The 10b–5 Guide A Survey of 2010-2011 Securities Fraud Litigation Robert F. Carangelo, Esq. Paul A. Ferrillo, Esq. David J. Schwartz, Esq. Matthew D. Altemeier, Esq. Weil, Gotshal & Manges LLP September 2012 BY Weil, Gotshal & Manges LLP Robert F. Carangelo, Esq. Paul A. Ferrillo, Esq. David J. Schwartz, Esq. Matthew D. Altemeier, Esq. Weil, Gotshal & Manges LLP 767 Fifth Avenue New York, New York 10153 Phone 212.310.8000 • Fax 212.310.8007 www.weil.com Table of Contents FOREWORD .................................................................................................................................................. iii INTRODUCTION ........................................................................................................................................... v CHAPTER 1: SECURITIES LITIGATION BASICS ............................................................................... 1 GENERAL PRINCIPLES OF SECURITIES LAW ................................................................................. 1 EXTRATERRITORIALITY UNDER MORRISON ................................................................................ 2 CHAPTER 2: PLEADING STANDARDS AND SCIENTER ................................................................ 11 PLEADING STANDARDS ................................................................................................................... 11 Federal Rule of Civil Procedure 9(b) ............................................................................................... 11 The PSLRA’s Statutory Pleading Requirements ............................................................................. 12 SCIENTER ............................................................................................................................................. 19 Methods of Pleading Scienter: Motive and Opportunity, Conscious Misbehavior, and Recklessness .............................................................................................................................. 25 PLEADING SCIENTER THROUGH MOTIVE AND OPPORTUNITY ............................................. 32 PLEADING SCIENTER THROUGH ALLEGATIONS OF CONSCIOUS MISBEHAVIOR OR RECKLESSNESS ...................................................................................................................... 44 CORPORATE SCIENTER ..................................................................................................................... 59 GROUP PLEADING .............................................................................................................................. 66 THE CORE OPERATIONS DOCTRINE .............................................................................................. 71 PLEADING ACCOUNTING FRAUD ................................................................................................... 74 PLEADING ALLEGATIONS BASED ON CONFIDENTIAL SOURCES OF INFORMATION ............................................................................................................................... 79 CHAPTER 3: MATERIALITY, SAFE HARBOR, AND LOSS CAUSATION .................................... 87 PLEADING MATERIALITY ................................................................................................................ 87 FALSITY DISTINGUISHED .............................................................................................................. 102 THE PSLRA’S SAFE HARBOR FOR FORWARD LOOKING STATEMENTS .............................. 107 The Bespeaks Caution Doctrine .................................................................................................... 116 LOSS CAUSATION ............................................................................................................................ 119 CHAPTER 4: LIABILITY ISSUES ........................................................................................................ 135 LIABILITY OF SECONDARY ACTORS IN SECURITIES MARKETS .......................................... 135 CONTROL PERSON LIABILITY ....................................................................................................... 150 CHAPTER 5: CLASS ACTION PROCEDURAL MECHANISMS .................................................... 157 THE LEAD PLAINTIFF PROVISIONS OF THE PSLRA ................................................................. 157 Largest Financial Stake/Greatest Economic Loss .......................................................................... 158 i Substitution of Lead Plaintiffs ....................................................................................................... 159 CLASS CERTIFICATION REQUIREMENTS UNDER RULE 23 .................................................... 161 Rule 23(a) Requirements ............................................................................................................... 161 Rule 23(b) Requirements ............................................................................................................... 168 LOOKING BEYOND THE PLEADINGS ........................................................................................... 181 CHAPTER 6: OTHER PROCEDURAL ISSUES .................................................................................. 183 STATUTE OF LIMITATIONS ............................................................................................................ 183 EXPERT TESTIMONY AND DAUBERT MOTIONS ....................................................................... 188 STANDING .......................................................................................................................................... 190 DAMAGES .......................................................................................................................................... 193 STAY OF DISCOVERY ...................................................................................................................... 194 IMPOSITION OF RULE 11 SANCTIONS.......................................................................................... 197 MOTIONS TO COMPEL DISCLOSURE OF CONFIDENTIAL WITNESSES DURING DISCOVERY .................................................................................................................................. 200 ABOUT WEIL, GOTSHAL & MANGES LLP .......................................................................................... 203 ROBERT F. CARANGELO ........................................................................................................................ 205 PAUL A. FERRILLO .................................................................................................................................. 207 DAVID J. SCHWARTZ .............................................................................................................................. 209 MATTHEW D. ALTEMEIER ..................................................................................................................... 211 TABLE OF AUTHORITIES ....................................................................................................................... 213 ii Foreword Years from now, when historians write the history of the Roberts Court, perhaps they will be able to explain why, in the second half of the first dozen years of the 21st Century, the Supreme Court suddenly became so interested in taking up cases under the federal securities laws. But whatever the reason, in recent years the Court has agreed to consider a cluster of securities cases, and the Court’s decisions have had and will have a far-reaching impact on securities litigation—particularly securities class action litigation. Among all of the litigation risks a company faces, the risk of a securities class action lawsuit may be among the most serious. These cases are complex, time-consuming and expensive to defend. As if that were not enough, the applicable law is constantly evolving, especially now with the Supreme Court’s new-found interest in securities cases. These factors also make litigation arising under the securities laws, particularly under Section 10(b) of the Securities Exchange Act of 1934, so interesting—which of course is cold consolation for the companies involved, but it does mean that securities cases reliably provide particularly rich blog fodder. Because the securities litigation landscape is so complex and rapidly changing, it is critically important—for in-house counsel, prognosticators, and historians alike—to have a reliable reference source. In their readable, interesting, and concise book, The 10b-5 Guide, Messrs. Carangelo, Ferrillo, Schwartz and Altemeier of Weil, Gotshal & Manges have again done a terrific job erecting useful structure around this complex topic, and identifying and explicating the most recent developments in this area of the law. Their book provides just the comprehensive guide that the topic requires. We can all be grateful for their work. Kevin M. LaCroix Author, The D&O Diary iii iv Introduction1 Perhaps there is something in the water on First Street. A review of the trends in private Section 10(b) and Rule 10b-5 cases reveals that during the last two years, the United States Supreme Court has issued more precedential opinions than were decided in the previous eighteen.2 The question remains whether Supreme Court jurisprudence over the last two years will significantly alter the 10b-5 landscape at the district and circuit court levels. In Merck & Co. v. Reynolds, 130 S. Ct. 1784, 1790 (2010), plaintiff investors