California Securities Litigation Recap

This is the first installment in a regular series offering a summary of recent opinions issued by courts in the 9th U.S. Circuit Court of Appeals impacting federal securities law. What follows is a synopsis of certain opinions issued from January through April.

In N.Y. City Employees' Ret. Sys. v. Jobs, No. 08-16488 (9th Cir. Jan. 28, 2010), the 9th Circuit partially affirmed the dismissal of a consolidated class action complaint brought against Apple and 14 of its officers and directors (collectively, Apple). Plaintiff alleged that Apple violated, among other things, Section 14(a) of the Securities Exchange Act by purportedly including false and misleading statements about the company's compensation practices in its 2005 proxy solicitation. The panel found, contrary to the district court, that the plaintiff successfully alleged a direct claim under Delaware law (as opposed to a derivative claim that requires a presuit demand) by alleging that "shareholders were deprived of the right to a fully informed vote." Nevertheless, the court affirmed the district court's dismissal of the Section 14(a) claim because the plaintiff - who only alleged dilution as a result of the false proxy solicitation - failed to adequately plead economic loss.

In so holding, the court reiterated that economic loss does not necessarily accompany dilution and rejected the plaintiff's argument that it was unnecessary to plead economic loss because its claims were purportedly equitable in nature. According to the court, "[t]he PSLRA does not differentiate between plaintiffs seeking legal and equitable remedies." The court did, however, reverse the district court's order denying the plaintiff's request to amend the complaint to reassert a Section 10(b) claim, which the plaintiff had originally asserted and then voluntarily eliminated when it filed an amended complaint. The court held that the plaintiff did not "waive" the right to amend the complaint to add back a Section 10(b) claim by voluntarily eliminating it from its original complaint.

In an unpublished opinion, the 9th Circuit affirmed the dismissal of the plaintiff's claim that Juniper Networks, to gain approval for a company stock option plan, violated Section 14(a) of the Securities Exchange Act and SEC Rule 14a-9 by issuing a false and misleading proxy solicitation in early 2006 concealing that backdating occurred under prior plans. Calamore v. Juniper Networks Inc., No. 08-17052 (9th Cir. Feb. 5, 2010). Although the court found (contrary to the district court) that the plaintiff satisfactorily stated a direct claim that did not require a presuit demand, the court nonetheless affirmed the district court's dismissal. The court held that the type of equitable relief sought - among other things, to void the 2006 shareholder vote and cancel the 2006 stock option plan - could not, as a matter of law, be granted. The requested relief could not be granted because, by the time plaintiff initiated the action nearly one year after the 2006 shareholder vote, Juniper had already issued "millions of options to thousands of employees" pursuant to the 2006 stock option plan. By that time, the proverbial "'eggs' ha[d] been irretrievably 'scrambled,'" eliminating the "'possibility of effective equitable relief.'"

The court also affirmed the district court's denial of leave to amend because the plaintiff's proposed revision to the complaint - which sought a new shareholder vote with a corrected proxy solicitation - was unlikely to have any effect. As the court explained, it was unlikely that the outcome would be any different if there were a new vote because the challenged 2006 stock option plan had survived three annual shareholder meetings since its adoption, despite the public's knowledge of the backdating of stock options.

Next, the 9th Circuit affirmed the SEC's order sustaining the NASD's lifetime ban on one securities salesperson and a one-year suspension and fine for a second securities salesperson based on their violations of Section 10(b) of the Securities Exchange Act and Rule 10b-5. Gebhart v. Sec. & Exch. Comm'n, No. 08-74943 (9th Cir. Feb. 17, 2010). The panel rejected the salespersons' primary challenge that they lacked the requisite subjective intent to violate the securities laws (as illustrated by, among other things, their own investment in the securities sold and their clients' statements that the salespersons never intended to deceive them). While the panel agreed that "scienter...is a subjective inquiry" that "turns on the defendant's actual state of mind," the panel nevertheless explained that proof that the defendants' actions are objectively unreasonable may provide an inference about their actual state of mind and overcome any "'not plausible'" defenses of subjective "good faith." The court held that the SEC utilized the correct standard in finding that the defendants had the requisite state of mind to commit securities fraud and that the SEC's finding of scienter was supported by substantial evidence.

Judge Jacqueline Nguyen of the U.S. District Court for the Central District of California dismissed with prejudice a putative class action brought by shareholders of Fremont General Corp., a financial services holding company with lending operations that included national subprime residential real estate loans. N.Y. State Teachers' Ret. Sys. v. Fremont Gen. Corp., No. 2:07-cv-5756 (C.D. Cal. Mar. 29, 2010). In the underlying action, the plaintiff alleged that the defendants made a series of materially false and misleading statements to conceal the true impact of the subprime crisis on Fremont General in violation of Section 10(b) of the Securities Exchange Act, Rule 10b-5, and Section 20(a) of the Securities Exchange Act. In September 2009, plaintiff's second amended complaint was dismissed for failure to meet the PSLRA's requirements to plead falsity and scienter, but the plaintiff was given an additional opportunity (which it took) to amend its complaint.

Judge Nguyen found that the plaintiff's latest amended complaint was equally unsatisfactory and again dismissed it - this time, with prejudice - for failure to plead falsity and scienter. The court held that the plaintiff's third amended complaint suffered from the same infirmities as the prior complaints, despite its inclusion of purported statements from an additional confidential witness identified as CW 43. The purported statements by CW 43 did not alter the result because the complaint failed to show, as required by 9th Circuit precedent, that the confidential witness had knowledge about the subject of its statements. Specifically, the complaint neglected to "describe how CW 43 acquired information about residential interest accounting - the subject of her purported statements - or, alternatively, detail how her knowledge is connected to her position in the company."

In addition, the complaint failed to define key terms used in CW 43's purported account and to provide anything other than a conclusory statement that the auditors were "'uncomfortable' with Fremont's valuation assumptions." Separately, the court criticized the plaintiff for its "willful disregard" of the September 2009 dismissal order of the prior complaint, including the plaintiff's disregard of the court's admonitions that any further amended complaint must neither contain certain non-actionable statements included in the dismissed complaint; nor force the court to sift through the complaint's various sections to assess the viability of the claims (so-called "puzzle pleading"). The court found that the plaintiff's willful disregard "serve[d] to highlight the weakness of plaintiff's case."

Judge Marsha Pechman of the U.S. District Court of the Western District of Washington dismissed California state law claims for fraud, negligent misrepresentation, and violations of the California Corporations Code brought against various directors of Washington Mutual and its auditor Deloitte & Touche relating to Washington Mutual's purported abandonment of "recognized underwriting standards used to evaluate both 'prime' mortgages and 'subprime' loans." In re Wash. Mutual, Inc. Sec. Litig., No. 2:08-md-1919 MJP (W.D. Wash. Apr. 28, 2010). Plaintiffs sought to hold the director defendants responsible based on their signing of Washington Mutual's financial statements and their allegedly integral role to the function of Washington Mutual. Plaintiffs attempted to hold Deloitte responsible based on its purported issuance of "clean" audit opinions that allegedly violated generally accepted accounting standards and misrepresented, among other things, Washington Mutual's financial condition. The Court dismissed plaintiffs' claims for fraud and negligent misrepresentation because plaintiffs' generic allegations of reliance failed to satisfy Rule 9(b). Critically, the court noted that "Plaintiffs only suggest that they read the Forms 10-K and Deloitte's certifications, without expressly alleging which documents they read, when they read them or how they impacted their decision to purchase or retain [Washington Mutual] debt securities."

The Court also rejected plaintiffs' negligent misrepresentation claim against Deloitte because plaintiffs were not alleged to be among a class of "intended beneficiaries of the auditor's opinion" - a general prerequisite under California law to hold an auditor liable for negligent misrepresentation. Separately, the Court rejected plaintiffs' claims predicated on a violation of Section 25401 of the California Corporations Code, which only creates liability if defendants actually sold the securities to plaintiffs, and under Section 25403(b), which does not provide a private right of action.

Jonathan D. Uslaner is a litigation associate in the Los Angeles office of Skadden, Arps, Slate, Meagher & Flom and assisted with the preparation of this column.

Jay B. Kasner heads the securities class action practice for Skadden, Arps, Slate, Meagher & Flom and is based in New York. He is experienced in federal and state court litigation, including securities, corporate and takeover litigation, and general commercial matters. He received the 2008 Business Trial Lawyer Award for Excellence from Chambers USA.
Peter B. Morrison is a litigation partner with Skadden, Arps, Slate, Meagher & Flom in Los Angeles and has a particular emphasis on securities and takeover litigation. He advises corporations on matters involving both federal and state securities laws, duties of corporate directors, SEC inquiries and contests for corporate control.