Opinion

Alison Frankel

How long did JPMorgan (allegedly) deceive investors?

Alison Frankel
Aug 19, 2013 20:28 UTC

Last week’s criminal complaints against former JPMorgan Chase derivatives traders Javier Martin-Artajo and Julien Grout – who allegedly mismarked positions in the bank’s infamous synthetic credit derivatives portfolio to hide hundreds of millions of dollars of trading losses in early 2012 by the JPMorgan Chief Investment Office – does not directly impact the shareholder class action under way in federal court in Manhattan. But you can be sure that the plaintiffs firms leading the class action were gratified that the Manhattan U.S. Attorney has decided the so-called “London Whale” losses merit criminal charges. When U.S. District Judge George Daniels hears arguments next month on the bank’s motion to dismiss the class action, shareholder lawyers will absolutely remind him that prosecutors believe a criminal cover-up took place. JPMorgan’s lawyers at Sullivan & Cromwell moved in June to dismiss the entire shareholder class action, but as I’ve said before, I don’t think there’s much chance Judge Daniels will toss claims based on bank officials’ statements about the London Whale losses. The government’s new criminal charges make that prospect even more remote.

But what about shareholder allegations that JPMorgan lied to them and the Securities and Exchange Commission back in 2010 and 2011, when the bank touted its superior internal controls and risk management procedures? Those allegations would dramatically extend the time frame for class membership, opening the case up to claims by shareholders who traded JPMorgan shares beginning in February 2010, not just those who traded the stock in the first half of 2012, before the bank issued a restatement of its earnings to reflect London Whale losses in July 2012. The government hasn’t alleged misconduct in those 2010 and 2011 statements, though according to Dealbook, the bank and the SEC may be negotiating a deal based on internal control failures. If the SEC does, in fact, secure an admission from the bank that its internal controls were deficient, shareholders’ burden would be narrowed to establishing that JPMorgan officials knowingly misrepresented the bank’s ability to manage risk.

JPMorgan’s arguments for why shareholders can’t meet that burden should be required reading for every investor operating under the apparently mistaken belief that you can rely on what you read in SEC filings and what you hear from corporate officials. JPMorgan was supposed to be different than financial institutions that teetered or fell in the financial crisis, and as shareholders wrote last week in their opposition to the bank’s dismissal motion, investors paid a premium for its supposed commitment to discipline and risk management. Yet now JPMorgan says that even if its representations about internal controls were false – which, of course, it insists they were not – those statements are not actionable because no investor actually relied upon such immaterial puffery. As JPMorgan depicts things, you should no more believe an SEC filing than the patter of a carney trying to convince you to knock over the pyramid of milk bottles.

To be fair, there’s plenty of case law to back JPMorgan’s argument that touting the bank’s culture and practices doesn’t expose it to class action liability. General statements about integrity and sound business practices are considered too vague for investors reasonably to rely upon. Forward-looking descriptions about what companies hope or intend their practices to accomplish aren’t actionable in shareholder class actions. And even a specific statement that the bank has robust risk management processes would probably be deemed immaterial because, as one federal judge in New York wrote, “almost every investment bank makes these statements.” (Yes, the same argument you’d hear from a kid whining about being grounded.)

Shareholder lawyers from Bernstein Litowitz Berger & Grossmann, Grant & Eisenhofer and Kessler Topaz Meltzer & Check said last week in their response to JPMorgan’s motion that the bank’s statements about risk management were much more than vague puffery. Even before 2010, they contend, JPMorgan officials positioned their institution as an exception to the financial industry’s excesses. (In one quotation cited by shareholders, CEO Jamie Dimon talked about the bank’s “steadfast focus on risk management and prudent lending, and our disciplined approach to capital and liquidity management.”) Investors swallowed JPMorgan’s line, according to the plaintiffs lawyers. They contend that shareholders were willing to pay extra for JPMorgan equity because Dimon and other bank officials convinced the market that they were, in fact, effective risk managers who took particular pride in the internal controls they’d adopted. Investors were duped, according to the class, and by 2010 Dimon and the other JPMorgan defendants knew or should have known that their assurances weren’t true.

The danger to states’ rights in 2nd Circuit’s ruling on Vermont nukes

Alison Frankel
Aug 16, 2013 21:03 UTC

On Wednesday, as my Reuters pal Nate Raymond ably reported, the 2nd Circuit Court of Appeals handed a big victory to the energy company Entergy and its lawyers at Quinn Emanuel Urquhart & Sullivan, upholding a Vermont federal court injunction that effectively bars the state from shutting down Entergy’s Vermont Yankee nuclear plant. A three-judge 2nd Circuit panel agreed with U.S. District Judge Garvan Murtha that Vermont state laws that would have had the effect of closing the plant are pre-empted by the federal Atomic Energy Act.

To reach that decision, the appeals court, like Murtha, looked beyond the plain language of the enacted laws to legislative history suggesting that the statutes were motivated by safety concerns about nuclear energy, which the U.S. Supreme Court has held to be the province of the federal government. Even though the laws on their face addressed economic and policy concerns that are within the state’s purview, the 2nd Circuit said the admittedly incomplete legislative record indicated that Vermont had engaged in statutory sleight of hand to hide its true intentions.

The appellate deep dive into the state legislative record should give pause to every state government within the 2nd Circuit. In fact, the panel’s ruling seems to confirm the worst fears of the National Conference of State Legislatures, as outlined in an amicus brief urging the appeals court to overturn Murtha. “Legislative record excerpts are neither an appropriate means of controlling legislative authority nor a reliable indicator of legislative motivation,” the brief said. “Left uncorrected, this type of misguided judicial inquiry will inevitably chill state legislatures’ willingness to debate policy issues robustly and to solicit a variety of viewpoints about proposed legislation openly. Accordingly, all state legislatures – and indeed all courts – should be concerned.”

How to define a market rate for fees in class action megacases

Alison Frankel
Aug 15, 2013 19:50 UTC

In a notable 2001 opinion called In the Matter of Synthroid Marketing Litigation, Judge Frank Easterbrook of the 7th Circuit Court of Appeals set out guidelines for trial judges awarding fees to plaintiffs lawyers in class action megacases, defined as those in which the class recovery exceeds $75 million. Easterbrook said there should be no automatic cap on fees, even in these very big cases. Instead, he pointed to the 7th Circuit’s oft-stated preference for fee awards that reflect both the risk borne by class counsel and “the normal rate of compensation in the market at the time.” The 7th Circuit has made it clear that the best way to assure a market rate is for class action lawyers and their clients to reach a fee agreement before the litigation begins, but the 2001 Synthroid opinion didn’t specify exactly how trial judges should approximate an arm’s-length negotiation if there’s no preset deal on fees. In a 2003 follow-up opinion, Easterbrook and his fellow panel members actually set class counsel fees themselves, finding that “a decent estimate of the fee that would have been established in ex ante arms’-length negotiations” was a sliding percentage of recovery that declined as the size of the settlement increased.

Objectors to a flat 27.5 percent fee award of $55 million to Robbins Geller Rudman & Dowd in a $200 million securities class action settlement with Motorola were counting on Judge Easterbrook’s two Synthroid opinions when they asked him and two other 7th Circuit judges to cut Robbins Geller’s fees. That proved a vain hope. In a seven-page opinion Wednesday, Easterbrook and his colleagues upheld U.S. District Judge Amy St. Eve‘s approval of the firm’s $55 million award, despite finding 27.5 percent in fees to be “exceptionally high” in a megacase and expressing concern about the flat percentage structure of the award.

The panel, which also included Judges Ilana Rovner and David Hamilton, said it was assuaged that none of the institutional investors in the class, which hold, in combination, more than 70 percent of the claims in the settlement fund, objected to Robbins Geller’s fees. They’re sophisticated litigants with a fiduciary duty to preserve class assets, the appeals court said. So even though the fee award was “at the outer limit of reasonableness,” it was within St. Eve’s discretion to award it. That finding seemed to me to be in keeping with the 7th Circuit’s customer-oriented preference for class action clients to determine the market rate for their lawyers’ fees, just like clients in other kinds of cases.

Does Dodd-Frank protect foreign whistle-blowers?

Alison Frankel
Aug 14, 2013 18:25 UTC

In the first full year of operation for the Securities and Exchange Commission’s Dodd-Frank whistle-blower program, the agency received 324 tips from whistle-blowers working outside of the United States – almost 11 percent of all the whistle-blower reports received by the SEC. If those tips eventually result in sanctions of more than $1 million, the SEC whistle-blowers will be in line for bounties. But if they’re fired by their companies for disclosing corporate wrongdoing, they may not be able to sue under Dodd-Frank because the law’s anti-retaliation protection for whistle-blowers does not specify that it extends overseas. And as you know, the U.S. Supreme Court’s 2010 ruling in Morrison v. National Australia Bank holds that civil laws should be presumed not to apply overseas unless they say otherwise.

Morrison’s application to Dodd-Frank’s whistle-blower protection is playing out right now in federal court in Manhattan, in a retaliation suit brought by a Taiwanese compliance officer for a Chinese subsidiary of Siemens. (The Wall Street Journal was the first to report on the case.) Meng-Lin Liu and his lawyer at Kaiser Saurborn & Mair allege that after Liu reported his suspicions to Siemens’ CFO for Healthcare in China, claiming that the company was violating the Foreign Corrupt Practices Act by engaging in a kickback scheme involving the sale to public hospitals of medical imaging equipment, he was dismissed from his job. In January 2013, Liu sued Siemens under Dodd-Frank for double his back pay.

Siemens’ lawyers at Kirkland & Ellis raised two defenses in the company’s motion to dismiss the suit. Liu wasn’t entitled to protection under Dodd-Frank, Siemens said, because he had initially reported his concerns internally, and not to the SEC. And moreover, he wasn’t covered by Dodd-Frank’s anti-retaliation provisions because they don’t specifically extend abroad.

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.)

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.)

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