On June 13, 2011, the U.S. Supreme Court issued its opinion in Janus Capital Group, Inc. v. First Derivative Traders.¹ In a five-to-four decision,² the Court ruled that the investor advisor and administrator for certain mutual funds, Janus Capital Management or “JCM,” could not be held liable under Section 10(b) of the Securities Exchange Act of 1934 for allegedly false and misleading statements in prospectuses issued by the Janus family of mutual funds.³

The Fourth Circuit had previously ruled that private investors could bring Section 10(b) claims against JCM because it had participated in the writing and dissemination of the fund prospectuses and, thus, investors would have likely viewed JCM as being responsible for the allegedly false and misleading statements.⁴ The Supreme Court reversed, holding that, as a matter of law, no such claims were possible under Section 10(b).

The Court’s Opinion. Rule 10b-5 prohibits the “mak[ing] [of] any untrue statement of material fact” in connection with the purchase or sale of securities.⁵ Thus, the Court’s decision in Janus turned on whether JCM could be said to have “made” the alleged misstatements at issue. No statements in the fund prospectuses were directly attributed to JCM and the funds were considered to be legally separate from JCM.

The Court started its analysis by recognizing that Section 10(b) does not provide an express private cause of action for investors, although the Court has previously ruled that such a cause of action may be implied.⁶ In the Court’s view, the fact that the cause of action had been implied by courts, and not expressly granted by Congress, counseled against its further expansion and required the Court to give such claims “narrow dimensions.”⁷

The Court next held that “[o]ne ‘makes’ a statement by stating it.”⁸ Thus, for purposes of Section 10(b) liability, “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.”⁹ Without such control, an entity may suggest what to say, but it does “not ‘make’ a statement in its own right.”¹⁰ The Court explained that this rule is best exemplified by the relationship between a speechwriter and a speaker. A speech writer may draft a speech, “but the content is still entirely within the control of the speaker, the person who delivers it.”¹¹ As a result, it is the speaker who takes the credit or the blame for what is ultimately said.¹²

The Court also concluded that this rule was consistent with its prior decisions in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A.¹³ and Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc.¹⁴ In Central Bank, the Court held that there was no private liability under Section 10(b) for “aiding and abetting” another party’s violation of the federal securities laws. A broader reading of “make” would have substantially undermined Central Bank by allowing claims against persons who were accused of providing “substantial assistance” to the making of a public statement.¹⁵

In Stoneridge, the Court had also previously ruled that certain product suppliers could not be liable for statements their customer made to its investors where the only conduct that could possibly be attributed to the suppliers was never communicated to investors. Like Stoneridge, the Court reasoned that the rule articulated in Janus properly focused on “the entity with the authority over the content of the statement and whether and how to communicate it.”¹⁶ Without such authority, it is not “‘necessary or inevitable’ that any falsehood will be contained in the statement.”¹⁷

The Court specifically rejected the Government’s request to define “make” more broadly to reach one who could be said to have “created” the statement.¹⁸ The Court explained that adopting this expansive definition would lead to results inconsistent with the prior precedent discussed above and would allow a plaintiff to sue any person who allegedly provided false information that another person chose to put into a statement.¹⁹ The Court similarly refused to accept Plaintiff’s suggestion that the uniquely close relationship between a mutual fund and its advisor required a different result.²⁰ The Court held that “the corporate formalities were observed here” and any possible reapportionment of liability based on the unique circumstances of this particular industry would be the responsibility of Congress and not the courts.²¹

Analysis and Conclusions. The Court’s decision in Janus is entirely consistent with the bright line rule on the scope of primary liability previously articulated in Stoneridge. The similarity between the two opinions is hardly surprisingly, given that the same five members of the Court were in the majority for both cases. Throughout the briefing and oral argument, counsel for Plaintiffs and the Government were never able to articulate a principled basis on which to distinguish the claims against JCM from those previously rejected in Stoneridge and Central Bank. The Supreme Court recognized that embracing the proposed claims in Janus had the potential to erode certain long-standing protections against abusive lawsuits established by its prior decisions.

In this respect, Janus covered familiar ground in the context of private securities litigation. The unique wrinkle that Janus presents is what effect the decision may have on enforcement actions brought by the Securities and Exchange Commission (“SEC”). Janus dealt with claims by private investors as opposed to an enforcement action undertaken by the SEC. Congress expressly gave the SEC the authority to bring aiding and abetting claims, which means that Central Bank does not apply to the SEC. Also, much of the analysis in Stoneridge turned on the reliance requirement, which is an essential element of private liability, but does not apply to the SEC.

In contrast, the SEC, just like private litigants, must prove that the defendant “made” an allegedly false or misleading statement. There is a greater likelihood, therefore, that Janus will have an effect on the type of defendants who can be pursued in enforcement actions. The SEC will have difficulty arguing that this opinion should be read to apply only to private claims.

¹No. 09-525, slip op. (June 13, 2011).
²Justice Thomas wrote the majority opinion in which Justices Roberts, Scalia, Kennedy, and Alito joined. Justices Breyer, Ginsburg, Sotomayor, and Kagan dissented.
³Janus, slip op. at 12.
⁴Id. at 4.
⁵Id. at 5.
⁶Id. at 5-6.
⁷Id. at 6.
⁸Id.
⁹Id.
¹⁰Id.
¹¹Id. at 6-7.
¹²Id.
¹³511 U.S. 164 (1994).
¹⁴522 U.S. 148 (2008).
¹⁵Janus, slip op. at 7.
¹⁶Id. at 8.
¹⁷Id. (citing Stoneridge, 552 U.S. at 161).
¹⁸Id.
¹⁹Id.
²⁰Id. at 9-10.
²¹Id. at 10.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was signed into law on July 21, 2010, included a provision establishing a program to pay an award to eligible whistleblowers who provide the Securities and Exchange Commission (SEC) and/or other government authorities with original information that leads to successful enforcement of federal securities law violations that result in monetary sanctions in excess of $1 million. Pub. L. No. 111-203, § 922.

On November 3, 2010, the SEC issued its Proposed Rule for implementing the whistleblower provisions. Proposed Rules for Implementing the Whistleblower Provisions of Section 21F, Exchange Act Release No. 34-63237, File No. S7-33-10 (Nov. 3. 2010) (to be codified at 17 CFR pts. 240 and 249). The Proposed Rule solicited comments through December 17, 2010. Id.

On May 25, 2011, by a 3 to 2 vote, the SEC adopted the Final Rule for implementing the Dodd-Frank Act whistleblower provisions. Exchange Act Release No. 34-64545, File No. S7-33-10 (May 25, 2011) (to be codified at 17 CFR pts. 240 and 249). This new whistleblower program aims to incentivize individuals to report violations early and directly to the SEC by providing rewards and protection from employer retaliation.

The Final Rule adopts much of the Proposed Rule, with several key changes regarding internal compliance and exclusions for award eligibility. The SEC received 240 comment letters and over 1,300 form letters on the Proposed Rule. The Final Rule discusses many of the comments considered by the SEC in modifying the Proposed Rule and the reasoning behind each change. Below is a summary of some of the relevant provisions of the Final Rule and the statute.

• Whistleblower: A whistleblower is any individual who provides the SEC with original information related to a possible violation of federal securities law that “has occurred, is ongoing, or is about to occur.” SEC Final Rule, 17 CFR § 240.21F-2(a).

• Award: Where all the conditions of the Final Rule are met, a whistleblower is entitled to between 10-30 percent of the total monetary sanctions of more than $1 million collected in successful SEC or other enforcement actions. The Final Rule clarifies that the size of the award lies in the discretion of the SEC. SEC Final Rule, 17 CFR § 240.21F-5. In making an award determination, there are several required criteria that the SEC must consider that will influence whether to increase or decrease the whistleblower’s percentage.

o The criteria that will increase a whistleblower’s percentage award include the significance of the information provided by the whistleblower, law enforcement interest in the action, the degree of assistance provided by the whistleblower and whether the whistleblower participated in internal compliance procedures prior to contacting the SEC. Id. at § 240.21F-6. This last factor is one of the most significant changes in the Final Rule. After much debate about whether the SEC should require a whistleblower to first participate in the company’s internal compliance process, the Final Rule includes no such requirement. Instead, as noted above, the SEC made the whistleblower’s participation in the company’s internal compliance process a factor that could increase their award percentage.

o The criteria that will decrease a whistleblower’s percentage include culpability, unreasonable delay and interference with internal compliance procedures. Note that culpability does not exclude a whistleblower from receiving an award, but is instead just one factor that the SEC will consider in determining the appropriate percentage.

• Anonymity of Whistleblower: Whistleblowers are entitled to remain anonymous. They must, however, be represented by an attorney and disclose their identity before collecting any award. SEC Final Rule, 17 CFR § 240.21F-7(b). The SEC notes in the Summary of the Final Rule that it has declined to include a rule on attorneys’ fees, and instead leaves that determination up to state bar authorities and private agreements.

• Exclusions for Award Eligibility: Individuals with a pre-existing legal or contractual duty to report securities law violations to the SEC or other government authorities are ineligible to collect the award. SEC Final Rule, 17 CFR § 240.21F-4(a)(3) & (b)(4). In a departure from the Proposed Rule, however, the Final Rule provides that the SEC will not exclude individuals with a duty to report to their employer or a third party from the possibility of collecting whistleblower awards. The SEC explains that “employers should not be able to preclude their employees from whistleblower eligibility by generally requiring all employees to enter into agreements that they will report evidence of securities violations directly to the [SEC].” In sum, individuals and information ineligible for the award include:

o Individuals under a “pre-existing legal or contractual duty to report securities violations” to the SEC or other enumerated government authorities. SEC Final Rule, 17 CFR § 240.21F-4(a)(3) [emphasis added].

o Information based on a communication that was subject to the attorney-client privilege. This exclusion applies to attorneys and non-attorneys in possession of the privileged information. SEC Final Rule, 17 CFR § 240.21F-4(b)(4)(i) [emphasis added].

o Information gained as a result of legal representation. This exclusion applies to all attorneys, “whether specifically retained or working in-house.” SEC Final Rule, 17 CFR § 240.21F-4(b)(4)(ii) [emphasis added].

o An entity’s officers, directors, trustees or partners “if they obtained the information because another person informed them of allegations of misconduct, or they learned the information in connection with the entity’s processes for identifying, reporting, and addressing potential non-compliance with law.” SEC Final Rule 17 CFR § 240.21F-4(b)(4)(iii)(A) [emphasis added]. If, however, an officer discovers information indicating that “other members of senior management are engaged in securities violations,” they are not excluded from reporting to the SEC and becoming eligible for the whistleblower award. Id.

o Compliance Officers or “employees whose principal duties involve compliance or internal audit responsibilities, as well as employees of outside firms that are retained to perform compliance or internal audit work for an entity.” SEC Final Rule, 17 CFR § 240.21F-4(b)(4)(iii)(B).

o Employees or other persons retained to conduct internal investigations or inquiries into possible violations. SEC Final Rule, 17 CFR § 240.21F-4(b)(4)(iii)(C).

o Independent public accountants performing duties required under the securities laws if the information relates to a violation by an engagement client or the client’s directors, officers or other employees. SEC Final Rule, 17 CFR § 240.21F-4(b)(4)(iii)(D).

o Information gathered by means or in a manner that is determined by a domestic court to violate applicable federal or state criminal law. SEC Final Rule, 17 CFR § 240.21F-4(b)(4)(iv). The exclusion does not cover information obtained in violation of civil or domestic foreign law, or judicial or administrative protective orders. Id.

o However, if certain circumstances are present, an excluded individual in any of the above categories may be eligible to receive a whistleblower reward using otherwise excluded information:

 If the person has a reasonable basis to believe that the disclosure is necessary to prevent the relevant entity from committing substantial harm. SEC Final Rule, 17 CFR § 240.21F-4(b)(4)(v).

 If the person has a reasonable basis to believe that the entity is engaging in bad faith conduct that will impede an investigation (e.g., shredding documents, influencing witnesses). Id.

 If 120 days have elapsed since the whistleblower reported the information internally, an officer, director or compliance officer may then report the information to the SEC and become eligible to receive a whistleblower award. Id.

• Eligibility for Award: Employees may be deemed to provide “original information” and, therefore, qualify as whistleblowers if, after reporting the information internally, the employee provides the same information to the SEC within 120 days. SEC Final Rule, 17 CFR § 240.21F-4(b)(7). While the SEC extended this “look-back period” from 90 days to 120 days, it again emphasized that it is not requiring whistleblowers to participate in companies’ internal compliance procedures.

• Credit for Employer’s Information: In addition to extending the time period, the Final Rule includes an important incentive for individuals to report internally. A whistleblower who internally reports information that leads to successful enforcement under the Final Rule’s criteria before or at the same time as he or she reports that information to the SEC will “receive full credit for the information [the organization] reports to [the SEC] as if the whistleblower had provided the information to [the SEC].” SEC Final Rule, 17 CFR § 240.21F-4(c)(3).

• Whistleblower Protection: Section 922 of the Dodd-Frank Act protects whistleblowers against retaliation from employers. Pub. L. No. 111-203, § 922 Sec. 21F(h). “No employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower” providing information to the SEC, initiating or participating in an action, or in making disclosures to the SEC. Pub. L. No. 111-203, § 922 Sec. 21F(h)(1)(A). This protection applies (i) regardless of whether the whistleblower procedurally qualifies for an award and (ii) even if it is ultimately determined that the conduct identified by the whistleblower does not constitute a violation of the securities laws. SEC Final Rule, 17 CFR § 240.21F-2(b)(1). However, the whistleblower must have a “reasonable belief that the information he is providing relates to a possible securities law violation . . . that has occurred, is ongoing, or is about to occur.” Id.

• Statute of Limitations for Actions Against Retaliatory Employers: A whistleblower may bring an action against an employer either within six years after the date on which the retaliatory action occurred or within three years after the date when the whistleblower becomes aware or should have become aware of the retaliatory action, but not later than 10 years after the date of the retaliatory action. Pub. L. No. 111-203, § 922 Sec. 21F(h)(1)(B).

• Expanded Jurisdiction: A whistleblower can bring a cause of action for retaliation in U.S. District Court. Pub. L. No. 111-203, § 922 Sec. 21F(h)(1)(B)(i). Previously, whistleblowers were required to file retaliation claims at the administrative level.

• Remedies of Aggrieved Whistleblower: A whistleblower who is successful against an employer on a retaliation claim is eligible for reinstatement with the same seniority he or she otherwise would have had and can recover double back pay, litigation costs and reasonable attorneys’ fees. Pub. L. No. 111-203, § 922 Sec. 21F(h)(1)(C).

What to Do Now:

• Reexamine and reevaluate your internal compliance procedures and policies to ensure consistency with the new rules and to encourage compliance.

• Review and reevaluate your record-keeping procedures and policies forcapturing, evaluating, investigating and resolving tips and complaints. Create a response plan that enables the company to stay on top of, and hopefully ahead of, any related investigation.

• Consider expanding your employee hotline to consultants, customers and suppliers and other business partners.

• Regularly train and communicate with employees about internal compliance procedures. Be clear that the company does not restrict their ability to go directly to the SEC. Make sure they understand there will be no retaliation and that utilizing the company’s procedures does not interfere with a whistleblower’s ability to receive a bounty and may, in fact, increase any ultimate award.

The Final Rule will be effective 60 days after it is submitted to Congress or published in the Federal Register.

On June 6, 2011, the Supreme Court delivered its unanimous opinion in Erica P. John Fund, Inc. v. Halliburton Co.¹ Prior to accepting the Halliburton appeal, the Court had agreed to hear only one prior appeal related to what is known as the “loss causation” requirement for claims brought under Section 10(b) of the Securities Exchange Act of 1934.² The loss causation requirement has become an increasingly important factor in whether shareholders will be able to recover on claims brought under the federal securities laws. Under the loss causation requirement, a plaintiff must plead and prove that any stock price losses were caused by the defendants’ alleged misstatements and not by other factors, such as changed economic circumstances and industry-specific events. By accepting the Halliburton appeal, the Court had the opportunity to provide helpful guidance to the lower courts and litigants on what type of evidence would be sufficient to establish loss causation.

The Supreme Court, however, opted for a different -- and more narrow -- approach in resolving the Halliburton appeal. The Court’s opinion does not address in any respect how a plaintiff should go about attempting to prove loss causation or what kind of evidence would be relevant to that issue. Indeed, the Supreme Court never even reached the issue of whether the plaintiff in Halliburton had failed to establish loss causation – which was the well-reasoned conclusion reached by two prior courts. Instead, the decision in Halliburton turned on the narrow question whether the Fifth Circuit properly applied another twenty-plus year old opinion from the Supreme Court – Basic Inc. v. Levinson.³ The Supreme Court concluded that the Fifth Circuit had improperly required the plaintiff to satisfy an additional requirement (loss causation) to invoke the rebuttable presumption of reliance described in Basic that, upon a proper showing, is available to investors under the “fraud-on-the-market” theory. The Court ruled that Basic did not contain a loss causation requirement and remanded the case to the Fifth Circuit for further proceedings consistent with the opinion.

Overview of Halliburton Decision. In Halliburton, the Supreme Court was asked to rule on what had long been the rule in the Fifth Circuit -- namely, that a plaintiff must prove loss causation by a preponderance of the evidence to certify a class of investors.⁴ The Fifth Circuit had agreed with the district court that, even though all of the other requirements for class certification had been met in the case, the investor class in Halliburton could not be certified because the plaintiff had failed to prove loss causation.⁵

The Supreme Court ruled that the Fifth Circuit erred by requiring proof of “the separate element of loss causation to establish that reliance was capable of resolution on a common, classwide basis.”⁶ For class certification purposes, most plaintiffs seek to rely on the rebuttable presumption of reliance described in Basic -- i.e., that all class members are presumed to have relied on public statements about a given company because that information is reflected in the price at which they bought the company’s stock. Class certification, however, must be denied if the presumption of reliance is unavailable to the class because individualized reliance issues will predominate over other issues that class members may have in common.

In Halliburton, the Supreme Court observed that two points were undisputed (1) that a plaintiff “must prove certain things in order to invoke” Basic’s presumption of reliance and (2) that a defendant is entitled to come forward with evidence to attempt to rebut that presumption.⁷ But the Court concluded that there was no justification in Basic or its logic to read into that opinion the additional requirement of having to prove loss causation in every case where Basic is invoked. The Court noted that the loss causation requirement is not even mentioned in Basic and the Supreme Court has consistently referred to loss causation and reliance (i.e., “transaction causation”) as being separate elements of a Section 10(b) claim.⁸

The Court also noted that the defendants had essentially conceded on appeal that Basic on its face did not require proof of loss causation, even though they argued that the Fifth Circuit’s conclusion that the class could not be certified could be supported on other grounds.⁹ The Supreme Court, however, refused to consider these alternatives because it felt constrained to “take the Court of Appeals at its word.”¹⁰ The Fifth Circuit had repeatedly stated it was requiring proof of loss causation from the plaintiff and, “[b]ased on those words, the decision below cannot stand.”¹¹ Accordingly, the Supreme Court declined to “address any other question about Basic, its presumption, or how and when it may be rebutted.”¹² Any relevant arguments on these points against class certification that had been preserved by defendants could be raised on remand.¹³

Analysis of the Opinion. Given the narrow nature of the opinion, the Halliburton decision is not expected to impact significantly how class certification issues are litigated in Section 10(b) cases. The Supreme Court expressly reiterated the long-standing rule that defendants are entitled to come forward with evidence to attempt to rebut the presumption of reliance described in Basic. The Court, thus, refused to accept the plaintiff’s invitation to adopt a more restrictive view that could have precluded a defendant from relying on any evidence at class certification that arguably spoke to the merits of the plaintiff’s underlying claim.

It is interesting to note that all of the facts on which the defendants based their loss causation arguments in Halliburton would have also been relevant to the question of whether the plaintiff could invoke Basic’s presumption of reliance and/or whether that presumption could be rebutted. Even though the Supreme Court refused to consider these arguments, the Court made clear that, if adequately preserved, all of those arguments would still be available to defendants on remand. The Supreme Court’s opinion, thus, leaves open the possibility that the same evidence that had previously proven to be successful in Halliburton may still be considered if deemed relevant to a plaintiff’s attempt to rely on Basic.

Moreover, the Halliburton opinion does not suggest that loss causation issues can never be raised by defendants at class certification. Indeed, the opinion supports the view that such issues can be raised if they are relevant to other well-established requirements for class treatment, such as the need for common issues to predominate. The Supreme Court specifically recognized that the starting point for assessing whether common issues predominate is an examination of the mandatory elements of the underlying claim, which, for Section 10(b) claims, includes the requirement of proving loss causation. Halliburton stands only for the narrow point that, at class certification, a court cannot require a plaintiff to prove loss causation to invoke Basic.

¹No. 09-14-3, 2011 WL 2175208 (June 6, 2011).
²Dura Pharms., Inc. v. Broudo, 544 U.S. 336 (2005).
³485 U.S. 224 (1988).
⁴Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330, 334 (5th Cir. 2010); see also Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007).
⁵Halliburton, 2011 WL 2175208, at *3.
⁶Id.
⁷Id. at *4.
⁸Id.
⁹Id. at *5.
¹⁰Id.
¹¹Id.
¹²Id.
¹³Id.
¹⁴Id. at *3.

In another significant federal court decision on the loss causation element of federal securities fraud claims, last week U.S. District Judge Ursula Ungaro (S.D. Florida) overturned a jury verdict for Plaintiffs in the securities fraud class action suit, In re BankAtlantic Bancorp, Inc. Sec. Litig., No. 07-Civ-61542 (UU).  Judge Ungaro’s April 25, 2011 order granted Defendant’s motion for judgment as a matter of law and set aside a potentially massive damages verdict against BankAtlantic and a number of its current and former officers and directors. 

Plaintiffs in the case, representing a class of BankAtlantic shareholders who purchased stock between November 9, 2005 and October 25, 2007, filed their initial Complaint on October 29, 2007 and their Consolidated Amended Complaint on April 22, 2008.  On December 12, 2008, the Court dismissed the Consolidated Amended Complaint without prejudice pursuant to Defendants’ motion to dismiss.  Plaintiffs filed their First Amended Complaint on January 12, 2009 and on May 12, 2009, the Court denied Defendants’ renewed motion to dismiss.  Thereafter, trial began on October 12, 2010 and the parties delivered closing arguments on November 10, 2010. 

After deliberating for five days, the jury returned a verdict mostly in Defendants’ favor with respect to many of the alleged misstatements in the Complaint.  However, the jury concluded that four alleged misstatements by Alan Levan—BankAtlantic’s former Chairman and CEO—regarding the value of the bank’s loan portfolio did, in fact, run afoul of federal securities laws, namely § 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.  The jury specifically found that one of these alleged misstatements by Mr. Levan proximately caused damages of $2.41 per share to BankAtlantic shareholders.  In addition, the jury concluded that BankAtlantic, Mr. Levan, and Valerie Toalson (BankAtlantic’s CFO) violated federal securities laws with respect to a fifth alleged misstatement during the Class Period. 

On December 10, 2010, Defendants moved the Court for post-trial judgment as a matter of law, arguing that Plaintiffs had failed to put forth sufficient evidence to support the jury’s findings of loss causation and damages and had thus fallen short of satisfying the elements necessary for their 10b-5 claims.  In a 112-page opinion, the Court granted Defendants’ motion, agreeing with Defendants that Plaintiffs’ evidence of loss causation and damages was insufficient as a matter of law. 

Judge Ungaro specifically based her decision on the issue of “whether Plaintiffs’ put forth sufficient evidence that their damages, if any, were ‘caused’ by the concealment of [BankAtlantic’s loan loss] risk.”  In the opinion, Judge Ungaro explains that Plaintiffs relied exclusively on the trial testimony of their damages expert to establish that the BankAtlantic share price decline resulted from the revelation of Defendants’ alleged misstatements.  Judge Ungaro found this expert testimony insufficient to support Plaintiffs’ 10b-5 damages element, holding: “[W]here a fraud is revealed contemporaneously with the announcement of other negative, but non-fraud-related information, plaintiffs bear the burden of disaggregating the effect of the unrelated negative information on the stock price.”  Finding that Plaintiffs’ damages expert failed to “disaggregate” the decline in BankAtlantic’s share price that was attributable to the release of non-fraud related negative information about the bank’s loan portfolio from the fall specifically attributable to the misstatements alleged by Plaintiffs in their Complaint, Judge Ungaro granted Defendants’ motion and overturned the jury’s verdict.

Last week, the United States Supreme Court unanimously affirmed a prior decision of the Ninth Circuit in Matrixx Initiatives, Inc. v. Siracusano, No. 09-1156, the latest securities case to be heard by the Court.  The Supreme Court agreed with the Ninth Circuit that the plaintiffs in that case had adequately pled both materiality and a fraudulent intent or “scienter” and, thus, the defendants’ motion to dismiss plaintiffs’ claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 should have been denied by the lower court. 

Plaintiffs alleged that Matrixx Initiatives, a manufacturer of over-the-counter pharmaceutical products, had violated the federal securities laws by failing to disclose reports it had received on a possible link between the use of Zicam Cold Remedy (Matrixx’s leading product) and anosmia (the loss of the sense of smell). The District Court held, inter alia, that materiality and scienter had not been plead adequately because the allegedly withheld data had not been shown to be statistically significant.  The Ninth Circuit reversed.

One can always speculate as to why the Supreme Court accepts a case for review. In this instance, the Supreme Court did not alter any existing standards, but rather applied them in the context of scientific data.  Many securities cases involve reporting of financial data as to which there are existing standards found in SEC regulations and/or accounting principles.  There is, in contrast, no such guidance as to disclosure of scientific information.  In ruling that the plaintiffs had alleged sufficient facts to plead material misstatements or an omission, the Supreme Court declined to adopt the bright-line rule put forth by the defendants, i.e., reports of adverse events related to a company’s product could never be material unless there were “a sufficient number of such reports to establish a statistically significant risk” that the company’s product is the cause of such adverse events.  (Slip Op. at 10-11.)  Instead, the Court invoked the longstanding rule set forth in its decision in Basic v. Levinson, 485 U.S. 224 (1988), which requires a court to examine whether there is “ ‘a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.’ ” Id. at 231-32. 

The Supreme Court reasoned that, although an event’s statistical significance may still be considered as part of the materiality analysis, it will not standing alone be determinative.  Under Basic, “the materiality of adverse event reports cannot be reduced to a bright-line rule.”  (Slip Op. at 1-2.)  The Court explained that lower courts must continue to engage in contextual analyses to determine whether the omission of information regarding adverse event reports could be considered materially misleading.  “Something more is needed, but that something more is not limited to statistical significance and can come from ‘the source, content, and context for the reports.’ ” (Slip Op. at 16.)

In a similar fashion, the Supreme Court also reaffirmed its decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), which held that courts must consider “plausible opposing inferences” with regard to whether the defendant acted with scienter.  Id. at 323.  In Matrixx, the Court deemed it relevant to the scienter analysis that the complaint alleged the company had withheld medical reports of potential adverse effects of the product, as well as information about several pending lawsuits.  Relying on the standard articulated in Tellabs, the Court observed that allegations of scienter must be reviewed holistically and that the “complaint adequately pleads scienter under the PSLRA ‘only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.’” (Slip Op. at 20.)  Although the company’s actions could be categorized as reckless, rather than intentional, the Court declined to decide whether recklessness was sufficient to establish scienter.  The Court further stated that it assumed without deciding that the scienter requirement may be satisfied by a showing of “deliberate recklessness.”  (Slip Op. at 20.)  In finding that the plaintiffs had adequately pled scienter, the Court held that “[t]he inference that Matrixx acted recklessly . . . is at least as compelling, if not more compelling, than the inference that it simply thought the reports did not indicate anything meaningful about adverse reactions.”  (Slip Op. at 21.)  Even though the Court held that the allegations against the company in this case were sufficient to plead scienter, it did caution that “[w]hether respondents can ultimately prove their allegations and establish scienter [at trial] is an altogether different question.”  (Slip Op. at 22.)