Why securities lawyers should give thanks to Native Americans
On this Thanksgiving Eve, as we recall the generosity of the Wampanoags who helped early Bay Colony settlers learn how to survive in the New World, securities class action lawyers may want to spare a thanks or two for 12 members of the Ute tribe as well. Why? Because if the U.S. Supreme Court ends up eliminating fraud-on-the-market reliance in the Halliburton case to be heard later this term, one of the few remaining avenues for securities class actions is open because of a case those Utes brought to the Supreme Court back in 1971.
The court’s 1972 ruling in Affiliated Ute v. United States established that securities fraud plaintiffs do not have to prove reliance to sustain claims based on a defendant’s failure to disclose material information. The 12 so-called “mixed-blood” Utes who brought the suit alleged that two officials at First Security Bank of Utah deceived them about the true value of their shares in a corporation established to manage tribal assets. The bank was serving as transfer agent for the corporation, and two of its officials had the good fortune to work at a branch office in a Utah town with a large population of Utes. Without telling the sellers about hot demand for the restricted shares in the secondary market, the two bankers snapped up stock for between $300 and $700 (sometimes not even paid for in cash but in goods such as used cars). When they resold the shares to white people, they realized tidy profits. The Utes accused the bankers of defrauding them about the true value of their stock, filing a suit under the fraud provisions of the Exchange Act of 1934.
The 10th Circuit Court of Appeals rejected the Utes’ claims, ruling that they couldn’t show they relied upon the bankers’ misrepresentations when they made decisions to sell their shares. But the Supreme Court, in an opinion by Justice Harry Blackmun, found that no showing of reliance was necessary because the bankers failed in their duty to disclose the vigorous outside market for the Utes’ shares. “It is no answer to urge that, as to some of the petitioners, these defendants may have made no positive representation or recommendation,” the opinion said. “Under the circumstances of this case, involving primarily a failure to disclose, positive proof of reliance is not a prerequisite to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of this decision.”
The Affiliated Ute precedent thus draws a line between securities fraud claims involving misrepresentations and those involving omissions. After the Supreme Court’s 1988 decision in Basic v. Levinson, the distinction didn’t matter much. Basic meant that proving reliance wasn’t a problem for investors in misrepresentation class actions; under its fraud-on-the-market framework, they simply had to show that shares were traded on an efficient market. Most securities class actions nowadays are framed as misrepresentation cases, with investors alleging that shareholders were deceived by false public statements, as demonstrated by the market’s reaction when the truth was revealed. Look at the numbers: According to Westlaw, Basic v. Levinson has been cited almost 17,000 times and Affiliated Ute (which preceded Basic by 16 years) only 6,852.
It’s widely accepted that if the Supreme Court reverses Basic and does away with fraud-on-the-market reliance, class actions based on misrepresentations will be decimated. But not cases based on omissions, thanks to Affiliated Ute.
And sometimes, as demonstrated by a decision Tuesday in a fraud class action against Hewlett-Packard, there’s a fine line between omissions and misrepresentations. U.S. District Judge Charles Breyer of San Francisco dismissed most claims by H-P investors who said they’d been deceived about the company’s acquisition of the British software company Autonomy, a $9 billion disaster for H-P. Breyer said, however, that class counsel from Kessler Topaz Meltzer & Check could proceed with allegations that CEO Meg Whitman failed to tell investors the whole truth about Autonomy after she hired PricewaterhouseCoopers to investigate a whistleblower’s allegations of Autonomy’s accounting fraud. In a conference call and a press interview after Whitman had reason to know about possible fraud at Autonomy, she instead emphasized the software company’s problems making the transition from a start-up to a big business.
Breyer said her comments kept material information away from investors. “Whitman’s decision to put forward entrepreneurial challenges as an explanation while choosing not even to mention the alternative possibility of accounting fraud, which she knew to be plausible, constitutes a material omission,” Breyer said. “The context of Whitman’s statements would have called for her to either decline to answer the question with any specific explanation or to at least mention the possibility that something other than entrepreneurial scaling challenges explained Autonomy’s lackluster performance.”
Whitman’s statements might also have been framed as overt misrepresentations, because she told investors that Autonomy’s problems were an issue of management when she knew or should have known that Autonomy’s problems weren’t just a matter of transition problems. In an example I’ve used before, when the JPMorgan Chase CEO told investors that losses in the bank’s Chief Investment Office were “a tempest in a teapot,” did he (allegedly, of course!) misrepresent the magnitude of the losses or omit a material disclosure?
You can be sure that the H-P class will, as Breyer indicates, define Whitman’s alleged misrepresentations as omissions, since that removes any need to show reliance under Affiliated Ute. And if the Supreme Court undoes Basic, you can bet that a lot of other class action lawyers will be dusting off this ruling and recasting their claims.
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