Ninth Circuit Finds NASDAQ Listing Material

In a rare case, based solely on a Section 12(a)(2) of the Securities Act of 1933 (the “Act”), 15 U.S.C. § 77l(a)(2) claim, the Ninth Circuit overturned a District Court Opinion finding that an implied promise to list the stock on NASDAQ, in the Final Draft of the Prospectus, was not material. In HOWARD MILLER v.THANE INTERNATIONAL, INC., the Ninth Circuit recites what this author finds to be almost an amusing flip-flop of experts (both of whom I respect) who normally take completely opposite positions in a 10b case where defendants argue that the "reliance" element of fraud cannot be established through the "fraud on the market presumption" in small cap stocks because the markets on which they trade on are not efficient :

Testifying for Thane International, Bradford Cornell, Professor of Finance at the Anderson Graduate School of Management at the University of California, Los Angeles, minimized the importance investors attach to the market in which a company trades, concluding “value derives from the company itself and not where it trades.” He also testified that liquidity is determined by a company’s inherent characteristics,5 not the market on which it trades. He generally regarded listing on the NASDAQ as a cosmetic benefit of secondary importance to investors who focus on a company’s fundamentals.

On behalf of the plaintiff class, Candace Preston, founding member of Financial Markets Analysis, LLC, emphasized the benefits that accompany NASDAQ listing as compared to listing on the OTCBB. She declared that NASDAQ stocks generally enjoy greater liquidity, and thus reduced spreads,6 leading to greater investor returns.7 NASDAQ-listed shares are also exempt from state-by-state “Blue Sky” laws, which require companies offering securities to undergo burdensome registration processes in certain states in addition to the various federal registration requirements. This translates into lower compliance costs, more favorable terms for raising capital, and thus, all things being equal, higher earnings and share prices. NASDAQ-listed shares can also be purchased on margin, i.e. purchased with money on loan from a stockbroker. This can lead, all things being equal, to a larger investor base and higher returns.Wall Street Journal, which further decreases their exposure to potential investors and decreases price transparency. She also explained that NASDAQ listing confers a degree of prestige on a stock because of that market’s more rigorous listing standards.

Preston testified, and Thane International did not dispute, that institutional investors almost universally shun OTCBB stocks, which significantly cuts into the base of demand for those shares (thus depressing their price). Preston also testified that OTCBB stocks are not regularly quoted in financial publications like the

See Thane_International_Ninth_Circuit.pdf. Also of interest to the Plaintiffs' Bar are affirmations of two long held principles. The first being the principle that even literally true statements can be misleading:

[A]n issuer’s public statements cannot be analyzed in complete isolation. “Some statements, although literally accurate, can become, through their context and manner of presentation, devices which mislead investors. For that reason, the disclosure required by the securities laws is measured not by literal truth, but by the ability of the material to accurately inform rather than mislead prospective buyers.” In re Convergent Tech. Sec. Litig., 948 F.2d 507, 512 (9th Cir. 1991) (quoting McMahan & Co. v. Wherehouse Entm’t, Inc., 900 F.2d 576, 579 (2d Cir. 1990)); see also Kaplan v. Rose, 49 F.3d 1363, 1372 (9th Cir. 1994).

The second is that Section 12(a)(2) claims have no scienter element:

“Section 12(a)(2) is a virtually absolute liability provision that does not require an allegation that defendants possessed scienter.” In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 269 (3d Cir. 2006) (internal quotation marks omitted); see also Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 578 (1995) (“It is understandable that Congress would provide [securities] buyers with a right to rescind, without proof of fraud . . . .” ). Moreover, the purchaser need not prove reliance on the misrepresentations. See Gustafson, 513 U.S. at 576, 578.

While plaintiffs may have won the war, they may have lost the battle. The Courts holding that the stock drop was immaterial for determining liability is moderated by the fact that the Court sent it back for the District Court to consider loss causation. Contrast Footnote 2:

2 In the context of a “fraud on the market” Rule 10b-5 class action, where reliance is presumed based on the price of a stock, availability to the public of truthful information may be relevant to the extent the stock’s price has not actually been skewed by any misrepresentations. However, in an action that does not involve the fraud on the market presumption, that truthful information is available elsewhere does not relieve a defendant from liability for misrepresentations in a given filing or statement. See Apple Computer, 886 F.2d at 1114-15.

With:

A Section 12 defendant is liable only for depreciation that results directly from the misrepresentation at issue. See 15 U.S.C. § 77l(b). Because the district court found no misrepresentation, however, it did not reach loss causation. Thane International urges that we should affirm the district court’s judgment because the district court’s factual findings necessarily establish that there was no loss resulting from any material misrepresentations. Specifically, Thane International argues that the district court’s finding that Thane International stock did not react during its first nineteen days of OTCBB listing supports a finding that its failure to list on the NASDAQ was not the direct cause of any loss of value.

Without expressing any opinion as to the strength of this argument, we remand to the district court to address the issue of loss causation in the first instance, following the “general rule [that] ‘a federal appellate court does not consider an issue not passed upon below.’ ” Golden Gate Hotel Ass’n v. City & County of San Francisco, 18 F.3d 1482, 1487 (9th Cir. 1994) (quoting Singleton v. Wulff, 428 U.S. 106, 120 (1976)).

What one hand gives, the other takes away. Prediction...early settlement.

Loser CEOs, Raking It In

The Washington Post has published an Op Ed by my former colleague, William Lerach on Sunday November 11, 2007.

While William Lerach's actions are not to be ignored, and he is not one to rightfully complain about inequitable distribution of wealth, his observations concerning the abuse of corporate power should be given consideration. As they say, and I say in half jest, "It takes a crook to know a crook."

Link: Loser CEOs, Raking It In.

No Accounting for It, Loser CEOs, Raking It In By William S. Lerach Sunday, November 11, 2007;

"How come I don't get nothin'?"

In light of the massive payoffs that corporations are handing to failing executives -- most recently the ousted chiefs of Merrill Lynch and Citigroup -- that could be the legitimate lament of millions of U.S. workers whose jobs have been sacrificed of late in the name of corporate competitiveness and free trade.

Cleaned up grammatically, that question would probably express the sentiments of many of the 24,000 Merrill employees fired in recent years and the 17,000 Citi employees who are soon to get the ax. Together, former Merrill chief executive E. Stanley O'Neal and former Citigroup chief executive Charles O. Prince have lost more than $20 billion in company money. Yet they left with $360 million in their own pockets.

The American principles of responsibility, accountability and justice require everyone, even corporate titans, to pay a price when they mess up. I've dedicated my career to holding powerful corporations accountable when they victimized innocent people. CEOs such as Enron's Jeffrey K. Skilling, WorldCom's Bernard J. Ebbers and Tyco's L. Dennis Kozlowski all went to prison for their fraud. Now I'm being held accountable for overzealously pursuing these corporate scam artists.

Two weeks ago, I pleaded guilty to a conspiracy charge involving payments made to plaintiffs in lawsuits against major corporations. Under the terms of the plea, which requires court approval, I agreed to pay the government $8 million in fines and penalties and to serve at least one year in federal prison.

But what about accountability for Wall Street CEOs who line their pockets while making stupid decisions that rob shareholders and pensioners of billions of dollars? Recently, corporate boards have been fundamentally misinterpreting the phrase "the buck stops here" -- and handing the bucks over to their miserably performing bosses.

Let's see if I've got this right. To try to boost profits in the new low-interest-rate era, O'Neal and Prince plunged Merrill and Citi into the high-risk world of subprime collateralized debt. The banks peddled billions of dollars of this stuff to pension funds and institutions, pocketing more than a billion in fees for feeding the pigeons. Apparently, Merrill and Citi got stuck with more than $50 billion of the riskiest debt that they couldn't unload on their customers. O'Neal had assured Merrill shareholders that these high-stakes bets would "not add to Merrill's risk profile." And when the subprime fiasco started to unravel, Prince famously said that Citi was "still dancing."

As Merrill and Citi took on these risky assets, their balance sheets ballooned and short-term profits flowed in. O'Neal, Prince and their executive teams crowed about their successes and their risk-management skills while pocketing bigger performance bonuses based on the "profits" and cashing in stock grants and options as the stock prices temporarily advanced. Several top Merrill executives received more than $30 million each in 2006. O'Neal led the pack with $91 million. For cream in his coffee, O'Neal unloaded about 235,000 shares of Merrill stock, pocketing an additional $20 million. At Citi, top executives were given more than $10 million per year, with Prince raking in $25 million. ( Continued )

Then the roof caved in. A tsunami of losses has swept over many big banks -- but none comes close to matching Merrill and Citi for their folly. At first, O'Neal told investors that the Merrill loss would be about $4.5 billion. Prince initially said that Citi's would be about $6 billion. Horrifying enough. But just a few weeks later, O'Neal admitted that Merrill's real loss would exceed $8 billion -- the largest subprime loss in the world. Then Citi announced that its real subprime loss could reach $11 billion.

The previously reported profits have been wiped out, and rumors of billions more in coming write-offs abound. Who knows what the class-action suits against Merrill and Citi for stock fraud will cost? Merrill's stock has deflated from almost $100 per share to $60. Citi's stock is down from $55 per share to $36. Ironically, the Merrill stock "bounced" only when it was disclosed that O'Neal had secretly talked to another bank about buying Merrill -- a bad move for shareholders at these depressed price levels, but one that would have paid O'Neal $250 million under the company's "change of control" provisions.

Let's not forget that Merrill was one of the key architects -- while O'Neal was a top insider -- of the unsurpassed Enron rip-off of thousands of investors. Merrill managers were indicted and convicted. While Prince was Citi CEO Sandy Weil's consigliere, Citi was also a "tier one" bank for Enron and was forced to pay $2 billion to settle lawsuits by Enron stockholders as part of the largest fraud settlement with stockholders in history.

Prince and O'Neal have admitted to "mistakes" and "flawed risk models." These "mistakes" and "risks" are reminiscent of those of Andrew Fastow, Kenneth L. Lay and the other Enron boys in their "structured" "off balance sheet" deals -- contrivances that were really designed to put shareholders at risk while lining the insiders' pockets. The more things change, the more they stay the same on the "Street."

One would think that having engineered these catastrophes, O'Neal and Prince would be in for some real financial reckoning. Some working stiff on the assembly line who forgot to tighten the lug nuts on the cars going past him or some clerk in the risk department who forgot to file an insurance claim would surely suffer some penalty. Like being fired without a huge going-away gift. But O'Neal got to pocket $160 million in stock-based compensation as his departure present -- on top of the more than $100 million he received during the past couple of years. Prince, it is said, left with $100 million, on top of the $100 million he got as Citi's CEO.

How can this comport with notions of fairness? If some Merrill or Citi lower-level manager lost $2 million -- let alone $100 million -- you can bet that the board would come down on that poor soul like a ton of bricks. And these boards would no doubt sue a defaulting counter-party who cost their corporation $800 million -- let alone these billions in losses -- because of a "mistake."

It would be one thing if this were an isolated incident reflecting just terribly bad judgment by these CEOs' pals on their boards. But it's not. It's a way of life in American executive suites, aided and abetted by lax regulations and politically compromised regulators at the Securities and Exchange Commission. Executive failure is consistently rewarded with giant payments -- or, really, payoffs -- to keep the parting sacrificial lamb quiet so that he or she won't bleat to the stockholders, lawyers and the media that the others at the top of the company (and in the boardroom) knew what was really going on.

Similar examples of excess abound. Take Morgan Stanley, where a few years ago, top executives Philip J. Purcell and Stephen Crawford were ousted after a series of managerial missteps swamped that bank with losses and crushed its stock. Their reward? More than $100 million -- as they were shown the door. Jerry Levin was pushed out as chairman and CEO of AOL Time Warner (oops, now it's just Time Warner; the AOL name is gone but not forgotten) after engineering the worst acquisition of the past century, which cost his shareholders $100 billion and sank the stock from $58 to $9. His going-away payoff -- $600 million. After Carly Fiorina ran Hewlett-Packard into the ditch, she was sent packing with a $100 million gift for her "leadership." Dick Grasso, New York Stock Exchange, $140 million. Michael Ovitz, Walt Disney Co., $135 million. And dozens more.

The real frustration is that there's so little that can be done. Shareholders supposedly have access to the courts for a remedy, but they won't get far. A stockholder suit filed more than two years ago challenging the Morgan Stanley payoffs languishes in court. The CEO-and-director club knows that pro-business judges in the corporate haven of Delaware and elsewhere in the legal system will protect them. Shareholder suits against Time Warner's Levin got nothing back from him.

The government -- forget it. The SEC, and even Congress, appear to be getting ready to cut back shareholder rights and court access even more. And the Justice Department is busy defending waterboarding and targeting Democratic activists. Why do you think corporate bigwigs behave so badly so often?

One great virtue of the American free-market capitalist system is that to date, it has been able to withstand all forms of excess. But "quis custodiet ipsos custodes?" -- "Who will guard the guards?" wrote the Roman poet Juvenal. How corporate boards treat the shareholder owners of the corporations they oversee is simply intolerable. And even the strongest camel's back can ultimately be broken.

Someone told me recently that Lenin was wrong about communism but right about capitalism. Maybe he was. I'm on my way to prison because, in my zeal to stand up against this kind of corporate greed over the years, I stepped over the line. It turns out that the legal system is a lot tougher on shareholder lawyers than it appears to be on Wall Street executives.

WilliamLerach@gmail.com

William S. Lerach is a longtime shareholder advocate and plaintiffs' lawyer.