Alison Frankel

SEC bounties should supplant securities class actions: law prof

Alison Frankel
Aug 13, 2013 19:52 UTC

There are a lot of plaintiffs lawyers out there hoping to reap big rewards from the Securities and Exchange Commission’s 2-year-old whistle-blower program. When the SEC, acting at the direction of Congress in the Dodd-Frank Wall Street Reform and Consumer Protection Act, implemented procedures last August to pay tipsters a bounty for information leading to sanctions of more than $1 million, law firms started running advertisements targeting corporate insiders with evidence of securities violations at their companies. If you run a Google search using the phrases “whistle-blower” and “SEC,” you’ll see exactly what I mean.

Those bounties – and accompanying legal fees for whistle-blower lawyers – have been slow to materialize. So far, the SEC has rewarded only two tipsters, though according to The Wall Street Journal, the agency’s regional director in Los Angeles, Michele Wein Layne, told the American Bar Association on Saturday to expect more (and more substantial) bounty payments. There’s certainly been no shortage of prospective whistle-blowers reaching out to the SEC. In fiscal year 2012, the Journal reported, the agency received about 300 whistle-blower tips, from all 50 states and several foreign countries. The time lag between tips and rewards, Layne reportedly said, is because it takes a while for the agency to check out and act upon the information it receives.

Despite the SEC bounty program’s slow start, a professor at Vanderbilt University Law School, Amanda Rose, is arguing in a new working paper that if the agency efficiently handles tips, the whistle-blower program should make shareholder securities class actions obsolete. Rose, a onetime associate at Gibson, Dunn & Crutcher, is no fan of private securities fraud litigation. In 2011 she published a University of Pennsylvania law review paper entitled “Fraud on the Market: An Action Without A Cause,” which should give you a good indication of her point of view. I’m pretty sure her latest hypothesis isn’t going to win over the shareholder class action bar. Nevertheless, Rose makes a provocative case, and with the fundamental viability of securities class actions under threat from U.S. Supreme Court justices who have questioned the fraud-on-the-market reasoning of 1988′s Basic v. Levinson, plaintiffs lawyers should take care to know their enemies. (Hat tip to the CLS Blue Sky Blog, where I first heard about Rose’s paper.)

Rose’s paper is based on the premise that securities class action settlements don’t actually deter corporate fraud, but the revelation of wrongdoing does. She considers class action settlements merely a transfer of money from one group of innocent shareholders – those who pay for the corporate insurance coverage that funds just about every settlement – to another group, with legal fees an unfortunate and inefficient transactional cost. Shareholders with diverse portfolio don’t see any real returns, since sometimes they’re in the group paying insurance premiums and sometimes they’re in the group that receives settlement money. Meanwhile, settlements accomplish little in the way of deterrence, Rose believes, because corporate officers are almost never required to contribute their own money.

But officials can be dissuaded from engaging in wrongdoing by the knowledge that their equity stake in their company (and their personal reputations) will suffer from the exposure of fraud in a securities class action, according to Rose. The only shareholder fraud suits that have true deterrent value, she argues, are the very rare cases that reveal misconduct previously unknown to the market and regulators. Plaintiffs lawyers’ contribution to the process, in Rose’s view, is just in their ability to detect fraud based on public filings and to convince corporate insiders to give them information.

Money damages should be good enough for Apple in smartphone wars

Alison Frankel
Aug 12, 2013 19:58 UTC

I hold few principles more dearly than the inherent value of intellectual property. I’d be crazy to think otherwise, considering that I’m a content creator. No one who starts from scratch, whether they’re writing a news story or developing a killer smartphone feature, abides copycats. So on one level my sympathies lie with the geniuses at Apple who developed the iPhone and iPad, only to see less innovative rivals steal ideas and market share.

But at this point in the long-running litigation between Apple and its smart device competitors, I believe the appropriate remedy for Apple’s injury is money – damages for past infringement of its patents plus a reasonable licensing fee for continued use – and not a ban on competing devices. I’d like to see the U.S. Trade Representative veto the exclusion order against certain Samsung devices issued Friday by the U.S. International Trade Commission, based on the ITC’s finding that Samsung’s infringed certain claims in two Apple patents. And I’m hoping that after oral arguments Friday, the Federal Circuit Court of Appeals agrees with U.S. District Judge Lucy Koh of San Jose, California, and concludes that Apple is not entitled to a post-trial injunction as the result of a jury finding last year that Samsung infringed six Apple smart device patents.

Patent laws, of course, entail the right to seek an injunction. The U.S. Supreme Court confirmed that right in 2006 in eBay v. MercExchange, though the court set a difficult-to-meet four-part test to determine whether courts should enjoin infringing products. MercExchange, as you probably know, was prompted by patent trolls’ use of injunctions (or the threat of injunctions) to extract favorable settlements from operating companies. But you also probably know that the smartphone patent wars have prompted courts and federal agencies to do a lot of thinking about injunctions in the context of products that employ thousands of patents. Much of that reconsideration has involved patents essential to technology standards, widely known as standard-essential patents. Patent owners are obliged, under agreements with standard-setting bodies, to license standard-essential patents on reasonable terms. That responsibility is in tension with the IP owner’s right to a bar on competing goods. Earlier this month, for instance, the U.S. Trade Representative made an extremely rare decision to overturn an ITC exclusion order that was based on Apple’s infringement of Motorola standard-essential technology. The ITC, like the Justice Department, the Federal Trade Commission, the U.S. Patent Office and several federal judges, said that, as a general rule, the danger of patent hold-up should preclude injunctions based on IP encumbered by licensing obligations.

The threshold question for MBS trustees’ new eminent domain suits

Alison Frankel
Aug 8, 2013 21:35 UTC

The long-anticipated fight over the constitutionality of using eminent domain to seize mortgages from mortgage-backed securities trusts is upon us. On Wednesday night, three MBS trustees filed complaints in federal district court in San Francisco, seeking declaratory judgments that Richmond, California, may not deploy its power of eminent domain to take over about 624 mortgages that belong to MBS noteholders. The suits, one brought on behalf of MBS trustees Wells Fargo and Deutsche Bank and the other on behalf of Bank of New York Mellon, raise overlapping though not identical arguments for why Richmond’s eminent domain plan violates the Takings, Contract, Equal Protection and Commerce Clauses of the U.S. Constitution as well as various state constitutional protections. The complaints introduce some new wrinkles in the eminent domain debate, such as an argument by BNY Mellon’s lawyers at Mayer Brown that the seizure of securitized mortgages will endanger the tax status of the MBS trusts that contain the loans, subjecting noteholders to a 35 percent tax on trust income. The trustees have also quantified the harm they face: The takeover of just the 624 loans Richmond has already proposed buying from MBS trusts for 80 percent of the current value of each house that’s collateral on the loan will cost noteholders as much as $200 million, according to Wells Fargo and Deutsche Bank lawyers at Ropes & Gray.

But before the MBS trustees can block Richmond and its eminent domain enabler, the private firm Mortgage Resolution Partners, from seizing securitized loans, they will have to show that they’re in danger of immediate, concrete harm from the plan. U.S. courts cannot issue advisory opinions, in the form of declaratory judgments, unless an actual controversy is before them, not just an abstract or hypothetical question of law. The test, as most recently articulated by the U.S. Supreme Court in the 2007 case of MedImmune v. Genentech, is whether a declaratory judgment case presents “sufficient immediacy and reality to warrant relief.”

Is the supposed harm to MBS trusts from Richmond’s eminent domain plan sufficiently concrete and nearby to present an actual controversy? The city has not actually snatched any securitized loans out of MBS trusts. It hasn’t even held a condemnation hearing on any of the loans it has proposed buying from trusts. It has just signed an agreement with MRP, sent notices to MBS trusts that it wants to buy the 624 loans, given the trusts an August 13 deadline to respond to its offer and announced that it reserves the right to use eminent domain to take over the loans if its offers are rejected. The new suits contend that the trustees’ case is ripe because Richmond has the ability, under California’s “quick take” law, to grab the mortgages with minimal notice. Then MRP can act quickly to arrange new financing for homeowners and bundle their new mortgages into new securities. Once that happens, the trustees assert, it will be nearly impossible to unwind the transactions and restore loans to MBS trusts if the seizures are later deemed unconstitutional.

Business judgment rule OK’d in another controlling shareholder deal

Alison Frankel
Aug 7, 2013 19:14 UTC

In May, when Chancellor Leo Strine of Delaware Chancery Court made new law on going-private deals – holding in In re MFW Shareholders Litigation that boards of companies with controlling shareholders are entitled to deference under the business judgment rule if they appoint an independent special committee to evaluate the buy-back offer and also obtain approval of the deal from a majority of the other shareholders – the judge said that one of the benefits of decision might be to reduce meritless breach-of-duty claims. Boards that provide double-barreled protection for minority shareholders, Strine said, should not have to endure full-blown trials to review those deals under the exacting “entire fairness” standard.

On Tuesday a second Chancery Court judge said the same thing, and this time in a case involving a sale to a third party rather than the controlling shareholder. Plaintiffs had claimed that Provident Equity Capital’s acquisition of the defense contractor SRA, whose founder and former CEO Ernst Volgenau controlled almost 72 percent of the company’s voting rights, should be evaluated under the entire fairness standard. But Vice-Chancellor John Noble ruled that because SRA’s board established an independent committee that engaged in a robust auction, then won approval of the company’s sale price from more than 80 percent of the minority shareholders, it’s entitled to review under the much more deferential business judgment rule. And under that rule, Noble said, there’s no question that SRA, its board members and Provident, fulfilled their fiduciary duties.

“As does MFW,” Noble wrote, “this case serves as an example of how the proper utilization of certain procedural devices can avoid judicial review under the entire fairness standard and, perhaps in most instances, the burdens of trial.” In combination, MFW and SRA should provide powerful incentives for the boards of companies with controlling shareholders to avoid the time and expense of protracted litigation by establishing two tiers of protection for minority equity holders.

Mortgage investor group enters fray over time bar on MBS put-backs

Alison Frankel
Aug 6, 2013 22:00 UTC

Remember the great statute of limitations schism that occurred in New York State Supreme Court in May? On the very same day, two state court judges issued drastically different decisions on when the statute begins to run in cases asserting that sponsors of mortgage-backed securities breached representations and warranties on the underlying loans. Justice Shirley Kornreich sided with investors in a put-back case against DB Structured Products, holding that the clock starts ticking when an MBS securitizer refuses a demand to repurchase defective loans in the mortgage pools. Justice Peter Sherwood, on the other hand, explicitly rejected that interpretation of the statute of limitations, ruling instead in a put-back case against Nomura that the statute is triggered when the MBS offering closes.

Given that so many mortgage-backed trusts are governed by New York state law – and that so many investors have only recently managed to amass sufficient voting rights to assert put-back claims – this divide over the statute of limitations has multibillion-dollar consequences. If Sherwood’s view ends up prevailing when New York appellate courts consider the issue, banks will knock out a swath of suits filed in 2012 and 2013 asserting contract breaches in MBS issued in 2006 and 2007. But if Kornreich is correct, MBS investors can continue directing trustees to sue for years to come under New York’s six-year statute for breach of contract claims.

The Association of Mortgage Investors, a trade group for MBS noteholders, considered the statute of limitations issue so significant that it filed an amicus brief in the Nomura case before Sherwood, arguing that the statute begins to run when an issuer refuses to buy back a deficient loan. Obviously, Sherwood didn’t find AMI’s position persuasive. But that hasn’t deterred the trade group. This week a new AMI amicus brief on the statute of limitations hit the docket in Manhattan federal district court, in a Federal Housing Finance Agency put-back case against GreenPoint Mortgage, which originated supposedly defective loans underlying a Lehman MBS trust.

The smartphone wars are ending, and nobody won (but the lawyers )

Alison Frankel
Aug 5, 2013 20:59 UTC

Over the weekend, the Obama administration made an extraordinary decision: The U.S. Trade Representative overturned a U.S. International Trade Commission injunction barring the import of Apple iPhones found to infringe Samsung standard-essential technology. It’s been almost 30 years since the ITC commissioners were previously overruled by the White House, but, as I told you last month, Apple argued that the ITC’s injunction was contrary to the emerging consensus among federal courts and executive-branch agencies that injunctions should not, except in rare instances, be based on standard-essential patents.

In a less dramatic but also consequential filing Friday, the Justice Department responded to a complaint Microsoft filed in federal district court in Washington on July 12, demanding that the U.S. Bureau of Customs and Border Protection enforce an ITC exclusion order barring the import of Motorola smartphones that infringe a Microsoft patent on Outlook calendar synchronization. Motorola, which is appealing the ITC’s determination that the patent is valid, evaded the ITC injunction by convincing Customs that it had removed the infringing feature from its phones. Microsoft argued that Customs made an improper ex parte determination and effectively undermined the ITC exclusion order. In the government’s response, the Justice Department cited a host of supposed procedural deficiencies in Microsoft’s suit, including the district court’s lack of jurisdiction to hear a case that should have been brought as an administrative proceeding.

But that’s not all. Justice said Microsoft’s suit is against public policy – and against Microsoft’s own arguments in other smartphone litigation. The U.S. Supreme Court’s test for injunctions requires a showing that the injured party would otherwise suffer irreparable harm. Here, the government brief said, damages based on a reasonable licensing fee from Motorola are a perfectly adequate redress for Microsoft. When the shoe has been on the other foot and Microsoft has been accused of infringing Motorola smart device IP, the Justice Department said, Microsoft itself has contended that relief should come through money damages. (I’m sure that Microsoft would argue that the situations are different in the two cases, since the Motorola technology at stake in the Microsoft case being litigated in federal district court in Seattle is standard-essential IP and the ITC exclusion order Microsoft is suing Customs to enforce concerns non-essential tech.)

Litigation funder feared Chevron case would taint fledgling industry

Alison Frankel
Aug 2, 2013 20:43 UTC

Regardless of what you think of the business of litigation funding, it’s here to stay. There are now hundreds of millions, if not billions, of dollars of capital invested in commercial litigation and arbitration in the United States, Britain and Australia, and some of the biggest litigation funding firms in the United States have begun to show a good enough return for their investors to justify the risk of taking sides in inherently lengthy and uncertain cases. Business groups that oppose investment in litigation tried mightily, but they simply haven’t managed to stem the industry’s steady spread, either through legislation or regulation.

For leading litigation financiers, the most significant impediment to growth is probably vestigial suspicion of their business by the big companies and major law firms they want to partner with. That’s why a newly released unredacted version of a filing by Patton Boggs in Chevron’s Manhattan federal court fraud litigation against the onetime lawyer for Ecuadorians with a $19 billion judgment against the oil company is so interesting. (Ted Folkman at Letters Blogatory was the first to spot the unredacted filing.)

The Patton Boggs brief addresses the relationship between the law firm, which is counsel to the Ecuadorian claimants in some of the multipronged litigation between them and Chevron, and Burford Capital, which once invested in the Ecuadorians’ case but has since alleged that it was deceived into taking part in the litigation. Precisely what Burford knew, and when it knew it, is yet another treacherous cul de sac on the long and ugly road of the Chevron litigation; Burford principal Christopher Bogart and Chevron itself present an abundance of contemporaneous evidence to rebut Patton Boggs’s premise that Burford knew more about flaws in the Ecuadorians’ case than Bogart said in a declaration to U.S. District Judge Lewis Kaplan in April. But the newly released brief quotes internal Burford communications showing the funder’s fear that the taint of its investment in the Chevron litigation would hurt not only its prospects but those of the entire litigation finance industry.

Mortgage investors’ inevitable constitutional challenge to eminent domain

Alison Frankel
Aug 2, 2013 15:44 UTC

On Tuesday, the small California city of Richmond announced that it has sent notices to 624 homeowners whose houses are worth less than they owe on their mortgages. Richmond said it intended to buy their mortgages for 80 percent of the fair value of their houses and to help them refinance with new, more affordable mortgages. In the event homeowners don’t want to participate in the program, Richmond said it would use its power of eminent domain to seize the mortgage loans.

Yes, the much-discussed eminent domain mortgage seizure idea is finally being realized, despite vehement opposition from just about the entire financial industry. It’s been more than a year since a San Francisco outfit called Mortgage Resolution Partners first floated the concept of partnering with troubled cities to reduce foreclosures by using the city’s eminent domain power to seize mortgages of underwater homeowners in the name of the public good. (MRP’s role is to provide cities with capital for the eminent domain purchases, issue modified mortgages to homeowners and then bundle and resell the new loans as mortgage-backed securities.) Proponents have pitched the plan as a public boon, a way to keep homeowners in their houses and preserve neighborhoods that would otherwise be blighted with foreclosures. The concept was alluring enough that over the last year, officials in several California cities, as well as North Las Vegas and even Chicago, have toyed with using eminent domain to stave off foreclosures.

Before Richmond, however, all of the cities that considered the scheme have been dissuaded, in part by concerted financial industry opposition. Investors in mortgage-backed securities hate the eminent domain idea. No mystery there: The vast majority of the mortgage loans that cities want to seize belong to MBS trusts. When cities talk about buying mortgages for 80 percent of the current value of a house, they’re not accounting for the value of the seized loan to the MBS trust that actually owns the mortgage, especially because these eminent domain proposals call for the takeover of performing loans, not mortgages on which homeowners have already defaulted. (More than 440 of the homeowners that received notices from the city of Richmond are up-to-date on their mortgage payments.) So as Timothy Cameron, the head of the Asset Management Group of the Securities Industry and Financial Markets Association, explained to me on Thursday, MBS investors believe that they’re twice injured by mortgage seizures under eminent domain plans. First, they’re shortchanged on the value of the revenue stream from a performing loan; and second, they’re damages by the decline in the value of their mortgage-backed securities, which are worth less when performing loans are terminated.

How limited is liability of limited-partner private equity funds?

Alison Frankel
Jul 31, 2013 19:26 UTC

The California Public Employees’ Retirement System, the largest public pension fund in the United States, rarely takes a stand as an amicus in trial court. But in an amicus brief filed earlier this month, Calpers warned that the future of private investment in California is at stake in a dispute over a few million dollars in unpaid bonuses to former employees of the now-defunct HRJ Capital. Unless a state-court judge overturns a colleague’s ruling that limited-partner investment funds are on the hook for liabilities of the general partner and fund manager, Calpers said, California risks losing its stature as an incubator of start-up business.

Lawyers for the former employees, meanwhile, contend that Calpers and the funds are drastically overstating the significance of a narrow, fact-based opinion with no precedential impact. On Thursday, both sides will make their cases to Judge Patricia Lucas of Santa Clara Superior Court.

Here’s the much-condensed backstory on the litigation that may – or may not – change the private equity industry. Darren Wong and Duran Curis once held coveted jobs with HRJ Capital and HRJ Capital Management, a fund-of-funds established by former San Francisco football stars Harris Barton and Ronnie Lott. But HRJ, which managed 22 limited-partner private equity funds, ran into trouble in the financial crisis. When management of the funds was eventually assumed by another company, Capital Dynamics, Wong and Curis lost their jobs. Their lawyers at Kirkland & Ellis eventually claimed Wong and Curis were owed about $4 million in unpaid bonuses and millions more in unpaid management fees.

Underemployed Cooley Law grads lose the war, but win the battle

Alison Frankel
Jul 30, 2013 20:07 UTC

Jesse Strauss of Strauss Law had two goals when he filed a fraud suit on behalf of 12 graduates of Thomas M. Cooley Law School. The first was to win compensation for the Cooley grads, who had paid tens of thousands of dollars of tuition in the misguided expectation that a Cooley law degree would lead to a full-time legal career. The second, he told me, was to dispel similar misguided expectations by anyone else considering enrollment at Cooley. A ruling Tuesday by the 6th Circuit Court of Appeals will probably spell the end of the hope that Cooley graduates can get any of their money back from the school, but it should also expose the law school as a highly questionable investment for prospective lawyers.

“Based on my clients’ reactions, everyone is proud of their involvement in this suit,” Strauss said. “We’ve done real justice.”

The Cooley suit, like 14 other class actions Strauss and co-counsel have filed against law schools that purportedly misrepresented employment and salary data about their graduates, claimed that the school deceived prospective students about their future job prospects. In reporting on the job status of its graduates, the grads alleged, Cooley failed to distinguish between those with legal careers and those with other kinds of jobs; a graduate working at Starbucks, for instance, would be counted in Cooley’s survey as employed in business. The school also claimed that its salary data was an average of all graduates’ incomes, but as the 6th Circuit noted, the reported number was actually an average of the salaries of graduates who responded to the law school’s survey.