defendant to give up the amount SEC and enters judgment accordingly. Collateral estoppel may be applied in civil by which he was unjustly enriched, rather (J. Ballard) (SLC Ref. No. 2010-40-06) cases to issues previously determined in a than to compensate the victims of his criminal conviction; a criminal conviction fraud. SEC v. Scoppetoulo, based on a guilty plea conclusively The Securities and Exchange Commission No. 10-20475-Civ-Cooke/Bandstra, establishes for purposes of subsequent (“SEC”) brought a civil complaint 2011 U.S. Dist. LEXIS 7819 (S.D. Fla., civil proceedings that the defendant against defendant Mark Salyer, alleging 1/27/11). engage in the criminal act for which he violations of the anti-fraud provisions of Enforcement Practices/Procedures was convicted. the federal securities laws. The complaint * Trading Issues (Insider Trading) * Danker was indicted for mail fraud and sought declaratory relief, disgorgement Culpability Standards * Materiality * money laundering. Danker pled guilty of all profits or proceeds that he and his Pleading Requirements * FRCP (Rule to two counts of mail fraud and to one companies received as a result of the fraud, 9). count of money laundering. In the civil and civil penalties. The SEC alleged that The materiality of non-public information enforcement action, the SEC moved for Salyer forged customer signatures on wire is mostly a question of fact and difficult to summary judgment arguing that, because transfer forms and convinced customers assess at the pleading stage; generally, Danker pled guilty to the underlying to invest in real estate ventures through a a decision on materiality must await allegations in the criminal case, he was company that he controlled. Salyer entered discovery and the summary judgment collaterally estopped from re-litigating into a consent judgment agreeing to a stage. those issues. The court agrees. Federal permanent injunction and providing that This decision of United States District preclusion law determines the preclusive the amount of his disgorgement would be Court Judge Marcia G. Cooke denies a effect of a federal criminal proceeding. set by the Court. The agreed order provided motion to dismiss by several defendants Collateral estoppel may be applied in civil that “the court shall order disgorgement in an SEC enforcement action alleging cases to issues previously determined in a of ill-gotten gains, prejudgment interest insider trading. The Commission alleged criminal conviction. A criminal conviction thereon, and a civil penalty,” pursuant to that before the release of financial based on a guilty plea conclusively § 20(d) of the Securities Act and § 21(d) information by World Fuel Services establishes for purposes of subsequent civil (3) of the Exchange Act. Salyer also Corporation (“World Fuel”) in May and proceedings that the defendant engaged agreed that he would be precluded from August of 2007, certain of the defendants in the criminal act for which he was arguing that he did not violate the Federal purchased shares of World Fuel options convicted. The SEC alleged that the facts Securities laws as alleged in the complaint. and stock and profited from the increase underlying Danker’s criminal convictions The Court notes that disgorgement in price. Defendants Scoppetoulo and conclusively established the elements of constitutes the giving up or divestment of White were executives of World Fuel the counts in the civil action. In responding ill-gotten funds flowing from a defendant’s and were alleged to have tipped off other to the SEC’s motion, Danker was required unlawful conduct. The purpose is to force defendants in the case, including securities to identify potentially determinative facts a defendant to give up the amount by broker Sarang Ahuja, with respect to and support them with admissible evidence which he was unjustly enriched and to the contents of financial information or the SEC’s supported facts would be deter others from violating the securities that was to be released by the company, admitted to exist without controversy. Pro laws, rather than to compensate the thereby allowing the other defendants to se litigants are subject to the same waiver victims of fraud. The remedy is equitable profit from their knowledge of material rules as represented parties. Because and the amount need only be a reasonable non-public information. The defendants Danker failed to identify any specific approximation of profits causally moved to dismiss the complaint for failure material fact in dispute, the factual basis connected to the violation. Salyer argued to state a cause of action, arguing that the underlying his guilty plea established the that the amount of disgorgement sought complaint did not allege materiality of elements of the counts in the civil action. by the SEC, $5.7 million, was excessive, the information disclosed, did not allege (W. Nelson) (SLC Ref. No. 2011-11-08) because some of the money taken was requisite scienter, and failed to satisfy the never under his control and still existed in particularity requirements of Rule 9(b) SEC v. Salyer, the client’s accounts. The Court finds this of the Federal Rules of Civil Procedure. No. 2:08-cv-179, 2010 U.S. Dist. LEXIS argument irrelevant, given the fact that In reviewing the defendant’s motion, the 85545 (E.D. Tenn., 8/18/10). the purpose of disgorgement was not to Court examines the question of whether 1933 Act (§17 & §20 (d)) * 1934 Act (§10 compensate the victims, but to force the or not the information that was allegedly “Rule 10-b”) & (§21(d)(3)) * Remedies defendant to give up the proceeds of his provided to the individuals who traded cont’d on page 54 53 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

the stock was material and also whether Collateral Estoppel/Res Judicata * the factual and legal bases of the SEC’s the information was “non-public.” The Enforcement Practice/Procedure * Section 17 (a) and Section 10 (b) claims, Court finds that the information allegedly Injunctive Relief * Misrepresentations/ rejects defendant’s arguments and grants disclosed may have been such as to alter Omissions * Parallel Proceedings the motion. First, the Court finds that the the total mix of information available (Criminal) * Product/Sales Practice SEC complaint was not an exhaustive to investors. Since the Court could not, Issues (ARS: Auction Rate Securities). recitation of every victim of defendants’ at the pleading stage, determine that a The SEC may use “offensive collateral fraudulent scheme and, therefore, must reasonable person could not determine that estoppel” to obtain summary judgment in be read to encompass the same corporate the information was not significant, it was an enforcement action where defendant customers named in the criminal action. inappropriate to dismiss the case. With was previously found guilty by a jury of It is the nature of the fraudulent conduct, respect to whether or not the information the same fraudulent conduct, even if the and not the specific identities of the was non-public, because it came from criminal conviction is on appeal. customer companies, which is relevant to executives of the company, including the Plaintiff SEC brought a civil enforcement the collateral estoppel analysis. Second, CFO of World Fuel, the Court believes that action against defendants for violations of the existence of appellate issues, based on a reasonable person would have known Section 17 (a) of the 1933 Act and Section allegedly erroneous rulings in the criminal that the information was inaccessible to 10(b) of the 1934 Act for misrepresenting, action, which Butler has appealed, does an ordinary investor. Moreover, the timing in the sale of over $1 billion of auction rate not defeat collateral estoppel. The appeal of the phone calls and text messages securities (“ARS”), that they were backed of a criminal conviction does not deprive that provided the information, vis-à- by federally guaranteed student loans, a judgment of its preclusive effect. Finally, vis the trading by the other defendants, when in fact they were collateralized the Court concludes that injunctive relief indicates that they clearly appreciated the by subprime mortgages, CDO’s, mobile is appropriate because there is a substantial significance of the information. The Court home contracts and other non-guaranteed likelihood that Butler will commit future finds that the defendants’ argument that collateral. Following defendant Tzolov’s violations based on (1) the egregiousness scienter had not been adequately pled is agreement to a Consent Order, the SEC of the violations, (2) the “high degree” also insufficient. Proof of knowledge that moved for summary judgment against of scienter, (3) the repeated nature of the information was non-public and material defendant Butler based on the collateral violations, and (4) Butler’s apparent lack gives rise to a strong inference of scienter. estoppel effects of a jury verdict finding of remorse—which, according to the The suspicious timing of communications Butler guilty of conspiracy to commit Court, is evident by his conduct, including and trading supports that inference. Thus, securities fraud, securities fraud, and his “almost frivolous” opposition to the the Court concludes that the SEC has conspiracy to commit wire fraud in a SEC’s motion. sufficiently pled scienter. Finally, with parallel criminal proceeding based on the (D. Franceski) (SLC Ref. No. 2011-09- respect to whether or not the allegations of same fraudulent ARS sales. “Offensive 08) fraud have been alleged with particularity, collateral estoppel” bars a defendant from as required by Rule 9(b) of the Federal re-litigating an issue when (1) the issues SIPC v. Bernard L. Madoff Rules of Civil Procedure, the Court finds in both proceedings are identical, (2) the Investment Services, Inc., that the complaint alleged suspicious issue was actually litigated and decided, No. 08-01789 (Substantively Consoli timing of phone calls and text messages; (3) there was a full and fair opportunity dated), 2010 U.S. Dist. LEXIS 81492 the proximity of the defendants obtaining to litigate the issue, and (4) the issue was (S.D. N.Y., 8/6/10). the information and the subsequent necessary to support a valid and final Bankruptcy Issues * Enforcement trades; specific trades that were made in judgment on the merits. Defendant Butler Practice/Procedure (SIPC Trustee) * advance of the earnings announcements; opposed the SEC’s motion on the ground Receivership/Trust/Estate (Trustee Fees) and defendants’ prior trading history. All that the issues in the criminal action * Disclosure Issues (Conflicts of Interest) of these factors demonstrated sufficient were not identical, not actually decided, * Appealability (Interlocutory Order) * particularity for the Commission’s and not necessary to support a valid and SIPA of 1970 (Constitutionality; Due allegations to survive the defendant’s final judgment because the jury in the Process). Rule 9(b) challenge. Having made these criminal proceeding rendered a general The appeal of an interlocutory order findings, the Court denies the defendants’ verdict on an indictment which covered will only be permitted in exceptional motions to dismiss the Commission’s misrepresentations to two corporate circumstances, if there is a question of complaint. customers who were not included in controlling law and the determination will (B. Wiand) (SLC Ref. No. 2011-07-07) the allegations of the SEC complaint. aid the resolution of the underlying action According to the Court, defendant as a whole, SEC v. Tzolov and Butler, “speculates” that the general verdict may, This decision relates to the repeated No. 08 Civ. 7699, 2011 U.S. Dist., LEXIS therefore, not have addressed the four objections filed by certain Madoff 8562 (S.D. N.Y., 1/26/11). 1933 Act (§ other customers that were the subject of claimants to fee requests submitted by 17) * 1934 Act (§ 10 “Rule 10b-5”) * the SEC complaint. The Court considers Irving Picard (“Trustee”) and Baker & cont’d on page 55 54 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Hostetler LLP (“B&H”), the law firm that there is not any significant question as placed a restriction on the transfer of represents him in connection with his task to controlling law. The Court must give Muller’s stock certificates. Nevertheless, as SIPC Trustee, for services rendered due consideration to the nature, extent, Muller deposited the shares with in the resolution of the aftermath of the and value of the services rendered and Ameritrade and attempted to sell them. Madoff Ponzi scheme fraud. The investors under SIPA must place considerable Ameritrade checked with NATCO, was who brought this objection initially reliance on the recommendation of SIPC informed of the freeze, and returned the challenged the method that the Trustee in determining fees. This had occurred shares to Muller. Ameritrade made an was utilizing to determine the amount in this case and there was little that was entry in Muller’s account that a court order of approved claims. Next, they began to inappropriate about this determination. prevented the sale of the shares. In June challenge each of his fee applications by The Court does not accept the Movant’s 2004, Muller deposited shares of Save the alleging that the Trustee had significant argument that Congress had impermissibly World Technologies (“STWT”) into his conflicts of interest because of his loyalty created a statutory scheme that was Ameritrade account. NATCO was also the to SIPC, as opposed to the interests permeated by a partiality and by conflicts transfer agent for STWT and, since STWT of the claimant creditor victims of the of interest; it is beyond dispute that the was never the subject of any court order, Madoff scheme. The Court has previously Securities Investor Protection Act affords NATCO cleared the transfer, and Muller examined these claims and determined that creditors due process. The Movants sold the shares. However, Ameritrade’s there was no conflict, as the bankruptcy raised the question that, since the entry stock broker apparently confused STWT court had initially held a hearing and of the Trustee in the New Jersey action with STWA and made the following entry determined the disinterestedness of the had occurred after the determination of in Muller’s account: “There was a court Trustee and B&H. The third objection disinterestedness, that that determination order prohibiting the shares from being related to a fee petition and asserted should not be binding. However, the Court transferred into street name. We returned that the Trustee had entered an action notes that further matters with respect to the shares to the client in November brought by the objectors in New Jersey this issue would require significant factual 2002. In June 2004, he deposited the and obtained an injunction regarding the determinations; in light of the necessity shares again. They are clear now and I claims of objections against SIPC. They of factual determinations, the matter was called the transfer agent to verify that the claimed this action demonstrated a conflict one that should not be determined on an shares had been transferred.” In December of interest with the investor plaintiffs who interlocutory appeal. The Court denies all 2006, Muller once again deposited the had sued SIPC directly in the New Jersey motions to allow an interlocutory appeal SWTA shares into his account. Without action. This objection was also denied by of the orders granting the fee petitions of contacting NATCO and relying on the the bankruptcy court. On appeal, the Court Trustee Picard and B&H. June 2004 account entry, Ameritrade reviews the standards as to whether or (B. Wiand) (SLC Ref. No. 2011-09-09) allowed Muller to sell the shares and not an interlocutory appeal under Section remove the sale proceeds from the 129(b) was appropriate. The Court finds TD Ameritrade, Inc. v. account. But, when Ameritrade presented that, in order for an appeal to be appropriate, The Nevada Agency and the shares to NATCO for transfer to street there must be a controlling question of law Trust Company, name, NATCO refused to transfer them, as to which there is substantial ground for No. 3:08-cv-00245-LRH-RAM, 2010 because the 2002 injunction was still in difference of opinion and the Movant must U.S. Dist. LEXIS 94781 (D. Nev., 9/9/10). effect. Ameritrade was then forced to show that an immediate appeal from the Account Administration (Stock cover the resulting short in the account at a order may materially advance the ultimate Transfers) * 1933 Act (Securities cost to it of $365,405. It then sued NATCO termination of the litigation. Moreover, the Registration; Restrictive Legends) because of the latter’s failure to effect Movant must demonstrate the existence of * Culpability Standards (Actual the transfer. NATCO filed a motion for “exceptional circumstances” to overcome Knowledge) * Trading Issues (Transfer summary judgment. The issue before the the general aversion to piecemeal Restrictions). Court was whether Ameritrade had actual litigation and to justify a departure from A transfer agent is not responsible for knowledge of the restriction on the STWA the basic policy of postponing appellate a holder’s mistaken belief that a prior shares. Ameritrade argued that it had no review until the entry of a final judgment. restriction on the transfer of a stock such knowledge, because it relied on the With respect to the issue of the conflicts of certificate had been removed. account entry made by its employee. The interest, the Court believes that the prior In July 2002, the Southern District of Court disagrees and rules that Ameritrade determination of disinterestedness had New York issued a temporary restraining had actual knowledge of the restriction. already been ruled upon in the case. In order (later converted into a preliminary Ameritrade was informed of the restriction addition, the Second Circuit in Securities injunction) prohibiting Guy Muller from in July 2002 and duly noted it. While the and Exchange Commission v. Oxford transferring 500,000 shares of Save the notes in Muller’s account also indicate Securities, Ltd., has ruled that Securities World Air (“STWA”). Accordingly, that, in 2004, the SWTA shares had Investor Protection Act provisions relating STWA’s transfer agent, The Nevada been cleared for transfer, it is undisputed to these issues are constitutional. Thus, Agency and Trust Company (“NATCO”), that this information was incorrect. No cont’d on page 56 55 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

evidence before the Court suggests that A short time later, and wholly separately Appealability (Standing) * Privity/ this mistake falls on any entity other from the Parklex proceeding involving Standing Issues * Statutory Definitions than Ameritrade and Ameritrade has not RBC Dain, Royal Bank of Canada, the (“Solely”). presented evidence indicating that, despite parent company of RBC Dain, extended The applicability of the broker-dealer its error, it has acted with due diligence. a significant line of credit to Deutsch, exception to the IAA hinges upon whether (P. Dubow) (SLC Ref. No. 2010-40-02) utilizing the funds in the RBC Dain the advice in question relates to or is securities account as collateral; Deutsch connected with the broker-dealer’s The Scher Law Firm, as Nominee now owes a large sum to Respondent RBC primary business, not upon the quantum and Claimants’ Representative Bank as the result of his use of this credit or importance of the advice. v. DB Partners I LLC, RBC line. Petitioners seek to preclude RBC’s We have previously summarized two Capital Markets Corporation, attachment of these funds, alleging, in earlier decisions in this case (SLAs Royal Bank of Canada, essence, that, at the time it extended its 2008-45 and 2009-38). This case of No. 24633/09, 2011 N.Y. Misc. LEXIS line of credit to Deutsch, RBC’s banking first impression among the federal 142 (N.Y. Sup. Ct., 1/28/11). affiliate had either actual or implied appellate courts centers around the State Statutes Interpreted (NY CPLR knowledge of the Parklex partners’ claims proper interpretation of the broker-dealer 5225(b); UCC 8-510(a)) * Liability to the funds in the RBC Dain accounts. exception to the Investment Advisers Act Issues (Imputed Knowledge; Corporate In denying Petitioners’ motion, the (“IAA”). That exception exempts brokers Subsidiary) * Account Administration Court rejects Petitioners’ claim that any and dealers who give investment advice so * Collection Issues (Debtor-Creditor knowledge possessed by the securities long as (1) the advice is solely incidental to Law: Notice of Claims) * Remedies arm of RBC, RBC Dain, must be imputed their conduct as brokers or dealers, and (2) (Attachment). to RBC’s bankers: information known to they receive no special compensation for Knowledge of adverse claims against the individuals within an organization who are that advice. Plaintiffs alleged that MetLife assets of an account holder at a securities not involved in a specific transaction, and failed to disclose to them conflicts of firm is not imputed to an affiliated which is not provided to those conducting interest created by MetLife’s commission corporate banking entity seeking to attach the transaction, may not provide a basis to structures and other incentives, which those assets to satisfy a debt. impute notice to the entire organization, gave MetLife representatives -- in this Petitioner Scher Law Firm brings a unless the transmission of such instance, broker Laxton -- a financial special proceeding, pursuant to NY information was deliberately impeded. interest in maximizing the sales of CPLR 5225(b), on behalf of itself The Court declines to find that the RBC proprietary products. Plaintiffs alleged and the judgment creditors of Fred Bank, at the time it extended the loan to that these material omissions violated Deutsch, formerly a partner with Parklex Deutsch, had either actual or implied §§ 206 and 215 of the Investment Advisors Associates. The special proceeding, notice of the adverse claims against RBC Act of 1940. The district court held that brought to preclude Respondents from Dain: the record shows that none of the Laxton fell within the IAA’s broker- attaching certain assets in Respondents’ information presented to RBC Dain by the dealer exception. On appeal, plaintiffs possession and traced back to Deustch, Parklex plaintiffs was shared with RBC argued that Laxton did not meet the first has its roots in transactions undertaken in Bank; further, the due diligence performed prong of the broker-dealer exemption, 2006. Specifically, in April 2006, Deustch by RBC Bank prior to approving the loan because the investment advice formed a opened the first of several securities was wholly in keeping with RBC Bank’s “central component” of all of Laxton’s accounts with Respondent RBC Dain. standard procedures. Indeed, as the Court transactions. The Court disagrees. Deustch funded these accounts with many notes after a detailed analysis and summary Under plaintiffs’ proposed reading, millions of dollars received through a sale of the record, the RBC Bank employees application of the exemption would of real estate. Subsequently, a number of who were involved with the extension hinge upon the quantum or importance Deutsch’s partners commenced an action, of the loan to Deutsch made reasonable of the advice. Besides creating a difficult alleging that Deutsch had committed fraud efforts to be assured that no such adverse problem of line-drawing, i.e., how much by transferring the proceeds from that claims existed against Deutsch. advice is too much and how to measure sale into the RBC accounts; the partners (N. Sorkin) (SLC Ref. No. 2011-08-02) the importance of the advice, under maintained that they were due a portion of plaintiffs’ interpretation “solely”would these proceeds and that Deustch, in effect, Thomas v. Metropolitan Life. not meaningfully modify ‘incidental was stealing the funds away from them. No. 09-6257, 2011 U.S. App. LEXIS 2024 to’ and would become superfluous. The Thereafter, in-house counsel at RBC Dain (10th Cir., 2/2/11). district court correctly concluded that the received, and responded to, a number of IAA of 1940 (§§ 206 & 215 “Broker- application of the broker-dealer exemption subpoenas issued by Petitioners, seeking Dealer Exception”) * Class Actions, hinges on whether the advice in question information about Deutsch’s transfers, Effects of * Statutory Definitions relates to or is connected with the broker- as well as court orders relating to the (“Investment Advisor”) * Fiduciary dealer’s primary business, not upon the action begun by the Parklex defendants. Standard (Investment Advisor) * quantum or importance of the advice. The cont’d on page 57 56 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Court also rejects plaintiffs’ argument motions to dismiss in the arbitration. and Privacy Act (“ECPA”). The factual that a broker-dealer receives “special After the motions to dismiss were denied, allegations bearing on the ECPA and compensation” whenever the broker- the Traderight parties filed suit in federal CFAA claims related only to defendants dealer receives an economic benefit from court, seeking a declaration that they did Mosqueira and Schultz and did not single a transaction involving investment advice. not breach any legal duties to defendants out any other defendant by name in Compensation received by a broker-dealer and to enjoin the FINRA arbitration. connection with these claims. Accordingly, is “special” only when the compensation Defendants countered by moving to the Court dismissed the ECPA and CFAA is received specifically in exchange for compel arbitration. The Court rules in claims against all defendants other than giving advice, as opposed to some other favor of defendants. By executing uniform Mosqueira and Schultz. The Court then service, and the compensation takes a form submission agreements, the Traderight went on to determine whether it had other than a commission or analogous parties explicitly agreed to arbitrate jurisdiction over Mosqueira and Schultz. transaction-based compensation received the claims in question. The Traderight To determine personal jurisdiction over for the sale of a product. Laxton’s advice parties did not object to arbitrability at the a non-domiciliary in a federal question was given only in connection with outset or make any reservation of rights case, the Court engages in a two-step selling a variable universal life policy to in their FINRA filings. To the contrary, analysis. The first step is to apply the plaintiffs. His advice was closely related to they seemed content to participate in the foreign state’s long-arm statute. If the the sale of the policy and selling the policy arbitration until the panel denied their foreign state’s long-arm statute permits was the primary object of the transaction. motions to dismiss, at which point they personal jurisdiction, the second step is Accordingly, the advice was “solely filed their lawsuit. If they wanted to to analyze whether personal jurisdiction incidental to” his conduct as a broker and challenge arbitrability, they needed to do comports with due process. Under New he did not receive “special compensation.” so upfront, rather than signing submission York’s long-arm statute, a plaintiff must (W. Nelson) (SLC Ref. No. 2011-09-06) agreements. Thus, defendants’ motion to show that the defendant transacted compel arbitration is granted. business in New York and that the claims Traderight Securities, Inc. (J. Komie: Given that Traderight is arose from those business transactions. v. Richard G. Kirschman IRA, a FINRA member firm and the other Alternatively, personal jurisdiction may No. 10 C 2042 (N.D. Ill., 2/15/11). plaintiffs presumably associated persons lie where a tortious act is committed Arbitration Agreement (Uniform – another basis for requiring arbitration outside the state causing injury to persons Submission Agreement) * Derivative/ – they seem fortunate not to have been or property within the state. Regarding Vicarious Liability (Aiding & Abetting) sanctioned for filing this suit.) (SLC Ref. the former, plaintiffs did not allege any * Stay of Arbitration * Waiver * No. 2011-10-01) business conducted by Mosqueira or Arbitrability * Agreement to Arbitrate. Schultz in New York. The only claims After signing a uniform submission Tradition Chile Agentes asserted against them occurred in Chile. agreement and filing an answer and v. ICAP Securities, Regarding the latter, the Court applies a a motion to dismiss in the arbitration, No. 09 Civ. 10343, 2010 U.S. Dist. LEXIS situs-of-injury test, which asks it to locate a party’s request for an injunction 123673 (S.D. N.Y., 11/5/10). the original event that caused the injury. restraining the arbitration from going Computer Fraud and Abuse Act * Here, the original event occurred in Chile. forward will be denied by the court. Electronic Communications and Lacking jurisdiction, the Court dismisses Defendants were clients of Enterprise Trust Privacy Act * Jurisdictional Issues the claims against Mosqueira and Schultz. Company (“Enterprise”), an investment (Personal; Diversity; Supplemental) * (W. Nelson) (SLC Ref. No. 2011-09-04) firm that was placed in receivership after Constitutional Issues (Due Process) * being sued by the SEC for defrauding Raiding/Recruiting Issues. UBS Financial Services, Inc. its clients. Enterprise maintained trading To impose jurisdiction on the basis of a v. WVU Hospitals, Inc., accounts with plaintiff Traderight tortious act committed outside the state 10 Civ. 4298 (S.D. N.Y., 1/4/11). Securities, Inc. (“Traderight”), a broker- causing injury to persons or property FRCP (Rule 65) * Injunctive Relief dealer and FINRA member. Defendants within the state, the court will apply a (Irreparable Harm; “Serious Questions” filed a FINRA arbitration against situs-of-injury test based on the original Standard) * Arbitration Agreement Traderight and several alleged control event that caused the injury. (FINRA Code) * Arbitrability * Venue persons at Traderight (the “Traderight We previously summarized an earlier Issues (Arbitration Situs) * Investment parties”), claiming that Traderight acted decision in this case (SLA 2010-06). Banking Issues * Sales Practice/Product negligently in supervising the trading in the Plaintiff is an inter-dealer brokerage firm in Issues (Municipal ARS: Auction Rate Enterprise accounts and aided and abetted Chile. The defendant brokers left plaintiff Securities) * SRO Rules (FINRA Enterprise’s fraud. The Traderight parties to join a competitor. Plaintiff commenced Rule 12200) * Statutory Definitions executed Uniform Submission Agreements this action, alleging violations of the (“Customer”). and filed answers in the FINRA arbitration. Computer Fraud and Abuse Act (“CFAA”) Because the FINRA Code constitutes the Subsequently, the Traderight parties filed and the Electronic Communications arbitration contract between UBS and cont’d on page 58 57 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

defendants, its provision on the hearing a proposed underwriting. A recent Second failed to show that the registration location is determinative. Circuit case holds that any ambiguity statement and prospectus omitted material Defendants commenced an arbitration in the meaning of customer should be facts necessary to insure that the contents before FINRA against UBS Financial construed in favor of arbitration. UBS of the documents were not misleading. Services and UBS moved to restrain has failed to present a strong prima facie The Court disagrees. Plaintiff did not defendants from proceeding with the case evidencing its likelihood of success allege that defendants intentionally FINRA arbitration or any form of action on the question of whether defendants misstated the facts nor made fraudulent against UBS outside of New York County. qualify as customers of UBS under the representations; rather, plaintiff’s claims In 2003, 2005 and 2006, UBS advised Code. Even if UBS could show that there are based on the negligent failure to defendants to issue, through UBS, are serious questions going to the merits, properly disclose facts and/or the failure to municipal bonds worth $329 million. the Court is not persuaded that the balance ascertain facts that could reasonably have Defendants contend that UBS failed to of hardships tips decidedly in UBS’s favor. been discovered through the exercise of disclose that the fixed interest rates that Any question of venue must be heard by due diligence. Although certain facts were UBS promised defendants were entirely the arbitrators. Because the FINRA Code generally disclosed, the disclosures should dependent on UBS’s continued willingness constitutes the arbitration contract between have been more detailed. Defendants had to dominate and manipulate the market by UBS and defendants, its provision on the knowledge of the details, which were not placing support bids at low interest rates hearing location is determinative. otherwise available to potential investors. to effectively cap the ARS interest rate at (S. Anderson) (EIC: We presume UBS The lack of detail constitutes an omission a level desirable to defendants. The Court based its position regarding a New York of facts material to potential investors. may issue a preliminary injunction only County venue upon a forum selection Defendants also argued that, for purposes when the moving party demonstrates an clause in its financial advisory agreement, of the § 12(a)(2) claim, they were not irreparable harm and either the likelihood but the Opinion does not indicate.) (SLC statutory sellers. The Court rejects that of success on the merits or sufficiently Ref. No. 2011-07-01) argument, concluding that solicitation for serious questions going to the merits to purposes of § 12(a)(2) liability includes make them a fair ground for litigation; the UFCWU v. Chesapeake Energy, both personal solicitation and substantial balance of hardships must tip decidedly No. CIV-09-1114-D, 2010 U.S. Dist. involvement in the offering process. Here, toward the party requesting the preliminary LEXIS 92208 (W.D. Okla., 9/2/10). plaintiff alleged sufficient facts to satisfy relief. The Second Circuit has held that it Class Actions, Effects of * 1933 Act (§ the applicable pleading requirements that would be irreparable harm to be forced 11, § 12(a)(2) & § 15 Control) * PSLRA defendants were involved in all stages of to expend time and resources arbitrating (Pleading Requirements) * FRCP: the offering. an issue that is not arbitrable. The Court Federal Rules of Civil Procedure * (W. Nelson) (SLC Ref. No. 2010-42-08) finds that UBS has satisfied its burden of Materiality * Statutory Definitions showing irreparable harm. The question (“Seller”; “Solicitation”) * Negligence, USA v. Radley, of arbitrability is resolved by the courts, Actionable. No. 09-20699, 2011 U.S. App. LEXIS rather than the arbitrators, unless the Solicitation for purposes of § 12(a)(2) 1715, (5th Cir., 1/27/11). Criminal Issues parties have explicitly agreed otherwise. potential liability includes both personal * CEA (§§ 2 & 13) * Trading Issues Pursuant to the FINRA Code, Rule 12200, solicitation and substantial involvement in (Natural Gas) * Market Manipulation * a FINRA member must arbitrate a dispute the offering process. Statutory Definitions (“Transactions”) if arbitration is required by a written Plaintiff United Food and Commercial * Wire Fraud. agreement or requested by the customer, Workers Union filed this purported The Fifth Circuit upholds a district court the dispute is between a FINRA member class action, alleging that defendants order dismissing indictments brought or associated person of a FINRA member violated §§ 11 and 12(a)(2) of the 1933 against natural gas commodities traders and its customer, and the dispute arises Act by misstating and omitting from the for violations of the Commodities Exchange in connection with the business activities registration statement and prospectus Act (“CEA”), because the conduct alleged of the member. The only question in the certain material facts, thereby rendering in the indictment consisted of transactions case at bar is whether defendants qualify the statement misleading to potential and thus fell within the exemption of §2(g) as “customers” of UBS under the Code. investors. The omitted facts related of the CEA. Customer is not defined under the Code; to margin accounts held by the CEO, Defendants were commodities traders in Rule 12100(i), it merely states that a hedging contracts with Lehman and who traded futures in “TET propane” customer shall not include a broker or certain “kickout” provisions in those on an electronic interface known as dealer. Courts have interpreted the term hedging contracts. Defendants, including Chalkboard. The government alleged customer broadly. In an early decision Underwriter Defendants UBS Investment that Defendants attempted to drive up the under the Code, the Third Circuit held Bank, ABN Amro, Banc of America price of TET propane by placing stacked that a securities issuer is a customer of a Securities and Wells Fargo Securities, bids on Chalkboard. This forced sellers member firm where a dispute arises over moved to dismiss, arguing that plaintiffs with naked short positions to purchase cont’d on page 59 58 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

TET at the higher price, often directly wire fraud statute, 18 U.S.C. § 1343. The Omissions * Conflicts of Interest from Defendants, in order to fulfill their Fifth Circuit affirms the dismissal of the (Investment Banking). A plaintiff may obligations. The government also alleged challenged indictments. plead scienter under the PSLRA by alleging that the Defendants withheld information (J. Ballard) (SLC Ref. No. 2011-10-09) facts (1) showing that the defendants had about their purchases and falsely denied both motive and opportunity to commit their attempts to control the TET propane Velez v. PHD Capital Corp, the fraud or (2) constituting strong market, in violation of the Commodities No. 10 Civ. 3735 (S.D. N.Y., 2/3/11). circumstantial evidence of conscious Exchange Act (CEA), 7 U.S.C. §13(a) Class Actions, Effects of * FLSA: misbehavior or recklessness. (2). Defendants successfully moved to Fair Labor Standards Act (Section Defendants move to dismiss Plaintiffs’ dismiss their indictments, arguing that 216 Collective Action) * SRO Rules Second Amended Complaint pursuant their conduct fell within the statutory Interpreted (FINRA Rules 13200 & to Fed. R. Civ. P. 12(b)(6) for failure to exemption of §2(g) of the CEA, which 13204) * Agreement to Arbitrate * FAA: state a claim upon which relief may be exempts off-exchange transactions in non- Federal Arbitration Act (§ 3 “Stay”). granted. Plaintiffs David T. Vining and agricultural commodities. Advocating FSLA collective actions are not class Patricia Burness bring this purported class for a narrow interpretation of the statute, actions within the meaning of FINRA Rule action against Defendants Oppenheimer the government asserts on appeal that 13204. Holdings Inc. (“Oppenheimer “transaction” should be defined as activities At issue in this case is whether the Holdings”) and Oppenheimer & Co., Inc. that create legally enforceable obligations. exemption of class action claims from (“Oppenheimer”), in connection with Because the complained of conduct arbitration under FINRA Rule 13204 their purchases of auction rate securities (placing “stacked bids,” withholding applies to FSLA collective actions claims. (“ARS”) from Oppenheimer, a wholly supply from the market, falsely denying a The Court concludes that it does not. owned subsidiary of Oppenheimer scheme to corner the market, and falsely Rule 13204 clearly states that class action Holdings. Plaintiffs allege that their stating that the company intended to claims may not be arbitrated under the Oppenheimer financial advisors omitted consume its propane) did not constitute FINRA Code of Arbitration Procedure. various material facts about ARS, the contracts, the government argued they However, the Rule is silent as to collective nature of the ARS market, and the alleged were not transactions protected by the action claims. Although collective and conflict of interest that existed between CEA exemption. However, applying the class actions have much in common, Oppenheimer’s investment banking and ordinary meaning of transactions, as well there is a critically important difference: brokerage businesses with respect to the as the CEA’s internal definition, which collective actions are opt-in actions, i.e., ARS. Plaintiffs assert claims for securities included conduct “commonly known each member of the class must take steps fraud under Section 10(b) of Securities to the trade as [a] bid [or] offer within to opt in, in order to participate, whereas Exchange Act of 1934 and Securities the scope of a “transaction”,” the Court class actions are opt-out actions, i.e., class and Exchange Commission Rule 10b-5, holds that the Defendants’ conduct falls members automatically participate unless promulgated thereunder, and for violations within the exemption of §2(g). Because they take affirmative steps to opt out. A of Section 20(a) of the Securities Exchange “transactions” can include more than the collective action binds only similarly- Act. In addition to meeting the standard for execution of a contract, negotiations could situated plaintiffs who have affirmatively motions to dismiss, securities fraud claims not be excluded from the exemption of consented to join the action. Here, the must also meet the heightened pleading §2(g). Defendants’ bids were placed on parties have agreed in writing to arbitrate requirements under Fed. R. Civ. P. 9(b) and Chalkboard, some of which were accepted. certain disputes as required by FINRA. the Private Securities Litigation Reform Because market participants were free The FSLA collective action comes within Act (“PSLRA”). Rule 9(b) requires that to accept or reject Defendants’ bids, the the scope of the parties’ agreement to the circumstances constituting fraud be bids were part of Defendants’ business arbitrate. stated with particularity. The PSLRA transactions and within the exemption (W. Nelson) (SLC Ref. No. 2011-11-02) applies to the element of scienter under of §2(g). Moreover, the other allegations Section 10(b), or the mental state against Defendants (withholding supply Vining v. embracing intent to deceive, manipulate from the market, falsely denying a scheme Oppenheimer Holdings, Inc., or defraud. In order to adequately plead to corner the market, and falsely stating No. 08-4435, 2010 U.S. Dist. LEXIS scienter under the PSLRA, the complaint, that the company intended to consume 103689 (S.D. N.Y., 9/27/10). with respect to each act or omission, must its propane) concerned general business Class Actions, Effects of * FRCP (Rules state with particularity facts giving rise to transactions and, therefore, fall within 9(b) & 12(b)(6)) * 1934 Act (§§ 10(b) a strong inference that the defendant acted the exemption as well. Because the same & 20(a)) * SEC Rule 10b-5 * PSLRA with the required state of mind. The Court conduct was used as the basis for the wire (Pleading Requirements) * Culpability holds that Plaintiffs’ Complaint fails to fraud charges and said conduct was legal Standards (Scienter) * Sales Practice/ give rise to a strong inference of scienter within §2(g), the conduct could not be re- Product Issues (Auction-Rate Securities and dismisses Plaintiffs’ 10(b) claim. characterized as illegal activity under the “ARS”) * Misrepresentations/ Because Plaintiffs fail to state a primary cont’d on page 60 59 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

claim for liability under Section 10(b), the inference that he acted with the requisite These securities were composed in part Court holds that Plaintiffs’ Section 20(a) state of mind. Plaintiffs neither allege facts of the conveyances of home equity loans claim against Oppenheimer Holdings showing that White possessed a motive to and adjustable rate mortgages originated necessarily also fails. A plaintiff may plead defraud, nor that he engaged in behavior by WaMu and were sold with offering scienter by alleging facts (1) showing exhibiting conscious misbehavior or circulars. The circulars described the that the defendants had both motive recklessness. The Court also takes into securities and portions of WaMu’s and opportunity to commit the fraud or account plausible opposing inferences, business operations and incorporated (2) constituting strong circumstantial as it is required to under the PSLRA. certain filings with the SEC and press evidence of conscious misbehavior or Plaintiffs’ basic theory is that high-level releases. Plaintiffs’ investment advisor recklessness. Additionally, when the Oppenheimer officials issued management and portfolio manager allegedly read and defendant is a corporate entity, the pleaded directives and uniform sales materials to relied on the offering circulars. Three facts must create a strong inference that Oppenheimer financial advisors regarding underwriters and broker-dealers sold the someone whose intent could be imputed ARS, and that these directives were issued securities to plaintiffs, having purchased to the corporation acted with the requisite recklessly or with the intention to defraud, them directly from WaMu. These Initial scienter. With respect to motive and because the prospect of ARS illiquidity Purchaser Defendants included disclaimers opportunity, Oppenheimer’s profit motive was either known to Oppenheimer or so of liability in the offering circulars. The in perpetuating the ARS market in order obvious that Oppenheimer must have core allegations track those made in the to maintain relationships with auction been aware of it. While this inference is WaMu Multi-District Litigation. In 2008, dealers and grow its underwriting business plausible, it is not at least as strong as the the FDIC took control of WaMu, causing is a generalized motive, one which could inference that Oppenheimer negligently or its Trust Securities to transform into be imputed to any publicly-owned, for- carelessly provided insufficient training preferred stock that was worthless. The profit endeavor, and is not sufficiently to its financial advisors and was merely offering circulars contain misstatements concrete for purposes of inferring scienter. negligent in not detecting and disclosing about WaMu’s underwriting, appraisal Plaintiffs’ allegations of insider sales are the imminent market collapse. The Court practices and credit risk management, as similarly insufficient to support a strong grants Defendants’ Motion to Dismiss well as incorporating several SEC filings inference of scienter, because they fail without prejudice. and press releases that contain false or to state the portion of stockholdings (P. Michaels) (SLC Ref. No. 2010-41-09) misleading information about WaMu’s sold and the change in volume of insider financial condition. Rule 9(b) imposes a sales. Moreover, these allegations do not Washington Mutual Securities heightened standard for pleading fraud specify what non-public information the Litigation, In Re, with particularity, even though it also Oppenheimer insiders were allegedly No. 2:08-md-1919 (W.D. Wash., permits pleading intent and knowledge trading on during the relevant timeframe. 6/21/10). Class Actions, Effects of generally. The claims against the Director In order to raise a strong inference of * FRCP: Federal Rules of Civil Defendants must meet Rule 9(b), because scienter by means of circumstantial Procedure (Rule 8(a) & 9(b)) * Motion they are grounded in the same course of allegations, Plaintiffs must allege that Practice Issues * Misrepresentations/ conduct alleged to be fraudulent. Claims Oppenheimer engaged in conduct that Omissions * 1934 Act (§ 10(b) Rule against the Initial Purchaser Defendants was highly unreasonable and which 10b-5”) * State Statutes Interpreted need only meet Rule 8(a) notice pleading. represented an extreme departure from (Cal. Corp. Code §§ 24500(d)/25500) Officer Defendants move to dismiss the the standards of ordinary care. Plaintiffs * Transaction Causation/Reliance common law and statutory claims of do not satisfy this requirement by alleging * Pleading Requirements (Group fraud against them, because there is no that Oppenheimer had knowledge of Pleading)* Timeliness Issues (Statutes showing that the plaintiffs themselves certain facts that purportedly contradict of Limitations). relied on any statements they allegedly the statements made to Plaintiffs about Disclaimers of liability in offering made. The pleadings establish the the ARS, because this knowledge does not circulars are void under California law agency relationship between plaintiffs give rise to the requisite level of scienter as a defense to certain claims, including and their investment advisor, so the fact and because the allegations are not pled negligent misrepresentation claims, which that they did not personally read and rely with sufficient specificity. With respect involve deceit. on the statements is not fatal. However, to the corporate scienter requirement, This matter comes before the court plaintiffs’ allegation that their investment Plaintiffs assert that the intent or on three motions to dismiss filed by advisor read and relied on the offering recklessness of Oppenheimer employee defendants. In the Amended Complaint, circulars and the incorporated documents David White, who purportedly made plaintiffs, four closed-end management is too thin to satisfy Rule 9(b) or the training presentations to financial advisors, investment companies, allege various state requirement of pleading actual reliance should be imputed to Oppenheimer. and federal causes of action in connection under California law; thus, the common The Court holds that White’s role in the with their purchase of WaMu securities and statutory law claims will be dismissed. alleged fraud does not give rise to a strong through two offerings in 2006 and 2007. Indeed, the allegations of reliance against cont’d on page 61 60 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 all defendants are too conclusory and Plaintiffs standing as to all three issues. Product Issues (Subprime Mortgages vague to raise them from the possible It caused the Underwriter Defendants, “MBS”) * Culpability Standard to the plausible and will be dismissed however, to object that the new class (Scienter). * as to all defendants. The disclaimers representatives were too late in joining A plaintiff asserting a violation of against liability in the offering circulars the suit. Their argument held that the Section 12 of the Securities Act of 1933 are void under California law, including one-year statute of limitations governing must allege a purchase directly from the negligent misrepresentation claims, 1933 Act claims expired in May 2009, at issuer at the offering, not subsequent to which involve deceit. Under the group the latest. The Court responds that, even the offering. **An erroneous appraisal pleading doctrine, plaintiffs have accepting that date, it still finds that the value is just an opinion and, hence, can adequately alleged Director Defendants’ new Plaintiffs joined on a timely basis. only give rise to a claim under Section negligent misrepresentations because The Court makes the point that “an 11 of the Securities Act of 1933, if the they signed SEC filings and participated amended pleading is effectively filed complaint alleges with particularity that in certain day-to-day functions and had when a motion to amend is filed… It is the statement was both objectively and a special relationship with the company. not, as Defendants suggest, the date the subjectively misleading. Plaintiffs’ claims under Cal. Corp. Code Amended Complaint is filed or when the In this class action, Wells Fargo § 25400(d) and § 25500 are viable under Court grants leave to amend.” Back when successfully moved to dismiss certain the broad view that persons who may the Court was considering the first motion allegations in the complaint but, with be liable for misrepresentations must be to dismiss against Brockton, Plaintiffs respect to some allegations, plaintiffs involved in market activity at the time indicated in their responsive brief that they were granted leave to amend. Plaintiffs of the misrepresentations. Here, the had lined up additional complainants, in thereupon filed an amended complaint. Officer Defendants sold WaMu stock at the event that the standing issue required Plaintiffs’ claim under Section 12 of the time that plaintiffs purchased WaMu amendment of the original complaint. the Securities Act of 1933 was initially securities. An offer or sale of a security is They even named the additional Plaintiffs dismissed, because plaintiffs failed to made in California when an offer to sell in their responsive briefs, so Defendants plead that they purchased the securities is made in the state or an offer to buy is were on notice well before May 2009. As at issue at the offering. In the amended accepted in the state or if both the seller leave to amend is liberally granted and complaint, plaintiffs asserted that they and the purchaser are domiciled in the courts have routinely regarded requests purchased the securities from Wells state and the security is delivered in the in responsive briefs as formal motions Fargo, but the dates of these purchases state. to amend, the amended pleading may be indicated that they occurred in the (S. Anderson) (SLC Ref. No. 2010-40- deemed to have been filed at that time. aftermarket. Wells Fargo again moved 05) Federal Rules even permit oral requests to dismiss, but plaintiffs assert that it is to be regarded as motions to amend. enough that they bought the securities Washington Mutual, Inc. FRCP 7(b)(1)(A) explicitly permits “a from the issuer of the prospectus. The Securities Litigation, In Re, party to satisfy the formal, written motion Court finds no authority in support of Lead Case No. 08-387 (W.D. Wash., requirement by making oral requests this contention. Section 12(a)(2) requires 1/28/11). Class Actions, Effects of of the Court for a ruling at a hearing or that a purchase be made directly from * Underwriting Issues * 1933 Act trial.” Defendants still object that the the issuer during the IPO. The plaintiffs (§11) * Timeliness Issues (Statutes of proper way to amend would have been to also claimed that the offering documents Limitations) * Notice Requirements supply the Court with a formal pleading, violated Section 11 of the Securities Act * FRCP (§15 “Leave to Amend”). along with a statement of intention. The of 1933, because they contained material For statute of limitations purposes, an Court thinks that suggestion ignores the misstatements regarding the appraisal amended pleading is deemed filed at the Rules it cited, as well as the “realities of values and the loan to value (“LTV”) time the motion to amend is first made. litigation.” Plaintiffs moved to amend ratios of the properties mortgaged by the This multi-district litigation began when and added the new class representatives underlying loans, and the ratings given to Brockton Contributory Retirement on a timely basis. (SLC Ref. No. 2011- the certificates purchased by plaintiffs. System brought suit in May 2008 12-07) They argue that the appraised value of regarding WaMu’s public offerings in the properties was inflated, which in August 2006, September 2006, and Wells Fargo Mortgage- turn skewed the LTV ratios, and that the October 2007. Due to a challenge to Backed Securities Litigation, ratings were unjustifiably high and did Brockton’s standing, which led to the In Re, not reflect the true risk of the investments. Court granting a motion to dismiss in No. 09-cv-01376-LHK, 2010 U.S. Dist. Wells Fargo moves to eliminate these 2009, Plaintiffs filed a Second Amended LEXIS 106687 (N.D. Cal., 10/5/10). bases for plaintiffs’ claims on the ground Complaint in June 2009 that added two Class Actions, Effects of * 1933 Act that ratings, appraisals, and LTV ratios additional named Plaintiffs, Pompano (§§ 11 & 12) * Pleading Requirements are opinions and, as such, are actionable and Detroit P&F. That gave the named * FRCP (Rule 15) * Sales Practice/ only if they are alleged to be knowingly cont’d on page 62 61 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

false. The Court agrees. Misleading because the named plaintiffs had not the amended complaint regarding these opinions can give rise to a claim under invested in them and, therefore, lacked offerings. Specifically, the original Section 11, only if the complaint alleges standing to bring claims regarding complaints cited to the same registration with particularity that the statements these offerings. On May 28, 2010, statements and many of the same alleged were both objectively and subjectively plaintiffs filed an amended complaint, misrepresentations and omissions within false or misleading. Plaintiffs did allege which identified five new plaintiffs who the registration statements. Although some facts tending to show that Wells had invested in ten of the 37 offerings the amended complaint expanded on Fargo intentionally manipulated the previously dismissed for lack of standing. these allegations, the information in the appraisal process, but they failed to Wells Fargo again moved to dismiss on original complaints was at least sufficient allege that Wells Fargo knew that the the ground that the claims of the new to put the new plaintiffs on notice of their appraisals, ratings, and LTV ratios were plaintiffs were barred by the statute of claims. Thus, the new plaintiffs either false or misleading. The Court rejects limitations, which requires that any claim knew of the basis for the revived claims Wells Fargo’s argument that plaintiffs under these statutes be filed within one or, through diligence, should have known must allege that the appraisers and the year of notice of the defendant’s acts and, of them more than one year before the rating agencies, as well as Wells Fargo, in any event, not later than three years amended complaint was filed. knew that these opinions were incorrect. after the offering. In the case of seven (P. Dubow) (SLC Ref. No. 2010-41-07) Plaintiffs need only adequately allege of the offerings purchased by the new that Wells Fargo knew that these opinions plaintiffs, the purchase occurred prior to Woodward v. were false or misleading to state a claim. May 28, 2007 and so the three-year statute Raymond James Financial, Inc., Further, because Wells Fargo failed to of repose would normally be expected to No. 09-CV-5347 (RPP) (S.D. N.Y., raise this argument in its first motion apply. Wells Fargo also argued that the 8/16/10). Class Actions, Effects to dismiss, plaintiffs are given leave to new plaintiffs had notice of their claims of * 1934 Act (§10 “Rule 10b-5”; amend the claim, in order to show that when the initial complaints were filed in §20(a) “Control”) * FRCP: Federal Wells Fargo knew that the appraisals, March and April 2009. Since those filings Rules of Civil Procedure (Rule ratings, and LTV ratios set forth in occurred prior to May 28, 2009, the 9b “Particularity”; Rule 12(b)(6) the offering documents were false or one-year statute of limitations applied. “Claim for Relief”) * PSLRA: Private misleading. Plaintiffs countered that the filing of the Securities Litigation Reform Act of (P. Dubow) (SLC Ref. No. 2010-41-06) initial complaints tolled both the three- 1995 (Pleading Requirements). year statute of repose and the one-year Class action defendants’ motion to Wells Fargo Mortgage-Backed statute of limitations. They relied chiefly dismiss granted where plaintiffs failed to Certificates Litigation, In Re, on American Pipe & Construction Co. allege fraud with requisite particularity. No. 09-cv-01376 LHK, 2010 U.S. Dist. v Utah, 414 US 538 (1974), where the Class action plaintiff shareholders LEXIS 106661 (N.D. Cal., 10/5/10). Supreme Court held that, when a class alleged that defendants Raymond Timeliness Issues (Statute of action is dismissed for failure to certify James Financial, Inc. (“RJF”) and four Limitations) * 1933 Act (§§ 11 & 15) the class, the statute of limitations is tolled of its principals engaged in a scheme * Class Actions, Effects of * Notice for class members who then intervene to to defraud shareholders by making Requirements * Tolling Principles assert the same claims individually. The material misrepresentations. The alleged * Sales Practice/Product Issues Court distinguishes American Pipe and misrepresentations concerned the (Subprime Mortgages “MBS”) * grants the motion to dismiss. Unlike the adequacy of its loan loss reserves for Standing/Privity Issues. putative class members in American Pipe, its subsidiary, Raymond James Bank *The three-year statute of repose and the new plaintiffs here had no reason to (“RJBank”), and the financial health one-year statute of limitations set forth in rely on the initial complaints to protect of that loan portfolio between April Sections 11 and 15 of the Securities Act their claims. The original complaints 28, 2008 and April 14, 2009 (the “class of 1933 will not be tolled for a plaintiff did not allege that the named plaintiffs period”). Specifically, plaintiffs alleged who is added to a complaint to replace had any ownership interest in the 37 that RJF concealed the fact that RJBank a plaintiff who had no standing. **The dismissed offerings. Thus, review of these was increasing risky commercial real filing of a class action complaint is notice complaints would have revealed that estate lending at a time when the industry to any other putative plaintiffs who join the plaintiffs in the original complaints was contracting in that area, that if one the action later. lacked standing to bring claims as to these large loan defaulted RJBank would take This consolidated class action complaint offerings. If named plaintiffs to a class a substantial hit to its earnings, and involved 54 separate offerings of action lack standing to bring a claim, no that RJ Bank’s loan to value (“LTV”) mortgage-backed certificates issued by putative class members can step into the ratios for its residential loans should Wells Fargo. In response to a motion standing breach. As to the three remaining have been adjusted in light of falling filed by Wells Fargo, the Court dismissed offerings, the original complaints stated home prices. Plaintiffs also claimed claims based on 37 of the offerings, many of the factual bases alleged in that RJF misrepresented the health of cont’d on page 63 62 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 its lending business by touting its risk Wright v. RBC Capital similarly situated plaintiffs, the Court management efforts and by claiming that Markets Corporation, determines that the Minnesota action it independently underwrote all loans No. CIV S-09-3601 FCD/GGH, 2010 was the first filed and that the California on its books. Finally, Plaintiffs claimed U.S. Dist. LEXIS 80165 (E.D. Cal., class action should not proceed. Given that RJF’s management recklessly 6/24/10). the advanced stage of the Minnesota ignored economic information that Collection Issues (Forgivable Loan) * litigation (summary judgment motions should have made it increase its loan Class Actions, Effects of (Arbitration) were then pending), it is appropriate to loss reserves. The Court notes that, in * Parallel Proceeding * Employment dismiss the California action, rather than order to prevail on their securities fraud Disputes * SRO Rules (FINRA Rule staying or transferring it. With respect to claims, the plaintiffs were required to 13204). the question of whether or not FINRA show that the defendants, in connection One may not block an existing arbitration rules prohibit the arbitration of RBC’s with the purchase or sale of securities, before FINRA by filing a purported claims against Wright, the Court spends made a materially false statement of a class action seeking declaratory relief significant time analyzing the application material fact which plaintiffs relied on, with respect to the issues raised in the of FINRA Rule 13204 to arbitrations that and to plead scienter with particularity. arbitration. involve similar class action claims. In Additionally, this securities fraud case This action arises from a dispute this case, the Court determines that the was subject to the heightened pleading that relates in part to an arbitration rule does not prohibit the pursuit of this standards specified in the Private proceeding filed by RBC Capital Markets collection matter by RBC. Even though Securities Litigation Reform Act of Corporation, RBC Dain Rauscher Inc., some claims might be similar, RBC’s 1995 (“PSLRA”). The Court examines RBC Wealth Management, and RBC action to collect its debt was instituted the alleged misrepresentations and finds Capital Markets Corporation, (“RBC”) prior to Wright’s class action. Wright was that nearly all of them are not actionable against a former broker, Carl Wright, essentially using his class action and his fraud. The representations regarding the (“Wright”) seeking to collect a forgivable asserted interpretation of Rule 13204 as a loan loss reserves are general statements loan that was made to Wright at the time sword and defensive tactic against RBC’s of optimism and amount at most to he was hired by RBC. The initial loan was previously filed arbitration, rather than as mismanagement, not fraud. Similarly, in the amount of $202,000. When Wright a shield against brokerage firms seeking statements regarding the health of the terminated his affiliation with RBC, to defeat pre-existing class actions by loan portfolio are classic puffery and $129,000 remained owing on the loan compelling arbitration. The Court finds not the type of statement that reasonable and after making demand, RBC instituted that Rule 13204(d) was never intended investors rely on. Additionally, the an arbitration proceeding. In response to preclude another party’s arbitration accounting related complaints regarding to the arbitration proceeding, Wright claim, but rather its purpose is to allow the LTV ratios, standing alone, are not filed in state court in California a class a Claimant to choose to pursue his own sufficient to state a securities fraud claim. action against RBC, alleging violations claim either in a class action in court However, the alleged misrepresentation of the California Labor Code and related or arbitration. Attempting to block an that RJF or RJBank independently claims, essentially asserting that, at the existing arbitration claim through the underwrote all loans was actionable, time of hiring when he was required to filing of a purported class action seeking because the plaintiffs had testimony sign the forgivable note with RBC, he was declaratory relief with regard to the issues from a confidential witness confirming required to turn over his book of business involved in the arbitration was deemed that a large commercial loan that failed and that contribution of property made by the Court to be a misuse of Rule and caused the stock price to plummet the forgivable note void. RBC removed 13204; such tactics cannot be condoned. was not independently underwritten. the case to federal court and moved to The Court dismisses a portion of the The Court next examines the pleadings dismiss on a number of grounds, the most purported class action on “the first-to- relating to scienter, and finds at most significant of which were “the first-to-file file rule” and stays all remaining portions evidence of mismanagement, not of rule” and that Wright’s action should be of the action pending resolution of the fraudulent intent. All corporate officers stayed and compelled to arbitration as the FINRA arbitration instituted by RBC. have a general motive to increase profits FINRA arbitration rules that prohibit the (B. Wiand) (SLC Ref. No. 2011-08- and present a strong balance sheet and arbitration of certain class action claims 01) the Court refuses to find an inference of did not apply to the class action instituted scienter without more direct evidence of by Wright. First the Court reviews the intent. Because the fraud claims fail, so “first-to-file rule.” There had been pending do the control person claims. The motion for some time a class action in Minnesota to dismiss for failure to state a claim is that involved similar allegations and granted. specific allegations relating to the (J. Ballard) (SLC Ref. No. 2010-39- California Labor Code. Because this 05) action was pending between RBC and

63 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

TABLE OF CASES

(United States Supreme Court listed first; federal circuits listed in numerical order: district and state courts listed alphabetically by state within each circuit; case titles listed chronologically within each jurisdiction)

FIRST CIRCUIT SECOND CIRCUIT Braintree Laboratories v. Holmes v. Grubman & Citigroup Global Citigroup Global Markets, Inc., Markets, Inc., No. 09-2540 (1st Cir., 10/12/10). If a trial court had meant to No. 06-5246-cv, 2010 U.S. App. LEXIS 12863 (2nd Cir., provide relief other than what was requested in the motion at 6/23/10). That the District Court dismissed claims on a basis bar, the presumption on appeal is that the court would have that was incorrect in the final analysis does not preclude an said so; thus, a court granting arbitration intended to stay the affirmance, if the Appellate Court finds the claims invalid on litigation, not dismiss it (thus thwarting an immediate appeal). other grounds. City of Dearborn Heights Act 345 Police & Iowa Public Employees’ Retirement System Fire Ret. Sys. v. Waters Corp., v. MF Global, Ltd., st No. 10-1514, 2011 U.S. App. LEXIS 1065 (1 Cir. (Mass.), No. 09-3919-cv, 2010 U.S. App. LEXIS 19138 (2nd Cir., 1/20/11). Motion to Dismiss class action against defendant for 9/14/10). A statement of confidence in a firm’s operations may fraudulent omission granted due to lack of scienter. be forward-looking – and thus insulated by the “bespeaks caution” doctrine – even while statements or omissions as to Huffington v. T.C. Group, LLC, the operations in place (and present intentions as to future st No. 10-1405 (1 Cir., 2/25/11). Court affirms district court operations) are not. order dismissing Plaintiff’s claims under Fed.R.Civ.P. 12(b) (6), concluding that the forum selection clause in Plaintiff’s Gonchar v. SEC, subscription agreement encompasses his claims and requires No. 09-4215, 2010 U.S. App. LEXIS 25763 (2nd Cir., that they be brought in Delaware and not Massachusetts. 12/17/10). SEC disciplinary proceedings are governed by a Akamai Technologies, Inc. v. preponderance-of-the-evidence standard even when they seek Deutsche Bank AG, to punish violations of anti-fraud provisions of the federal securities laws. No. 10-10254-JLT (D. Mass., 2/15/11). Any distinction between omissions and misrepresentations is illusory, where the broker- Amorosa v. AOL Time Warner Inc., dealer owes a fiduciary duty to the client. No. 09-5270-cv (L), 2011 U.S. App. LEXIS 2149 (2nd Cir., Morales v. UBS Trust Co. of Puerto Rico, 2/2/11). Although the absence of loss causation is an affirmative defense to a Section 11 claim under the 1933 Act, a complaint No. 09-2205 (D. P.R.. 1/20/11). A party moving to compel may be dismissed pursuant to Rule 12(b)(6), if the loss causation arbitration must show that the other party is bound by the defect is apparent from the face of the pleading. arbitration clause at issue. Dever v. Oppenheimer & Co., Inc., Litwin v. Blackstone Group, LP, No. 09-4426-cv, 2011 U.S. App. LEXIS 2641 (2nd Cir., 2/10/11). No. 09-5051 (Mass. Super. Ct., Suffolk Cty., 6/28/10). Enforcement of a confidentiality order contained in an It is only when there is both materiality and a duty to disclose arbitration Award invokes the Court’s enforcement powers and, that a company may be held liable for omitting information therefore, represents “state action;” endorsing such an order from a registration statement or prospectus. when it broadly and without sufficient justification restricts Genworth Financial v. McMullan, conduct, and possibly speech, offends public policy. No. 09-CV-1521 (D. Conn., 6/10/10). *Misappropriation of Dever v. Oppenheimer & Co., Inc., trade secrets by a competitor is not necessarily irreparable No. 09-5051 (Mass. Super. Ct., Suffolk Cty., 12/22/10). harm, because the misappropriator is likely motivated to Impoundment of documents is the courts’ way of protecting protect the secret to serve its own purposes. **Injunctive relief documents produced in litigation from becoming publicly may be warranted in cases where there is a danger that, unless available, where the documents are proprietary in nature, are enjoined, a misappropriator of trade secrets will disseminate covered by a privilege, or, if made public, would invade the those secrets to a wider audience or otherwise irreparably privacy of an individual. impair the value of those secrets. cont’d on page 65 64 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

Chapple v. Fahnestock & Company, Inc., nothing to the question of standing, for even named plaintiffs No. 03-4989 (E.D. N.Y., 8/5/10). While evidence of a hostile who represent a class must allege and show that they personally work environment can extend to incidents not necessarily have been injured, not that injury has been suffered by other, involving the plaintiff, evidence of other lawsuits filed against unidentified members of the class to which they belong and the defendants making similar harassment allegations are likely whom they purport to represent. to be more prejudicial and speculative than probative. Kearney v. ABN Amro, Inc., SIPC v. No. 04 CV 6885, 2010 U.S. Dist. Lexis 100419 (S.D. N.Y., Bernard L. Madoff Investment Services, Inc., 9/15/10). *While the duties and responsibilities of similarly No. 08-01789 (Substantively Consolidated), 2010 U.S. Dist. situated employees need not be identical in order for a Title VII LEXIS 81492 (S.D. N.Y., 8/6/10). The appeal of an interlocutory plaintiff to demonstrate discrimination or disparate treatment, order will only be permitted in exceptional circumstances, if they must be similar in all material respects. **Stray comments there is a question of controlling law and the determination will by the very individual who took steps to protect plaintiff’s job aid the resolution of the underlying action as a whole, are not sufficient, in the context of the totality of the evidence, to demonstrate discriminatory animus. Woodward v. Raymond James Financial, Inc., No. 09-CV-5347 (RPP) (S.D. N.Y., 8/16/10). Class action Vining v. Oppenheimer Holdings, Inc., defendants’ motion to dismiss granted where plaintiffs failed to No. 08-4435, 2010 U.S. Dist. LEXIS 103689 (S.D. N.Y., allege fraud with requisite particularity. 9/27/10). A plaintiff may plead scienter under the PSLRA by alleging facts (1) showing that the defendants had both Morgan Stanley Mortgage Pass-Through motive and opportunity to commit the fraud or (2) constituting Certificates Litigation, In Re, strong circumstantial evidence of conscious misbehavior or No. 09 Civ. 2137 (LTS)(MHD), 2010 U.S. Dist. LEXIS 84146 recklessness. (S.D. N.Y., 8/17/10). That a suit may be a class action adds cont’d on page 66

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65 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Morgan Stanley & Co., Inc. v. Seghers, 1/26/11). The SEC may use “offensive collateral estoppel” No. 10 Civ. 5378, 2010 U.S. Dist. 107686 (S.D. N.Y. 10/8/10). to obtain summary judgment in an enforcement action where Broker-Dealer is successful on a motion for a preliminary defendant was previously found guilty by a jury of the same injunction, enjoining customer from proceeding with FINRA fraudulent conduct, even if the criminal conviction is on appeal. arbitration where customer had filed several previous suits arising out of the same set of facts. Bernard L. Madoff Investment Services, LLC, In Re: Picard v. Cohmad Securities Corp., Tradition Chile Agentes v. ICAP Securities, No. 09-1305 (BRL) (S.D. N.Y., 2/3/11). If a party requires No. 09 Civ. 10343, 2010 U.S. Dist. LEXIS 123673 (S.D. N.Y., enforcement of a provision in a settlement agreement, any 11/5/10). To impose jurisdiction on the basis of a tortious stipulation of dismissal in connection with that settlement must act committed outside the state causing injury to persons or either specifically reserve enforcement authority to the court or property within the state, the court will apply a situs-of-injury the order must incorporate the relevant terms of the settlement. test based on the original event that caused the injury. Velez v. PHD Capital Corp, Absolute Activist Value Master Fund Ltd. No. 10 Civ. 3735 (S.D. N.Y., 2/3/11). FSLA collective actions v. Homm, are not class actions within the meaning of FINRA Rule 13204. No. 09 Civ. 08862 (GBD), 2010 U.S. Dist. LEXIS 137150 (S.D. N.Y., 12/22/10). Under Morrison v. National Australia Bank’s Cloke-Browne v. “transactional test,” “F-Cubed” cases (i.e., foreign investors Bank of Tokyo-Mitsubishi UFJ, LTD, suing foreign (and American) defendants for misconduct No. 10 Civ. 2249, 2011 U.S. Dist. LEXIS 14116 (S.D. N.Y., relating to securities purchased on a foreign exchange) may 2/9/11). Defendant’s motion to dismiss Plaintiff-employee’s now be swiftly dispatched with for lack of subject matter breach of contract claims is granted, where Plaintiff failed to jurisdiction, even where there is some connection to the United execute a post-termination release, but denied, where Plaintiff States. has adequately pled employment discrimination claims. Public Employees’ Retirement System of Merrill Lynch Auction Rate Securities Ltgn., Mississippi (“MISSPers”) v. Goldman Sachs In Re: Anschutz Corp. v. Merrill Lynch & Co., Group, Inc., Inc., No. 09 CV 1110, 2011 WL 135821 (S.D. N.Y., 1/12/11). No. 09 MD 2030, 2011 U.S. Dist. LEXIS 7337 (S.D. N.Y., Plaintiffs’ 1933 Act claims that the registration statement and 2/9/11). Court granted Defendant’s Motion to Dismiss, ruling prospectus failed to accurately disclose that loan originators that Plaintiff’s complaint did not sufficiently allege any failed to follow loan underwriting standards survive the misrepresentations or omissions and that it failed to adequately dismissal motions of the Underwriting defendants, but not the plead scienter. motions of the Rating Agency defendants. Farber v. Goldman Sachs Group, UBS Financial Services, Inc. v. No. 10 Civ. 873, 2011 U.S. Dist. LEXIS 16673 (S.D. N.Y., WVU Hospitals, Inc., 2/16/11). In a Rule 12(b)(6) motion to dismiss, plaintiff’s 10 Civ. 4298 (S.D. N.Y., 1/4/11). Because the FINRA Code obligation is to provide proof of his entitlement to relief, which constitutes the arbitration contract between UBS and defendants, requires more than labels and conclusions and a formulaic its provision on the hearing location is determinative. recitation of the elements of a cause of action. New Jersey Carpenters Health Fund Foragazzo v. Lehman Bros., v. Residential Capital, LLC,; New Jersey No. 03 Civ. 5194 (S.D. N.Y., 2/23/11). In a class action, Carpenters Vacation Fund v. The Royal Bank any percentage award of attorneys’ fees will be assessed for of Scotland Group, PLC, reasonableness using the Goldberger criteria, which include Nos. 08 CV 8781, 08 CV 5093, 2011 Dist. Lexis 4343 (S.D. the time and labor expended by counsel, the magnitude and N.Y., 1/18/11). Class Plaintiffs’ Section 11, 12(a)(2) and 15 complexities of the litigation, the risk of the litigation, the 1933 Act claims for misrepresentations about loan origination quality of representation, the requested fee in relation to the guideline compliance in the offering materials of mortgage- settlement and public policy considerations. backed securities fail the class certification requirements of predominance and superiority under Rule 23(b). Municipal Derivatives Antitrust Ltgn., In Re: Hinds County, MS v. Wachovia Bank, NA, SEC v. Tzolov and Butler, No. 08 Civ. 2516, 08 MDL 1950 (S.D. N.Y., 3/1/11). No. 08 Civ. 7699, 2011 U.S. Dist., LEXIS 8562 (S.D. N.Y., Class actions seeking damages and regulatory settlements seeking restitution may conflict, requiring judicial intervention cont’d on page 67 66 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 to weigh the public interest in allowing one or both to go No. 24633/09, 2011 N.Y. Misc. LEXIS 142 (N.Y. Sup. Ct., forward. 1/28/11). Knowledge of adverse claims against the assets of an account holder at a securities firm is not imputed to an Brady v. Williams Capital Group, LP & AAA, affiliated corporate banking entity seeking to attach those No. 36 (N.Y., 3/25/10). When a petitioner’s statutory rights are assets to satisfy a debt. imperiled by the costs of arbitration, a court must determine whether to enforce the arbitration agreement and sever any fee- Pine Street Associates, LP v. sharing provision or, in the alternative, give the petitioner the Southridge Partners, LP, right to remain in court or pay the contracted-for costs and stay No. 652109/2010 (N.Y. Sup. Ct., NY Cty., 3/3/11). That the in arbitration. directives of an arbitration Award have been complied with and performed does not constitute a defense to confirmation of that Kirschner v. KPMG LLP, Award. Nos. 151 & 152, 2010 N.Y. LEXIS 2959 (N.Y., 10/21/10). The adverse interest exception, blocking imputation of knowledge THIRD CIRCUIT of fraud from controlling corporate officers to the corporation (thus preventing application of the in pari delicto defense), CFTC v. Perkins, applies narrowly to the circumstance where the corporation is No. 09-2507, 2010 U.S. App. LEXIS 13593 (3rd Cir., 7/1/10). actually a victim of the insiders’ wrongdoings. The purpose of the CEA would be undermined if one entity could escape regulation merely by having another entity execute its trades. MBIA Insurance Corp. v. Merrill Lynch International, McGowan Investors, LP v. Frucher, No. 4163 (N.Y. App., 1Dept., 2/1/11). A contractual promise to No. 07-3980, 2010 U.S. App. LEXIS 16908 (3rd Cir., 8/12/10). provide AAA-rated securities to an investor is not a promise of Objecting to a class action settlement does not prevent it from credit quality; it is merely a promise to provide securities that having a preclusive effect, once approved, upon the objector’s have an AAA rating. ability to re-litigate the issue in another forum. The Scher Law Firm, as Nominee and Claimants’ ING Life Insurance and Annuity Co. Representative v. DB Partners I LLC, RBC v. Gitterman, Capital Markets Corporation, Royal Bank of No. 10-4076, 2010 WL 3283526 (D. N.J., 8/18/10). A financial Canada, advisor whose fiduciary duty requires consideration of the whole cont’d on page 68

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of a client’s assets does not violate a written non-solicitation Bilyeu v. Johanson Berenson LLP, agreement by contacting former clients about assets which No. 1:08-cv-02006 (W.D. La., 9/27/10). The preferred method include those still managed by the former employer. of petitioning for enforcement of an agreement to arbitrate is to move pursuant to the Federal Arbitration Act, rather Popkave v. John Hancock Distributors LLC, than to seek dismissal of all claims under the Federal Rules; No. 10-3680, 2011 WL 382713 (E.D. Pa., 2/7/11). An dismissal, as opposed to a stay of litigation under Section 3, is arbitration Award, which is at least “barely colorable” based only appropriate in special circumstances. on the facts and the law, the result of confusion and uncertainty on the part of the arbitrators as to the applicable law, but not Grant v. Houser, completely irrational, does not exceed powers and is not in No 10-1919 (E.D. La., 1/10/11). Court denying brokerage manifest disregard of the law. firm’s motion to compel arbitration of customer claims based on firm’s failure to supply sufficient evidence of assignment of Credit Suisse Securities (USA) LLC v. arbitration agreement and upon a determination that equitable West Coast Opportunity Fund, LLC, estoppels did not apply to compel arbitration. No. 4380-VCN, 2010 Del. Ch. LEXIS 209 (Del. Chancery, 10/11/10). Under Delaware Chancery Court Rule 60(b), Pendergest-Holt v. Certain Underwriters at where exceptional circumstances have deprived the parties of Lloyd’s of London, appellate review, the court may vacate a prior ruling, even after No. 09-3712, 2010 U.S. Dist. LEXIS 86393 (S.D. Tex., the case is settled. 8/23/10). Court denying motion in limine seeking to preclude (i) use of plea agreement and transcript of guilty plea proceeding FOURTH CIRCUIT of former CFO of Stanford Financial Group Company, and (ii) use of declarations and affidavits prepared by forensic Levin v. Alms & Assoc., Inc., accountant hired by Receiver for Stanford Financial Group, No. 10-1896, 2011 U.S. App. LEXIS 2494 (4th Cir., 2/10/11). based on findings that such items met hearsay exceptions and An appeal of arbitrability automatically divests the district that no unfair prejudice would result from the admission. court of jurisdiction over the underlying claims and requires a stay of the action unless the district court certifies the appeal Billitteri v. Securities America, Inc., as frivolous or forfeited. No. 3:09-01568 (N.D. Tex., 2/18/11). The All Writs Act permits a federal court to enjoin pending arbitration proceedings, at Newman & Register v. least for TRO purposes, that might threaten approval of a class First Montauk Financial Corp., action settlement. No. 7:08-CV-116-D, 2010 U.S. Dist. LEXIS 74695 (E.D. N.C., 7/23/10). Possible inefficiency may occur due to referral of a Billitteri v. Securities America, Inc., claim to arbitration, because the relevant federal law requires No. 3:09-cv-01568-F (N.D. Tex., 3/7/11). Intervenors who wish piecemeal resolution when necessary to give effect to an to object to a class action settlement must be unrepresented in arbitration agreement. the action and, yet, have an interest in the property or subject of the action that will be impeded or impaired by the Court’s FIFTH CIRCUIT approval of the settlement. USA v. Radley, SIXTH CIRCUIT No. 09-20699, 2011 U.S. App. LEXIS 1715, (5th Cir., 1/27/11). The Fifth Circuit upholds a district court order dismissing Louisiana School Employees’ Retirement indictments brought against natural gas commodities traders System, et al. v. Ernst & Young, LLP, for violations of the Commodities Exchange Act (“CEA”), No. 08-6194, 2010 U.S. App. Lexis 19636 (6th Cir., 9/22/10). because the conduct alleged in the indictment consisted of *In order for red flags to create a strong inference of scienter transactions and thus fell within the exemption of §2(g) of the in securities fraud claims against outside auditors, they must CEA. be in the nature of an egregious refusal to see the obvious or to investigate the doubtful. **Accounting errors alone cannot Davis v. Karl, support a plausible inference of scienter under Tellabs. No. 10-875, 2010 U.S. Dist. LEXIS 85318 (E.D. La., 8/19/10). Civil conspiracy claims must plead all elements of SEC v. Payne, the underlying tort in which defendants conspired; statutory No. 1:00 cv 1265, 2010 U.S. Dist. LEXIS 136105. (S.D. Ind., rights of action under the Securities Act of 1933 do not permit 12/23/10). Collateral estoppel may be applied in civil cases a conspiracy claim. to issues previously determined in a criminal conviction; cont’d on page 69

68 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12 a criminal conviction based on a guilty plea conclusively the amount by which he was unjustly enriched, rather than to establishes for purposes of subsequent civil proceedings that compensate the victims of his fraud. the defendant engaged in the criminal act for which he was convicted. Regions Morgan Keegan Securities, Derivative, and ERISA Litigation, In Re, SEC v. Payne (Danker), No. MDL 2009 08-2260, 2010 U.S. Dist. LEXIS 101987 No. 1:00 cv 1265, 2010 U.S. Dist. LEXIS 136108 (S.D. Ind., (W.D. Tenn., 9/24/10). Under Maryland law, when a plaintiff 12/23/10). Collateral estoppel may be applied in civil cases to simultaneously argues that they have made a demand on the issues previously determined in a criminal conviction; a criminal board of directors and that demand is excused, the plaintiff’s conviction based on a guilty plea conclusively establishes for arguments that demand would be futile are mooted. purposes of subsequent civil proceedings that the defendant engage in the criminal act for which he was convicted. CFTC v. Bolze, No. 3:09 Civ. 088 (E.D. Tenn., 3/2/11). Bankruptcy does not Clayton v. Heartland Resources, Inc. insulate fraudsters from responsibility to pay restitution and No. 1:08CV-94, 2010 U.S. Dist. LEXIS 123654 (W.D. Ky, civil penalties that flow from their fraudulent activities. 11/16/10). Whether attendance at investor meetings and answering investors’ legal questions constituted an attempt Hantz Group, Inc. v. Haney, Mattes and to effect the sale of securities by an attorney, the content of Sterling Agency, Inc., the attorney’s answers and not simply the act of answering the No. 292954, 2010 Mich. App. LEXIS 2288 (Mich. App., questions is the key factor. 11/30/10). In the absence of a well-founded, legally sound or binding relationship, or expectancy of a relationship, tortious Haase v. GunnAllen Financial, Inc., interference with a business relationship cannot be proved. No. 2:08-cv-10927, 2011 U.S. Dist. LEXIS 19454 (E.D. Mich., 2/28/11). Claims based on control person liability for an SEVENTH CIRCUIT underlying primary violation of fraud must satisfy the pleading particularity requirements of Rule 9(b) and the PSLRA; RK Company v. See, conclusory allegations of participation as a “control person” No. 07-3894, 2010 U.S. Dist. LEXIS 19666 (7th Cir., 9/22/10). or seller will not suffice to state claims for relief under the 1933 A party that successfully prosecutes a claim under federal law Act, 1934 Act or state statutory or common law. is presumptively entitled to prejudgment interest. SEC v. Salyer, CFTC v. Lake Shore Asset Management, Ltd., No. 2:08-cv-179, 2010 U.S. Dist. LEXIS 85545 (E.D. Tenn., No. 07 CV 3598, 2010 U.S. Dist. LEXIS 65370 (N.D. Ill., 8/18/10). The purpose of disgorgement of profits acquired 6/30/10). A party that wishes to appeal an order approving a through securities fraud is to force a defendant to give up method of distribution from a common fund can ask the trial cont’d on page 70 SECURITIES LITIGATION COMMENTATOR SEARCH ELEVEN YEARS OF SLC CASES: Free legal research for SLC Subscribers! That is the mission we set for the SLC Archive at the Research Center on SAC’s WebSite, www.sacarbi- BACK tration.com. “Search Back Issues – Securities Litigation Commentator (SBI-SLC)” launched in 2009 with free service to SLC subscribers (non-subscribers pay $25 per download). ISSUES We combined the valuable legal resource of 5,000+ decision synopses written by SLC’s Board of Contributing Legal Editors since 2000 with a search facility allowing quick, online access. The result? A library of legal learning for lawyers seeking legal research focused on broker-dealer disputes and related law. Best of all, SLC subscribers have free access to the SBI-SLC facility and a great way to draw added value from their annual SLC subscription! Please visit today if you haven’t yet been by to see the updates we’ve made to the search capabilities. Take the direct route to SBI-SLC, sacarbitration.com/SLC/search. php. For assistance in using SBI-SLC, please contact SAC at help.sacarbitration.com or call 973-761-5880.

69 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

court to stay the order pending appeal or to set aside a reserve FINRA arbitrations, where the restrictions were adopted after to enable its claim to be paid if it prevails on appeal. he was engaged in active representation. Traderight Securities, Inc. Wright v. RBC Capital Markets Corporation, v. Richard G. Kirschman IRA, No. CIV S-09-3601 FCD/GGH, 2010 U.S. Dist. LEXIS No. 10 C 2042 (N.D. Ill., 2/15/11). After signing a uniform 80165 (E.D. Cal., 6/24/10). One may not block an existing submission agreement and filing an answer and a motion to arbitration before FINRA by filing a purported class action dismiss in the arbitration, a party’s request for an injunction seeking declaratory relief with respect to the issues raised in restraining the arbitration from going forward will be denied the arbitration. by the court. SEC v. Loomis, EIGHTH CIRCUIT No. 2:10-cv-00458, 2010 U.S. Dist. LEXIS 87021(E.D. Cal., 8/24/10). In a multi-defendant case, where claims against all Detroit General Retirement System defendants overlap and where some of the defendants fail to v. Medtronic, Inc., answer the complaint, a motion for default judgment against No. 09-2518, 2010 U.S. App. LEXIS 19379 (8th Cir., 9/16/10). the non-responding defendants will not be granted prior to trial Plaintiffs’ securities fraud class action lawsuit was of the matter, unless there is a just reason to grant the motion. dismissed for failure to state a claim, where plaintiffs’ Charles Schwab Corp. Securities Litigation, pleadings did not satisfy the heightened pleading In Re, requirements for securities fraud and there was no indication that statements were false when made or that No. 08-cv-01510 (N.D. Cal., 9/13/10). Notice of the pendency they were made with the requisite scienter. of a class action, as well as the settlement terms proposed between the parties, must be provided to all class members, so CFTC v. Hays, that they have a reasonable opportunity to opt out of the class No. 09-259, 2011 U.S. Dist. LEXIS 9243 (D. Minn., 1/27/11). or object to the settlement before a release of claims is imposed District courts have the power to order disgorgement as a upon them in exchange for settlement payments. remedy for violations of the Commodities Exchange Act for the Wells Fargo Mortgage-Backed Securities purpose of depriving the wrongdoer of his ill-gotten gains and Litigation, In Re, determining violations of the law. No. 09-cv-01376-LHK, 2010 U.S. Dist. LEXIS 106687 (N.D. NINTH CIRCUIT Cal., 10/5/10). *A plaintiff asserting a violation of Section 12 of the Securities Act of 1933 must allege a purchase directly from the issuer at the offering, not subsequent to the offering. Betz v. Trainer Wortham & Co., **An erroneous appraisal value is just an opinion and, hence, th No. 05-17054, 2010 U.S. App. LEXIS 13821 (9 Cir., 7/6/10). can only give rise to a claim under Section 11 of the Securities A remand to the district court is warranted in situations where Act of 1933, if the complaint alleges with particularity that the the district court has procedures available to it relating to statement was both objectively and subjectively misleading. the scope of the record and the determination of the facts not available to the court of appeals. Wells Fargo Mortgage-Backed Certificates Litigation, In Re, Northstar Financial Advisors, Inc. No. 09-cv-01376 LHK, 2010 U.S. Dist. LEXIS 106661 (N.D. v. Schwab Investments, Cal., 10/5/10). *The three-year statute of repose and one-year th No. 09-16347, 2010 U.S. App. LEXIS 16706 (9 Cir., 8/12/10). statute of limitations set forth in Sections 11 and 15 of the The fact that the Sudan Accountability and Divestment Act Securities Act of 1933 will not be tolled for a plaintiff who is of 2007, which was codified in part as Section 13(c) of the added to a complaint to replace a plaintiff who had no standing. Investment Company Act, gave investment companies a safe **The filing of a class action complaint is notice to any other harbor from lawsuits arising from the divesture of Sudanese putative plaintiffs who join the action later. related investments, does not mean that there is an implied private right of action under Section 13(a) of the Investment Bank of America Corp. ARS Marketing Company Act. Litigation, In Re: Bondar v. BOA, No. 09-md-02014 JSW, 2011 US Dist LEXIS 18208 (N.D. Cal., Sacks v. SEC, 2/24/11). A cause of action for market manipulation will fail if it th No. 07-74647 (9 Cir., 2/22/11). A non-attorney representative is shown that the defendant disclosed the allegedly manipulative is exempt from forum restrictions upon NAR appearances in conduct prior to the purchase of the security. cont’d on page 71 70 Securities Litigation Commentator Vol. 2011 • No. 2 Case Summaries • SLAs 2011 • 07-12

TD Ameritrade, Inc. v. Hagman v. Citigroup Global Markets, Inc., No. The Nevada Agency and Trust Company, BS128800 (Cal. Super. Ct., Los Angeles Cty., 2/9/11). An No. 3:08-cv-00245-LRH-RAM, 2010 U.S. Dist. LEXIS 94781 arbitrator who fails to disclose his involvement in litigation involving (D. Nev., 9/9/10). A transfer agent is not responsible for a similar subject matter to the assigned dispute provides grounds holder’s mistaken belief that a prior restriction on the transfer under California law for vacatur on evident partiality grounds. of a stock certificate had been removed. Citigroup Smith Barney v. Henderson, SEC v. Earthly Mineral Solutions, Inc., No. A139707, 2011 Ore. App. LEXIS 180 (Ore. App., 2/23/11). No. 2:07-CV-1057, 2010 U.S. Dist. LEXIS 1019872 (D. Nev., *A non-signatory to a contract with an arbitration clause will 9/24/10). Guilty pleas in a criminal action suffice to support the be required to arbitrate a dispute arising from the contract, if application of collateral in a civil enforcement action; active the non signatory enjoys the benefit of the contract. **A New participation in a related civil proceeding also suffices, even if York court will determine whether a right to arbitrate has been the case ends in a default judgment, so long as the defendant waived only if the underlying contract provides that it will be actively participated in defense of the claims. enforced pursuant to New York law. ***Under the FAA, if an agreement is silent on whether a court or an arbitrator will Washington Mutual Securities Litigation, decide the issue of waiver, then the default position is that the In Re, issue will be decided by the arbitrator. No. 2:08-md-1919 (W.D. Wash., 6/21/10). Disclaimers of liability in offering circulars are void under California law as a TENTH CIRCUIT defense to certain claims, including negligent misrepresentation claims, which involve deceit. Dronsejko v. Grant Thornton, Nos. 09-4222 & 10-4074, 2011 U.S. App. LEXIS 1052 (10th Washington Mutual, Inc. Securities Litigation, Cir., 1/20/11). Claims of accounting irregularities or violations In Re, of GAAP support a claim of scienter only when coupled with Lead Case No. 08-387 (W.D. Wash., 1/28/11). For statute of evidence that the violations or irregularities are the result of the limitations purposes, an amended pleading is deemed filed at defendant’s fraudulent intent to mislead investors. the time the motion to amend is first made. Thomas v. Metropolitan Life. Grand v. Nacchio, No. 09-6257, 2011 U.S. App. LEXIS 2024 (10th Cir., 2/211). No. CV-09-0317-PR, 2010 Arizona LEXIS 35 (Ariz., 8/5/10). The applicability of the broker-dealer exception to the IAA One may simultaneously induce and participate in an illegal hinges upon whether the advice in question relates to or is securities sale;however, participation and inducement involve connected with the broker-dealer’s primary business, not upon separate factors and are not coterminous. the quantum or importance of the advice. Lu Yu v. Global Merchant Center, Inc., Aspen Insurance UK, Ltd. v. Fiserv, Inc., No. B218388, 2010 Cal. App. Unpub. LEXIS 9825 (Cal. App., No. 09-CV-02770 (D. Colo., 12/9/10). Exclusionary clauses 2Dist., 12/14/10). A court case will be stayed under the doctrine designed to except particular conduct or situations from of forum non conveniens if there is a suitable alternate court insurance coverage provisions must be drafted in clear and and the private interests of the parties and the public interests specific language; to benefit from an exclusionary clause, an in litigating the case are preserved. The fact that the law of insurer must establish that the exclusion applies and is not another forum is less favorable to a litigant is of no weight. subject to any other reasonable interpretation. Choy v. Nopuente, UFCWU v. Chesapeake Energy, No. A126779, 2011 Cal. App. Unpub. LEXIS 727 (Cal. App., No. CIV-09-1114-D, 2010 U.S. Dist. LEXIS 92208 (W.D. 1Dist., 1/28/11). A motion to vacate an award on the ground Okla., 9/2/10). Solicitation for purposes of § 12(a)(2) potential that the arbitrator(s) failed to admit material evidence will only liability includes both personal solicitation and substantial be granted upon a showing of substantial prejudice. involvement in the offering process. Hansalik v. Wells Fargo Advisors, LLC, ELEVENTH CIRCUIT No. BS128947 (Cal. Super. Ct., LA Cty., 2/7/11). The law Badger v. Southern Farm Bureau Life Ins. Co., disfavors default judgments and that principle requires strict No. 09-12999, 2010 U.S. App. LEXIS 15895 (11th Cir., 7/30/10). interpretation of notice requirements, even in arbitration In an arms-length securities transaction, the seller may have settings; inadequate notice leads to vacatur of this Award. disclosure duties to the purchasing corporation, but that duty does not extend to the purchasing corporation’s shareholders. cont’d on page 72 71 Securities Litigation Commentator Vol. 2011 • No.2 Case Summaries • SLAs 2011 • 07-12

Board of Trustees of the City of Delray Beach GunnAllen Financial, Inc, In Re.: GunnAllen Police and Firefighters Retirement System v. v. U.S. Specialty Ins. Co., Citigroup Global Markets Inc., f.k.a. Salomon No. 8-10-cv-2855, 2011 Bankr. Lexis 334 (M.D. Fla., 2/3/11). Smith Barney, Settlement of the Liquidating Trustee’s claims against one of No. 09-13451, 2010 U.S. App. LEXIS 20880 (11th Cir., Debtor’s liability carriers for the balance of policy limits, on 10/8/10). *A brokerage account agreement to arbitrate disputes condition of a bar order which extends to claims against non- under “other agreements between us” extends to other related debtors as well, is not fair and equitable to claimants and will roles that a broker may play, e.g., as pension consultant. not be approved over their objections. **A governing board that authorizes its agent to complete an agreement for investment management services also, by Regions Financial Corporation, Morgan Asset implication, authorizes the agent to enter into agreements that Management, Inc. and Kelsoe, Ex Parte: Rice v. will expedite that investment manager’s performance. RFC, In Re, No. 1090425, 2010 Ala. LEXIS 183 (Ala. Sup. Ct., 9/30/10). An Citigroup Global Markets, Inc. v. Potter, independent wrong and damages separate and apart from the No. 6:07-cv-00163-JA-JGG 9 (M.D. Fla., 2/14/07). Both damage done to the issuer corporation must be demonstrated Florida and Maryland law recognize that customer lists can to avoid having the class action dismissed as an improperly constitute trade secrets. instituted derivative action.

SEC v. Scoppetoulo, D.C. CIRCUIT No. 10-20475-Civ-Cooke/Bandstra, 2011 U.S. Dist. LEXIS 7819 (S.D. Fla., 1/27/11). The materiality of non-public Riordan v. SEC, information is mostly a question of fact and difficult to assess No. 10-1034, 2010 U.S. App. LEXIS 26277 (D.C. Cir., at the pleading stage; generally, a decision on materiality must 12/28/10). The applicable statute of limitations for fines, await discovery and the summary judgment stage. penalties and forfeitures that may result from regulatory actions does not apply to the remedies of disgorgement or cease-and- Great Florida Bank, v. Countrywide Home desist orders. Loans, Inc., Countrywide Securities Corp., and BAC Home Loans Servicing, LP (F/K/A Full Value Advisors, LLC v. SEC, Countrywide Home Loans Servicing, LP), No. 10-1053, 2011 U.S. App. LEXIS 3167 (D.C. Cir., 2/4/11). No. 10-22124-CIV-Huck/O’Sullivan (S.D. Fla., 2/3/11). The SEC reporting requirements applicable to institutional “Shotgun pleading,” or the practice of naming numerous investment managers under § 13(f) of the 1934 Act regarding defendants and then making allegations of misconduct that proprietary securities positions do not compel speech in are attributable to all of them without distinction, is not an violation of the First Amendment; nor do they constitute an appropriate form of pleading, especially when the particularity uncompensated taking in violation of the Fifth Amendment. requirements of FRCP Rule 9(b) are considered applicable to the claims.

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