DEFENSE COUNSEL BEWARE. THAT’S THE MESSAGE FROM ROBERT KHUZAMI, DIRECTOR OF the SEC’s division of enforcement, who in the past year has pointedly criticized defense and in-house counsel for impeding agency investigations. He has repeatedly promised to wield the tools
at his disposal—from withdrawing typical courtesies to possible suspension from the bar and
investigation by the Department of Justice. Our panel of experts discusses this as well as trends in
mergers and acquisition litigation, and Canada’s potential as a forum for securities class actions. They are Matthew Larrabee of Dechert; Michael D. Celio of Keker & Van Nest; Kenneth Herz-
inger and Michael Torpey of Orrick, Herrington & Sutcliffe; Pete M. Stone of Paul Hastings; and Mary Blasy of Scott + Scott. The roundtable was moderated by California Lawyer and reported by Krishanna DeRita of Barkley Court Reporters.
MODERATOR: How does the SEC and the Public Company Account-
ing Oversight Board’s increased focus on attorney and witness misconduct in investigations affect your practice?
CELIO: The answer for me—and I hope for most lawyers—is
“not at all.” The SEC is a party to these cases, and it should not
also be judge and jury. I’ve been surprised by the SEC’s emphasis
on attorney misconduct, and while I don’t condone bad behavior,
it is inappropriate for the SEC to attempt to police the conduct
of its litigation adversaries. It can really chill zealous advocacy.
HERZINGER: Having been at the SEC, everyone knows that you
are at a major disadvantage during an SEC deposition. You don’t
have all the normal protections of the Federal Rules of Civil Pro-
cedure. Rules of evidence don’t apply, and often times there are
two to three questioners asking questions interchangeably. They
may ask your client to speculate and answer hypothetical ques-
tions, which frankly is improper. Oftentimes the staff encounters
defense lawyers who are used to dealing with the Federal Rules
of Civil Procedure and inserting objections where they think the
questions are improper. They are not happy about that.
The SEC has said they don’t want to create a chilling effect,
but they are telling the defense lawyers that they may be censured
and referred for DOJ prosecution for objecting during deposition
testimony. We still intend to vigorously and zealously defend our
clients within the framework of the rules and the ethical code.
CELIO: Has anyone seen the SEC move to disqualify someone?
Other than S.E.C. v. King Chuen Tang (831 F. Supp. 2d 1130
(N.D. Cal. 2011))
LARABEE: Being suspended or disbarred is probably not a real-
istic threat, but the broader point for our clients arises because the SEC serves as judge, jury, and executioner. To a large degree we are at their mercy, since they have significant discretion to do what they think is best. Our job is to zealously represent our cli-
ents, but ultimately that means persuading the SEC not to pursue a prosecution. That threat is very real and what’s at stake is our credibility. If we lose that by being so strident that they disbelieve us—rightly or wrongly—that’s a serious problem.
STONE: As an adversary, it seems improper for the SEC to com-
plain about how its opponent does its job. But the message for the practitioner is a practical one about presentation of your clients to the SEC. There are three basic situations that lawyers defending clients in front of the SEC find themselves in.
First, when defending a wholly innocent person, you ought to
cooperate with the SEC, showing you have nothing to hide and
are honest because your client is honest and innocent. Second,
where your client really is culpable, you shouldn’t talk to the SEC
at all. Most of the time you find yourself in the third situation—a
gray area where mistakes were made and perhaps your client acted
negligently, but not culpably wrong. In that case, impeding the
SEC investigation is completely counterproductive because the
SEC is trying to decide whether to proceed against your client.
The more they believe that you have something to hide, the
worse it gets for your client. So, while it’s unfair for the SEC to say, “don’t act this way,” the message is also that to do so is ineffective.
HERZINGER: A government investigatory setting is like
internal investigations. In an internal investigation, the SEC will
allow you to run the investigation as you see fit. They may or may
not agree with your findings, but typically they will wait for you
to do your job. The DOJ, on the other hand, shows no such will-
ingness to wait—they will have FBI agents talking to witnesses as
dealing with a state trooper when you get pulled over. You quickly
get your license and registration, you answer their questions directly, and are as helpful as possible. We all understand that they have the power, so the cases they cite must be the rare exception because most defense lawyers I know take the completely opposite tack. Most of us would never cross those lines.
TORPEY: Let’s assume a smart guy actually went to the Wall Street Journal and planned that article, what’s his agenda? Possibly he has been frustrated by the way the SEC staff proceeds compared to the DOJ. The DOJ is very clipped and close to the vest. Khu-
zami has been signaling that he wants SEC enforcement proceed-
ings to be more like a DOJ proceeding. For example, he wants individuals separately represented because he thinks he will get better deals and more cooperation that way.
CELIO: The article emphasized both deposition conduct and
well. The SEC is on record that it feels some of the investigations
it is seeing are of poor quality. One way to deal with this concern
is to reject the SEC’s historical willingness to let internal investi-
gations run their course in favor of the DOJ’s approach. If that
came to pass, it would have huge implications for the defense bar.
If the comments from the SEC are taken at value, there is a
real risk that we will see securities practice become more and
more like white-collar defense, and that would be dangerous.
SEC enforcement is not the same thing as criminal prosecution.
There’s an overlap, but the two fields are supposed to be different.
LARABEE: That’s a very dangerous model if you are in a regulated
industry where the SEC is conducting regular examinations. If
they present themselves as the FBI every time they come in to
do an examination of a registered issuer, imagine what kinds of
cooperation they are going to get? There has to be some balance
for their overall system to work and in some industries routine
examinations are the primary source of the prosecution. It’s really
dangerous for them to go as far as the DOJ. It’s not like the FBI walks around public companies to do routine examinations look-
ing for crimes.
MODERATOR: What is the impact of the Second Circuit court deci-
sion in denying class certification in the New Jersey Carpenters case
Securities
BLASY: What about the new Facebook IPO actions?
The company puts out some additional risk disclosures,
privately tells analysts to downgrade their earnings mod-
els, and the analysts talk to some people. How many peo-
ple got that information? Unfortunately, I could see this
coming up outside the mortgage-backed security arena.
(New Jersey Carpenters Health Fund v. Rali Series 2006-QO1 Trust,
2012 WL 1481519 (2nd Cir.))?
LARABEE: There aren’t many cases where class certification is
denied under Section 11 of the 1933 Act, but this is one. Until
now the idea that a defendant could present evidence showing
that large numbers of class members may have had individual
knowledge of the fraud has been more theoretical than real. It’s
a significant case and being affirmed by the Second Circuit as an
important precedent. But I’m already litigating the importance
or unimportance of this precedent. The plaintiffs bar is doing its
best to paint this case as unusual and to limit it to the facts.
BLASY: Hopefully it has no impact whatsoever in the Ninth Cir-
cuit, but even in the Second Circuit this decision merely dem-
onstrates the importance of vetting class representatives. Several
district courts, including this one, have since certified mortgage-
backed securities classes, distinguishing the problems here, and
even Judge Baer wouldn’t have done this based just on class com-
position. The real issue is that institutional investors’ outside
money managers don’t get vetted at the lead plaintiff stage, so now
they’re going to start being vetted at the class certification stage.
LARABEE: The vetting is already happening. We represent clients with in-house lawyers who spend a significant amount of time fending off third-party subpoenas seeking evidence about the knowledge in the marketplace in order to prove what the plain-
tiffs must have known.
Just one of our clients is facing dozens of subpoenas and is
trying to figure out how to stop this. I’m in multi-district litiga-
tion right now where we issued 40 third-party subpoenas and the
principal driving force was an effort to gather third-party evi-
dence of knowledge in the industry and either direct or indirect
knowledge of class members about alleged misrepresentations.
TORPEY: This was very mortgage-backed focused. What are your
views of its application beyond the mortgage-backed area? These
are often really sophisticated buyers, and it seems to be a different
phenomenon than an open market 10(b)5 case with an issuer.
HERZINGER: The one instance where the case may apply is where you have an issuer whose stock is predominantly held by large institutional investors. Those institutions have their own finan-
cial analysts and perform their own valuations and frankly know more about the company than some people at the company. However, I agree that except for the few cases such as this, the Second Circuit’s decision will have little impact.
CELIO: In the Second Circuit opinion you can see a significant
emphasis on the standard of review. It seems this is as far as the
court is willing to go. The opinion is not hinting at the endorse-
ment of a theory of the law that would be extended to cover a
Rule 10(b)5 case. The structure of Section 11 is different than
the structure of a traditional fraud case—the availability of an
affirmative defense based on the plaintiffs’ unique knowledge
make a big different. New Jersey Carpenters could be a big deal in
the Section 11 context, but I don’t see it expanding beyond that.
LARABEE: The lesson of that analysis—if you are a defense lawyer
trying to defeat class cert—is to focus on the evidentiary record
you put before the district court. You might persuade a district
court judge that class cert shouldn’t be granted, but that will
depend significantly on the evidentiary record, which in turn
leads to the kind of discovery I was talking about. For our clients,
most of this activity is related to mortgage-backed securities. But
my recent cases are more analogous to the fact situation with
Facebook, where there’s an issue about what the market knows
through a lot of sophisticated purchasers. In cases involving the
disclosure or nondisclosure of investment risks it’s not that hard
to take this idea and put it in a different fact pattern if you can get
the evidence.
TORPEY: Two things will come out of it. One is an evidentiary battle pre-class certification. There’s no question it’s already started and will continue. Second, the idea behind these cases is directly inconsistent with the idea in the Private Securities Litiga-
tion Reform Act (PSLRA)—that the person with the largest loss will proceed as the lead plaintiff because he or she will have the most sophisticated analysis and individualized approach to the purchase and the sale of the stock. Your mom and pops are not going to have any of that and they are more likely to rely on the evaluations that are inherent in stock price and less likely to do a separate analysis. The statute forces the plaintiffs lawyers to the people most vulnerable to this argument.
LARABEE: The lesson of that analysis—if you are a defense lawyer
trying to defeat class cert—is to focus on the evidentiary record
you put before the district court. You might persuade a district
court judge that class cert shouldn’t be granted, but that will
depend significantly on the evidentiary record, which in turn
leads to the kind of discovery I was talking about. For our clients,
most of this activity is related to mortgage-backed securities. But
my recent cases are more analogous to the fact situation with
Facebook, where there’s an issue about what the market knows
through a lot of sophisticated purchasers. In cases involving the
disclosure or nondisclosure of investment risks it’s not that hard
to take this idea and put it in a different fact pattern if you can get the evidence.
TORPEY: Two things will come out of it. One is an evidentiary
decision seems to indicate that if you have factual ques-
tions about whether the class members present on day
six knew more than the members present on day two,
there won’t be the ability to certify a class. That’s how
it could come up in everyday practice, otherwise it’s a
battle pre-class certification. There’s no question it’s already
started and will continue. Second, the idea behind these cases is directly inconsistent with the idea in the Private Securities Litigation Reform Act—that the person with the largest loss will proceed as the lead plaintiff because he or she will have the most sophisticated analysis and individualized approach to the purchase and the sale of the stock. Your mom and pops are not going to have any of that and they are more likely to rely on the evaluations that are inherent in stock price and less likely to do a separate analysis. The statute forces the plaintiffs lawyers to the people most vulnerable to this argument.
BLASY: It is a PSLRA lead plaintiff provision defect. The issue came up during congressional debate. Investors with the largest share losses typically have bigger interests in the debt of these same companies, but Congress kind of dismissed the issue.
LARABEE: Having the PSLRA push forward more knowledge-
able plaintiffs is both a class cert and a trial issue. It might even
promote the truth. Deposing a bunch of class plaintiffs who don’t
know anything, doesn’t seem focused on justice. Talking to people
who understand the company and can differentiate between what
was and was not known in the marketplace could get to the truth
a lot sooner, and limit cases to more credible claims more quickly.
TORPEY: It hasn’t worked out that way. In 1990, one could take
ten cases into a conference room in San Diego and sit down with
a plaintiffs lawyer and settle five of them. You can’t do that any-
more because the dynamic has changed on the plaintiffs’ side.
Getting past a motion to dismiss is everything. Now the case is
worth way more if you do. Plaintiffs need to do that to justify
their economic model. But the record in the defense bar for win-
ning motions to dismiss is very high, and as a consequence, as a
plaintiff, the economic model had to change. I’m not complain-
ing. It’s a fact of life. You file ten. The two you are going to settle
are going to be higher priced than if you got eight through.
CELIO: To be fair, it’s not just the economics that have altered the settlement dynamics. Given the tools that the Reform Act has given the defense bar, the cases that get by a motion to dismiss tend to be the ones that have issues. There are exceptions, but on the whole the Reform Act does a reasonably good job sifting out the unmeritorious cases.
STONE: Turning back to the decision, the only way that the
knowledge of the plaintiff comes up in a typical 1933 Act IPO
case is where the plaintiffs allege a leak of information over time
so that you have a disclosure on day one, day five, and day ten,
and you are arguing which class members knew what when. This
fairly unusual case and one that probably won’t be that important
unless there’s this kind of leakage of disclosure.
HERZINGER: The Second Circuit seemed to say either pick the
more cohesive class or suggest sub-classes, and that’s exactly right.
That was the hint from the Second Circuit for the plaintiffs bar to
more narrowly define your class and avoid some of these conflicts.
BLASY: We don’t do sub-classes if it’s not necessary, because it marginalizes part of the class or requires additional class represen-
tatives, but sometimes it’s necessary. Some lawyers like to certify the biggest class possible and it sounds like that happened here. They didn’t want to leave anyone out. But your duty is to the entire class, not to getting every single person in it.
STONE: You get into manageability issues. How are you going to try
a case with all these sub-classes? But it can be effective in some cases.
MODERATOR: What developments are you seeing in M&A litigation, particularly in handling multi-jurisdictional deals?
STONE: In the last decade we’ve seen a lot of changes in the way
M&A deal litigation proceeds. A number of years ago it was typi-
cal that when a deal was announced you might have lawsuits in
one jurisdiction, typically in Delaware, and you would fight one
case. Statistics of recent deal cases show that 95 percent or more
of all deals involving public companies are drawing litigation.
And, a very large percentage of those cases are multi-jurisdic-
tional; typically you are proceeding in both the state of incorpo-
ration, which is almost always Delaware, and the state of head-
quarters. On the West Coast that is often California.
How do you deal with lawsuits in two or more jurisdictions?
All of us might answer that question a little differently.
LARABEE: There is a growing trend involving one-forum motions
in Delaware. Sixteen were filed in Delaware Chancery Court in
2011, and in 15 circumstances the result was one forum. Those
motions are pretty novel in their structure—it requires two
judges to get on the phone. The purpose is for the Chancellor in
Delaware talk to the judge in the Northern District of California,
or wherever the other cases are filed, and they decide the forum.
STONE: Are those motions really a good idea from a defense per-
spective? You are ceding control of the case’s venue. You may end up dealing with folks with whom you don’t want to deal. A better approach is to try to herd the plaintiffs, if you will, in the direc-
tion you want them to go under threat that you could always file this motion and it will be up to the judges to decide which sets of plaintiffs lawyers get to run the case.
BLASY: This wasn’t a problem until Delaware stopped
deferring to the first-filed rule. Chancellor Laster came
to San Diego a couple of months ago and said corpo-
rate law is like Delaware’s entire gross domestic product
and so they want to keep the cases there. The Delaware
anti-injunction.
TORPEY: The defense always wants to be in Delaware. It’s the
plaintiffs bar that should be fighting to get out. In Delaware you
lose your jury. You have chancellors who are following a devel-
judges began ignoring case law that they had applied for years. For
instance, in Paul N. Gardner Defined Plan Trust v. Draper (1993 WL 125517 (Del.Ch.,1993)), Vice Chancellor Harnett said that California judges are just as competent to apply Delaware law as Delaware judges. But the newer chancellors get the cases to Dela-
ware by ignoring which court first assumed jurisdiction.
Presented with one-forum motions, Delaware chancellors
easily talk other state court judges into ceding the cases. All cases
going to Delaware isn’t a good idea. If you are a California cor-
poration, it’s going to cost you a lot more money to try a case in
Delaware. It’s also just a bad idea to have a few judges and a few
plaintiffs lawyers running all corporate M&A litigation. Monop-
oly is never good.
CELIO: I share Mary [Blasy]’s unease with domination of any
one court. Delaware has immense influence. On the whole, that’s
been a good development. But it can go too far. I look at what our
IP colleagues faced in the Eastern District of Texas. I don’t think
that anybody on either side of the bar views the outsized impor-
tance of that court as an unmitigated good. There are important
differences between Delaware Chancery Court and the East-
ern District of Texas, but it shows that when any small group of
judges becomes very powerful, the impacts can be unpredictable.
TORPEY: This is going to get decided by those cases where the companies put an exclusive venue provision in their bylaws. A number of companies have done that and it is being actively liti-
gated in Delaware. If the exclusive venue provision survives, every company will do it because they will view Delaware as the place most advantageous to them.
STONE: There are variations on whether the bylaws are adopted by shareholders or the board. Delaware has hinted that an exclu-
sive venue is enforceable. But what about a company headquar-
tered in California if our courts say they are not enforceable? Then you have an irresolvable conflict of law.
LARABEE: Typically the defendant has a lot of practical say in the
outcome. If the defendant wants to go to Delaware, and plaintiffs
have filed there already, there’s a good chance that will happen.
The venue provisions may matter, but the practicalities do too.
In these cases, the whole game is usually a preliminary injunction.
If you don’t enjoin the transaction, the resolution of these
cases 99.5 percent of the time is a modest settlement or dis-
missal. In considering venue, a defendant therefore tries to assess
whether they can get an injunction and in Delaware there are
only a few chancellors and you know exactly how each chancel-
lor thinks about these issues because they have many injunction
decisions. Recently, that body of law has been almost uniformly
oped set of precedents that favor the defendant. But the plaintiffs
bar is split on this. Practioners in Delaware want those venue pro-
visions to stand up and plaintiffs lawyers elsewhere do not. I pre-
dict the Delaware courts are going to approve them, and unless
the U.S. Supreme Court steps in, there will be constitutional
implications that many states will have a hard time swallowing.
HERZINGER: In the Galaviz case here in the Northern District of
California, the district ruled on and rejected the forum selection
bylaw provision, but there were unique facts because it wasn’t
approved by shareholders. (See Galaviz v. Berg, 763 F.Supp.2d
1170 (N.D. Cal. 2011).) This case may have serious repercus-
sions for corporations because these provisions are a lot of work
to enact and it’s a major issue and it’s unclear whether it’s going
to hold up in court, so they are questioning whether it’s worth it.
TORPEY: Returning to the preliminary injunction. That was true ten years ago. My concern now is the plaintiffs bar handling them as back-end cases and I have seen lightweight moves toward preliminary injunction. It’s almost as if some plaintiffs firms are doing things to ensure they keep the case, but they are more inter-
ested in the back-end cases.
STONE: We’ve seen this practice in the past few years. Plaintiffs threaten to keep seeking damages post-closing of the deal. It’s because as other securities litigation has gone down, this gives them a group of cases to keep active. The results in some cases have been good for plaintiffs.
There’s insurance that covers the damages case, at least to the point where you have judgment issues. As long as the insurers are paying defense costs, they have to worry about the case. Of course, in an M&A case, there’s a big distinction between defend-
ing the target and the acquirer. If I’m the target lawyer, I don’t care much if the damages case goes forward so long as I had suf-
ficient insurance. As the acquirer, the last thing you want is litiga-
tion that hangs over the close.
TORPEY: The shift is dramatic. You can pay six-figure attorneys
fees, fix the disclosure, get rid of the case, and close the deal. The
cases representing eight-figure numbers are the back-end cases
that last a long time. Those are impacted by whether you name the
acquirer as a defendant. Because of the non-indemnifiable nature
of a ’33 and ’34 Act judgment, if you don’t have enough insurance,
there’s tension between the target, boards, and the acquirer as to
whether there is an obligation to indemnify. You have to advise
them that if you go to trial and lose, it won’t be filed from the
acquirer. And if the insurance is enough, you are fine, but if not,
there are a lot of problems.
MODERATOR: Securities class actions hit an all-time high
in Canada last year. In March, the Ontario Court of Appeals
allowed a global class to proceed in which the company
Canadian Solar, which was incorporated in Canada, only
traded on NASDAQ and does its business in China. So will
STONE: I don’t think Canada will become the place where Mor-
rison-prevented cases go to rest. And it’s not necessarily the case
that the world will have some court to go to when their claims
are excluded from the U.S. because of Morrison. That court could
spring up in Venezuela, but nonetheless people who get their
Canada become an alternate forum post-Morrison v. National Australia
Bank Ltd. (130 S.Ct. 2869 (2010))?
LARABEE: The Court of Appeals ruling was very limited, because the jurisdictional test under the Ontario statute was whether the company had a substantial connection to Ontario, and no one was disputing that. The only argument the Court of Appeal addressed was whether they had to be traded on the Canadian exchange and the court said no. Since the basic test was not in dispute on appeal, the class was approved. There’s a pretty narrow ruling, well short of Canada taking over the world’s securities litigation.
TORPEY: The news here is that this is the first time that the Ontario courts have certified a class that is not a company traded on a Canadian exchange.
BLASY: Some cases may go up there. But unless you can show
knowing misstatements in Canada, you have unfavorable dam-
age caps—roughly a million dollars for the issuer and $25,000 for
officers. Some big settlements are coming out of there in the right
cases, but the loser still pays in much of Canada, including Ontario.
TORPEY: I’m hearing that Morrison is a big problem for the plain-
tiffs bar and they don’t see any way around this. Plaintiffs firms have offices in Toronto and now one defense firm does too. It’s going to be a panacea if there’s a case that certifies a class in Can-
ada without the company headquarters there. We are going to see a flight of global classes in Canada.
BLASY: They are getting past motions to dismiss and the cases do well. But there has to be a tie to Canada, which is going to rein in the number. There is also growing cross-border litigation, and what will be interesting is where you have different claims in dif-
ferent regimes. I don’t see why you can’t get recovery for the same people in Canada that you get in the U.S. It’s a different claim. It’s almost like a section 10 versus a section 11 recovery.
TORPEY: One possibility is a European company that has a problem, and the U.S. shareholders sue in the U.S., but because of Morrison, the class gets limited to U.S. shareholders. Every-
body else needs to go somewhere and the two global forums are Toronto and Amsterdam. Those are the courts that have shown some interest in litigating global classes.
As long as Morrison isn’t changed legislatively, it is going to have some collateral consequence. If you’re in Singapore and buy U.S. Steel on the Tokyo exchange, and U.S. Steel gets sued with a possibility of a big settlement, under Morrison you are excluded from that settlement. So where are those people going to go? If it can’t be the U.S., where is it?
judgment there will have to enforce it in the jurisdictions where
they reside.
This case illustrates a trend for decades to come. There will be
a rise of class cases, securities cases, and class securities cases in lots
of jurisdictions worldwide with an increasingly global economy.
A few years ago I spoke in Seoul about Korea’s class action stat-
ute. It has not generated tons of cases, but in the right circum-
stance someone could sue a Korean company for a class action.
In Japan if you have been wronged because you bought on the
Tokyo exchange, Nikko, then you have to follow Tokyo’s rules or
Japan’s rules to validate the claim. It doesn’t mean you have more
remedy, but that you have to follow the rules where you live. Can-
ada is developing their jurisprudence in this area just as I expect
many countries will.
HERZINGER: Europe has been talking about class action systems for years, and none of that has taken a foothold. It’s probably many years before the legislation is passed in any of those countries.
TORPEY: Mary [Blasy], what’s the plaintiffs bar thinking about Morrison and what will they do about it?
BLASY: It was a huge deal when it came down. It hurt a lot of cases
and left a lot of wreckage, but people have moved on. You take
Morrison into consideration now when you bring cases. What
can we do about it? Legislation is really the only way to go. This
really threatens U.S. retirement savings. If you are CalPERS, can
you really keep purchasing stock overseas? You have no protection
under the U.S. securities laws now unless you purchase on a U.S.
exchange.
HERZINGER: There’s almost a premium in investing on U.S. mar-
kets because you have a remedy, depending on the market.
TORPEY: The reality is you don’t always have a choice. There are some securities that you can buy only in the U.S., some only in Tokyo, and some you have a choice.
