Why plaintiffs’ lawyers would rather sue Facebook than JPMorgan
Securities class action lawyers have short attention spans. It was only last week, after all, that JPMorgan Chase and its $2 billion (and counting) loss on its credit default swap hedge was the topic of the moment. Plaintiffs’ lawyers and their institutional clients were figuring out whether they bought the bank’s shares in the one-month period between CEO Jamie Dimon telling analysts that the hedge was a “tempest in a teapot” and Dimon disclosing the initial $2 billion loss. But after an initial flurry of filings and press releases about the JPMorgan case, this week has brought no additional complaints against the bank – even as the impact of JPMorgan’s hedge ripples through credit markets and regulatory debate.
Instead, the securities class action bar has scurried this week to grab a piece of what will undoubtedly become known as In re: Facebook IPO Securities Litigation. On Tuesday Alistair Barr of Reuters reported that Morgan Stanley, the lead underwriter for Facebook’s initial public offering, told favored clients that the bank’s Internet analyst was cutting his revenue forecast for the company. Almost as soon as plaintiffs’ firms could cut and paste Barr’s story into a complaint, the shareholder class actions began piling up. By Thursday evening, at least eight suits against Facebook and its underwriters had been filed in federal court in Manhattan and San Francisco. Some big-name plaintiff firms were among the early filers, including Hagens Berman Sobol Shapiro, Girard Gibbs, Wolf Haldenstein Adler Freeman & Herz and (inevitably) Robbins Geller Rudman & Dowd.
Neither the JPMorgan nor the Facebook IPO case is a slam-dunk, by any means. Despite increasing concern about the risk of JPMorgan’s $100 billion CDS bet – and its alleged failure to disclose that risk – shareholders won’t have an easy time proving that they bought JPMorgan shares because they relied on Dimon’s “tempest in a teapot” remark. In the Facebook IPO case, meanwhile, underwriters will argue that Facebook’s uncertain revenue prospects were adequately disclosed in the IPO offering materials, and whatever additional information was conveyed to favored clients was permissible oral communication under rules the Securities and Exchange Commission adopted in 2005.
But there are two reasons why I think plaintiffs’ lawyers are more excited about their prospects in the Facebook IPO litigation than in the JPMorgan case: scienter and damages. First, a caveat. It’s been more than 15 years since Congress passed securities class action reform, which was intended to put control of shareholder litigation in the hands of investors, not plaintiffs’ lawyers. The securities class action bar will shout from the rooftops that clients decide what suits to file, especially when those clients are the savvy pension and healthcare funds that usually wind up as lead plaintiffs. (Interestingly, no big funds have yet surfaced in either the Facebook IPO or JPMorgan cases.) That said, plaintiffs’ lawyers decide where they want to devote their own resources, and, in these early days, more of them seem to be putting their time into Facebook.
The JPMorgan complaints assert that the bank committed securities fraud under the Exchange Act of 1934, claiming that Dimon’s “tempest” remark deceived investors. That’s a high bar for shareholders, who have to allege specific evidence of scienter, or fraudulent intent. In this case, that means that before they’re permitted any discovery, plaintiffs’ lawyers will have to offer a judge pretty convincing allegations that JPMorgan intentionally misled the market about the bank’s CDS position. Given that Dimon, according to the Wall Street Journal, told his operating committee that he didn’t even entirely understand the trades and their risks until soon before he disclosed the $2 billion loss, it will be tough to show he deliberately lied to analysts.
In the IPO litigation, on the other hand, there’s no need to show scienter because the complaints assert claims under Sections 11 and 12 of the Securities Act of 1933, which involve disclosures in offering documents. As Steven Davidoff and Peter Henning explained in a terrific piece in DealBook on exposure from the Facebook IPO, those claims entail strict liability: If there were material misstatements, Facebook and the underwriters are on the hook. As a general rule, it’s much easier to show simply that there was a misstatement than to unearth convincing evidence that someone deliberately misspoke with the intent to defraud.
Then there’s the question of damages. I’ve previously talked about the short class period asserted in the early JPMorgan suits. That means only investors who bought JPMorgan shares in that one-month time frame are part of the class. So even though the bank lost billions in market capitalization after it disclosed its $2 billion loss, only a portion of it – specifically, whatever losses were incurred by shareholders who bought in the one-month class period – can be claimed in the class action.
By contrast, Facebook investors who bought directly from underwriters are entitled to demand that the shares be repurchased at the offering price under Section 12 of the Securities Act. Shareholders who bought on the open market can claim the difference between their purchase price and the price when they filed suit – but if the class is certified, just about every Facebook shareholder who bought stock before the litigation began will be a member. Davidoff and Henning said the potential damages in the Facebook IPO litigation are in the billions of dollars.
In the big picture of the U.S. economy, JPMorgan’s blunder will almost surely turn out to be more important than the allegedly botched IPO of a single company, however many users that company has. In the peculiar world of securities class action litigation, though, that’s not what matters.
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