Opinion

Alison Frankel

The near-impossible standard for showing auditor fraud

Alison Frankel
Apr 9, 2013 20:47 UTC

A couple weeks back, Dena Aubin of the Reuters tax team had a very insightful story about the risks auditors face as more countries permit some form of mass shareholder litigation. With class actions or their like now permitted in more than 20 countries, Aubin said, auditors’ structural firewall – in which national operating units are legally isolated from each other and from the parent firm – isn’t as liability-proof as it once seemed. Aubin cited Ernst & Young’s recent $118 million settlement of a Canadian class action stemming from its audits of the collapsed Chinese forestry company Sino Forest as a possible preview of what’s in store for the Big 4 accounting shops, thanks to a surge in international litigation. Their potential exposure is so large, according to Aubin, that commercial insurers no longer offer affordable liability coverage to audit firms, which have shifted to a self-insured model.

That’s outside of the United States, though. In this country, Aubin found, shareholders rarely even bother to name audit firms as defendants in class actions: Only two securities class actions filed in 2012 made claims against top audit firms. And if you want to know why, read U.S. District Judge Shira Scheindlin’s 72-page opinion Monday dismissing allegations that the Chinese unit of Deloitte Touche failed investors in its audits of the Chinese financial software firm Longtop Financial Technologies, which admitted in 2011 to cooking its books and was subsequently sued by the Securities and Exchange Commission. Scheindlin concluded that Deloitte may have been lazy, at worst, but under U.S. laws and accounting standards, the audit firm should be considered a victim of Longtop’s fraud, not an abetter of it.

What’s unusual in this case, as Scheindlin explained, is that shareholder lawyers from Grant & Eisenhofer andKessler Topaz Meltzer & Check had more evidence than plaintiffs usually get in securities class actions. The judge had previously refused to dismiss claims against Longtop’s CFO, who then had to produce millions of pages of documents and emails to shareholders. They argued in an amended complaint that evidence obtained from the CFO showed that Deloitte had red-flag warnings of Longtop’s internal control problems, misreporting of revenue and underpayment of social welfare obligations. The audit firm, plaintiffs claimed, confronted Longtop officials about some of the issues but never disclosed problems to investors. In a brief opposing dismissal of their claims, the plaintiffs said Deloitte “chose the path of least resistance” and abdicated “its corporate watchdog responsibilities.”

Deloitte’s lawyers at Sidley Austin contended that the new discovery only bolstered their arguments that the audit firm performed dutifully but was duped by its client. The CFO’s documents showed that the firm asked the proper questions and demanded answers, Deloitte said, which it wouldn’t have done if it had the requisite fraudulent intent to mislead investors.

Scheindlin agreed. To meet the standard for scienter, she said, shareholders would have had to show Deloitte’s audits were so deficient that they fell outside any acceptable bounds. It’s easy in retrospect, she said, to say that an audit firm should have followed up on one concern or another, but U.S. laws require evidence that fraud is the most plausible explanation for an auditor’s failures. As long as the auditor can offer an equally reasonable explanation for its conduct, it’s off the hook.

S&P: State AGs trying to usurp federal regulation of rating agencies

Alison Frankel
Apr 8, 2013 21:20 UTC

Over the next few weeks, federal courts in more than a dozen states are going to begin to consider a very interesting question: Does coordination between and among state attorneys general and the U.S. Department of Justice constitute an improper attempt to override federal regulation?

The credit rating agency Standard & Poor’s is asserting that it does, in an argument that could affect how state AGs enforce consumer laws against defendants in regulated industries. You’ll recall that when the Justice Department announced its $5 billion suit against S&P in February, seven state AGs were in attendance to announce their own parallel state-court claims that the rating agency lied about its independence and objectivity, in violation of state consumer protection and trade practice laws. Three such suits, by Connecticut, Illinois and Mississippi, were already under way at the time of the Justice Department filing, and several more states have since brought claims in their home courts. S&P has now removed all of the state-court AG cases to federal court and has asked the Judicial Panel on Multidistrict Litigation to consolidate the proceedings before one of two judges in federal court in Manhattan.

The rating agency’s lawyers at Cahill Gordon & Reindel argue that the coordinated attack by the Justice Department and the state AGs is a de facto pre-emption of the Credit Rating Agency Reform Act of 2006, which gave oversight of S&P and its competitors to the Securities and Exchange Commission. “Taken as a whole, the actions represent a concerted effort to undermine, if not supplant, a detailed, comprehensive and carefully balanced federal scheme through patchwork and inevitably conflicting rulings across the country,” Cahill wrote in S&P’s brief to the JPMDL. “These nominally separate actions – the vast majority of which were filed on the same day and touted as the result of a ‘coordinated’ effort at a joint press conference held by several of the Attorneys General to announce their filing – are, in effect, a single hindsight-infused attempt by the states to lay blame with S&P for failing to predict the financial crisis and they should be treated collectively.”

Delaware Supreme Court rebukes Chancery for litigation territorialism

Alison Frankel
Apr 5, 2013 21:11 UTC

There is little doubt that the judges on Delaware’s Chancery Court believe they are unrivalled in the business of overseeing corporate litigation. Their challenge in recent years has been to persuade plaintiffs’ lawyers – who, after all, decide where to file their cases – of Delaware’s primacy. Chancery’s waxing and waning share of the booming market in shareholder M&A and derivative suits is an issue that gets considerable attention at securities conferences, and Chancellor Leo Strine in particular has been so unabashed an advocate for his court that New York State Supreme Court Justice Shirley Kornreich recently complained to my Reuters colleague Tom Hals about Delaware’s proprietary attitude.

Chancery’s grabby ways reached their apex last year with Vice Chancellor’s Travis Laster’s controversial ruling in derivative litigation against the board of Allergan, which was sued in connection with the company’s off-label marketing of Botox. Competing plaintiffs’ firms brought cases in both Delaware Chancery and California federal court. Before Chancery ruled on Allergan’s motion to dismiss, the judge in California tossed the case in his court, finding that shareholders hadn’t established the futility of demanding action from the board before bringing their suit. The Allergan defendants argued before Laster that the Delaware case should also be tossed under the doctrine of collateral estoppel. The vice chancellor disagreed, finding that the Delaware plaintiffs and California plaintiffs weren’t equivalent under the internal affairs doctrine, and that the California shareholders weren’t adequate representatives because they didn’t conduct a presuit books-and-records investigation.

The ruling created considerable furor, with defendants complaining that Laster’s reasoning would give shareholders a chance to relitigate derivative claims in Delaware after they failed in other jurisdictions. In July, Laster said in an extraordinary transcript decision that he’d been misconstrued, but nevertheless granted the Allergan defendants – who are represented by Gibson, Dunn & Crutcher and Morris, Nichols, Arsht & Tunnell- leave to seek an interlocutory appeal.

Repercussions from Rakoff ruling in Dexia MBS case vs JPMorgan?

Alison Frankel
Apr 4, 2013 22:20 UTC

Amid the fusillade of securities suits against the banks that sponsored and underwrote mortgage-backed notes, there have been a couple of reasons to pay particular attention to the Franco-Belgian bank Dexia’s case against JPMorgan Chase and its predecessors Bear Stearns and WaMu Mortgage. For starters, it was a big case: $1.6 billion in MBS and supposed damages of about $800 million. Moreover, Dexia’s lawyers at Bernstein Litowitz Berger & Grossmann had piled allegations into an amended complaint so apparently damning that it was the basis of a splashy story in The New York Times. And finally, the case was shaping up as a bellwether for MBS claims by individual investors. The litigation was on the rocket docket of U.S. Senior District Judge Jed Rakoff of Manhattan, who denied the bank’s motion to dismiss last September and talked in a recent hearing about a July trial date on Dexia’s claims. Given the resounding victory Rakoff delivered in February to the bond insurer Assured Guaranty in Assured’s MBS case against Flagstar Bank, the Dexia case seemed like it could be a perfect storm for defendants: a strong plaintiffs’ firm trying a high-profile case before a judge with demonstrated skepticism for bank defenses.

There may still be a Dexia trial in July, but it will be of considerably less interest after a ruling Wednesday in which Rakoff granted summary judgment to JPMorgan on claims stemming from 60 of the 65 MBS certificates in Dexia’s case. According to a statement by JPMorgan’s lawyers at Cravath, Swaine & Moore, Dexia’s potential losses are now only about $5.7 million, down $769 million from Dexia’s original claims. In a case that had the potential to set settlement standards for individual MBS suits, $6 million in exposure isn’t the kind of leverage MBS investors were hoping for.

What’s worse, Rakoff’s ruling could put new obstacles in the way of MBS plaintiffs who didn’t purchase their notes directly from sponsors. Lots of individual investor claims are based on certificates that have changed hands over the years. Rakoff’s reasoning could complicate those cases.

The future of securities litigation? Shareholders sue RBS (in London)

Alison Frankel
Apr 3, 2013 20:29 UTC

There may be no more glaring example of the shifting terrain for securities litigation than the case against the Royal Bank of Scotland. Back in January 2011, RBS was one of the early beneficiaries of the U.S. Supreme Court’s bar on shareholder suits against foreign defendants. U.S. District Judge Deborah Batts of Manhattan dismissed most of a class action claiming that the bank misled investors about its subprime exposure and the success of its ABN Amro deal. The judge tossed the few remaining claims last September, erasing any chance that RBS would be held liable to shareholders in U.S. courts. The American plaintiffs’ firms that sued RBS and the U.S. pension fund clients that vied to lead the litigation were plumb out of options.

But their counterparts in the United Kingdom pressed on. Shareholder litigation has been a relative rarity in England, not least because of the loser-pays rule, said London lawyer Robin Ellison of Pinsent Masons, who counsels pension funds, insurance companies and other institutional investors on their litigation rights. But in recent years, as England has relaxed old prohibitions on outside investment in litigation, insurers have begun issuing so-called After the Event policies, taking over the risk that plaintiffs will have to pay defendants’ fees if they lose. That innovation, Ellison told me, has made shareholder litigation a realistic prospect in the UK. His group, the Institutional Investors Tort Recovery Association, evaluates about 20 or 30 potential claims a year, Ellison said, and follows up with a suit in about one-third of the cases. Ellison informally refers to shareholder suits in the UK as class actions, but they’re really not class actions in the U.S. sense. The cases are akin to American mass tort or consolidated litigation.

In the last week, two shareholder groups have initiated actions against RBS in the UK, claiming that the bank’s prospectus for a $23 billion offering in April 2008 contained material misstatements. One of the groups consists of British and international institutional investors represented by Stewarts, which filed a one-page claim on their behalf at London’s High Court last week. The second group filed an actual complaint against RBS and several board members at the High Court on Wednesday. That group, which is represented by Bird & Bird and includes about 12,000 individual RBS shareholders and more than 100 institutional investors, has said that its claims could top 4 billion pounds. Ellison, who said he has clients “across the board in this litigation,” told me that these are the biggest claims in UK history.

Justices throw up Comcast obstacle in two more class actions

Alison Frankel
Apr 2, 2013 21:31 UTC

Last week, after the U.S. Supreme Court issued its deeply divided 5-to-4 ruling in Comcast v. Behrend, the antitrust class action bar breathed a sigh of relief. Lawyers had been worried the court would rule broadly that in order to be certified, classes must show that they are “susceptible to awarding damages on a classwide basis,” which was the question the Supreme Court had asked Comcast counsel to address. The majority, in an opinion written by Justice Antonin Scalia, seemed to answer the somewhat different question of whether trial and appellate courts may delve into the merits of the plaintiffs’ damages theory before certifying the class. Antitrust plaintiffs’ lawyers told my Reuters colleague Andrew Longstreth that the Comcast decision would have little impact on class certification because they could tailor damages allegations to match their theories of liability.

But yesterday the Supreme Court signaled that, at the very least, class action lawyers – and not just those in the antitrust bar – will have to address the Comcast opinion if they’re going to win certification rulings. In two different cases, one involving consumer product defect claims against Whirlpool, the other over alleged wage-and-hour violations by Charter One bank, the justices granted certioriari, vacated class certification rulings by the federal circuits and sent the cases back to the appellate courts for reconsideration in light of Comcast. The dissent in Comcast, written jointly by Justices Ruth Ginsburg and Stephen Breyer, said that the majority’s holding “should not be read to require, as a prerequisite to certification, that damages attributable to a classwide injury be measurable ‘on a class-wide basis,’ (since) recognition that individual damages calculations do not preclude class certification under Rule 23(b)(3) is well nigh universal.” Nevertheless, it’s now going to be up to the federal circuits to confirm the Comcast dissenters’ reading of the majority opinion.

The Whirlpool case, which comes out of the 6th Circuit Court of Appeals, is precisely the sort of class action the dissent was concerned about. The trial court, and then the appeals court, certified a statewide class of about 200,000 Ohio consumers who purchased front-loading Whirlpool washing machines that are allegedly prone to develop mold or emit a moldy smell. (The litigation is part of a much broader consumer offensive against makers and sellers of supposedly defective washing machines, as Whirlpool discusses in its petition requesting Supreme Court review.) The class contains some members who claim that their machines developed mold or a moldy smell and others whose machines are still fine, so obviously there are disparities in the damages class members may ultimately be entitled to. The trial judge dealt with that issue by certifying the class only for the purpose of determining whether Whirlpool’s machines are defective. Damages, he said, would be determined individually after any finding of Whirlpool’s classwide liability. The class affirmed by the 6th Circuit, in other words, is a liability-only class, though the appeals court said that all Whirlpool buyers could show injury, and thus standing to sue, if they paid a premium price for a defect-prone product.

What remains of Libor litigation with antitrust, RICO knocked out?

Alison Frankel
Apr 1, 2013 21:10 UTC

Make no mistake: A 161-page ruling late Friday by the New York federal court judge overseeing private litigation stemming from manipulation of the benchmark London Interbank Offered Rate (Libor) has devastated investor claims that they were the victims of artificially suppressed Libor rates. U.S. District Judge Naomi Reice Buchwald of Manhattan ruled that owners of fixed and floating-rate securities do not have standing to bring antitrust claims against the banks that participated in the Libor rate-setting process, even though some of those banks have admitted to collusion in megabucks settlements with regulators. If that result, which Buchwald herself called “incongruous,” weren’t bad enough, the judge also cut off an alternative route to treble damages for supposed Libor victims when she held that federal racketeering claims of fraud by the panel banks are precluded under two different defense theories.

Buchwald’s opinion didn’t address every Libor case that’s been filed, since she only ruled on bank motions to dismiss two class actions (one by owners of Libor-pegged securities and the other by derivatives traders) and individual claims by Charles Schwab entities. She held, moreover, that some claims based on the banks’ supposed violations of the Commodity Exchange Act may go forward, although she also said she had doubts that Eurodollar contract traders would ultimately be able to tie losses to misconduct by the Libor banks. But unless and until the 2nd Circuit Court of Appeals reverses Buchwald, Libor antitrust and RICO claims in federal court seem to me to be dead.

That’s because Buchwald’s ruling is based on her interpretation of the law, not on facts. The judge said investors simply couldn’t show that any injury they received from manipulation of the Libor process was the result of anticompetitive behavior by panel banks because the rate-setting process was collaborative, not competitive. (In that process, 12 or so banks would report their own interbank borrowing rate to Thomson Reuters, which would calculate the daily mean rate to be disseminated by the British Bankers’ Association.) And though plaintiffs argued that the banks colluded to suppress Libor in order to lower the interest rates they would have to pay on securities pegged to the interbank rate, Buchwald said that the manipulation was not designed to hamper competition between the banks, which she said was a necessary element of antitrust standing.

Gay marriage, voters’ rights and the thorny Prop 8 standing problem

Alison Frankel
Mar 27, 2013 19:14 UTC

On Tuesday morning at the U.S. Supreme Court, Charles Cooper of Cooper and Kirk was no more than a sentence into his spiel on the sanctity of traditional marriage when Chief Justice John Roberts interrupted with the request that he first address a more prosaic issue: Do Cooper’s clients, as leading proponents of the 2008 California ballot initiative that banned same-sex marriage, even have standing to defend the initiative, known as Proposition 8, in federal court? By the time oral arguments concluded more than an hour later, it seemedlikelier than not that the court would avoid a sweeping ruling on equal protection under federal law for gays and lesbians – and that they’d do it via a finding that Cooper’s clients did not have standing to bring an appeal.

That holding, which was advocated by lawyers for the same-sex couples who sued to invalidate Prop 8, would assure gays and lesbians the right to get married in California. But it would also implicate some difficult issues that the Supreme Court has not previously addressed. What qualifies someone to act as an agent of the state for the purposes of defending a ballot initiative? If state officials choose not to defend a law passed by the voters, may private citizens who backed the initiative act on the state’s behalf? And if the law’s private proponents don’t have federal standing, does that mean state officials have the de facto ability to undo voter-passed laws they don’t support? If the Supreme Court answers these questions in its Prop 8 decision, the ruling may end up being better remembered for setting precedent on standing, stage agency and ballot initiatives than for civil rights.

To understand why, you have to know a little about the procedural history of the case. In 2009, six months after California voters passed Prop 8 and amended the state constitution to ban same-sex marriage, two same-sex couples filed a suit in federal court in San Francisco against the state officials tasked with enforcing the ban. The complaint, filed with great fanfare by Theodore Olson of Gibson, Dunn & Crutcher and David Boies of Boies, Schiller & Flexner, asserted that Prop 8 violated the Equal Protection and Due Process clauses of the 14th Amendment. The state officials named in the suit chose not to defend the law’s constitutionality, but U.S. District Judge Vaughn Walker (now retired) permitted private citizens who had championed the law to intervene as defendants. After a 12-day bench trial in 2010, Walker found Prop 8 to be unconstitutional.

Robbins Geller faces sanctions in Boeing witness controversy: Posner

Alison Frankel
Mar 26, 2013 20:47 UTC

Robbins Geller Rudman & Dowd has had more than its share of problems with recanting confidential witnesses in securities class actions, but an 18-page ruling Tuesday from the 7th Circuit Court of Appeals is the worst news yet for the plaintiffs’ firm. Judge Richard Posner, writing for a panel that also included Judges William Bauer and Diane Sykes, said the firm had ignored red flag warnings that its lone informant in a securities class action against Boeing was unreliable. No lawyer from the prolific plaintiffs’ firm took the trouble of checking out the informant’s allegations, Posner said, yet the firm didn’t hesitate to repeat his claims in an amended complaint against the aerospace company. The appeals court, not surprisingly, refused to revive the class action claiming Boeing misled investors about its Dreamliner planes, but remanded the case to U.S. District Judge Ruben Castillo to determine whether Robbins Geller should be sanctioned under Rule 11, and, if so, for how much money.

“The plaintiffs’ lawyers had made confident assurances in their complaints about a confidential source – their only barrier to dismissal of their suit – even though none of the lawyers had spoken to the source and their investigator had acknowledged that she couldn’t verify what (according to her) he had told her,” Posner wrote. “Their failure to inquire further puts one in mind of ostrich tactics – of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing.”

Ouch. But that wasn’t all. Posner also noted that Robbins Geller has been accused of “similar misconduct” in three other reported cases: Campo v. Sears Holdings, a 2010 ruling in which the 2nd Circuit said that deposition testimony from confidential informants didn’t match up with the plaintiffs’ complaint; Applestein v. Medivation, a 2012 ruling by U.S. District Judge Edward Chen of San Francisco, who held that Robbins Geller confidential informants were not reliable; and Belmont v. Suntrust, a 2012 decision in which U.S. District JudgeWilliam Duffey of Atlanta found the firm’s amended complaint to be “misleading or, at least, unsupported,” after confidential witnesses recanted allegations attributed to them. (Duffey denied a motion for Rule 11 sanctions against Robbins Geller, though he said it was “a close and reluctant call.”)

Retired NFL stars reject settlement of their own licensing class action

Alison Frankel
Mar 25, 2013 20:28 UTC

In 2009, six retired pro football stars filed a class action against the National Football League in federal court in Minneapolis, claiming that the NFL misappropriated their names and images without their consent. The class action, led by (among others) former Houston Oiler Hall of Famer Elvin Bethea and former Los Angeles Ram All Pro and television star Fred Dryer, asserted that the NFL didn’t compensate its retired players when it used clips from old games to promote the league. In September 2011, the Dryer case was consolidated with two other similar class actions. Three firms, Zimmerman Reed, Hausfeld and Bob Stein, were named interim lead counsel.

Last week the NFL and the class filed a $50 million settlement with U.S. Senior District Judge Paul Magnuson. Two days later, Dryer, Bethea and the other four retired players who filed the original suit – and who are still the first six name plaintiffs in the case - objected to the settlement, arguing that it delivers no cash directly to class members and, as such, should be treated with the judicial skepticism that has lately greeted settlements involving no money for class members and millions for their lawyers. That argument may be familiar, but the circumstances of this objection are anything but. How often do you see six original name plaintiffs repudiate the settlement of their case? Aside from the widespread retailer discontent with the recent Visa and MasterCard interchange fee settlement, I can’t think of an example. Nor can I remember a case in which plaintiffs’ lawyers fought so nastily over settlement terms that the court had to appoint a lawyer outside of the lead counsel triumvirate to negotiate on behalf of the class. What a mess for Judge Magnuson to clean up.

Court-ordered settlement talks began before U.S. Magistrate Arthur Boylan last summer, after the class filed an amended complaint (adding more retired players as plaintiffs) and discovery got under way. But it turns out that a deep schism had developed between some of the players and their counsel Michael Hausfeld. (Hausfeld was actually the second lawyer for Dryer, Bethea and their fellow original name plaintiffs, who began the case with counsel from Charles Zimmerman of Zimmerman Reed.) Last November, former journeyman quarterback Dan Pastorini filed a notice in the Minnesota class action, informing the court that he had sued Hausfeld and his eponymous firm for malpractice in state court in Harris County, Texas. Pastorini said that he and many of Hausfeld’s other clients “do not support the present actions of defendants to attempt to settle their own class action case in a way that lines the pockets of defendants with legal fees, creates nonsensical entities orchestrated by defendants to obtain still more additional side benefits to them, but does nothing to effectively further the interest of plaintiff and the class members that he represents.”

  •