A New Way to Curtail Class Actions?

ATTORNEY: MARK B. GOLDSTEIN
The Pomerantz Monitor, September/October 2013 

A recent decision by the Third Circuit has the potential to further restrain consumer and other types of class actions. Last August, in Carrera v. Bayer Corp., the Third Circuit reversed and remanded the certification of a class of Florida consumers who purchased Bayer's One–A–Day WeightSmart diet supplements. 

This was a potential class action by consumers claiming that Bayer falsely and deceptively advertised its supplement. When the District Court certified the class, Bayer appealed, arguing that class certification was improper because the class members were not “ascertainable”. This requirement means that “the class definition must be sufficiently definite so that it is administratively feasible to determine whether a particular person is a class member.” This is important because all class members have to be notified if a class has been certified or if a settlement has been reached, and because, if there is a recovery for the class, the court can determine who is entitled to share in it, and who isn’t. 

Here the class was to consist of everyone who purchased the supplement in Florida. Figuring out who these people are is no easy matter. In securities cases, for example, there are brokerage and other records identifying everyone who bought or owned a particular security at a particular time. Similarly, records are kept of everyone who purchases prescription drugs. But no one keeps a comprehensive list of everyone who buys consumer products like over the counter diet supplements. If such a list must exist in order to certify a class action, it will be a major roadblock in many cases. 

Plaintiffs here proposed that class members could be identified through retailers’ records of online sales and of sales made through store loyalty or reward cards. They also suggested that when class members file their individual proofs of claim to share in any recovery, they could submit affidavits attesting that they purchased WeightSmart and stating the amount they paid and the quantity purchased. 

The Third Circuit rejected those arguments, concluding that it could not know for certain whether retailers’ records would identify all or most of the class members. It also held that affidavits from people who claimed, without documentary proof, that they bought the product could be unreliable. 

It is too soon to know whether other Circuits will follow suit and adopt this standard for ascertainability. If they do that would be a problem. There are many products sold for which there is no comprehensive and authoritative source identifying all purchasers. In such cases, purchasers may have no feasible method for seeking recourse if defendants engage in deceptive or illegal conduct.

SEC Wrests Admissions in Settlement of Falcone Case

ATTORNEY: MURIELLE STEVEN WALSH
Pomerantz Monitor, September/October 2013 

The JPMorgan “London Whale” case is not the first time the SEC has insisted on admissions of wrongdoing as part of its settlement agreements. A few weeks earlier, for example, the SEC secured admissions as part of its settlement of charges against Hedge Fund manager Philip Falcone. 

The current push to insist on admissions of wrongdoing in these settlements can probably be traced to November of 2011, when Judge Rakoff of the Southern District New York famously rejected Citigroup’s $285 million settlement with the SEC, primarily because it did not contain any admission of wrongdoing by the bank. The judge found that the deal was "neither fair, nor reasonable, nor adequate, nor in the public interest." Judge Rakoff has been highly critical of settlements that allow defendants to neither “admit nor deny,” and has called them “a stew of confusion and hypocrisy unworthy of such a proud agency as the S.E.C.” 

Judge Rakoff was criticized as overstepping his bounds and challenging the authority of the SEC. Wall Street interests argued that admissions of wrongdoing in SEC settlements would encourage private investor litigation. Others pronounced that a requirement for admissions would make it difficult, if not impossible, for the SEC to settle cases. The Second Circuit is now reviewing whether, in fact, the court went too far. 

But regardless of the outcome of that appeal, Judge Rakoff’s opinion has had profound repercussions. When Mary Jo White was first appointed as the new SEC chair, she announced that henceforth the Commission would require admissions of wrongdoing as a condition to settlement in certain situations. 

Judge Rakoff’s colleague in the Southern District, Judge Marrero, recently approved a settlement between SAC Advisors and the SEC that also had no admissions of wrongdoing. However, he conditioned his approval on a finding by the Second Circuit in the Citigroup matter that district courts lack the authority to reject SEC settlements solely because of “admit or deny” policy. If the Second Circuit does not make such a finding, SAC will be back on the hook. 

The recent $18 million civil settlement between hedge-fund manager Philip Falcone and securities regulators is a case in point. Falcone and his hedge fund, Harbinger Capital Partners, had been accused of engaging in an illegal “short squeeze” to force short-sellers to sell distressed, high yield bonds at inflated prices, and favoring certain investors over others when granting redemption requests. An earlier agreement reached between Falcone and the SEC’s enforcement staff did not contain any admissions of wrongdoing. In a rare move, the SEC commissioners rejected the agreement and sent the parties back to the table. The new deal contains Falcon’s admissions of underlying facts of alleged improper behavior, specifically, that he had acted “recklessly” with regard to several market transactions. It does not, however, include admissions of specific securities law violations. Obviously, the facts can potentially be used as fodder in private litigation – in this case, an admission of reckless conduct has important ramifications for fraud claims. 

At the same time, Falcone won’t be limiting his legal options in other lawsuits that may follow on the heels of this settlement. As noted by James Cox, a law professor at Duke University School of Law, the admitted facts “may be helpful, but not perfectly helpful, to follow-on litigation."

Not So Fabulous After All

ATTORNEY: TAMAR A. WEINRIB
Pomerantz Monitor, September/October 2013 

In August, the SEC scored a much-needed win when a nine-member jury, after deliberating for two days, found Fabrice Tourre, a former Goldman Sachs bond trader once known as “Fabulous Fab,” liable on six of seven civil fraud charges. 

The SEC brought the action in 2010 against both Mr. Tourre and Goldman Sachs, accusing both of misleading investors about a complex mortgage-based financial product known as “Abacus 2007-AC1.” Abacus was a “collateralized debt obligation,” a financial vehicle based on a collection of underlying mortgage-related securities. Tourre played a major role in putting Abacus together; but he (and Goldman) allegedly failed to disclose to potential investors that hedge fund titan John Paulson, a key Goldman Sachs client, had also played a major role in selecting the securities underlying Abacus. Paulson’s involvement was critical because he himself made a huge bet against Abacus, selling millions of shares short, and made a killing when Abacus failed. In other words, the SEC claimed that Abacus was secretly designed to fail so that Paulson could make a killing at the expense of Goldman’s other clients. 

Goldman settled the SEC’s claims some time ago, agreeing to pay a $550 million fine, without admitting or denying wrongdoing. Abacus, and the large fine it generated, heavily damaged Goldman’s reputation, helping to earn it the sobriquet “great vampire squid.” 

Even after Goldman settled, Tourre fought on, and lost. Tellingly, his lawyers opted not to call any witnesses at trial, an interesting strategy which perhaps reflected the weakness of their case. The SEC called two witnesses, Laura Schwartz from the ACA Financial Guaranty Corporation, and Gail Kreitman, a former Goldman saleswoman, who testified that they were misled about who was investing in Abacus. Also key to Mr. Tourre’s downfall was a number of emails to his girlfriend, which he called “love letters,” in which he joked about selling toxic real estate bonds to “widows and orphans.” 

As of Monitor press time, Mr. Tourre was planning to ask the court at the end of September to either overturn his securities fraud verdict or grant a new jury trial. If the judge declines that request, the question will then become one of punishment. Mr. Tourre faces three potential remedies. First, the court can impose civil monetary penalties ranging from $5,000 to $130,000 for each violation. Second, the court can order that Mr. Tourre forfeit any profits he received from his violations, though it is unclear at this point what that would encompass. Third, Mr. Tourre could also face an administrative proceeding before the SEC, which could permanently bar him from any future association with the financial industry. One potential obstacle for the SEC in pursuing a bar, however, is that it obtained the power to do this when Congress passed the Dodd-Frank Act in 2010, three years after Mr. Tourre’s violations occurred. It is unclear whether the SEC’s authority to issue a bar applies retroactively. Given that Goldman continues to bankroll all of Mr. Tourre’s legal fees, it is likely he will appeal any bar order, challenging retroactivity, and continue to drag this case on further. 

Mr. Tourre is now enrolled in a doctoral economics program at the University of Chicago and seems to be gearing up for a future in academia. Other than damage to his reputation, which he has already incurred in spades, it is questionable whether a bar would make much of a difference. 

Meanwhile, the Tourre trial, though clearly a success for the SEC, has led many to question why the agency continues to pursue mid-level employees like Mr. Tourre while leaving the high-level executives unscathed. Mr. Tourre clearly did not commit these violations on his own.

Mergers Foreclose Derivative Litigation

ATTORNEY: SAMUEL J. ADAMS
Pomerantz Montitor, September/October 2013 

In a case involving the notorious Countrywide Corporation, with implications for derivative actions filed across the country, the Delaware Supreme Court, has declined to expand the circumstances under which a derivative action, brought on behalf of the injured corporation, can survive a merger of that corporation into another. Because mergers often happen while derivative suits are pending, and in fact are sometimes motivated by the directors’ desire to eliminate derivative claims against them, this decision will make it harder in many cases to hold directors of Delaware corporations accountable for their reckless mismanagement. 

As is well known, Countrywide played a major role in the financial crash of 2008, because it was probably the most prolific perpetrator of toxic mortgage securities. When the mortgage market imploded, Countrywide nearly collapsed and was sold under the gun to Bank of America (“B of A”) – the unlucky purchaser of last resort not only of Countrywide but also of equally ill-fated Merrill Lynch. If ever there were directors who deserved to be sued for destroying their company, the directors of Countrywide fit the bill. Yet, when they were sued by Countrywide shareholders, they claimed that the sale to B of A wiped out the plaintiffs’ claims. 

The directors were invoking the so-called “continuous ownership” rule, which says that in order to assert a derivative claim a plaintiff shareholder must have owned stock in the injured corporation continuously from the time of the alleged wrong until the resolution of the litigation. Should the corporation be sold in a cash-out merger before the litigation is resolved, the shareholder plaintiff would be divested of his holdings, and therefore his chain of continuous ownership would be broken. 

Here, plaintiffs sued the former directors of Countrywide in California federal court, claiming that they were responsible for allowing Countrywide to engage in a host of reckless and fraudulent mortgage practices. The District Court dismissed the derivative claims under the “continuing ownership” rule, holding that under Delaware law plaintiffs lost standing to pursue the derivative claims upon consummation of Countrywide’s Merger with B of A. Plaintiffs had argued that there was an exception to this rule in cases where it was the alleged wrongdoing that forced the company to enter into the merger in the first place. On appeal, the United States Court of Appeals for the Ninth Circuit asked the Delaware Supreme Court to consider, as a “certified question,” whether this exception actually existed and, if so, whether it applied here. The certified question was prompted, in part, by the fact that state and federal courts had reached divergent results in previous cases applying Delaware law in this situation. 

In a famous decision decades ago in Lewis v. Anderson, the Delaware Supreme Court recognized a “fraud exception” to the continuous ownership rule, allowing plaintiffs to litigate post-merger derivative claims “where the merger itself is the subject of a claim of fraud,” meaning that the merger served “no alternative valid business purpose” other than eliminating derivative claims. Although there is a very low threshold for finding a “valid business purpose” for a merger, it is a short step from this doctrine to the proposition that the exception should apply if the very fraud that was the subject of the derivative action also drove the corporation to enter into the merger. 

Arguing before the Delaware Supreme Court, plaintiffs, in a twist, urged the court to consider resolving the certified question by creating a new cause of action, which they referred to as a “quasi-derivative” claim. Defendants argued that there is “no need and no basis” to recognize an exception to the continuous ownership rule even where the conduct in question forced the company to merge with another company. 

The Delaware Supreme Court found in favor of defendants, holding that shareholders cannot pursue derivative claims against a corporation after a merger divests them of their ownership interest, even if a board's fraud effectively forced the corporation into the merger. However, the court was careful to note that shareholders who lose derivative standing in a merger may nonetheless have post-merger standing to recover damages from a direct fraud claim, should one be properly pleaded.