Tag Archives: Southern District of New York

RMBS

Where There’s Smoke, There’s FIRREA

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Few can ignite a legal firestorm like U.S. District Judge Jed Rakoff of the Southern District of New York. Last week, in a mortgage fraud suit against Bank of America and Countrywide, Judge Rakoff refused to dismiss a novel claim for civil penalties under the obscure Financial Institutions Reform Recovery Enforcement Act (“FIRREA”). The ruling will surely encourage civil prosecutors to make wider use of FIRREA, which provides a generous ten-year statute of limitations and low burden of proof, in pursuing financial fraud cases.

FIRREA was enacted in response to the Savings and Loan debacle of the 1980s, as well as the fraud scandals that emerged during that era. The statute includes a clause imposing a civil penalty for mail and wire fraud and other violations “affecting a federally insured financial institution.” Until recently the civil penalty provision has been ignored by prosecutors, leaving courts without occasion to decide what exactly the statute means by “affecting” a financial institution. Read More

SEC

Making a Statement: The Two Faces of Janus in the SDNY

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Almost two years after the Supreme Court issued its momentous decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), lower courts continue to reach significantly different conclusions concerning its scope. The Supreme Court held that, for purposes of SEC Rule 10b-5, “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” Id. at 2302. Specifically, in Janus, the Supreme Court held that an investment advisor could not be liable for statements in prospectuses filed by a related, but legally separate entity. Because the investment advisor did not “make” the statements—that is, did not have “ultimate authority” over them—it could not be liable as a primary violator of Rule 10b-5 for any misstatements or omissions contained therein.

Janus established a bright-line rule. But the Southern District of New York, in particular, has split over whether Janus applies beyond the context of private actions brought under Rule 10b-5(b). In the most recent decision from that district to address the issue, SEC v. Garber, No. 12 Civ. 9339, 2013 WL 1732571 (S.D.N.Y. Apr. 22, 2013), Judge Shira A. Scheindlin deepened this divide. Read More

SEC

Record SEC Settlement in S.A.C. Capital Investigation. Well….Kind Of.

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On April 16, 2013, Judge Victor Marrero conditionally approved a $600 million consent judgment between the SEC and CR Intrinsic Investors LLC (“CR”) where CR “neither admitted nor denied” the allegations brought against it. The settlement was on the heels of a highly publicized investigation and lawsuit regarding CR’s purported insider trading scheme involving S.A.C. Capital Advisors and former S.A.C. trader Mathew Martoma. Despite finding the proposed injunctive and monetary relief “fair, adequate, and reasonable, and in the public interest,” Judge Marrero questioned the appropriateness of the “neither admit nor deny” provisions because of the extraordinary public and private harm caused by CR’s alleged wrongful conduct.

Approval of the CR settlement was conditioned upon the outcome of the pending Second Circuit appeal in S.E.C. v. Citigroup Global Markets, Inc., 11-cv-5227 (2d Cir.). In Citigroup, Judge Rakoff (of the Southern District of New York) denied approval of the SEC’s proposed settlement of fraud charges against Citigroup. Rakoff’s opinion harshly critiqued the agency’s use of “no admission” settlements as imposing “substantial relief on the basis of mere allegations.” He questioned whether “no admission” settlements could be properly judged when the Court did not know the relevant facts and therefore “lack[ed] a framework for determining adequacy.” Both Citigroup and the SEC appealed Rakoff’s decision to the Second Circuit, where the decision remains pending. Read More

Scienter

In the SDNY, Hindsight Is No Substitute for Red Flags When Alleging Scienter

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On April 8, 2013, Judge Shira A. Scheindlin of the Southern District of New York granted auditor Deloitte Touche Tohmatsu CPA’s (“DTTC”) motion to dismiss a shareholder class action, finding that plaintiffs failed to sufficiently allege scienter or any misstatements by DTTC pursuant Section 10(b) and Rule 10b-5 of the Securities Exchange Act. Plaintiffs alleged that DTTC issued unqualified audit opinions on behalf of its client Longtop from 2009 to 2011. During that period, Longtop reported very strong financial results, which were later revealed to be fraudulently inflated.

In May 2011, DTTC released a public letter of resignation as Longtop’s auditor, disclosing that its second round of bank confirmations were cut short by Longtop’s deliberate interference, that Longtop’s CEO admitted the company’s books were fraudulent, and that DTTC had resigned due to that admission and Longtop’s deliberate interference with its audit. As a result, the NYSE stopped trading on Longtop’s securities and delisted the company.

In dismissing shareholder claims against DTTC, the court applied the stringent test for plaintiffs to meet when alleging scienter against an auditor. Because “an outside auditor will typically not have an apparent motive to commit fraud, and its duty to monitor an audited company for fraud is less demanding than the company’s duty not to commit fraud,” an auditor’s mere failure to identify problems with a company’s internal controls and accounting practices will not constitute recklessness.  Read More

Corporate Governance

Purchase Timing a Wall to Facebook Derivative Litigation Despite Unenforceability of Forum Selection Clause

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Four derivative lawsuits against Facebook’s directors relating to alleged disclosure issues surrounding the company’s initial public offering have a new status: Dismissed. Last month, Judge Robert Sweet of the Southern District of New York dismissed the suits on standing and ripeness grounds, finding that IPO purchasers have no standing to pursue claims related to alleged misconduct that took place before the IPO. The dismissed derivative suits were “tag-along” actions that largely parroted allegations made by investors in a parallel securities class action also pending before Judge Sweet, and had sought to hold Facebook’s directors liable for damages the company might incur as a result of the securities class action.

In dismissing the suits, Judge Sweet held that plaintiffs who buy stock in an IPO lack standing to pursue derivative claims based on alleged misstatements in an IPO registration statement. As Judge Sweet explained, in order to have standing to sue derivatively on behalf of a company, a plaintiff must have owned stock in the company at the time of the alleged misconduct. The registration statement that the plaintiffs allege to have been misleading, however, was finalized and filed with the SEC two days before the IPO. Judge Sweet rejected plaintiffs’ attempts to create standing by arguing that the wrong continued through the date of the IPO because the directors did not correct the allegedly misleading statements by that date. Read More

Fraud-on-the-Market Presumption

Basic Gets Complicated: Vivendi Rebuts Fraud-on-the-Market Presumption

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In what Judge Shira A. Scheindlin of the Southern District of New York called an “extraordinary case,” French multimedia company Vivendi, S.A. has scored an unusual victory based on a successful rebuttal of the fraud-on-the-market presumption of reliance, which the Supreme Court established 15 years ago in the seminal decisions of Basic v. Levinson, 485 U.S. 224 (1998). Though the stakes were relatively small—the Vivendi investor alleged only $3.5 million in damages—the decision is significant. It is one of the few in which a defendant successfully rebutted the almost impenetrable fraud-on-the-market presumption.

The court’s opinion in Gamco Investors, Inc. v. Vivendi, S.A. came after a two day bench trial on the limited issue of whether Vivendi could rebut the fraud-on-the-market presumption. Vivendi was collaterally estopped from challenging any elements of the plaintiff’s 10b-5 claims, other than reliance, following an earlier class action jury verdict concerning similar claims regarding Vivendi’s liquidity status. Read More

Internal Investigations

Internal Investigation Fees Awarded to Goldman Sachs

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On Monday, February 25, Goldman Sachs won its bid to force former director Rajat K. Gupta to pay legal fees it incurred while investigating Gupta’s insider trading activities. In October 2012, Gupta was sentenced to two years in prison following his conviction on conspiracy and securities fraud charges. As part of those sentencing proceedings, Judge Jed Rakoff of the Southern District of New York has now ordered Gupta to pay Goldman Sachs $6.2 million, an amount equal to approximately 90 percent of the legal expenses the banking firm sought to recover. See United States v. Gupta, Case No. 11 CR 907 (S.D.N.Y. Feb. 25, 2013).

Background on the Ruling

Goldman Sachs sought its fees under the Mandatory Victim Restitution Act (“MVRA”), which allows some crime victims to recover expenses they incur as a result of a criminal defendant’s wrongful conduct. See 18 U.S.C. §3663A.

Judge Rakoff’s restitution order requires Gupta to pay the legal fees Goldman Sachs incurred conducting an internal investigation; responding to grand jury subpoenas and document requests from the U.S. Attorney’s Office, the Securities and Exchange Commission (“SEC”), and from Gupta himself; collecting and reviewing millions of documents leading to document productions of over 400,000 pages; and providing counsel to represent various of its officers and employees in depositions and at trial. The restitution order also covered fees Goldman Sachs incurred relating to the criminal investigation of Raj Rajaratnam, who was unaffiliated with Goldman Sachs but convicted for his role in the same insider trading scheme. Finally, Judge Rakoff ordered Gupta to pay Goldman Sachs its fees associated with preparing the request for restitution.

Implications of the Ruling

In ordering restitution, Judge Rakoff found that the requested attorney’s fees were “necessary,” were “incurred during participation in the investigation or prosecution of the offense or attendance at proceedings related to the offense,” and were incurred by a “victim.” While one may not have thought of Goldman Sachs – the entity from whom Gupta, the tipper, acquired the inside information – as a traditional victim of insider trading, in interpreting that term as anyone who was “directly and proximately harmed” by the offense of conviction, the Court had no difficulty in finding that Goldman was a victim and thus awarding it the attorney’s fees. Read More

SEC

Lesser-Known SEC Rule Compels Dismissal of Securities Act Claims

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Relying on a lesser-known U.S. Securities and Exchange Commission rule, the Southern District of New York dismissed over forty underwriter and director defendants from a securities action against General Electric Co. on April 18, 2012.  Shareholders alleged that GE made false statements in connection with a $12 billion secondary stock offering in 2008, including misrepresentations about its ability to sell commercial paper.  GE, which was mostly financed by 30-day commercial paper, encountered difficulties in funding its operations after the collapse of Lehman Brothers in September 2008.

District Judge Denise Cote ruled that older statements incorporated by reference into the offering documents were modified and superseded by subsequent statements under SEC Rule 412, and that statements made by GE in its Forms 10-K between 2004 and 2007, expressing confidence in its commercial paper position, could not be relied upon to state a Securities Act claim.  Citing SEC Rule 412, Judge Cote found that the 2008 offering’s prospectus supplement warned of potentially impaired access to the commercial paper market, and thus “directly modif[ied] and replace[d] the earlier statements” of GE.  Judge Cote also rejected lead plaintiff’s argument that the newer statements were merely standardized “boilerplate.”

The ruling modified a January 2012 opinion from District Judge Richard Holwell in one of his last opinions before retiring from the bench.  Upon reassignment of the matter Judge Cote granted defendants’ pending motions for reconsideration of the January opinion with respect to all surviving claims under the Securities Act and Exchange Act.  Judge Cote’s ruling did not dispose of the entire action, keeping intact the Exchange Act claims against GE and its chief financial officer for alleged misstatements about the quality of the company’s loan portfolio.

In re: General Electric Co. Securities Litigation, case number 1:09-cv-01951, United States District Court for the Southern District of New York.