THE NEW SUPREME COURT TERM: TWO IMPORTANT SECURITIES CASES
The first Monday in October marks the opening of the new Supreme Court Term each year. Last year, the High Court heard five cases which are having a significant impact in securities litigation. Jones, discussed here, reaffirmed the traditional Second Circuit standard for bringing suits under Section 36(b) of the Advisers Act to challenge adviser fees. That standard had been adopted by each circuit which considered the question. Morrison, in contrast, rejected the consensus which had built around the Second Circuit’s jurisprudence on the extraterritorial application of Exchange Act Section 10(b). In this case the Supreme Court held that the question of is one of substance, not jurisdiction and then delimiting the scope of the Section to U.S. transactions on exchanges and those in this country. Dodd-Frank, however, restored the reach of the Section for the SEC and DOJ.
In Skilling, the Court also limited the reach of a statute, this time Section 1346 regarding honest services fraud, a charge frequently brought in criminal securities cases. A possible legislative fix sought by DOJ, discussed here, is in progress. Rounding out the term were two cases focused on potions of the Sarbanes-Oxley Act. Merck clarified the application of the SOX statute of limitations to in private actions, discussed here. PCAOB struck down a portion of the SOX provision which set up the Board, discussed here, but left its operations in tact.
At the opening of this Term, the Court has agreed to hear two cases which may have a significant impact on securities litigation. One is Matrixx Initiatives v. Siracusano, No. 09-1158 cert. granted June 14, 2010, which presents a key question regarding materiality. The complaint here claims that Matrixx made false statements about its key product Zicam, a nasal spray. In 2003, the company issued statements about the success of the product.
At one point, Matrixx revised its earnings guidance upward due to the success of the product. The company had however received some information from researchers and individuals that the nasal spray caused a loss of smell. Product liability suits had been filed against the company.
Matrixx maintained in press releases that none of the clinical trials supported claims that the drug caused a loss of smell. The company denied pres reports discussing complaints about a loss of smell. A report of an FDA investigation was followed by a drop in the share price despite statements by the company that it was not aware of any such inquiry.
A shareholder suit was filed alleging securities fraud based on claims that the denials of the company were false and misleading. The district court dismissed the complaint. In its ruling, the court held that adverse product reports regarding a loss of smell did not have to be disclosed because they were not material. Specifically, the court concluded that a pharmaceutical company need not disclose every adverse report it receives. Rather, those reports need only be disclosed when they are statistically significant. The court based its conclusion on the decision of the Second Circuit in In re Carter-Wallace, Inc., Sec. Litig., 220 F.3d 36 (2nd Cir. 2000). This rule has also been adopted by the First and Third Circuits.
The Ninth Circuit reversed. Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167 (9th Cir. 2009). Citing Basic v. Levinson, 485 U.S. 224 (1988) the court rejected the statistically significant test used by the district court. Materiality, the court stated, is a question generally reserved for the fact finder. Here, the question is whether the allegations are properly pleaded under the PSLRA and state a cause of action under Bell Atlantic Corp., v. Twombly, 550 U.S. 5543 (2007). Following these principles, the court reviewed the claims in the complaint regarding adverse product information about Zicam and concluded that the allegations met the pleading requirements. Accordingly, the decision of the district court was reversed.
The critical question before the Supreme Court is the test for materiality under the circumstances of this case. This is a crucial issue for the business community and the pharmaceutical industry in particular. This case is in briefing and will be argued later this term.
The second securities case the Court will hear this term focuses on the question of primary liability. Janus Capital Group v. First Derivative Traders, No. 09-525, cert. granted June 28, 2010. Defendant Janus Capital Group, Inc. (“JCG”) is a publicly traded asset management firm. It sponsors a family of mutual funds known as the Janus Funds. Janus Capital Management LLC (“JCM”) is a wholly owned subsidiary of Janus Capital.
Plaintiffs claim that JCG and JCM violated Exchange Act Section 10(b) because the prospectuses for the funds created the misleading impression that steps would be taken to curb market timing. In fact, the complaint claims there were secret agreements which permitted market timing. As a result of these misrepresentations plaintiffs claim they purchased their shares at an inflated price. Following the revelation of the truth in 2003, the price fell.
The district court dismissed the complaint. The court concluded that the complaint did not contain any allegations that JCG actually made or prepared the prospectuses or that any of the statements were attributable to it. As to JCM, the court held that the investment adviser did not owe any duty to the shareholders of its parent company when they have not purchased shares of the mutual fund.
The court of appeals reversed. In re Mutual Funds Investment Litig., 556 F.3d 111 (4th Cir. 2009). The defendants adequately alleged that defendants “made” the misleading statements and that they were properly attributed to JCM the court held. Under the circumstances here, plaintiffs adequately alleged that defendants participated in the writing and dissemination of the prospectuses. The court declined to establish an attribution rule.
The allegations as to JCG, however, are insufficient to state a claim for primary liability the court concluded. Its limited role here was not sufficient to cause interested investors to believe that JCG had prepared or approved the Janus fund prospectuses. The court did find that plaintiffs had adequately pleaded a claim for control person liability.
The question of primary liability in Janus traces back to the Supreme Court’s decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994). There, the Court held that there is no liability for aiding and abetting under Section 10(b). Since that time the courts have struggled with the question of what constitutes primary liability. Congress restored aiding and abetting for the SEC in the PSLRA but declined to do so for private actions. Dodd-Frank does require the SEC to prepare a report for Congress on whether such a provision should be enacted for private actions. Prior to the completion of that study, the decision here should clarify the applicable standards which are currently split between the Second Circuit “bright line” test (here) and the Ninth Circuit “substantial participation” test (here). Janus Capital is scheduled for oral argument on December 7, 2010.
Program: Fifth Annual Securities Fraud National Institute, October 7-8, 2010 in New Orleans. For further information on this excellent program please click here: http://www.abanet.org/cle/programs/securitiesfraud/