When should investor reliance be presumed in securities class actions?

Business Lawyer

Volumn 63, Issue 1, 2007, Pages 25-54

  Karmel, Roberta S ^a,b  

^a Department of Law ^*

^b BROOKLYN LAW SCHOOL   (United States)

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EID: 38849135517     PISSN: 00076899     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (235)

1. Section 10(b) provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange - ... To use or employ, in connection with the purchase or sale of any security... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
2. Securities Exchange Act of 1934, ch. 404, § 10(b), 48 Stat. 881, 891 (codified as amended at 15 U.S.C § 78j(b) (2000)) [hereinafter "Exchange Act"].
3. Section 18 provides: Any person who shall make or cause to be made any statement in any application, report, or document filed pursuant to [the Exchange Act] or any rule or regulation thereunder... which statement was at the time and in the light of the circumstances under which it was made false or misleading with respect to any material fact, shall be liable to any person (not knowing that such statement was false or misleading) who, in reliance upon such statement, shall have purchased or sold a security at a price which was affected by such statement, for damages caused by such reliance, unless the person sued shall prove that he acted in good faith and had no knowledge that such statement was false or misleading.
4. Exchange Act, supra note 1, § 18, 84 Stat. at 897 (codified as amended at 15 U.S.C. § 78r(a) (2000)).
5. Securities Act of 1933, ch. 38, § 11, 48 Stat. 74, 82 (codified as amended at 15 U.S.C. § 77k (2000)) [hereinafter "Securities Act"].
6. See infra note 185 and accompanying text.
7. See infra Part III.
8. See THE COMMITTEE ON CAPITAL MARKETS REGULATION, INTERIM REPORT OF THE COMMITTEE ON CAPITAL MARKETS REGULATION 5 (Nov. 2006), available at http://www.capmktsreg.org/pd/s/11. 30Commlttee_Interim_ReportREV2.pd/ [hereinafter "CAPITAL MARKETS REGULATION"];
9. MICHAEL R. BLOOMBERG & CHARLES E. SCHUMER, SUSTAINING NEW YORK'S AND THE US' GLOBAL FINANCIAL SERVICES LEADERSHIP 101 (Jan. 2007), available at http://www.senate.gov/schumer/SchumerWebsite/ pressroom/special_reports/2007/NY_REPORT%20_FINAL.pdf [hereinafter "BLOOMBERG & SCHUMER"].
10. See also U.S. CHAMBER OF COMMERCE, COMMISSION ON THE REGULATION OF U.S. CAPITAL MARKETS IN THE 21ST CENTURY, REPORTS AND RECOMMENDATIONS (March 2007), available at http://www.uschamber. com/publications/reports/0703capmarketscomm.
11. See CAPITAL MARKETS REGULATION, supra note 6, at 80-82;
12. BLOOMBERG & SCHUMER, supra note 6, at 100-04.
13. See infra notes 161-62.
14. See infra Part IV.
15. See, e.g., Editorial, Holding Accomplices Accountable, N.Y. TIMES, May 13, 2007, at 11.
16. See CAPITAL MARKETS REGULATION, supra note 6, at 11.
17. See Exchange Act, supra note 1, § 10(b), 48 Stat, at 891 (codified as amended at 15 U.S.C. § 78j(W (2000)).
18. Id.
19. According to Professors Louis Loss and Joel Seligman, the restrictive language and interpretations of section 18 gave plaintiffs suing pursuant to this section no advantage over those suing pursuant to a common law action for deceit. LOUIS LOSS & JOEL SELIGMAN, SECURITIES REGULATION § 11-C-3(c) (3d ed. 1995).
20. See Barnes v. Osofsky, 373 F.2d 269, 272 (2d Cir. 1967).
21. Exchange Act, supra note 1, § 10(b), 48 Stat, at 891 (codified as amended at 15 U.S.C. § 78j(b) (2000)).
22. Rule 10b-5 provides:
23. It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange, (a) to employ any device, scheme, or artifice to defraud, (b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
24. C.F.R. § 240.10b-5 (2007). See also Thomas F. McInemey III, Habermas, Proceduralism and the Private Cause of Action Under Rule 10b-5: The Implications for Democracy, 31 CREIGHTON L. REV. 805, 806-29 (1998).
25. Milton Freeman, the staffer who drafted the rule, recounted its origins in Conference on Codification of the Federal Securities Laws, 22 BUS. LAW. 793, 922 (1967).
26. Kardon v. Nat'l Gypsum Co., 69 F. Supp. 512, 514 (E.D. Pa. 1946).
27. See Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 13 n.9 (1971);
28. see also Herman & MacLean v. Huddleston, 459 U.S. 375, 380 (1983).
29. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 739-47 (1975). See also Huddleston v. Herman & MacLean, 640 F.2d 534, 541 n.6 (5th Cir. 1981), rev'd in part on other grounds, 459 U.S. 375 (1983).
30. See, e.g., United States v. O'Hagan, 521 U.S. 642, 650-66 (1997) (holding that partner in law firm that represented a company in a tender offer for common shares of another company was criminally liable for misappropriation when he purchased call options in the target company and then sold them for a substantial profit).
31. See, e.g., Musick, Peeler & Garrett v. Employers Ins., 508 U.S. 286, 297 (1993) (holding that insurer had a right to contribution from accountants and attorneys involved in misleading public offering);
32. Wharf (Holdings) Ltd. v. United Int'l Holdings, Inc., 532 U.S. 588, 594-97 (2001) (holding that an option consisting of an oral contract was enforceable, and defendants failure to disclose its intention not to honor the option upon forming the contract amounted to actionable fraud);
33. SEC v. Zandford, 535 U.S. 813, 819-25 (2002) (holding that stockbrokers sale of customers securities and personal use of the proceeds without the customers, knowledge or consent constituted fraud "in connection with" the sale of a security and was therefore actionable).
34. See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 198-99 (1976) (holding that negligence cannot be the basis for an action under Rule 10b-5 and the plaintiff must allege and prove scienter);
35. Chiarella v. United States, 445 U.S. 222, 232-33 (1980) (holding that employee of a financial printer was not liable under Rule 10b-5 because he did not violate any fiduciary duty by identifying takeover targets from unpublished corporate announcements and purchasing shares in the targets which he would then sell for large profits);
36. Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164, 175-77 (1994) (holding that a private action for aiding and abetting a fraud is not actionable under Rule 10b-5).
37. Insider Trading Sanctions Act of 1984, Pub. L. No. 98-376, 98 Stat. 1264 (codified as amended in scattered sections of 15 U.S.C); Insider Trading and Securities Enforcement Act of 1988, Pub. L. No.100-704, 102 Stat. 4677 (codified as amended in scattered sections of 15 U.S.C).
38. Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (codified as amended in scattered sections of 15 U.S.C.) [hereinafter "PSLRA"]; Securities Litigation Uniform Standards Act of 1998, Pub. L. No. 105-353, 112 Stat. 3227 (codified as amended in scattered sections of 15 U.S.C.) [hereinafter "SLUSA"].
39. Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341 (2005). Looking to tort law to interpret Exchange Act fraud is not new. In Moody v. Bache & Co., Inc., 570 F2d 523, 527 (5th Cir. 1978), the court observed that Rule 10b-5 is "essentially a tort claim."
40. Basic Inc. v. Levinson, 485 U.S. 224, 244 n.22 (1988) (plurality opinion). Not all justices have agreed with this rationale. See, e.g., Va. Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1110 (1991) (Scalia, J., concurring in part).
41. Robert B. Thompson, Federal Corporate Law: Torts and Fiduciary Duty, 31 J. CORP. L. 877, 887 (2006).
42. Compare Joseph A. Grundfest, Why Disimply?, 108 HARV. L. REV. 727, 742-43 (1995) (arguing that a substantial percentage of settlements of private matters are merely an effort to avoid litigation costs and that therefore the SEC must act to make meritless claims more difficult to pursue),
43. with Joel Seligman, The Merits Do Matter: A Comment on Professor Crundfests "Disimplylng Private Rights of Action Under the Federal Securities Laws: The Commission's Authority," 108 HARV. L. REV. 438, 448-57 (1994) (arguing against limits on private rights of action because courts are equipped to weed out non-meritorious claims, settled claims often have more merit than studies suggest, and private rights of action provide an important police function).
44. See also Roberta Romano, The Shareholder Suit: Litigation Without Foundation?, 7 J.L. ECON. & ORG. 55, 84 (1991);
45. but see generally James D. Cox, Making Securities Fraud Class Actions Virtuous, 39 ARIZ. L. REV. 497 (1997) (arguing for the continuation of securities class actions).
46. See Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 VA. L. REV. 549, 549-50 (1984).
47. See Eugene F. Fama, Effectent Capital Markets; A Review of the Theory and Empirical Work, 25 J. FIN. 383, 388 (1970).
48. Id.
49. Id, The "weak" version of the ECMH commands nearly universal acceptance; the "semi-strong" version is generally accepted; and the "strong" version is controversial because it assumes the existence of insider trading. Even if the markets are efficient In any of these ways, stock market prices do not necessarily reflect accurate estimates of a securityls intrinsic value. See JAMES D. COX ET AL., SECURITIES REGULATION: CASES AND MATERIALS 106-08 (5th ed. 2006).
50. Although section 10(b) encompasses other varieties of fraud, such as insider trading, the focus of this Article will be on false OT misleading statements by issuers and cases against research analysts and other third parties.
51. See RICHARD A. EPSTEIN, TORTS 549 (1999).
52. Leviticus 19:14.
53. Hershey H. Friedman, Placing a Stumbling Block Before the Blind Person: An In-Depth Analysis (2002), http://www.jlaw.com/Articles/ placingstumbllng.html.
54. Id.
55. E.R, 450, 452, 457-58 (K.B.) (1789) 100.
56. RESTATEMENT (SECOND) OF TORTS § 525(1977).
57. Thompson, supra note 29, at 879.
58. Deny v. Peek, (1889) 37 App. Cas. 337, 374 (H.L.). Yet, more recently, the common law has developed the tort of negligent misrepresentation. See Epstein, supra note 36, at 568-74.
59. 425 U.S. 185, 198-99 (1976).
60. THOMAS LEE HAZEN, THE LAW OF SECURITIES REGULATION 499 (5th ed. 2005). In a recent case, the judge remarked that "transaction causation is akin to reliance." In re Credit Suisse-AOL Sec. Litig., 465 F. Supp. 2d 34, 51 (D. Mass. 2006).
61. See RESTATEMENT (SECOND) OF TORTS § 538(2) (1977).
62. Id. § 537.
63. See Currie v. Cayman Res. Corp., 835 F2d 780, 785 (11th Cir. 1988).
64. Reisman v. KPMG Peat Marwick LLP, 787 N.E.2d 1060, 1066-68 (Mass. App. Ct.), review denied, 787 N.E.2d 1060 (Mass. 2003) (unpublished table decision).
65. Ernst & Young L.L.P. v. Pacific Mut. Life Ins. Co., 51 S.W.3d 573, 579-82 (Tex. 2001).
66. In this respect it is easier to prosecute a case under section 18 than under section 10(b). See Wachovia Bank & Trust Co., N.A. v. Nat'l Student Mktg. Corp., 650 F.2d 343, 356-58 (D.C. Cir. 1980) (noting that fraud is required for a section 10(b) claim), cert. denied sub nom. White & Case v. Wachovia Bank & Trust Co., N.A., 452 U.S. 954 (1981);
67. Ross v. A.H. Robbins Co., Inc., 607 F.2d 545, 556 (2d Cir. 1979) ("A plaintiff seeking recovery under [§] 18 faces a significantly lighter burden" than a plaintiff seeking recovery under § 10), cert. denied, 446 U.S. 946 (1980).
68. Theresa A. Gabaldon, Causation, Courts, and Congress: A Study of Contradiction in the Federal Securities Laws, 31 B.C. L. REV. 1027, 1038, 1060-64 (1990).
69. See In re Suprema Specialties, Inc. Sec. Litig., 438 E3d 256, 283-84 (3d Cir. 2006);
70. Ross, 607 F2d at 552;
71. Heit v. Weitzen, 402 F2d 909, 916 (2d Cir. 1968), cert. denied, 395 U.S. 903 (1969).
72. Jacobson v. Peat, Marwick, Mitchell & Co., 445 F. Supp. 518, 525 (S.D.N.Y. 1977). Fraud-on-the-market reliance is unavailable.
73. See In re MDC Holdings Sec. Litig., 754 F. Supp. 785, 798 (S.D. Cal. 1990).
74. In re Orthopedic Bone Screw Liab. Litig., 159 E3d 817, 826-29 (3d Cir. 1998), rev'd sub nom. on other grounds, Buckman Co. v. Plaintiffs' Legal Comm., 531 U.S. 341 (2001).
75. Taffet v. S. Co., 930 E2d 847 (11th Cir. 1991), vacated & reh'ggranted, 958 F2d 1514 (11th Cir. 1992). This theory was utilized in Cariety v. Grant Thornton, LLP, 368 F3d 356, 369 (4th Cir. 2004), in a section 10(b) case, and succeeded in the district court, but was reversed on appeal on the ground that the lower court needed to address on remand whether the defendant "made a public misrepresentation for which it may be found primarily liable." For a discussion of aiding and abetting liability,
76. see infra notes 151-53 and accompanying text.
77. Taffet, 930 E2d at 856-57. The court in Taffet, 930 E2d at 857, reversed the district court and found that the plaintiffs alleged a cognizable claim under RICO. On rehearing, the court of appeals decided that the filed rate doctrine precluded plaintiffs' claim and upheld the district court. Taffet v. S. Co., 967 E2d 1483, 1494 (11th Cr.), cert. denied, 506 U.S. 1021 (1992). For another case in which plaintiffs alleged a fraudulent misrepresentation as the basis for a RICO claim,
78. see Suffolk v. Long Island Lighting Co., 907 F2d 1295, 1305-08, 1311-12 (2d Cir. 1990) (holding that fraudulent misrepresentation regarding building of Shoreham nuclear plant by state-regulated utility could be the basis for a RICO claim, but affirming judgment notwithstanding the verdict entered by the trial court because there was not enough of a causal connection between the fraud and plaintiffs' alleged injury).
79. Holmes v. Sec. Investor Prot. Corp., 503 U.S. 258, 272 n.19 (1992).
80. See Gabaldon, supra note 52, at 1061.
81. Marc I. Steinberg, The Propriety and Scope of Cumulative Remedies Under the Federal Securities Laws, 67 CORNELL L. REV. 557, 598-600 (1982).
82. See Basic, 485 U.S. at 257-58 (White, J., dissenting). It is ironic that this change was prompted by testimony by Richard Whitney, President of the New York Stock Exchange, later indicted for embezzlement.
83. See Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 13 n.9 (1971).
84. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737 (1975).
85. 401 E2d 833, 860-62 (2d Cir.), cert. denied, 404 U.S. 1064 (1972).
86. 459 U.S. 375, 382-87 (1983).
87. See PSLRA, supra note 26, 109 Stat. 737 (codified as amended in scattered sections of 15 U.S.C);
88. SLUSA, supra note 26, 112 Stat. 3227 (codified as amended in scattered sections of 15 U.S.C).
89. In Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 341-43 (2005), the Court set forth the elements of a Rule 10b-5 case as follows: Da material misstatement or omission; 2) made with scienter; 3) in connection with the purchase or sale of a security; 4) on which the plaintiff relied (referred to as "transaction causation" in fraud-on-the-market cases); 5) economic loss; and 6) "loss causation," or a causal connection between the material misrepresentation or omission and the loss.
90. See Green v. Wolf Corp., 406 E2d 291, 301 (2d Cir. 1968), cert. denied, 395 U.S. 977 (1969). Courts therefore have recognized that proof of direct reliance by class members would be an unreasonable burden. See Semerenko v. Cendant Corp., 223 F3d 165, 178 (3d Cir. 2000), cert. denied sub nom. Forbes v. Semerenko, 531 U.S. 1149 (2001).
91. 406 U.S. 128, 153-54 (1972).
92. See Binder v. Gillespie, 184 E3d 1059, 1063-64 (9th Cir. 1999), cert. denied sub nom. Binder v. Wilson, 528 U.S. 1154 (2000). Even in face-to-face transactions courts declined to utilize the presumption of reliance in a misrepresentation case. See Feinman v. Dean Witter Reynolds, Inc., 84 E3d 539, 541-42 (2d Cir. 1996).
93. 485 U.S. 224, 245-47 (1988) (plurality opinion).
94. Id.
95. Id. at 245.
96. Id. This holding was presaged in Blacfete v. Barracfc, 524 F2d 891, 905-08 (9th Cir. 1975), cert. denied, 429 U.S. 816 (1976),
97. and Peil v. Speiser, 806 F.2d 1154, 1160-63 (3d Cir. 1986).
98. Basic, 485 U.S. at 227-28.
99. Id. at 255 (White, J., dissenting).
100. Id. at 256.
101. See Daniel R. Fischel, Efficient Capital Markets, the Crash, and the Fraud on the Market Theory, 74 CORNELL L. REV. 907, 908 (1989).
102. In re Verifone Sec. Litig., 784 F. Supp. 1471, 1479 (N.D. Cal. 1992), aff'd, 11 F.3d 865 (9th Cir. 1993).
103. Id. at 1479.
104. Dura Pharms., Inc., 544 U.S. at 341-46.
105. Id. at 342-46.
106. The number of accounting restatements between 1990 and 1997 averaged 49 annually. See Steve Liesman, Deciphering the Black Box: Many Accounting Practices, Not Just Enron's, Are Hard To Penetrate, WALL ST. J., Jan. 23, 2003, at C1. However, between 1997 and 2005, U.S. public companies filed 3,642 restatements to correct accounting inaccuracies.
107. See Lynn E. Turner & Thomas R. Weirich, A Closer Look at Financial Statement Restatments, CPA J., Dec. 1, 2006, at 3. In 2006, U.S. companies issued a record of 1,420 financial restatements, although large companies issued fewer restatements than in 2005.
108. See Steven Marcy, Total Financial Restatements Increase in 2006, but Decline for Large Entities, 39 SEC. REG. & L. REP. (BNA) 366 (Mar. 5, 2007).
109. See, e.g., In re Cyberonics Inc. Sec. Litig., 468 F. Supp. 2d 936, 938 (S.D. Tex. 2006) (suit arising from Cyberonicss efforts to secure approval from the FDA for marketing a device for the treatment of depression); Noble Asset Mgmt. v. Allos Therapeutics, Inc., No. CIVA-04CV-1030-RPM, 2005 WL 4161977, at *1 (D. Colo. Oct. 20, 2005) (suit arising from Allos press releases which created a perception in the stock market that the FDA would likely approve a new drug); In re Geopharma, Inc. Sec. Litig., 399 F. Supp. 2d 432, 435 (S.D.N.Y. 2005) (claim arising out of press release that caused investors to believe that the FDA had approved a new Geopharma drug when in fact the FDA had only approved a much less lucrative medical device); In re Transkaryotic Therapies, Inc. Sec. Litig., 319 F. Supp. 2d 152, 155-57 (D. Mass. 2005) (suit based on misleading public statements made by Transkaryotic regarding the results of FDA clinical tests of a new drug); Anderson v. Abbott Labs., 140 F. Supp. 2d 894, 900-01 (N.D. Ill.), aff'd sub nom. Gallagher v. Abbott Labs., 269 E3d 806 (7th Cir. 2001) (suit arising from Abbotts failure to disclose ongoing compliance issues with FDA regulations); In re Medimmune, Inc. Sec. Litig., 873 F. Supp. 953, 956-59 (D. Md. 1995) (action arising out of statements made by Medimmune regarding the effectiveness of a new drug, FDA review of the drug, and medical journal articles concerning the drug).
110. See id.
111. See, e.g., Medimmune, 873 F. Supp. at 968 (noting that most state courts have rejected "the fraud-on-the-market concept in connection with common law fraud claims"); Kaufman v. I-Stat Corp., 754 A.2d 1188, 1200-01 (N.J. 2000); Kahler v. E.E Hutton & Co., Inc., 558 So. 2d 144, 145 (Fla. Dist. Ct. App. 1990).
112. Gilson & Kraakman, supra note 31, at 549-50.
113. Id. at 554. The ECMH originated with economic theorists.
114. See generally Stephen F. LeRoy, Efficient Capital Markets and Martingales, 27 J. ECON. LIT. 1583 (1989).
115. Fama, supra note 32, at 388.
116. Id.
117. Id.
118. See Lynn A. Stout, The Unimportance of Bang Efficient: An Economic Analysis of Stock Market Pricing and Securities Regulation, 87 MICH. L. REV. 613, 640-58 (1988) (arguing that informational efficiency has little bearing on the allocation of capital among corporations since corporations rarely rely on equity issues for funding, and because stock price rarely determines the funds an issuer receives when issuing stock).
119. For another point of view, see John C. Coffee, Jr., Market Failure and the Economic Case for a Mandatory Disclosure System, 70 VA. L. REV. 717, 734-37 (1984) (outlining the argument for the necessity of informational efficiency if the securities market is to be the principal allocative mechanism for investment capital).
120. See, e.g., Donald C. Langevoort, Theories, Assumptions, and Securities Regulation: Market Efficiency Revisited, 140 U, PA. L. REV. 851, 857-71 (1992);
121. Larry E. Ribstein, Fraud on a Noisy Market, 10 LEWIS & CLARK L. REV. 137, 138-43 (2006).
122. See, e.g., Steven M. Bainbridge, Mandatory Disclosure: A Behavioral Analysis, 68 U. CIN. L. REV. 1023, 1033-53 (2000);
123. Lawrence Cunningham, From Random Walks to Chaotic Crashes: The Linear Genealogy of the Efficient Capital Market Hypothesis, 62 GEO. WASH. L. REV. 546, 592-607 (1994);
124. Henry T. C. Hu, Faith and Magic: Investor Beliefs and Government Neutrality, 78 TEX. L. REV. 777, 802-07 (2000);
125. Lynn A. Stout, The Mechanisms of Market Inefficiency: An Introduction to the New Finance, 28 J. CORP. L. 635, 659-66 (2003). The observation that markets are heavily influenced by psychological factors is of very long standing.
126. See CHARLES MACKAY, EXTRAORDINARY POPULAR DELUSIONS AND THE MADNESS OF CROWDS (Harriman House 2003) (1841).
127. See COX ET AL., supra note 34, at 109-10.
128. Proposed Comprehensive Revision to System for Registration of Securities Offerings, Securities Act Release No. 33-6235, 45 Fed. Reg. 63693, 63698 (proposed Sept. 25, 1980) (to be codified at 17 CER. pts. 230 & 239).
129. Reproposal of Comprehensive Revision to System for Registration of Securities Offerings, Securities Act Release No. 33-6331,46 Fed. Reg. 41902, 41915 (proposed Aug. 18, 1991) (to be codified at 17 CER. pt. 239).
130. See Milton H. Cohen, "Truth in Securities" Revisited, 79 HARV. L. REV. 1340, 1342 (1966).
131. See Securities Offering Reform, Securities Act Release No. 33-8591, 70 Fed. Reg. 44722, 44727-31 (proposed Aug. 3, 2005) (to be codified in scattered parts of 17 C.F.R.). Although this release does not discuss the ECMH, in making distinctions between well-known seasoned issuers ("WKSI") and other issuers, and permitting WKSIs immediate access to the capital markets, the SEC is essentially relying on the informational efficiency of the pricing mechanisms for WKSI securities.
132. See JOHN T. BOSTELMAN, THE SARBANES-OXLEY DESKBOOK § 9:2.2 (Practicing Law Institute 2007).
133. See supra note 83.
134. Former New York State Attorney General Elliot Spitzer uncovered a scandal among investment banks whereby research analysts were issuing positive recommendations regarding issuers that were clients in order to inflate stock prices. See Peter Martin, Who Pays the Piper?: Offering Independent Analysis Can Be a Delicate Task When Commercial and Investment Interests Hang In the Balance, FIN. TIMES (LONDON), May 20, 2002, at 18 (noting that in 1999 there were eight times as many "buy" recommendations as "sell," and that in 2000, stocks most highly rated by analysts fell 31% while stocks least favorably rated rose 49%).
135. See Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, § 408, 116 Stat. 745, 790 (codified at 15 U.S.C. § 7266 (Supp. IV 2004)) [hereinafter "SOX"].
136. See, e.g., N.Y. STOCK EXCH. R. 472;
137. NAT'L ASS'N OF SEC DEALERS R. 2711; Self-Regulatory Organizations; New York Stock Exchange LLC and the National Association of Securities Dealers, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Changes Relating to NYSE Rule 472 and NASD Rule 2711, Exchange Act Release No. 34-54616, 71 Fed. Reg. 62331 (Oct. 24, 2006).
138. In 2001 approximately 497 securities fraud class actions were filed, more than twice than in any other year from 1995 to 2000. See Stanford Law School Securities Class Action Clearinghouse, Index of Filings, http://securities. stanford.edu/companies.html (last visited Aug. 15, 2007). According to COMMITTEE ON CAPITAL MARKETS REGULATION, supra note 6, at 75-77, although there has been a drop in the number of securities class action suits in recent years, there has been an extreme rise in the value of an average settlement.
139. Hevesi v. Citigroup Inc., 366 E3d 70, 77 (2d Cir. 2004).
140. 711 F. Supp. 1264 (D.N J.), appeal dismissed, 993 F2d 875 (3d Cir. 1989) (unpublished table decision).
141. Id. at 1286-87.
142. Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc., No. 05 Civ. 1898(SAS), 2006 WL 2161887, at * 5 (S.D.N.Y. Aug. 1, 2006).
143. In re Initial Public Offering Sec. Litig., 471 E3d 24, 33 (2d Cir. 2006).
144. See West v. Prudential Sec., Inc., 282 E3d 935, 937 (7th Cir. 2002). In this case, the court refused to apply the fraud-on-the-market doctrine to statements purporting to convey inside information. Id.
145. Initial Public Offering Sec. Litig., 471 E3d at 33.
146. Id.
147. 432 E3d 1 (1st Cir. 2005).
148. Id. at 14.
149. Id. at 19.
150. Id. at 14-16.
151. Id. at 16.
152. 430 E3d 503 (1st Cir. 2005).
153. See id. at 508.
154. See Teamsters local 445, 2006 WL 2161887, at *5.
155. See Gariety v. Grant Thornton, LLR 368 E3d 356, 368 (4th Cir. 2004); Greenberg v. Crossroads Sys., Inc., 364 E3d 657, 662 n.6 (5th Cir. 2004); Freeman v. Laventhol & Horwath, 915 E2d 193, 198 (6th Cir. 1990); No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. West Holding Corp., 320 E3d 920, 947 (9th Cir.) (Tallman, J., dissenting), cert. denied, 540 U.S. 966 (2003); Joseph v. Wiles, 223 E3d 1155, 1164 n.2 (10th Cir. 2000);
156. Kowal v. MCI Commc'ns Corp., 16 E3d 1271, 1276 n.1 (P.C. Cir. 1994).
157. See In re Burlington Coat Factory Sec. Litig., 114 E3d 1410, 1425 (3d Cir. 1997).
158. See Teamsters Local 445, 2006 WL 2161887, at *6.
159. Id.
160. Xcelera.com, 403 E3d at 516.
161. In re Polymedica Corp. Sec. Litig., 453 F. Supp. 2d 260, 278 (D. Mass. 2006).
162. Id.
163. Teamsters Local 445, 2006 WL 2161887, at *12.
164. See Xcelera.com, 430 E3d at 512;
165. Polymedica, 453 F. Supp. 2d at 266, 269;
166. Teamsters Local 445, 2006 WL 2161887, at *9.
167. Initial Public Offering Sec. Litig., 471 E3d at 42-43.
168. Id. at 27.
169. Id.
170. Id. at 42-45 (citing Freeman, 915 F.2d at 199).
171. Id. at 43. Ironically, a similar requirement was imposed by rule after the research analysts cases, brought by the New York Attorney General and then followed up upon by the SEC, upon which this private lawsuit was based. See Stephen J. Hilgers, Under the Influence: Analyzing Wall Street Research Analyst Conflicts of Interest and the Responses Designed To Induce Impartiality, 31 SEC. REG. L.J. 427, 475 (2003) [hereinafter "Hilgers, Under the Influence"].
172. See Press Release, Office of the New York Attorney General, SEC, NY Attorney General, NASD, NASAA, NYSE and State Regulators Announce Historic Agreement To Reform Investment Practices: $1.4 Billion Global Settlement Includes Penalties and Funds for Investors (Dec. 20, 2002), http://www.oag. state.ny.us/press/2002/dec/dec20b_02.html.
173. See id.
174. See generally Hilgers, Under the Influence, supra note 135.
175. See DeMarco v. Robertson Stephens Inc, 318F. Supp. 2d 110, 121(S.D.N.Y.2004);DeMarcov. Lehman Bros., Inc., 309 F. Supp. 2d 631, 636 (S.D.N.Y. 2004). See also Lentell v. Merrill Lynch & Co., Inc., 396 E3d 161, 172 (2d Cir.), cert. denied, 126 S. Ct. 421 (2005). But see In re Merrill Lynch & Co., Inc., 273 F. Supp. 2d 351, 375 (S.D.N.Y. 2003) (granting defendants motion to dismiss a class action in holding that the allegedly fraudulent research reports were not a "fraud upon the market").
176. In re Credit Suisse-AOL Sec. Litig., 465 F. Supp. 2d 34, 52-53 (D. Mass. 2006).
177. DeMarco v. Lehman Bros., Inc., 222 ER.D. 243, 247 (S.D.N.Y. 2004).
178. Hevesi, 366 F.3d at 81.
179. Id. at 80 n.7 (quoting John C. Coffee, Jr., Security Analyst Litigation, N.Y. L.J., Sept. 20, 2001, at 5).
180. Initial Public Offering Sec. Litig., 471 E3d at 33.
181. Demarco v. Lehman Bros., Inc., 222 ER.D. at 246.
182. Lentell, 396 E3d 161.
183. Id. at 173.
184. Joffee v. Lehman Bros., Inc., 410 F. Supp. 2d 187, 193 (S.D.N.Y.), aff'd, 209 F. App'x 80 (2d Cir. 2006).
185. See Chiarella v. United States, 445 U.S. 222, 232-33 (1980).
186. See In re Merrill Lynch & Co., Inc., 273 F. Supp. 2d at 388-89.
187. 511 U.S. 164, 175-77 (1994).
188. Exchange Act, supra note 1, § 20, 48 Stat. at 899 (codified as amended at 15 U.S.C. § 78t (2000)).
189. 511 U.S. at 191.
190. 368 E3d 356 (4th Cir. 2004).
191. Id. at 369. Accord Wright v. Ernst & Young LLP, 152 E3d 169, 175 (2d Cir. 1998), cert. denied, 525 U.S. 1104 (1999).
192. Gariety, 368 E3d at 369.
193. 452 E3d 1040 (9th Cir. 2006).
194. Id. at 1052.
195. Id.
196. In re Parmalat Sec. Litig., 376 E Supp. 2d 472, 509-10 (S.D.N.Y. 2005).
197. See also In re Lemout & Hauspie Sec. Litig., 236 E Supp. 2d 161, 173-74 (D. Mass. 2003).
198. 443 F.3d 987, 991-93 (8th Cir. 2006), cert. granted sub nom. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 127 S. Ct. 1973 (2007).
199. 482 E3d 372, 390 (5th Cir. 2007), petition for cert, filed, 75 U.S.L.W. 3557 (U.S. Mar. 5, 2007) (No. 06-1341).
200. See State AGs Contend Enron Suit Properly Certified as Class Action, SEC. REG. Sr L. REP. (BNA) 102 (Jan. 22, 2007).
201. Regents of the Univ. of Cal., 482 E3d at 390-92.
202. Id. at 385.
203. Id.
204. Chiarella, 445 U.S. at 229.
205. It has long been the law that when a broker-dealer makes a recommendation to buy or sell a security, the recommendation must have a reasonable basis, Hanly v. SEC, 415 E2d 589, 597 (2d Cir. 1969). But this law developed under the shingle theory to protect broker-dealers' customers from overreaching, not to protect all investors in the public securities markets from unwarranted recommendations. While the advent of the star research analyst who regularly appears on television to tout stocks may have magnified the effect of analyst recommendations on stock market prices, these recommendations seem to be just part of the general "noise" in the public securities markets. However, the SEC and banking regulators should be able to sanction banks that engage in questionable financial transactions designed to falsify issuer financial statements, and accountants who improperly fail to uncover, or even assist, such fraud.
206. Securities Act, supra note 3, § 11(a), 48 Stat, at 82 (codified as amended at 15 U.S.C § 77k(a) (2000)).
207. Id.
208. Id.
209. Securities Act, supra note 3, § 11(b)(3)(C), 48 Stat, at 82 (codified as amended at 15 U.S.C. § 77k(b)(3)(C) (2000)).
210. See id.
211. Rule 436, 17 CER. § 230.436 (2007).
212. Securities Act, supra note 3, § 11(b)(3)(A), 48 Stat. at 82 (codified as amended at 15 U.S.C. § 77k(b)(3)(A) (2000)).
213. Whether the added costs of due diligence are worth the benefits of more efficient allocation of resources in raising capital is a question for another article. See Barbara Ann Banoff, Regulatory Subsidies, Efficient Markets and Shelf Registration: An Analysts of Rule 415, 70 VA. L. REV. 135,1 45-84 (1984);
214. Marcel Kahan, Securities Laws and the Social Costs of "Inaccurate" Stock Prices, 41 DUKE L.J. 977, 1005-42 (1992). The cases that exist can be divided into three rough groups;
215. the classic cases in which courts discuss underwriter liability prior to integrated disclosure, especially Escott v. BarChris Construction Corp., 283 E Supp. 643, 692-97 (S.D.N.Y. 1968),
216. and Feit v. Leasco Data Processing Equipment Corp., 332 F Supp. 544, 581-83 (E.D.N.Y. 1971);
217. more recent cases in which courts find, on motions for summary judgment, that underwriters have fulfilled their due diligence responsibilities, especially In re Worlds of Wonder Securities Litigation, 35F.3d 1407, 1414-21 (9th Cir. 1994), cert. denied sub nom. Miller v. Pezzani, 516 U.S. 868
218. and (3) the post-2000 cases, following the bursting of the technology bubble in which courts again set high standards for due diligence, especially In re Enron Corp. Securities Derivative 6V ERISA Litigation, 235 F. Supp. 2d 549, 596-613 (S.D. Tex. 2002), and In re WorldCom, Inc. Securities Litigation, 346 E Supp. 2d 628, 656-59, 678-81 (S.D.N.Y. 2004).
219. See Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 583 (1995).
220. See REGULATION OF CAPITAL MARKETS, supra note 6, at 5;
221. BLOOMBERG & SCHUMER, supra note 6, at 101.
222. See Securities Act, supra note 3, § 11(a), 48 Stat. at 82 (codified as amended at 15 U.S.C. § 77k(a) (2000)).
223. APA Excelsior III L.P. v. Premiere Techs., Inc., 476 E3d 1261, 1273-74 (11th Cir. 2007).
224. Id. at 1274.
225. See In re Initial Public Offering Sec. Litig., 471 E3d 24, 42-43 (2d Cir. 2006).
226. JOHN C. COFFEE, JR. Sr JOEL SELIGMAN, SECURITIES REGULATION: CASES AND MATERIALS 285-87 (9th ed. 2003).
227. AMERICAN LAW INSTITUTE, FEDERAL SECURITIES CODE §§ 1703, 1704 (1980).
228. See SEC v. Alliance Leasing Corp., 28 E App'x. 648, 652 (9th Cir. 2002); SEC v. Rana Research, Inc., 8 E3d 1358, 1364 (9th Cir. 1993).
229. The Federal Account for Investor Restitution ("FAIR") provision is contained in section 308 of SOX. See SOX, supra note 103, § 308, 116 Stat. at 784 (codified at 15 U.S.C. § 7246 (Supp. IV 2004)).
230. See William H. Donaldson, Chairman, U.S. Sec. & Exch. Comm'n, Testimony Concerning the Impact of the Sarbanes-Oxley Act Before the House Committee on Financial Services (Apr. 21, 2005), available at www.sec.gov/news/testimony/ts042105whd.htm.
231. U.S. SECURITIES AND EXCHANGE COMMISSION, REPORT PURSUANT TO SECTION 308(C) OF THE SARBANESOXLEY ACT OF 2002 18-21 (Jan. 24, 2003), available at www.sec.gov/news/studies/sox308creport.pdf.
232. See CAPITAL MARKETS REGULATION, supra note 6, at 82.
233. The latest example of how Congress deals with these problems is that Barney Frank, now the Democratic Chairman of the House Financial Services Committee, is pressuring the SEC to file a brief on behalf of the plaintiffs in the Credit Suisse case, but the plaintiffs are represented by William Lerach who may be indicted for improper behavior in class action lawsuits. See Kara Scannell, SECs Allegiances Are Put to Test, WALL ST. J., May 29, 2007, at A2. Furthermore, at least one of the institutional investors, California Public Employees' Retirement System, lost money in Enron's stock investing in off balance sheet Enron deals, in some respects similar to the deals at issue in this case.
234. See Richard A. Oppel, Jr., Employees' Retirement Plan Is a Victim as Enron Tumbles, N.Y. TIMES, NOV. 23, 2001, at A1.
235. Initial Public Offering Sec. Litig., 471 F.3d at 33.