The Continuing Impact of Dura Pharmaceuticals v. Broudo

As part of an occasional series leading up to the arguments before the Supreme Court in Stoneridge in the first week of October, we examined the impact of the Court’s decision in Dura, decided two years ago. That case held, as previously discussed here, that a securities law plaintiff must allege and prove more to establish a claim under Section 10(b) claim than mere price inflation. In addition, plaintiff must prove loss causation – the link between the claimed fraud and injury. Overall, Dura is making it more difficult to plead and prove a securities fraud case.

Dura is having an impact in other areas not discussed in the earlier series. Class certification is one such area. In Oscar Private Equity Inves. v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007), the Fifth Circuit vacated and remanded a district court class certification decision, concluding that “loss causation must be established at the class certification stage by a preponderance of all admissible evidence.”

The case is a class action against telecom company Allegiance. The complaint alleged that the company had fraudulently misrepresented it line-installation count in violation of Section 10(b). When the final quarterly results were announced for 2001, the company had to restate the line-installation count. Earnings were also reported below street expectations. Plaintiffs’ suit followed the drop in the share price.

The District Court certified the class following a hearing at which it concluded that class certification should not be a mini-trial on the merits. The Fifth Circuit held otherwise. The circuit court concluded that full consideration to the requirements of Federal Civil Rule 23 was required even if they overlap into the merits. This included consideration of whether loss causation had been established, thus extending the reach of Dura into critical the class certification area. See also In re Organogenesis Securities Litig., Case No. 04-10027-JLT (D. Mass. March 15, 2007) (considering expert affidavit arguing no Dura causation in denying class certification).

The Dura decision is also having an impact on non-securities, common law fraud cases. For example, in Glaser v. Enzo Biochem, Inc., 464 F.3d 474 (4th Cir. 2006), plaintiff investors brought a common law fraud action against Enzo Biochem and several of its officers. The complaint alleged that plaintiffs purchased their shares at an inflated price that resulted from a conspiracy by defendants to conceal the fact that clinical trials for a key drug had not progressed well so that they could sell their shares at an inflated price.

The Fourth Circuit affirmed the dismissal of the complaint based, in part, on Dura, despite the fact that the case was based on a common law fraud claim, not the federal securities laws. Although plaintiffs repeatedly claimed that they purchased shares at an inflated price, they failed to link the price inflation to the claimed economic injury. But see Merrill Lynch & Co. V. Allegheny Energy, Inc., 2007 WL 2458411 (2d Cir. Aug. 31, 2007) (declining to apply Dura to a common law fraud claim, citing New York law re proximate cause). Overall, courts are continuing to extend the reach of Dura.

THE RENEWED CAMPAIGN ON INSIDER TRADING: Part II: If This is A Return to the “Den of Thieves,” is the Answer Better Enforcement?

In a widely quoted comment, an SEC enforcement official recently noted that insider trading is “rampant.” Another SEC official stated earlier that there is an increase in insider trading among market professionals. Both of these comments are reflected in the ever increasing number of insider trading cases brought by the SEC. Indeed, the trend seems to be reminiscent of the days chronicled in James Stewart’s book, Den of Thieves, about the insider trading scandals of the 1980’s.

Perhaps the 1980’s have returned. Consider, for example, SEC v. Guttenberg, Case No. 1:07-cv-01774-PKC (S.D.N.Y. Filed March 1, 2007) and related cases (originally discussed here). There, the SEC brought insider trading cases against 14 defendants. The cases involved two basic insider trading schemes. One scheme is the UBS scheme which ran from 2001 to 2006 where UBS insider Guttenberg tipped two Wall Street traders regarding up coming UBS analysts’ recommendations. The two traders had downstream tippees at other firms and hedge funds.

The second scheme involved a Morgan Stanley attorney, her husband attorney and other professionals. There, according to the allegations, the Morgan Stanley attorney misappropriated M&A information and tipped others.

What is perhaps most significant about the cases is the defendants: a “who’s who” of Wall Street players: a UBS registered representative, a Morgan Stanley attorney, a Lyford Cay hedge fund manager, an Andover brokerage representative, a Chelsey Capital portfolio manager, a representative from Jefferies & Co. and others.

The criminal case, U.S. v. Jurman, Case No. 1:07-cr-00140-TPG (S.D.N.Y. Filed Feb. 26, 2007) (and related cases) contained many of the same Wall Street professionals as defendants.

A second significant case involving Wall Street professionals is SEC v. Barclays Bank, Civil Action No. 07-CV-04427 (S.D.N.Y. Filed May 30, 2007). There, a major Wall Street bank and its proprietary trader for distressed debt were named as defendants in an insider trading case. The complaint alleged illegal profits from trading in debt securities of bankrupt companies where the bank and its trader obtained the inside information from positions held on various creditors committees.

While the Barclays case raises significant questions about the use of so-called “Big Boy” letters, discussed here, what is perhaps more important is the fact that is was brought directly against a major Wall Street institution.

A third case brought this year named a fund manager as a defendant, SEC v. Frohna, Civil Action No. 07-C-0702 (E.D. Wis. Filed August 1, 2007). In this case, the fund manager is alleged to have received inside information from his brother, who was leading a major clinical study for a significant drug at XOMA. The fund, which held a large stake in XOMA, is alleged to have avoided a large loss based on information Mr. Frohna obtained from his brother about the study. While there are significant materiality questions raised by this case, which are discussed here, again what is perhaps more significant is the defendant: another Wall Street professional.

These cases and another involving two Wall Street professionals, SEC v. Smith, discussed here, follow last year’s block buster cases, SEC v. Anticevic, Case No 05 Civ. 6991 (S.D.N.Y. Filed August 5, 2006) and the related criminal case, U.S. V. Plotkin, Case No. 06 CR 380 (RLH) (S.D.N.Y.) (and related cases). These cases involved three overlapping insider trading schemes: one involving inside information obtained from on Merrill Lynch M&A deals; a second involving advance information on copies of Business Week; and a third involved inside information concerning a grand jury inquiry into Bristol Myers. Again, however, what is disturbing is the involvement of Wall Street professionals.

Collectively these cases raise significant questions regarding the reasons for the current wave of “rampant” insider trading. While many argue that the current generation of traders have forgotten the lessons of the past that explanation seems a bit to glib. No doubt the amount of money to be made is tempting. Perhaps this wave of rampant insider trading says something about compliance and enforcement. Prevention often begins with good compliance not only by Wall Street players, but also every company. At the same time, no compliance program is bullet proof. In the end, consistent, effective enforcement by the SEC is key to preventing “rampant” insider trading. While the SEC is clearly stepping up its efforts in this area and there is no doubt that investigation and proof of these cases is difficult, perhaps it is time to carefully reevaluate enforcement in this critical area.