THE ORRICK GUIDE TO SECURITIES LITIGATION October 2010 Orrick, Herrington & Sutcliffe LLP

COPYRIGHT Copyright 2011 Orrick, Herrington & Sutcliffe LLP www.Orrick.com ISBN 978-0-615-50866-5

SUMMARY OF CONTENTS ABOUT ORRICK PREFACE HOW TO USE THIS GUIDE SECURITIES LITIGATION & REGULATORY ENFORCEMENT GROUP I. II. III. JURISDICTION AND EXTRATERRITORIAL REACH OF THE SECURITIES LAWS OVERVIEW OF SECURITIES CLASS ACTIONS ELEMENTS OF FEDERAL SECURITIES CLAIMS

IV. THEORIES OF SECONDARY LIABILITY V. STATE LAW SECURITIES CLAIMS

VI. SEC INVESTIGATIONS AND ACTIONS VII. WHITE COLLAR LITIGATION VIII. INTERPLAY OF SECURITIES CLASS ACTIONS, DERIVATIVE ACTIONS, SEC INVESTIGATIONS AND CRIMINAL PROSECUTIONS

ABOUT ORRICK Founded in San Francisco in 1863, Orrick today ranks among the world's leading global law firms. We offer a comprehensive set of the highest quality practices and a platform that spans the United States, Europe and Asia. Orrick maintains a well-balanced practice, including a mix of transactional, litigation and regulatory expertise. Our winning record at trial sets us apart from other litigation firms, while we act in the most complex and novel corporate and finance transactions. Our clients include the world's preeminent public companies, emerging growth companies, government entities and virtually every major global bank, as well as other financial markets participants. The firm is known for our strength in the technology, energy and financial services sectors.

PREFACE Orrick has a long history of providing our annual "Guide to Securities Litigation." In fact, we are in our 24th year of this publication, and look forward to an exciting 25th edition in 2011. In 2010, we have seen the global economic crisis continue to have a profound effect on mortgage markets, our nation's banking system, the global economy, and securities litigation. The impact of the crisis on securities class actions and regulatory proceedings cannot be overstated. The important trends for 2010 are easy to spot. 1. Dodd-Frank has forever changed the landscape of securities litigation. 2. Significant changes have occurred at the Securities and Exchange Commission. 3. We have seen massive litigation arising out of the mortgage meltdown. 4. There is a significant impact on securities law as a result of the Supreme Court's decision in Morrison. 5. We continue to see a decline in the number of class action filings in federal courts in 2009 and 2010. First, the passage of Dodd-Frank is historic. Not only does it fundamentally change the way that financial institutions will be regulated in the future but it unleashes an enormous amount of activity by a variety of federal agencies that will go on for years. It also regulates hundreds of funds that have never faced regulation before. All of that change creates risk and opportunity for securities litigators. Second, and related to the first, is the rebirth of the SEC. The SEC is conducting at least a dozen statutorily mandated studies that could result in future changes in law. They range from a review of private aiding and abetting to a review of the rules that apply to municipal issuers. Further, the new director of enforcement has made great changes in the enforcement division. He has created nationwide subject matter groups. He has shortened the SEC’s processes. He has brought the DOJ to the SEC. Currently, the budget battles have slowed these efforts. Once those are resolved, we should see increased activity from the SEC. Third, the tsunami of mortgage crisis litigation is still gathering strength. Some firms are already riding the wave. The litigation has taken the form of class and individual actions against banks, mortgage originators, underwriters, insurance companies and trustees. The most significant cases involve investors in mortgage securities alleging that they were misled when they purchased the mortgage certificates. This litigation seeks billions of dollars and will occupy hundreds of securities litigators in dozens of firms. Fourth, the Supreme Court’s decision in Morrison marks a significant change in the theory and scope of the securities law as it applies to foreign private issuers. Not only did the Supreme Court end decades of “jurisdictional” analysis and introduce a transactional approach, it significantly contracted the practice. As expected, many fewer foreign private issuer cases are being filed. Many fewer are surviving a motion to dismiss and class certification. Finally, the decline in the overall practice remains one of the dominant trends of the last two years. Fewer cases are being filed. There is less work to do. What work there is to do is coming in different ways and from different sources. This means that securities litigation groups must change their approach to getting the work and doing the work. The amount of change in this practice area is breathtaking. While the future is always uncertain, the shape of securities litigation for the next five years is particularly unclear. This practice guide, now older than some of our associates, is intended for practitioners. We hope it is useful. October, 2010 San Francisco, CA Michael Torpey

Partner and Chair of the Securities Litigation Group mtorpey@orrick.com (415) 773 - 5932

HOW TO USE THIS GUIDE The Orrick Guide to Securities Litigation is created by securities litigators for securities litigators. Yes, it contains a very thorough discussion of securities law and would be a valuable asset for any securities law student who wants to drill down on a particular issue. But the outline is not a textbook. It is not meant to be read to cover to cover and does not purport to tell the history of the law or put it in a broader social perspective. Instead, the Guide is the securities litigator’s bible, how-to guide and book of war – the one place that every securities litigator should start whenever a question arises. Whether the issue is consolidating multi-district actions, grappling with the “continuous ownership rule” or responding to a Wells Notice, the Guide will get you started down the path that leads to an ultimate answer. As we tell our junior associates here at Orrick: always start with the Guide – if it does not have at least the beginning of an answer, you probably have the question framed wrong. To use the Guide properly, begin with the table of contents. The Guide is dense and lengthy, so it can be very helpful to narrow down the chase. Does a question implicate pleading requirements or evidentiary concerns? Is loss causation at issue or is a damages analysis necessary? By targeting in on the particular area of practice, an answer will be more quickly forthcoming. Within each section of the Guide, it makes sense to read. Lawyers often have no idea of the question they should be asking, and by reading a section of the Guide a more thorough understanding of the issue can arise and, with it, new questions can be formed. While reading, note the density of the Guide’s string cites. The Guide is not intended to provide only one or two exemplary cases, but to list one or two cases in each district – the “classic” case that everyone cites and the more recent case that explains the evolution of the law. Instead of plugging away aimlessly online and praying for a hit, one look at the Guide instantly provides you the substantive cite necessary to put your search on the road to completion. When helpful, the Guide also provides context, describing, for example, the pleading standards for scienter in each circuit prior to the Reform Act, how the Reform Act conflicted with those standards and how the circuit courts responded. The Guide also offers practice suggestions, transferring the wisdom of Orrick’s distinguished securities litigation partners through their published articles and war stories. So much of the securities litigation practice can be learned only by experience, and wherever possible that experience has been transcribed here. Of course, the Guide cannot be entirely comprehensive, and some discussions are better shorthanded in a volume such as this (see, e.g., the discussion of shareholder derivative litigation and the special litigation committee process). But again: the Guide is a starting point, a jump-off to the more granular details that can be wrought through directed research. Begin your search here every time. Learn the layout of the book and familiarize yourself with how to find things in quickly. If you do, the Guide may not always instantly give you every answer you need, but it will always point you in the direction of the ultimate answer you desire. And when all else fails, call one of the trained securities litigators whose names appear at the front of this book for help. We wrote this bible, this how-to guide and book of war, and we are standing by to help you in all your securities litigation needs.

ORRICK, HERRINGTON & SUTCLIFFE LLP SECURITIES LITIGATION & REGULATORY ENFORCEMENT GROUP Partners William F. Alderman James E. Burns, Jr. Robert Cohen Russell D. Duncan Daniel J. Dunne Richard Gallagher Joseph Frank Penelope A. Graboys Blair George E. Greer Kenneth Herzinger James N. Kramer Richard Martin James A. Meyers Lori Lynn Phillips Susan D. Resley Amy M. Ross Michael Torpey - Chair Michael C. Tu Robert P. Varian Counsel Patryk Chudy Steve Knaster Senior Associates Charles J. Ha M. Todd Scott Teodora Manolova Danielle P. Van Wert Managing Associates

Benjamin Geiger Joseph E. Giometti Christin Hill Amy Laughlin Rebecca Lubens Justyna Walukiewicz Lee Paul Rugani James Thompson Associates Justin Bagdady Lily Becker Stephanie Cowles Josh Deitz Michael Duckworth Steven Hong David Keenan Susanne Klaric Katie Lieberg Christine Louie Katie Lubin Rebecca Mroz Antoin Newman Nahas Jennifer Nejad Alexander Talarides Matthew Tolve

Cover Page Title Page Copyright Page About Orrick Preface How To Use This Guide ORRICK, HERRINGTON & SUTCLIFFE LLP SECURITIES LITIGATION & REGULATORY ENFORCEMENT GROUP I. JURISDICTION AND EXTRATERRITORIAL REACH OF THE SECURITIES LAWS A. Jurisdiction And Venue Provisions 1. The "Jurisdictional Means" Requirement 2. Venue Considerations 3. Forum Non Conveniens In Securities Cases B. Extraterritorial Application Of Securities Laws 1. Statutory Ambiguity Relating To Extraterritoriality 2. Jurisdictional Issues Relating To Extraterritoriality a. Subject Matter Jurisdiction b. Personal Jurisdiction 1) Jurisdiction Over Entities 2) Jurisdiction Over Individuals II. OVERVIEW OF SECURITIES CLASS ACTIONS A. Consolidating Multiple Complaints And Actions B. Selection Of Lead Plaintiff And Lead Class Counsel 1. Court Appointment Of Lead Plaintiff a. Presumption Of Most Adequate Plaintiff b. Rebutting The Presumption c. Single Largest Loss d. Multiple Lead Plaintiffs Or Aggregation Of Numerous Plaintiffs

e. Institutional Investors f. Investment Advisors g. Discovery Related To Purported Most Adequate Plaintiff h. Restrictions On Professional Plaintiffs i. Filing Requirements 2. Selection Of Lead Class Counsel 3. Legal Fees For Non-Lead Counsel a. Pre-appointment Work b. After Appointment Of Lead Counsel c. Representation Of Individual Class Members d. Representation of Uncertified Subclasses 4. Other Responsibilities And Rights Of Lead Plaintiff 5. Defendants' Role In Appointment Of Lead Plaintiff a. Multiple Lead Plaintiffs b. Statutory Criteria 1) The Representative Should Not Be Subject To Unique Defenses 2) The Lead Plaintiff Should Not Be A Professional Plaintiff C. Motion To Dismiss 1. Pleading Requirements For All Civil Actions a. Pleading Requirements Before Twombly And Iqbal b. Twombly And Iqbal: To Survive A Motion To Dismiss, The Complaint Must Be "Plausible On Its Face" c. Application to Securities Cases 1) Iqbal Raises The Pleading Standards For SEC Civil Enforcement Actions 2) Iqbal May Give Courts Greater Latitude To Dismiss Securities Claims Outside The PSLRA's Ambit 3) Iqbal Raises Pleading Standards For Federal Derivative Actions 2. Pleading Requirements For Claims Sounding In Fraud

3. Claims To Which The PSLRA Applies 4. The Reform Act's Effect On Pleadings Standards a. The Reform Act's Innovations 1) Heightened Standard As To Statements And Omissions 2) Heightened Standard As To Scienter 3) Stay Of All Proceedings 4) Mandatory Sanctions For Frivolous Securities Fraud Claims 5. The PSLRA's Pleading Requirements With Respect To Statements And Omissions a. Increased Factual Specificity And Analysis Required b. Specification Of Each Allegedly Misleading Statement c. The Reason Or Reasons Why The Statement Is Misleading d. "All Facts" Forming Basis For "Information And Belief" 1) Use Of Experts Or Consultants In Support Of Allegations 2) Use Of Unnamed Confidential Witnesses 6. The Safe Harbor For Forward-Looking Statements a. Forward-Looking Statements b. Applicability Of The Safe Harbor c. No Duty To Update d. Effect On Bespeaks Caution Doctrine 7. The PSLRA's Pleading Requirements With Respect To Scienter a. Heightened Pleading Standard b. Following The PSLRA, The Circuits Split As To The Stringency Of The "Strong Inference" Standard c. The Supreme Court Resolves The Split In Tellabs d. Statements Of Present Or Historical Fact e. Heightened Scienter Standard For Forward-Looking Statements f. Use Of Sarbanes-Oxley Certifications To Plead Scienter g. Use Of GAAP Violations To Plead Scienter

1) Misapplication Of Accounting Principles 2) Red Flags 3) Magnitude Of The Restatement 4) Misstated Earnings Figures 5) Simplicity Of Accounting Rules Violated 6) Indicia Of Fraudulent Intent In General 8. Non-Speaking Defendants And Group Pleading a. Overview Of Tactics And the Doctrine b. Did The Reform Act Abolish Group Pleading? 9. Other Procedural Considerations At The Motion To Dismiss Stage a. Documents The Court May Consider On A Motion to Dismiss b. Mandatory Sanctions Under PSLRA For Frivolous Securities Fraud Claims c. Leave To Amend D. Motions For Class Certification 1. Timing Of Certification Motion And Decision a. Dispositive Motions b. Impact Of The Reform Act's Stay Of Discovery 2. The Lead Plaintiff And Class Must Have Article III And Statutory Standing 3. Required Elements:  Federal Rule Of Civil Procedure 23 4. Class Certification – Prerequisites Of Rule 23(a) a. Numerosity b. Commonality And Predominance c. Adequacy Of Representation d. Typicality 1) Damages 2) Reliance 3) Time Of Purchase

4) Unique Defenses (a) In-And-Out Traders (b) Professional Plaintiffs (c) Impact Of "Fraud On The Market" Theory (d) The La Mar Doctrine 5) Limiting The Class In A Multiple Offering Case e. Superiority Of Class Action Treatment 5. Alternatives To Denial When Prerequisites Are Not Met a. Subclasses b. Length Of Class Period 1) Court's Discretion 2) Variance In Factual Issues 3) Curative Disclosures (a) Partial Curative Disclosures (b) Effectiveness Of Curative Statements (c) Whether Statement Was Curative May Merit Inquiry 6. Statute Of Limitations Considerations On Dismissal 7. Rule 23(f) Interlocutory Appeal E. Class And Merits Discovery Issues 1. Class Discovery 2. The Reform Act's Discovery Stay a. Automatic Stay Of Discovery b. Cases Interpreting The Discovery Stay c. Exceptions To The Discovery Stay d. Applicability Of The Discovery Stay On Renewed Motions To Dismiss e. The Discovery Stay And Related State Actions 1) Motions To Stay Discovery Brought In Federal Court

2) Motions To Stay Discovery Brought In State Court 3) Motions To Stay Proceedings Brought In State Court 3. Depositions a. Ten Deposition Statutory Limit b. Rule 30(b)(6) Depositions 1) Speaking For The Corporation 2) Designation Of Knowledgeable Persons F. Privilege Considerations 1. Public Policies Supporting The Attorney-Client Privilege And Work Product Doctrine 2. Attorney-Client Privilege Issues a. Immunity From Disclosure b. Relevance Of Communications And Challenges To Privilege 3. Reliance On Counsel Defense a. Asserting Defense Waives Privilege b. Limitation Of Implied Waiver c. Assertion Of Defense Waives Accountant-Client Privilege 4. Dissemination Of Information To Third Parties a. No Privilege, Or Implied Waiver b. No Implied Waiver c. Prejudice d. Joint Defense Privilege e. Dissemination To Regulatory Agencies 1) Waiver Of Privilege? 2) Selective Waiver Theory f. Federal Rule Of Evidence 502 g. Sarbanes-Oxley "Professional Responsibility" Dissemination 1) Duty To Report Evidence Of A Material Violation

2) Disclosure Of Confidential Information 5. Crime-Fraud Exception 6. The Accountant-Client Privilege a. No Federal Accountant-Client Privilege b. State Statutory Privilege c. Federal Court – Federal Rules Of Evidence Apply d. Federal Court – No Privilege If Both Federal And State Claims e. Federal Court – Diversity Action 7. Fifth Amendment Privilege a. Corporations b. Producing Documents c. Adverse Inference d. Preclusion Of Evidence 8. Assertion Of "Work Product" Protection Over Identities Of Confidential Witnesses G. Motions For Summary Judgment 1. Legal Standard a. Burden On Moving Party b. Opposing Party 2. Scienter a. Insider Trading b. Inconsistencies Between Internal Documents And Public Statements c. Liability Of Outside Directors d. Liability Of Auditors 3. False Or Misleading Statement Of Material Fact a. False Or Misleading Statement b. Adopting Statements In Analyst Reports c. Materiality

4. Reliance 5. Loss Causation H. Trial Of Securities Class Actions 1. Jury Education 2. Simple Strategy 3. Plaintiff Witnesses 4. Pre-Trial Elimination Of Claims 5. Damages I. Settlement Considerations 1. The Court's Role In The Settlement Process a. Court Approval Or Disapproval b. Notice 1) General 2) Reform Act's Settlement Notice Requirements 3) Case Law On Notice c. Fairness Hearing 1) Burden Of Proof 2) Objections 3) Fairness Factors 2. Settlement Prior To Certification Of A Class a. Hesitancy b. Court Approval c. Temporary Class 3. Settlement Prior To Appointment Of Lead Counsel 4. Settlement With Individual Class Members 5. Rule 23 And The "Opt-out" 6. Practical Considerations With Settlements

a. Timing b. Parties c. Publicity d. Admissions e. Releases f. Scope Of The Class g. Consideration 1) Stock 2) Warrants 3) Contingent Value Rights 4) Waiver Of Rights As Consideration 5) Corporate Restructuring 6) Corporate Governance Changes h. Future Litigation Costs i. Effect On Other Litigation j. Appeal And Collateral Attack 7. Partial Settlements a. Global Settlements Not Always Possible b. Indemnity c. Contribution 1) General 2) The Reform Act 3) Settlement Bar Statutes (a) General (b) The Reform Act Settlement Bar (c) Examples of State Good Faith Settlement Statutes 4) Judicial Approval Is Required

5) Application Of Settlement Bars By Federal Courts 6) Calculating Set-off Amounts For Non-Settling Defendants (a) The Pro Tanto Method (b) The Pro Rata Method (c) The Proportional Method 7) The Reform Act Approach To Set-offs 8) Parties Not In Suit d. Cross-Actions e. Severance Of Claims 8. Collateral Attack Of Settlement a. Potential Derivative Suits b. Issue Preclusion Of Federal Claims 9. Insurance Issues a. Allocations Are Made From Time Of Settlement b. An Insurer's Ability To Allocate 10. Attorneys' Fees After Settlement a. Lead Counsel b. Reasonable Fee c. Non-Lead Counsel III. ELEMENTS OF FEDERAL SECURITIES CLAIMS A. Section 10(b) Of The 1934 Act And Rule 10b-5 1. Definition Of Security 2. Private Right Of Action 3. Overview Of The Elements Of Rule 10b-5 4. Purchaser/Seller Requirement 5. The Materiality Requirement a. Definition

b. Mixed Question Of Law And Fact c. Materiality Of Small Accounting Misstatements d. Materiality Of Statements Concerning Medical Devices e. Materiality Of Proposed Mergers f. The Level Of Detail g. Information Of Which The Market Is Already Aware 6. Actionable Misstatements a. Accurate Statements Of Historical Fact b. General Statements Of Optimism And Puffery c. Qualitative Statements Of Opinion d. Statements Rendered False Due To GAAP Violations e. Statements Regarding Legal Compliance f. Forward-Looking Statements And The Reform Act's Safe Harbor 1) Covered Forward-Looking Statements 2) Definition Of The Safe Harbor 3) The Safe Harbor Applies To Oral Statements 4) No Duty To Update Forward-Looking Statements 5) Defining "Meaningful Cautionary Language" 6) Some Forward-looking Statements Ineligible For The Safe Harbor g. Statements That "Bespeak Caution" 1) Evolution Of The "Bespeaks Caution" Doctrine And Its Application 2) Cautionary Language Need Not Necessarily Be In Same Document 3) Limitations On The "Bespeaks Caution" Doctrine h. Projections i. Mosaic Misrepresentation Thesis j. Statements In Analyst Reports 1) The "Adoption" Or "Entanglement" Theory

2) The "Conduit" Theory 7. Omissions a. The Requirement Of Identifying A Duty To Disclose b. Affirmative Misstatements May Trigger A Duty To Disclose c. No Duty To Disclose Mismanagement d. Duty To Update And Duty To Correct e. No Duty To Disclose Forecasts f. Duty To Disclose Triggered By Insider Trading g. Attorneys' And Accountants' Duty To Disclose Misconduct 1) Section 10A Of The Exchange Act 2) Section 307 Of The Sarbanes-Oxley Act 3) Auditors' Duty To Correct Prior Audit Opinions h. Duty To Disclose Under Item 303 i. Duty To Disclose Under Item 103 j. No Duty To Disclose Business, Products And Plans Of Competitors k. Duty To Disclose Technical Or Development Problems 8. Market Manipulation 9. The "In Connection With" Element 10. Causation a. Transaction Causation b. Loss Causation c. Dura Pharmaceuticals d. Dura's Effect In The Eighth And Ninth Circuits e. Dura's Effect In Other Circuits f. "Corrective Disclosure" Approach To Pleading Loss Causation Since Dura g. The "Materialization Of Risk" Approach To Pleading Loss Causation h. Pleading Standard For Loss Causation After Dura

i. Limitations On The Scope Of Dura 11. Reliance a. Fraud On The Market Presumption Of Reliance 1) Existence Of An Efficient Market 2) Misrepresentation Must Be A Public Presentation 3) Application Of Fraud On The Market Theory To Short Sellers 4) Application Of Fraud On The Market Theory To State Securities Law And State Common Law Fraud Claims b. Rebutting The Presumption Of Reliance 1) Underdeveloped Or Inefficient Markets 2) Truth On The Market Defense c. Variations On The Fraud On The Market Presumption 1) "Fraud Created The Market" (a) Evolution Of The "Fraud Created The Market" Theory (b) Courts Utilizing The "Fraud Created The Market" Theory (c) Cases Rejecting Or Uncertain About The Fraud Created The Market Theory 2) Reliance On Integrity Of Regulatory Process d. Reliance On Omissions And The Affiliated Ute Presumption e. Additional Issues Relating To Reliance 1) Effect Of Central Bank 2) Plaintiff's Diligence To Discover The True Facts 3) Forced Sale Doctrine 12. Scienter a. Scienter Defined b. Pleading Scienter Prior To The Reform Act c. The Reform Act Pleading Standard For Scienter d. The Post-Reform Act Debate

1) The Supreme Court's Decision In Tellabs 2) The Pre-Tellabs Circuit Split e. First Circuit f. Second Circuit g. Third Circuit h. Fourth Circuit i. Fifth Circuit j. Sixth Circuit k. Seventh Circuit l. Eighth Circuit m. Ninth Circuit n. Tenth Circuit o. Eleventh Circuit p. DC Circuit q. Corporate Scienter 13. Damages Under Section 10(b) a. Pre-Reform Act Damage Theories b. Post-Reform Act Damage Calculations 1) Basic Effect 2) Effect On "Largest Financial Interest" Standard c. Burden Of Proof 14. Statute Of Limitations a. The Lampf Standard b. Period Extended By Sarbanes-Oxley Act c. Concerns Raised By The Extended Limitations Period d. "Inquiry Notice" v. "Discovery" e. Equitable Tolling

B. Section 11 Of The 1933 Act 1. Elements Of A Section 11 Claim a. Liability Limited To Registration Statement Or Prospectus b. Material Misstatement Or Omission 1) Materiality 2) Misrepresentation Or Omission 3) Statements That "Bespeak Caution" c. Plaintiff's Standing To Assert Claim 1) Split Authority Over "Tracing" 2) No Privity Requirement d. Limited Class Of Defendants e. Reliance f. Causation g. Statute Of Limitations 2. Defenses To Liability Under Section 11 a. Plaintiff's Knowledge b. Due Diligence Defense c. Reliance On Counsel Defense d. The Good Faith Or Due Care Defense e. "Negative Causation" Defense 3. Damages Under Section 11 a. Measure Of Damages b. Underwriter's Liability Limited c. Outside Director's Liability Limited d. Attorney's Fees And Costs e. Interest On Damages 4. Contribution And Indemnity

5. Applicability Of The Heightened Pleading Requirements Of Rule 9(b) And The Reform Act 6. Due Diligence – Defense Or Duty a. The Statutes b. The SEC's View c. The FINRA View d. Judicial Views 7. The Due Diligence Defense a. No Issuer Defense b. Due Diligence Defenses For Non-Issuer Defendants 1) "Non-Expertised" Portions 2) "Expertised" Portions 3) "Official" Portions c. Scope of Due Diligence Defenses 1) Section 11(c) 2) "Standard Of The Street" 3) Financial Industry Regulatory Authority (FINRA) Delineations Of "Reasonableness" 4) SEC Rule 176 d. Due Diligence Defense For Underwriters 1) Reliance On Management Representations 2) Reliance On Accountant Representations 3) Factors In Determining "Reasonableness" 4) Considerations For Due Diligence (a) The Issuing Entity (b) Business and Industry (c) Management, Counsel, and Auditors (d) Financial Statements (e) Properties

(f) Material Contracts (g) Employees (h) Litigation and Administrative Proceedings (i) Use of Proceeds (j) Prior Filings (k) Investigate "Red Flags" 5) Non-Managing Underwriters 6) Counsel For The Underwriters e. Officers And Directors Of The Issuer f. Counsel For The Issuer g. Accountants And Other Experts 8. Documenting Due Diligence 9. The Timing Of Due Diligence 10. Drafting Offering Documents a. Risk Factors b. Forward-Looking Information c. Safe Harbor 11. Professional Malpractice a. Elements Of Cause Of Action For Professional Malpractice b. To Whom Is The Duty Owed? 1) Privity 2) Accountant Liability C. Section 12 Of the 1933 Act 1. Elements Of A Section 12 Claim a. Definition Of Security b. Definition Of "Sale" Of Securities 1) Stock And Stock Options

2) Affirmative Investment Decision c. Defendant Must Be A "Seller" Of Securities d. Supreme Court Definition of "Seller" 1) Privity 2) Supreme Court Rejects "Substantial Factor" Test 3) In Pari Delicto e. Officers And Directors Of A Corporate Seller 2. Section 12(a)(1) a. Elements Of A Section 12(a)(1) Claim b. Exempt Security c. Exempt Transaction d. No Due Diligence Defense e. Measure Of Damages Under Section 12(a)(1) 3. Section 12(a)(2) a. Elements Of A Section 12(a)(2) Claim 1) No Reliance 2) No Scienter 3) No Causation 4) Limited To Initial Offering Or Sale – No Tracing 5) Scope Of Investors' Duty b. "Seller" Status Issues Under 12(a)(2) 1) Defendants In Public Offering Litigation 2) Firm Commitment Indemnity 3) Actual Participation 4) Section 12 Claims Against Professionals 5) Professionals As Sellers 6) No Secondary Liability

c. Measure Of Damages Under Section 12(a)(2) 1) Rescission 2) Damages 3) Reform Act Limitation 4) Attorney's Fees 5) Punitive Damages d. Not Applicable To Private Offerings e. Defenses Available Under Section 12(a)(2) 1) Plaintiff's Knowledge 2) Reasonable Care/Due Diligence 3) Materiality 4) Statute Of Limitations 5) Equitable Tolling 6) Rule 9(b) 7) Not Applicable To Aftermarket Transactions 4. Comparison Of Due Diligence Defense Under Sections 11 And 12(a)(2) a. Different Standards 1) The Section 11 Standard As More Stringent 2) The Sections 11 And 12(a)(2) Standards As Equivalent 3) The Section 12(a)(2) Standard As More Stringent D. Section 14 Of The 1934 Act 1. Section 14(a) And SEC Rule 14a-9 a. Section 14(a) b. Rule 14(a)‑9 c. Elements Of A Section 14(a) And Rule 14(a)(9) Violation d. Breach Of Fiduciary Duty e. Applicability Of The Reform Act

f. Statute Of Limitations 2. Section 14(d) And SEC Rule 14d-10 a. Best Price Provision b. SEC Rule 14d-10 c. Elements Of A Rule 14d-10 (a)(2) Violation 1) During Pendency Of The Tender Offer (a) Formal Test (b) Possible Exception For Successive Tender Offers (c) Functional Test (d) The Third Circuit's Approach 2) Pursuant To The Tender Offer d. Other Important Provisions In Rule 14d-10 1) The "All-Holders" Rule 2) Offering More Than One Type Of Consideration In A Tender Offer e. Applicability Of The Reform Act To Section 14(d) Claims 3. Section 14(e) a. Purpose b. Private Cause Of Action c. Elements Of A Section 14(e) Claim For Misstatements Or Omissions 1) Materiality 2) Scienter 3) In Connection With A Tender Offer 4) Reliance/Causation (a) Permanent Injunctions (b) Omissions (c) Misstatements d. Section 14(e)'s Prohibition Of "Fraudulent, Deceptive, Or Manipulative" Practices

e. Applicability Of The Reform Act E. Section 16 Of The 1934 Act 1. Purpose 2. Strict Liability 3. Standing 4. Statute Of Limitations F. Section 17 Of The 1933 Act 1. Existence Of A Private Right Of Action 2. SEC Enforcement Actions G. Section 18 Of The 1934 Act 1. Elements Of Claim a. Purchaser/Seller b. Specific Reliance c. Material Misstatement 2. Documents To Which Section 18(a) Applies 3. Liability Under Section 18 4. Defenses Under Section 18 5. Attorneys' Fees 6. Statute Of Limitations H. Insider Trading Claims Under Section 10(b) And Section 20A 1. Statutory Provisions a. Section 10(b) Of The 1934 Act b. Section 20A Of The 1934 Securities Exchange Act 2. Private Right of Action For Insider Trading a. Actions Brought Under Rule 10(b) 1) Classical Theory 2) Misappropriation Theory

b. Actions Under Section 20A 1) Independent Violation Required 2) Contemporaneous Traders 3) Same Class Of Securities c. Civil And Criminal Liability Under A Misappropriation Theory d. Definition Of Insider e. Materiality I. Securities-Related RICO Suits J. The Investment Company Act Of 1940 1. Section 36(b) Of The Investment Company Act 2. Initial Litigation – The Excessive Fee Cases 3. Recent Attempts To Expand The Scope Of Section 36(b) a. Mergers b. Rights Offerings c. Leveraged Funds d. Annuity Contracts e. Multiple Fund Boards f. Membership Dues To ICI 4. Preemption Of State Law Claims In Section 36(b) Action 5. Implied Right Of Action Under The 1940 Act a. Legislative History b. Courts Finding Implied Rights Of Action c. Courts Finding No Implied Rights Of Action 6. Section 36(a)—The Perceived Catchall a. Elements Of Section 36(a) b. Judicial Evolution Of Section 36(a) c. Private Right Of Action

d. Eliminating The Implied Right Of Action Under Section 36(a) e. Breach Of Fiduciary Duty Cases Involving Board Actions 7. Avoiding The Reform Act a. Section 13(a)(3) (Investment Objectives) b. Section 7 (Unregistered Non-US Investment Companies) c. Section 35(d) (Misleading Names) d. Section 12(b) (Distribution Plans) 8. Defenses To Implied Rights Suits a. Statute Of Limitations b. Aiding And Abetting c. Direct Versus Derivative d. Failure To Make A Demand e. Bespeaks Caution K. Sarbanes-Oxley And Dodd-Frank

IV. THEORIES OF SECONDARY LIABILITY A. Control Person Liability Under Section 15 Of The 1933 Act and Section 20(a) of the 1934 Act 1. Statutory Provisions a. Section 15 Of The 1933 Act b. Section 20(a) Of The 1934 Act 2. Elements Of A Control Person Cause Of Action a. Primary Violation b. Nature And Degree Of Control Over Corporate Operations 1) SEC Definition Of Control 2) Other Definitions Of Control c. Exercising Control:  A Circuit Split 1) Culpable Participation Test

(a) Culpable Participation Required (b) Culpable Participation Not Required (c) Allegations Of Status Alone Deemed Sufficient (d) Status Alone Deemed Insufficient (e) Potential Control Test 3. Factual Nature Of Inquiry 4. "Transitive" Control Liability 5. Defenses Under Control Person Statutes  a. Securities Act, Section 15 b. Securities Exchange Act, Section 20(a) c. Burden Of Proof 1) Good Faith Defense 2) Duty 3) Sliding Scale 4) Fact-Intensive Inquiry 5) Statute Of Limitations B. Respondeat Superior Liability 1. Respondeat Superior Available a. Application of Respondeat Superior To Corporations b. Respondeat Superior After Stoneridge c. Third Circuit View C. Aiding And Abetting Liability 1. No Aiding And Abetting Liability In Private Suits 2. Impact Of Central Bank a. Expansion Of Primary Liability Allegations 1) Bright-Line 2) Substantial Participation

b. Application To SEC Enforcement Actions c. Effect On Conspiracy Claims d. Effect On Group Pleading Doctrine e. Reliance D. Scheme Liability 1. Application Of Stoneridge 2. Pre-Stoneridge Scheme Liability Decisions a. Eighth Circuit b. Ninth Circuit c. District Courts V. STATE LAW SECURITIES CLAIMS A. The Uniform Standards Act: Limiting State Court Claims 1. Impetus For The Uniform Standards Act 2. Background On The Uniform Standards Act a. Exclusive Federal Jurisdiction And Preemption Of State Securities Law For Most Shareholder Class Actions b. In Connection With c. Strong Preemption d. Retroactive Application of SLUSA e. Shareholder Actions Brought In State Court Are Removable To Federal Court f. Reviewability of Remand Order g. Federal Courts Can Issue Stays Of State Court Actions 3. Requirements For Removal a. Misrepresentation Or Omission Must Be "In Connection With" Purchase Or Sale Of Covered Security b. Covered Securities c. Covered Class Actions 1) Actions Seeking Damages

2) Presence Of Uncovered Claims 3) 1933 Act Claims In State Court d. Scienter Pleading Requirement 4. Exclusions Under The Uniform Standards Act a. Derivative Actions Excluded b. Actions Brought By A State c. Trustee Actions d. "Delaware Carve-Out" 1) Venue Limitation 2) Remand Of Improperly Removed Actions Required 5. Practical Effect Of The Uniform Standards Act B. Securities Fraud Claims 1. Individual Actions In State Court 2. Internal Affairs Doctrine 3. California Corporations Code Section 25400 a. California's Blue Sky Laws 1) Section 25400 2) Elements 3) Reliance 4) Privity 5) Section 25500Id. at 113. 4. California Business And Professions Code Sections 17200 and 17500 5. California Civil Code Sections 1709 And 1710 6. Common Law Fraud And "Holding" Claims C. Shareholder Derivative Actions 1. Definition 2. Standing

a. Shareholder Requirements b. Effect of Merger c. Choice Of Law d. Fair And Adequate Representation e. Security 3. Demand Requirement 4. Pleading Demand Futility a. Burden b. Must Be Pled Without The Benefits Of Discovery 5. Standard For Board Action a. Challenges To Board Action b. Challenges To Board Inaction 6. Responding To The Demand a. Acceptance Of Demand b. Rejection Of Demand c. Demand Deferred 7. Special Litigation Committees D. California Corporations Code Section 1101: The All-Holders Rule 1. Statutory Provisions 2. Inapplicability Of Tender Offers 3. Existence Of A Private Right Of Action VI. SEC INVESTIGATIONS AND ACTIONS A. The Power Of The SEC 1. Broad Investigatory Powers 2. Enforcement Actions: Key Statutory Provisions a. Securities Act Of 1933 b. Securities Exchange Act Of 1934

1) Section 10(b): Anti-fraud 2) Section 13: "Books And Records" And Internal Controls 3) Section 15: Broker-Dealer Regulation And Enforcement c. Investment Company Act Of 1940 d. Investment Advisers Act Of 1940 e. Sarbanes-Oxley Act Of 2002 B. The Initiation And Escalation Of An SEC Investigation 1. Sources Of An SEC Investigation 2. Informal Inquiries a. Guidelines Governing Informal Inquiries b. Document And Testimonial Discovery In Informal Inquiries c. Conclusion Of An Informal Inquiry 3. Formal Investigations a. Formal Order Of Investigation b. Contents Of A Formal Order c. Guidelines Governing Formal Inquiries d. Conclusion Of A Formal Inquiry 4. Wells Notice And Submission a. No Right To Receive A Wells Notice b. Whether To Make A Wells Submission c. Content Of A Wells Submission 5. Internal Investigations 6. Action By The Commission 7. Litigating Against The Commission C. Disclosing An SEC Investigation 1. Nondisclosure By The SEC 2. Disclosure By The Company Under Investigation

D. Commission Enforcement Actions 1. Types Of Cases a. Accounting And Financial Fraud b. False And Misleading Statements c. Insider Trading d. Market Manipulation e. Mutual Fund Cases – Market Timing/Late Trading f. Options Backdating g. Foreign Payments h. Regulation FD i. Ponzi Schemes, Investment Schemes And A Renewed Focus On Enforcement j. "Implied Representation" Theory 2. Remedies a. Injunctive Actions 1) Preliminary Injunction 2) Final Injunction b. Civil Penalties c. Disgorgement d. Prospective Relief 1) Undertakings 2) Appointment Of Independent Consultant Or Corporate Monitor E. Administrative Proceedings F. Rule 102(e) Proceedings 1. Process a. Conduct Of Hearings b. Appeal To The Commission c. Appeal To United States Court Of Appeals

2. Sanctions a. Cease And Desist Orders 1) Enforcing A Cease And Desist Order 2) Disgorgement And Accounting b. Monetary Penalties c. Suspension/Permanent Bar VII. WHITE COLLAR LITIGATION A. Parallel Civil And Criminal Proceedings 1. Potential Benefits To Defendants a. Civil Discovery b. Collateral Estoppel And Persuasive Effect Of Civil Victory 2. Benefits To The Government, Regulators, And Civil Plaintiffs a. SEC Information Gathering And Disclosure 3. Judicial Scrutiny 4. Self-Regulatory Organizations 5. Communicating With The Government a. Fifth Amendment b. Proffer Agreements c. Immunity 1) Transactional Versus Derivative Use Immunity 2) Informal Immunity d. Privilege And The Holder/Thompson/McCallum/McNulty/Filip Memos 1) Holder Memo 2) Thompson Memo 3) McCallum Memo 4) McNulty Memo 5) Filip Memo

6) KPMG Cases 6. Grand Juries And Subpoenas a. The Grand Jury b. Subpoenas 7. Criminal Discovery And Trial a. Defendants' Discovery Rights b. Defendant's Discovery Obligations 8. Double Jeopardy 9. Multiple Defendant Issues a. Ethical Considerations b. Joint Defense Agreements 10. Stays And Protective Orders a. Stays b. Protective Orders B. Penal Provisions Of The Federal Securities Laws 1. Section 24 Of The 1933 Act And Section 32(a) Of The 1934 Act a. Sentencing 2. Mens Rea: Knowingly And Willfully 3. Sarbanes-Oxley Act Of 2002 a. Certification Of Periodic Reports – Section 906 b. Certification Of Quarterly And Annual Reports – Section 302 c. Whistleblower Provisions C. The Non-Securities Criminal Code 1. Mail And Wire Fraud a. Elements Of Mail And Wire Fraud b. Scheme To Defraud And Fraudulent Representations c. Use Of The Mails Or Wires In Furtherance Of The Scheme

d. Specific Intent To Defraud e. Honest Services 2. Conspiracy a. Elements Of Conspiracy b. Agreement c. Specific Intent d. Overt Act e. Pinkerton Liability 3. Racketeer Influenced And Corrupt Organizations Act a. Elements b. Enterprise c. Conducting Or Participating In The Activities Of The RICO Enterprise d. Pattern Of Racketeering Activity 4. False Statements Statute a. Section 1001 b. "Conceals Or Covers Up By Any Trick, Scheme, Or Device" c. "False, Fictitious Or Fraudulent Statements Or Representations" d. "Makes Or Uses Any False Writing Or Document" e. Materiality 5. Perjury a. General Perjury b. Subornation Of Perjury c. Perjury Before A Grand Jury d. False Testimony e. Materiality f. Oath Administered And Oath Authorized g. Proceeding

h. Willfully And Contrary To Such Oath i. One Witness Plus Or Corroboration Rule 6. Obstruction Of Justice a. Elements Of Obstruction Of Justice b. Specific Intent c. Corruptly d. Endeavors VIII. INTERPLAY OF SECURITIES CLASS ACTIONS, DERIVATIVE ACTIONS, SEC INVESTIGATIONS AND CRIMINAL PROSECUTIONS A. Case Initiation B. Preliminary Discovery C. Privilege Concerns D. Representation Issues E. Discovery F. Written Discovery G. Depositions H. Settlement I. Insurance Concerns

I. JURISDICTION AND EXTRATERRITORIAL REACH OF THE SECURITIES LAWS The forces of globalization have not bypassed the practice of securities litigation. In recent years, plaintiffs have initiated large numbers of cases – many in New York – against foreign companies that have restated their financials or experienced other business setbacks. This development has raised interesting and evolving questions pertaining to the extent of the courts’ jurisdiction to apply the federal securities laws to foreign companies and foreign transactions. Understanding these issues requires a basic familiarity with the jurisdiction and venue provisions of the U.S. securities laws. A. Jurisdiction And Venue Provisions 1. The “Jurisdictional Means” RequirementPursuant to 28 U.S.C. § 1331, the general federal question jurisdictional statute, federal courts possess subjectmatter jurisdiction over securities class actions and other suits under the federal securities laws. Sec. Investor Prot. Corp. v. Vigman, 764 F.2d 1309, 1314 (9th Cir. 1985). Despite this general subject matter jurisdiction, many federal securities provisions are implicated only where the purported violator used the requisite “jurisdictional means” in connection with the securities transaction or transactions at issue. See, e.g., Securities Act of 1933 §§ 5, 12, 17; Securities Exchange Act of 1934 §§ 9(a), 10(b), 15(c)(1), 15(c)(2). Such jurisdictional means are generally present where the alleged violation occurred by use of the mails, by means of transportation or communication in interstate commerce, or under some provisions – notably Section 10(b) of the Securities Exchange Act – by use of the facilities of a national securities exchange. See Hooper v. Mountain States Sec. Corp., 282 F.2d 195, 205 (5th Cir. 1960) (holding that use of interstate telephone lines to call one person in another state was sufficient use of jurisdictional means). As a practical matter, the jurisdictional means requirement is rarely disputed in major securities litigation cases insofar as such cases almost always involve large entities that are active in more than one state and are listed on national securities exchanges. Furthermore, courts have largely denuded the jurisdictional means requirement and it is well-recognized that “the jurisdictional hook need not be large to fish for securities law violations.” Lawrence v. S.E.C., 398 F.2d 276, 278 (1st Cir. 1968) (citing several circuit authorities). However, as a jurisdictional prerequisite to invoking the federal securities laws, the jurisdictional means requirement cannot be ignored, and defense counsel should remain aware of its occasional significance. No matter how clearly it appears that jurisdiction exists in an action, plaintiffs still have the burden of both pleading and proving that the appropriate jurisdictional means were used. See Wells v. Monarch Capital Corp., No. 91-10575-MA, 1991 WL 354938, at *10 (D. Mass. Aug. 23, 1991) (requiring plaintiff to amend complaint to allege jurisdictional means despite fact that allegations in complaint made it “difficult to imagine that the allegedly fraudulent statements detailed in the complaint did not necessitate the use of the mail, telephone or some other interstate facility”). 2. Venue ConsiderationsThe special venue provisions applicable in federal securities class actions are quite broad. See Securities Act § 22(a); Securities Exchange Act § 27. Under both the 1933 Act and the 1934 Act, plaintiffs may file an action in the federal district where (a) the defendant is found or is an inhabitant, (b) the defendant transacts business, or

(c) any act or transaction constituting the securities law violation occurred. Id.; Bourassa v. Desrochers, 938 F.2d 1056, 1057 (9th Cir. 1991) (holding telephone call to resident of district was “act or transaction” supporting venue in district); Kansas City Power & Light Co. v. Kansas Gas & Elec. Co., 747 F. Supp. 567, 572-73 (W.D. Mo. 1990) (holding that “found” in district means having presence and continuous activity there and “transacts business” in district requires that activities be continuous and substantial part of ordinary business). But see Luther v. Countrywide Home Loans Servicing LP, 533 F.3d 1031, 1032-24 (9th Cir. 2008) (affirming remand to state court after removal because “the Class Action Fairness Act of 2005, which permits in general the removal to federal court of high-dollar class actions involving diverse parties, does not supersede § 22(a)’s specific bar against removal of cases arising under the ‘33 Act”). Contra Katz v. Gerardi, 552 F.3d 558, 562 (7th Cir. 2009) (disagreeing with Luther and holding that § 22(a)’s general grant of state court jurisdiction is modified by the Class Action Fairness Act). In securities fraud actions under § 10(b) involving several defendants acting across more than one district, any material act committed by any defendant in furtherance of the purported scheme will satisfy the Securities Exchange Act’s venue requirement as to all defendants. In re Triton Ltd. Sec. Litig., 70 F. Supp. 2d 678, 687 (E.D. Tex. 1999); FS Photo, Inc. v. PictureVision, Inc., 48 F. Supp. 2d 442, 446 (D. Del. 1999). The breadth of this “co-conspirator venue” rule is counter-balanced by the liberal venue transfer rules under the federal venue statute, 28 U.S.C. § 1404. Section 1404(a) allows a district court to transfer a securities suit, despite the propriety of plaintiffs’ initial choice of venue, “to any other district or division where [the suit] might have been brought.” 28 U.S.C. § 1404(a). While courts will accord some deference to plaintiffs’ initial choice of forum, a court may transfer a class action to another district for any one of a number of reasons, including the convenience of the parties and witnesses, the cost of obtaining the presence of witnesses, the relative ease of access to sources of proof, relative court congestion, relative proximity to where material events occurred, as well as the court’s determination of whether a transfer will enhance the administration of justice. See Wash. Pub. Utils. Group v. Dist. Court, 843 F.2d 319, 326-27 (9th Cir. 1987) (holding change of venue wholly within trial court’s discretion); Troyer v. Karcagi, 488 F. Supp. 1200, 1207 (S.D.N.Y. 1980) (according little weight to plaintiffs’ choice of forum “where the operative facts of the case have no material connection with [the chosen] district”). Contractual forum selection clauses may be voided. See, e.g., NutraCea v. Langley Park Invs. PLC, No. 2:06-cv-2019-MCE-DAD, 2007 WL 135699, at *2 (E.D. Cal. Jan. 16, 2007) (declaring a forum selection clause mandating litigation be brought in New York void under Cal. Corp. Code § 25701). 3. Forum Non Conveniens In Securities Cases The special venue provisions of the 1933 and 1934 Acts, as well as Section 1404(a), do not supersede the applicability of the common law doctrine of forum non conveniens in securities cases. See Alfadda v. Fenn, 159 F.3d 41, 46-49 (2d Cir. 1998) (affirming dismissal on forum non conveniens grounds of lawsuit in which Saudi Arabian investors in corporation brought suit under U.S. federal securities and other antifraud laws); Warlop v. Lernout, 473 F. Supp. 2d 260 (D. Mass. 2007) (dismissing lawsuit on forum non conveniens grounds because plaintiff sought to form class of investors who bought stock on European exchange and, under facts of case, alternative forum was available and private and public factors supported dismissal); In re Corel Corp. Sec. Litig., 147 F. Supp. 2d 363, 365-67 (E.D. Pa. 2001) (finding that Canadian courts would provide adequate forum for securities class action, but declining to transfer action to Canada due to balance of factors under forum non conveniens analysis). Defendants often invoke the doctrine of forum non conveniens where plaintiffs have sought out the protections of U.S. securities laws despite the fundamentally foreign character of the dispute at issue. In this sense, the doctrine of forum non conveniens is a venue-based challenge to the application of U.S. court processes in an extraterritorial securities dispute. As discussed next, plaintiffs’ attempt to apply U.S. securities laws extraterritorially may, in certain cases, move beyond a matter of mere venue convenience or inconvenience, and may stretch the jurisdiction of the securities laws further than was intended. B. Extraterritorial Application Of Securities Laws

Private plaintiffs continue to seek to haul foreign issuers into U.S. courts, raising a number of difficult legal issues relating to the extraterritorial reach of U.S. securities laws in light of due process and minimum contacts requirements. While these topics could fill a treatise, some basic issues and signposts are touched on here, culminating in a discussion of the Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010). 1. Statutory Ambiguity Relating To Extraterritoriality The federal securities laws do not expressly define the extent to which provisions apply extraterritorially. Section 22 of the 1933 Securities Act, for example, states simply that: The district courts of the United States … shall have jurisdiction of offenses and violations under this title … of all suits in equity and actions at law brought to enforce any liability or duty created by this title. Any such suit or action may be brought in the district wherein the defendant is found or is an inhabitant or transacts business, or in the district where the offer or sale took place, if the defendant participated therein, and process in such cases may be served in any other district of which the defendant is an inhabitant or wherever the defendant may be found. Section 27 of the Securities Exchange Act of 1934, Section 44 of the Investment Company Act of 1940, and Section 214 of the Investment Advisors Act of 1940 similarly provide for federal jurisdiction over a defendant in any district where the defendant inhabits or is found, transacts business, or offers or sells securities. Since the statutory language is quite general in scope, these provisions provide little guidance when confronted with an issue relating to a specific party’s potential liability under U.S. securities laws. Prior to Morrison, numerous courts had candidly recognized that the extraterritorial application of the securities laws involves policy considerations and the courts’ best judgment rather than clear statutory guidance. See, e.g., Robinson v. TCI/US W. Commc’ns, Inc., 117 F.3d 900, 904-905 (5th Cir. 1997) (“[W]ith one small exception the Exchange Act does nothing to address the circumstances under which American courts have subject matter jurisdiction to hear suits involving foreign transactions.”); Itoba Ltd. v. Lep Group PLC, 54 F.3d 118, 121 (2d Cir. 1995) (“It is well recognized that the Securities Exchange Act is silent as to its extraterritorial application.”); Zoelsch v. Arthur Andersen & Co., 824 F.2d 27, 30 (D.C. Cir. 1987) (stating that provisions of 1934 Act furnish “no specific indications of when American federal courts have jurisdiction over securities law claims arising from extraterritorial transactions”). But see S.E.C. v. Kasser, 548 F.2d 109, 114 (3d Cir. 1977) (“[T]he anti-fraud laws suggest that such [extraterritorial] application is proper. The securities acts expressly apply to ‘foreign commerce,’ thereby evincing a Congressional intent for a broad jurisdictional scope for the 1933 and 1934 Acts.”) (citing preambles to Acts). In Carnero v. Boston Scientific Corp., 548 U.S. 906, the U.S. Supreme Court denied certiorari of a First Circuit decision holding that the whistleblower provisions of the Sarbanes-Oxley Act did not have extraterritorial effect. 2. Jurisdictional Issues Relating To Extraterritoriality Due to the ambiguity in federal securities legislation, courts are required to make an independent determination of subject matter and personal jurisdiction. See S.E.C. v. Carrillo, 115 F.3d 1540, 1542 (11th Cir. 1997) (quoting In re Chase & Sanborn Corp., 835 F.2d 1341, 1344 (11th Cir. 1988)) (“It is well established that ‘[t]he due process clause . . . constrains a federal court’s power to acquire personal jurisdiction’ over a nonresident alien.”). a. Subject Matter Jurisdiction

In determining whether to exercise subject matter jurisdiction over an action, U.S. courts have long focused on the policy considerations that led to the extraterritorial application of the laws – protecting or punishing U.S. parties and markets. Interbrew v. Edperbrascan Corp., 23 F. Supp. 2d 425, 429 (S.D.N.Y. 1998). In so doing, courts have developed two tests to determine whether the exercise of jurisdiction is proper – the conduct test and the effects test. Under the “conduct test,” the inquiry in pre-Morrison cases focused on whether a defendant’s alleged conduct in the U.S. was material to fraud committed elsewhere. To the extent that circuit courts adopted the conduct test, they were divided as to how to apply the test. See In re Cable & Wireless, PLC, 321 F. Supp. 2d 749, 75859 (E.D. Va. 2004) (observing the circuit split regarding the extent of domestic conduct that triggers subject matter jurisdiction and noting that the Fourth Circuit had not yet adopted either the conduct or effects test). The most restrictive version of the conduct test was applied by the Second, Fifth, and District of Columbia Circuits. The conduct test was met in these circuits only when the defendant’s allegedly fraudulent conduct in the U.S.: (1) amounts to more than just actions that are “merely preparatory” and (2) is the direct cause of the claimed losses. S.E.C. v. Berger, 322 F.3d 187, 193 (2d Cir. 2003) (holding subject matter jurisdiction existed over New York resident who formed an offshore investing company). See also Europe & Overseas Commodity Traders, S.A. v. Banque Paribas London, 147 F.3d 118 (2d Cir. 1998) (affirming dismissal for lack of subject matter jurisdiction under the conduct test); Robinson v. TCI/U.S. W. Commc’ns, Inc., 117 F.3d 900, 904-905 (5th Cir. 1997); In re Vivendi Universal, S.A., 381 F. Supp. 2d 158, 168 (S.D.N.Y. 2003) (applying “conduct test” and concluding court had subject matter jurisdiction); Zoelsch v. Arthur Andersen & Co., 824 F.2d 27, 33 (D.C. Cir. 1987). In applying the second prong of the conduct test, the court in In re AstraZeneca Sec. Litig., 559 F. Supp. 2d 453 (S.D.N.Y. 2008), aff’d, 33 F. App’x 404 92d Cir 2009), declined to adopt a “global fraudon-the-market” presumption. While the court noted that previous courts had rejected such a presumption because of the belief that it would over-extend the extraterritorial reach of the United States securities laws, the court refused to apply the theory absent guidance from the Second Circuit on the issue. Id. at 466. Applying a less restrictive version of the “conduct test,” the Third Circuit exercised subject matter jurisdiction where there is material and substantial conduct that occurs in the United States in pursuit of the fraudulent scheme, regardless of whether it has a substantial effect on the larger fraud. See S.E.C. v. Kasser, 548 F.2d 109, 114 (3d Cir. 1977); In re Royal Dutch/Shell Transp. Sec. Litig., 380 F. Supp. 2d 509, 543 (D.N.J. 2005) (under the “conduct test,” court held there were significant and material acts relating to the alleged fraud that occurred within the U.S.). The Seventh, Eighth, and Ninth Circuits prior to Morrison employed a middle ground approach to the conduct test. These circuits held, to various degrees, that a court has subject matter jurisdiction when a defendant’s U.S.-based conduct was (1) significant and (2) substantial or material to the larger scheme. Kauthar SDN BHD v. Sternberg, 149 F.3d 659, 666-67 (7th Cir. 1998); Butte Mining PLC v. Smith, 76 F.3d 287 (9th Cir. 1996); Cont’l Grain (Austl.) Pty. Ltd. v. Pac. Oilseeds, Inc., 592 F.2d 409, 420-21 (8th Cir. 1979). Notwithstanding the Fourth Circuit’s silence on this issue, the Eastern District of Virginia adopted the middle ground approach in a 2004 decision. In re Cable & Wireless Sec. Litig., 321 F. Supp. 2d 749, 762-64 (E.D. Va. 2004) (exercising subject matter jurisdiction over foreign purchasers’ claims where defendants’ U.S.-based conduct involved transactions worth hundreds of millions of dollars and served as the basis for defendant’s allegedly material overstatement of its revenues and earnings). Under the “effects test,” courts directed their “attention to the impact of overseas activity on U.S. investors and securities traded on U.S. securities exchanges.” Interbrew v. Edperbrascan Corp., 23 F. Supp. 2d 425, 429 (S.D.N.Y 1998). Although only one of the two tests must be satisfied for a court to properly exercise subject matter jurisdiction, certain courts have analyzed the conduct and effects tests in conjunction with each other. Itoba Ltd. v. Lep Group PLC, 54 F.3d 118, 122 (2d Cir. 1995). “Indeed an admixture or combination of the two often gives a better picture of whether there is sufficient United States involvement to justify the exercise of jurisdiction by an American court.” Nikko Asset Mgmt. Co. v. UBS AG, 303 F. Supp. 2d 456 (S.D.N.Y. 2004) (noting that the effects test and the conduct test provide independent grounds for establishing subject matter jurisdiction, yet dismissing the case because neither test was satisfied). In the face of this variety of approaches, a district court

may choose to examine a number of different tests before reaching a conclusion. See Blechner v. Daimler Benz AG, 410 F. Supp. 2d 366 (D. Del. 2006) (applying a range of different tests before concluding that jurisdiction was not supportable under any of them). In Morrison v. Nat’l Australia Bank, Ltd., the Second Circuit applied the conduct and effects tests to a securities class action in which foreign plaintiffs sued a foreign issuer in the United States for a violation of American securities laws based on securities transactions in foreign countries (a so-called “foreign-cubed” class action). 547 F.3d 167, 175 (2d Cir. 2008). The court affirmed dismissal of the class action, but declined to adopt a bright-line ban on foreign purchaser claims and expressed concern that such a rule would “conflict with the goal of preventing the export of fraud from America.” Id. See also Lapiner v. Camtek, Ltd., No. C-08-1327 MMC, 2009 WL 1542708 (N.D. Cal. June 2, 2009) (dismissing “foreign cubed” securities class action) (slip op.) In In re CP Ships Ltd. Sec. Litig., the Eleventh Circuit distinguished Morrison and affirmed the exercise of subject matter jurisdiction in a case between foreign parties because, although the relevant financial statements were issued abroad, the alleged conduct that took place in the U.S. “represente[d] substantial acts in furtherance of the fraud which directly caused the claimed losses.” 578 F.3d 1306, 1316 (11th Cir. 2009). The Supreme Court affirmed the Second Circuit’s decision in Morrison, but on different grounds. Morrison v. Nat’l. Australia Bank, Ltd., 130 S. Ct. 2869 (2010). Holding that the district court had subject matter jurisdiction, the court nevertheless concluded that dismissal had been proper because the complaint failed to state a claim in light of the fact that the “presumption against extraterritoriality applies in 10b-5 cases. The court rejected the Second Circuit’s “conduct” test and instead adopted a bright-line “transactional” that asks “whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange.” Nothing that courts’ failure to apply the presumption against extraterritoriality in 10b-5 cases had “produced a collection of tests for divining what Congress would have wanted, complex in formulation and unpredictable in application,” the Court rejected the fact-intensive approach required by the “conduct” test as “judicialspeculation-made-law” that risked interfering with other nations’ regulation of transactions on their own securities exchanges. While the Supreme Court’s adoption of a bright-line “transactional” test in Morrison makes clear that “foreigncubed” cases (private actions by foreign purchasers of foreign companies’ securities on foreign exchanges) may not be brought in U.S. courts, as either individual or class actions, it has not ended plaintiffs’ efforts to pose questions that continue to arise in post-Morrison cases. See, e.g., Stackhouse v. Toyota Motor Co., 2010 U.S. Dist. LEXIS 79837 (C.D. Cal. Jul. 16, 2010) (rejecting attempt to escape Morrison in “foreign-squared” case of U.S. purchasers of foreign securities on foreign exchange). A further example of uncertainty in the wake of Morrison is the divergent treatment of ADRs. In In re Alstom SA Sec Litig., 2010 U.S. Dist. LEXIS 98242 (S.D.N.Y. Sept. 14, 2010), the court rejected plaintiff’s claim that stock purchasers on foreign exchanges should be able to sue in the U.S. because ADRs are traded here, but allowed claims to proceed on behalf of purchasers of the ADRs in the U.S. In contrast, the court in In re Société Générale Sec. Litig., 2010 U.S. Dist. LEXIS 107719 (S.D.N.Y. Sept. 29, 2010), held that Morrison precluded claims by purchasers of ADRs in the U.S. because “trade in ADRs is considered to be a predominantly foreign securities transaction.” Id. at 19. b. Jurisdiction To satisfy the due process requirements of the Fifth Amendment, every defendant must have sufficient “minimum contacts” with the U.S. for the court of the forum state to exercise personal jurisdiction. Exercise of personal jurisdiction comports with due process if “(1) the nonresident defendant has purposefully established minimum contacts with the forum . . . and (2) the exercise of jurisdiction will not offend traditional notions of fair play and substantial justice.” Carrillo, 115 F.3d at 1542 (analyzing personal jurisdiction in the context of the extraterritorial reach of the federal securities laws) (quoting Francosteel Corp. v. M/V Charm, 19 F.3d 624,

627 (11th Cir. 1994)). See also Pinker v. Roche Holdings Ltd., 292 F.3d 361, 369 (3d Cir. 2002); S.E.C. v. Knowles, 87 F.3d 413, 416 (10th Cir. 1996). While the “minimum contacts” test is framed in the plural, a multiplicity of contacts are not required to establish personal jurisdiction. Knowles, 87 F.3d at 419 (“Even a single purposeful contact may be sufficient to meet the minimum contacts standard when [the] underlying proceeding is directly related to that contact.”).

1) Jurisdiction Over Entities To determine if a court has personal jurisdiction over a foreign entity within the securities context, courts consider a number of factors. Typically, courts consider whether the defendant entity transacts business within the U.S., acts wrongfully in the U.S. within the context of the allegations, or purposefully avails itself of U.S. commerce while directly and foreseeably causing injury within the U.S. based on wrongs committed outside U.S. borders. See S.E.C. v. Unifund SAL, 910 F.2d 1028, 1033 (2d Cir. 1990) (noting that due process permits “exercise of jurisdiction over a defendant whose ‘conduct and connection with the forum State are such that he should reasonably anticipate being haled into court there.’ … One circumstance making such anticipation reasonable is where defendant has acted in such a way as to have ‘caused consequences’ in a forum state”); Bersch v. Drexel Firestone, Inc., 519 F.2d 974, 998-99 (2d Cir. 1990) (noting that the Second Circuit considers whether the defendant is: (1) doing business in the forum; (2) doing an act in the forum; or (3) causing an effect in the forum from an act originating outside the forum); Europe & Overseas Commodity Traders, S.A. v. Banque Paribas London, 940 F. Supp. 528 (S.D.N.Y. 1996), aff’d, 147 F.3d 118 (2d Cir. 1998). Courts also consider whether the entity is registered to do business in the United States, maintains an office, bank account, property, or personnel within the United States, or advertises within the United States. See, e.g., Pinker, 292 F.3d at 369 (“Just as solicitation of business in the forum state is generally sufficient to establish personal jurisdiction over the defendant for claims arising out of injuries to purchasers within the forum state . . . so too is personal jurisdiction appropriate where a foreign corporation has directly solicited investment from the American market.”) (internal citations omitted); Bersch, 519 F.2d at 998-99 (finding that a firm’s discontinued office, sporadic visits to investment houses in New York, trading securities on Canadian Exchanges for Americans and arranging, through American brokers, for Canadians to trade on American exchanges did not amount to “doing business” within the United States because “if it were, every securities dealer of any significant size anywhere in the world would be ‘doing business’ here”); Carrillo, 115 F.3d at 1540 (“It is well settled that advertising that is reasonably calculated to reach the forum may constitute purposeful availment of the privileges of doing business in the forum.”). A foreign entity will not be subject to personal jurisdiction simply because it possesses an American subsidiary. Fed. Deposit Ins. Corp. v. Milken, 781 F. Supp. 226, 231 (S.D.N.Y. 1991) (concluding that parent-subsidiary relationship itself did not create personal jurisdiction over foreign parent corporation in the absence of any indication that the subsidiary was the alter ego or mere agent of the defendant).

2) Jurisdiction Over Individuals A U.S. court’s jurisdiction over a foreign corporation does not necessarily confer jurisdiction over the foreign corporation’s officers and directors. Rather, jurisdiction over each employee must be assessed individually. See Calder v. Jones, 465 U.S. 783, 790 (1984); Keeton v. Hustler Magazine, Inc., 465 U.S. 770, 781 n.13 (1984). Individual defendants are better positioned to contest personal jurisdiction if they: (1) did not prepare, sign, or issue the challenged public disclosure; (2) did not sign the issuer’s filings with the SEC; and (3) did not act as a corporate spokesperson. See In re CINAR Corp. Sec. Litig., 186 F. Supp. 2d 279, 305 (E.D.N.Y. 2002) (finding personal jurisdiction solely on vice-president general counsel’s signing of fraudulent registration statement, since, as general counsel, she must have known that the statement would be used and relied on by U.S. investors).

If a court possesses personal jurisdiction over a foreign entity, it may find jurisdiction over an individual participating in the actions which formed the basis of jurisdiction over the entity. See, e.g., Carrillo, 115 F.3d at 1547-48 (“By virtue of [the Costa Rican defendants’] control over [the Costa Rican corporation] and their admitted involvement in the alleged contacts with the United States, we find it appropriate to apply essentially the same minimum contacts analysis to them as to [the Costa Rican corporation] itself.”); Knowles, 87 F.3d at 418 (“As the Supreme Court held in Calder v. Jones, employees of a corporation that is subject to personal jurisdiction of the courts of the forum may themselves be subject to jurisdiction if those employees were primary participants in the activities forming the basis of jurisdiction over the corporation.”). An officer or director residing outside the United States may be subject to a federal court’s personal jurisdiction when participating in the alleged fraud through conduct directed at the United States while acting in an official capacity. See Calder, 465 U.S. at 790 (writing an article directed at California residents with knowledge of its potentially devastating impact makes defendants primary participants in wrongdoing and thus subject to personal jurisdiction); UI, 115 F.3d at 1547-48. However, a defendant’s control person status over a corporation violating the securities laws cannot be the sole basis for personal jurisdiction. See In re Baan Co. Sec. Litig., 81 F. Supp. 2d 75, 79-82 (D.D.C. 2000) (holding that, because minimum contacts were lacking and alter ego was not shown, the corporation’s domestic contacts could not be automatically imputed to a related company that owned a significant share of the corporation nor to the corporation’s director-president. Cf. McNamara v. Bre-X Minerals Ltd., 46 F. Supp. 2d 628 (E.D. Tex. 1999) (finding personal jurisdiction where investors made a prima facie showing of corporation’s CEO’s ability to control corporation’s general operations and directly exercise control over corporate activities). U.S. courts have also found personal jurisdiction in cases involving insider trading. See S.E.C. v. Unifund SAL, 910 F.2d 1028, 1033 (2d Cir. 1990) (upholding personal jurisdiction over foreign investors alleged to have conducted insider trading in the purchase of U.S. Securities traded on a U.S. exchange because “[i]nsider trading . . . has serious effects that can reasonably be expected to be visited upon United States shareholders where, as here, the securities are those of a United States company traded exclusively on a United States exchange”); S.E.C. v. Euro Sec. Fund, No. 98 CIV. 7347 (DLC), 1999 WL 76801, at *1-3 (S.D.N.Y. Feb. 17, 1999) (finding personal jurisdiction over an Italian national domiciled in Switzerland and a president of an investment entity located in Switzerland for purchasing $6 million worth of a Netherlands corporation’s securities registered under the Exchange Act and traded exclusively on the New York Stock Exchange in a one month period while in possession of material nonpublic information). But see S.E.C. v. Alexander, 160 F. Supp. 2d 642, 655-57 (S.D.N.Y. 2001) (finding lack of personal jurisdiction against an Italian resident who sold shares of an Italian corporation through an Italian bank while unaware that the shares would be sold through the sale of ADRs listed on the New York Stock Exchange).

II. OVERVIEW OF SECURITIES CLASS ACTIONS From rigorous motion practice to lengthy discovery, “committees” of aggressive plaintiffs to sky-high settlements, securities class actions are a complex and daunting creature all their own. They demand that securities litigators take the broadest of world views, attuning themselves to procedural and business concerns that are not usually thought to be part of litigation. They require the securities litigator to also be a consultant, a disclosure expert and, at times, a wizard of negotiation, all the while staying focused on a nuanced area of the law that is constantly in flux. To help provide some perspective on the complexities surrounding securities class action, the following section addresses big picture considerations and other practical issues before then turning to the substantive elements of securities claims in Section III. A. Consolidating Multiple Complaints And Actions In securities class actions, plaintiffs will typically file multiple identical or virtually identical complaints, sometimes in different jurisdictions. Until these actions are consolidated, the lead plaintiff and lead counsel appointments cannot be made. Sections 27(a)(3)(B)(ii) of the Securities Act and 21D(a)(3)(B)(ii) of the Securities Exchange Act, as amended by the Private Securities Litigation Reform Act of 1995 (“the Reform Act” or “the PSLRA” ), provide that “if more than one action on behalf of a class asserting substantially the same claim or claims arising under this chapter has been filed, and any party has sought to consolidate those actions for pretrial purposes or for trial, the court shall not” appoint the lead plaintiff “until after the decision on the motion to consolidate is rendered.” See also Takeda v. Turbodyne Techs., Inc., 67 F. Supp. 2d 1129, 1133 (N.D. Cal. 1999). Consolidation in a single federal district court is proper “[i]f actions before the court involve a common question of law or fact.” Fed. R. Civ. P. 42(a). “In securities actions where the complaints are based on the same ‘public statements and reports’ consolidation is appropriate if there are common questions of law and fact and the defendants will not be prejudiced.” Mitchell v. Complete Mgmt., Inc., No. 99 CIV. 1454 (DAB), 1999 WL 728678, at *1 (S.D.N.Y. Sept. 17, 1999) (citations omitted). Pending suits need not be identical in order to be consolidated. A.F.I.K. Holding SPRL v. Fass, 216 F.R.D. 567, 570 (D.N.J. 2003). “[I]n deciding whether to consolidate, . . . the court must balance the risk of prejudice and possible confusion against the risk of inconsistent adjudications of common factual and legal issues, the burden on the parties and witnesses, the length of time required to conclude multiple lawsuits as against a single one, and the relative expense to all concerned of the single-trial and multiple-trial alternatives.” Id. Courts have held that a motion for consolidation will not be denied simply on the basis that the actions to be consolidated allege claims against different parties. See, e.g., Werner v. Satterlee, Stephens, Burke & Burke, 797 F. Supp. 1196, 1211 (S.D.N.Y. 1992). Courts have also held that differences in alleged class periods will not bar consolidation. See Takeda, 67 F. Supp. 2d at 1133; Constance Sczesny Trust v. KPMG, 223 F.R.D. 319, 322 (S.D.N.Y. 2004) (“Although some variations exist in the parameters of the alleged class periods, such ‘minor differences’ are insufficient to preclude consolidation.”). Consolidation typically occurs by motion of one or more parties or by stipulation of all the parties. This process is not controversial, as all parties typically benefit from streamlining the litigation. The cases are usually consolidated under the first-filed case and assigned to that judge. After each individual class action is

filed, defendant’s counsel usually requests the consent of plaintiff’s counsel to delay filing the response to the complaint until after the various actions are consolidated. If the delay is not agreed upon, an answer to the complaint is required within 21 days of service of the complaint. Fed. R. Civ. P. 12(a)(1)(A)(i) (effective Dec. 1, 2009). While no longer an indicator of which plaintiff will control the litigation, the first-filed case often determines the judge who will hear the consolidated matter and also appoint the lead plaintiff and lead counsel. The consolidation order typically provides that later-filed actions will automatically be consolidated and re-assigned to the same judge. Plaintiffs will typically be allowed 60-90 days to file a consolidated amended complaint. Counsel will often use this time to conduct additional fact investigation in an attempt to strengthen the allegations of fraud in order to defeat a challenge to the pleadings. Defendants are well-served during this time period to conduct their own factual investigation to determine how best to defend against the claims anticipated in the consolidated amended complaint. Once the consolidated amended complaint is filed, a response by the defendant is required within 21 days unless a longer time period is agreed to by the parties. The district courts have “broad discretion” in determining the propriety of consolidation, “although they generally espouse the view that ‘considerations of judicial economy favor consolidation.’” Bassin v. deCODE Genetics, Inc., 230 F.R.D. 313, 314 (S.D.N.Y. 2005) (citations omitted). B. Selection Of Lead Plaintiff And Lead Class Counsel Under the Reform Act, where multiple plaintiffs have filed suits against the same defendants the court is required to appoint the “most adequate plaintiff” as lead plaintiff for the consolidated actions. 15 U.S.C. § 77z-1(a)(3)(B)(i); 15 U.S.C. § 78u-4(a)(3)(B)(i). The Reform Act changed the standards and procedures for selecting the lead plaintiff in securities class actions in order to eliminate abuses involving the use of “professional plaintiffs” and the race to the courthouse to file the complaint. 1. Court Appointment Of Lead Plaintiff Prior to the enactment of the Reform Act, courts generally selected the first plaintiff to file suit as lead plaintiff. See H.R. Conf. Rep. No. 104-369, at 33 (1995). The Reform Act sought to eliminate that practice by directing the court to “appoint as lead plaintiff the member or members of the purported plaintiff class that the court determines to be most capable of adequately representing the interests of class members.” Id. at 3, 9. In addition, the Reform Act requires that the plaintiff in the first-filed action publish a notice advising of the pendency of the action so that any member of the proposed class can come forward and move to be appointed lead plaintiff. See 15 U.S.C. § 77z-1(a)(3)(A)(i)(II); 15 U.S.C. 78u-4(a)(3)(A)(i)(II). See also Janovici v. DVI, Inc., No. CIV. A. 2:03CV04795-LD, 2003 WL 22849604, at *4-5 (E.D. Pa. Nov. 25, 2003) (holding that lead plaintiff should be appointed as soon as practicable after resolution of any motions to consolidate; also ruling that parties may file to be lead plaintiff within sixty days of the time of the effective notice). Under the Reform Act, the notice should allow a potential class member to (1) determine whether she is eligible for lead plaintiff status based on the class period; (2) learn enough about the asserted claims to make an initial judgment as to whether to obtain a copy of the Complaint; and (3) contact the clerk’s office to obtain a copy of the Complaint and discover the procedures for filing the motion. The reader should be able to achieve these objectives independently, without being forced to contact noticing plaintiff’s counsel for additional information. Id. at *5. See also Marsden v. Select Med. Corp., No. CIV. A. 04-4020, 2005 WL 113128, at *3 (E.D. Pa. Jan. 18, 2005). The content of the published notice may be inadequate, moreover, if it fails to specify the bases for the relief sought. See In re White Elec. Designs Corp. Sec. Litig., 416 F. Supp. 2d 754, 775 (2006) (holding that plaintiffs lacked standing to pursue Securities Act claims because the required PSLRA notice did not mention Securities Act claims or the bases for them). a. Presumption Of Most Adequate Plaintiff

In a case where more than one complaint has been filed or a putative class member moves for appointment as lead plaintiff, the Reform Act further provides that the court “shall adopt a presumption that the most adequate plaintiff” is that person or group of persons possessing the largest financial interest in the relief sought who otherwise satisfies the requirements of Fed. R. Civ. P. Rule 23. 15 U.S.C. § 77z-1(a)(3)(B)(iii)(I); 15 U.S.C. § 78u-4(a)(3)(B)(iii)(I). The Ninth Circuit has laid out a three-step process for identifying the lead plaintiff: (1) verification of proper notice posting; (2) the presumptive lead plaintiff is the one who has the largest financial interest; and (3) provision to the other plaintiffs of an opportunity to rebut the presumptive lead plaintiff on typicality and adequacy grounds. In re Cavanaugh, 306 F.3d 726, 729-30 (9th Cir. 2002). b. Rebutting The Presumption The presumption may be rebutted by proof that the presumptively most adequate plaintiff: 1. will not fairly and adequately protect the interests of the class; or 2. is subject to unique defenses that render such plaintiff incapable of adequately representing the class. 15 U.S.C. § 77z-1(a)(3)(B)(iii)(II); 15 U.S.C. § 78u-4(a)(3)(B)(iii)(II). See In re Vonage IPO Sec. Litig., No. CIV A 07-177 FLW, 2007 WL 2683636, at *9-11 (D.N.J. Sept. 7, 2007) (finding the presumptively most adequate plaintiff inadequate because of a lack of familiarity with the litigation and because he “failed to demonstrate the willingness and ability to select competent class counsel;” by contrast the group with the second-greatest losses also had a significant stake in the litigation, had executed a reasonable retainer agreement with counsel and otherwise showed adequacy under Rule 23). See also Levitt v. Rogers, 257 F. App’x 450 (2d Cir. 2007) (remanding for determination of the appropriate lead plaintiff following the restatement of one defendant and the settlement of certain claims against other defendants, which resulted in the current lead plaintiff not having the largest financial interest in the outcome of the remaining claims). Note, however, that this presumption is not rebutted simply because the plaintiff is unable to assert all of the claims brought by the class. That is, under the PSLRA, the selection of lead plaintiff is premised on the loss suffered, “not on the most adequate complaint filed.” In re WorldCom, Inc. Sec. Litig., 219 F.R.D. 267, 286 (S.D.N.Y. 2003) (emphasis in original). Thus, although a lead plaintiff may be unable to personally assert every claim made by the class, provided he can establish the largest financial stake in the litigation (and can show that at least some class representatives are able to bring each of the claims), the presumption stands. Id. See also In re Nat’l Golf Props. Inc., No. CV 02-1383 GHK (RZX), 2003 WL 23018761 (C.D. Cal. Mar. 19, 2003) (concluding that presumption for the lead plaintiff survived despite his lack of standing to assert a Section 11 claim brought by other members of the class). Moreover, a court is under no obligation to accept a proposed lead plaintiff solely because the appointment is unopposed by other members of the putative class. Clair v. DeLuca, 232 F.R.D. 219 (W.D. Pa. 2005). See also Cordova v. Lehman Bros., Inc., 237 F.R.D. 471 (S.D. Fla. 2006) (rejecting last-minute attempt to substitute new lead plaintiff); In re Flight Safety Techs., 231 F.R.D. 124 (D. Conn. 2005) (ignoring plaintiffs’ stipulation in appointment of lead plaintiff). Finally, where the original lead plaintiff is determined to lack standing after the PSLRA lead plaintiff selection process is complete, the court may allow the plaintiffs to substitute a new lead plaintiff during the pleading stage. In re Impax Labs. Inc. Sec. Litig., No. C 04-04802 JW, 2008 WL 1766943, at *8 (N.D. Cal. April 17, 2008). c. Single Largest Loss Courts have typically appointed the single investor with the greatest individual loss who otherwise satisfied the statutory criteria. See, e.g., Wenderhold v. Cylink Corp., 188 F.R.D. 577, 586-87 (N.D. Cal. 1999) (rejecting lead plaintiff application from aggregation of investors in favor of single investor with greatest individual losses); Sakhrani v. Brightpoint, Inc., 78 F. Supp. 2d 845, 850-54 (S.D. Ind. 1999) (appointing as lead plaintiff the single investor with the largest losses where no institutional investors sought lead plaintiff status); Janovici, 2003 WL 22849604, at *4 (recognizing the rebuttable presumption that the most adequate plaintiff has the

largest financial interest in the litigation); In re Copper Mountain Sec. Litig., 305 F. Supp. 2d 1124, 1129-30 (N.D. Cal. 2004) (holding that the presumptive lead plaintiff was the investor with the greatest financial stake in the case). But see Sofran v. LaBranche & Co., 220 F.R.D. 398, 402 (S.D.N.Y. 2004) (appointing as lead plaintiff the investor group with the largest financial loss while fulfilling the remaining statutory requirements of typicality and adequacy); In re Enron Corp. Sec. Litig., 206 F.R.D. 427, 455-59 (S.D. Tex. 2002) (rejecting the plaintiff with the largest financial loss for the most adequate plaintiff); In re Gemstar-TV Guide Int’l, Inc. Sec. Litig., 209 F.R.D. 447 (C.D. Cal. 2002) (same). Cf. In re Bausch & Lomb Inc. Sec. Litig., 244 F.R.D. 169, 173-74 (W.D.N.Y. 2007) (considering debt securities in evaluating potential plaintiffs’ largest financial interest and concluding that a “net seller” and “net gainer” is an inadequate lead plaintiff). In Mayo v. Apropos Tech., Inc., No. 01 C 8406, 2002 WL 193393, at *3 (N.D. Ill. Feb. 7, 2002), the court listed a four-factor test, first promulgated in Lax v. First Merchants Acceptance Corp., No. 97 CIV. 2715, 1997 WL 461036 (N.D. Ill. Aug. 11, 1997), to determine who has the largest loss. Per Mayo, the court should inquire as to “(1) the number of shares purchased; (2) the number of net shares purchased; (3) the total net funds expended by the plaintiffs during the class period; and (4) the approximate losses suffered by the plaintiffs.” Id. See also In re Milestone Scientific Sec. Litig., 183 F.R.D. 404, 413 (D.N.J. 1998) (same four factor test); Pirelli Armstrong Tire Corp. v. LaBranche & Co., 229 F.R.D. 395 (S.D.N.Y. 2004) (describing four-factor “Lax test”). d. Multiple Lead Plaintiffs Or Aggregation Of Numerous Plaintiffs The Reform Act’s use of the singular term “plaintiff” does not preclude courts from appointing multiple persons to act as lead plaintiff. See Friedman v. Quest Energy Partners LP, 261 F.R.D. 607, 615 (W.D. Okla. 2009) (appointing two lead plaintiffs due to conflict between subclasses); In re Able Labs. Sec. Litig., 425 F. Supp. 2d 562 (D.N.J. 2006) (permitting city employee retirement plan and foreign company to combine to form an international investors group and appointing them as lead plaintiff); Rozenboom v. Van Der Moolen Holding, No. 03 CIV. 8284 (RWS), 2004 WL 816440, at *5 (S.D.N.Y. Apr. 14, 2004) (allowing the appointment of two co-lead plaintiffs in order to ensure the stability and control of the litigation); Ferrari v. Gisch, 225 F.R.D. 599, 608 (C.D. Cal. 2004) (allowing a group of persons to serve as lead plaintiff so long as “the proposed plaintiff group can effectively manage the litigation and direct lead counsel”); In re Oxford Health Plans, Inc., Sec. Litig., 182 F.R.D. 42 (S.D.N.Y. 1998) (appointing three entities as co-lead plaintiffs, each with one vote over control of the litigation); In re Advanced Tissue Scis. Sec. Litig., 184 F.R.D. 346, 352-53 (S.D. Cal. 1998) (designating six members of a group as co-lead plaintiffs out of a proposed unrelated group of 250; finding that appointment of large amalgamations of unrelated persons as lead plaintiffs is contrary to the Reform Act and potentially threatening to the interests of the class); In re Cephalon Sec. Litig., No. CIV. A. 96-CV-0633, 1996 WL 515203 (E.D. Pa. Aug. 27, 1996) (appointing three plaintiffs as lead plaintiff); Greebel v. FTP Software, Inc., 939 F. Supp. 57 (D. Mass. 1996) (same). See also In re NYSE Specialists Sec. Litig., 240 F.R.D 128 (S.D.N.Y. 2007) (holding, where co-lead plaintiffs have been appointed to adequately represent the interests of the class and one plaintiff is thereafter removed, the court need not appoint a replacement co-lead plaintiff if such an appointment would be disruptive and the remaining lead plaintiff is capable of prosecuting the action by itself). Consolidation of multiple plaintiffs’ claims may be improper where there is a conflict of interest amongst the plaintiffs as to some of the claims. See Horizon Asset Mgmt. Inc. v. H&R Block, Inc., 580 F.3d 755, 768-69 (8th Cir. 2009) (holding that the district court abused its discretion in appointing sole lead plaintiff where it was clear that the appointed plaintiff would not pursue derivative claims asserted by other plaintiffs). Other courts have rejected the option of appointing co-lead plaintiffs. See, e.g., In re Milestone Scientific Sec. Litig., 183 F.R.D. 404, 417-18 (D.N.J. 1998); Gluck v. CellStar Corp., 976 F. Supp. 542, 549-50 (N.D. Tex. 1997). Where the appointment of multiple “lead plaintiffs” or “lead counsel” threatens investor control of the litigation, courts have refused to appoint multiple lead plaintiffs in favor of a single qualified plaintiff. Id. at 549; Tanne v. Autobytel, Inc., 226 F.R.D. 659, 672 (C.D. Cal. 2005) (reasoning that the co-lead plaintiff structure is unnecessary, and might harm the class by dividing responsibility for the supervision of class counsel); In re Enron Corp. Sec. Litig., 206 F.R.D. 427, 451 (S.D. Tex. 2002) (rejecting the theory of multiple plaintiffs because “the litigation should proceed as a unified class with [one] strong Lead Plaintiff”); In re Baan

Co. Sec. Litig., 186 F.R.D. 214, 217 (D.D.C. 1999) (allowing a twenty-member subgroup of the 466 investor plaintiffs to act as “lead plaintiff” and espousing the view that “where unrelated investors are to be lead plaintiff, a triumvirate is preferable”); In re Donnkenny Inc. Sec. Litig., 171 F.R.D. 156, 157-58 (S.D.N.Y. 1997) (hoping that one lead plaintiff would seek out the lawyers, rather than having lawyers seek multiple plaintiffs to increase the financial stake and take control of the litigation). See also Cohen v. Dist. Court, 586 F.3d 703, 711 n.4 (9th Cir. 2009) (in dicta, calling into doubt the practice of appointing “co-lead plaintiffs”). Some courts have interpreted the Reform Act to permit the appointment of a group of unrelated persons to act as lead plaintiff. See, e.g., In re Nature’s Sunshine Prods., Inc. Sec. Litig., No. 2:06-CV-267 TS, 2006 WL 2380965 (D. Utah Aug. 16, 2006) (concluding aggregation was appropriate on the facts of the case); In re XM Satellite Radio Holdings Sec. Litig., 237 F.R.D. 13 (D.D.C. 2006); In re Star Gas Sec. Litig., No. 3:04CV1766, 2005 WL 818617, at *5 (D. Conn. Apr. 8, 2005) (allowing a group of unrelated investors to serve as lead plaintiffs when it would be most beneficial to the class under the circumstances of a given case); Ferrari v. Gisch, 225 F.R.D. 599, 608 (C.D. Cal. 2004) (“[The Reform Act] expressly authorizes the appointment of a ‘group’ of persons to serve as Lead Plaintiffs.”); Funke v. Life Fin. Corp., No. 99 CIV. 11877 (CBM), 2003 WL 194204, at *5 (S.D.N.Y. Jan. 28, 2003) (“[Group] is not too large a group to convene for the purpose of reaching a decision and directing litigation.”); In re Ride, Inc., Sec. Litig., No. C 97-402 WD, 1997 WL 33628677, at *1 (W.D. Wash. Aug. 5, 1997) (“On its face this language calls for aggregation. Any suggestion to the contrary, based on legislative history, cannot prevail against the statute’s plain wording.”). Cf. In re eSpeed, Inc. Sec. Litig., 232 F.R.D. 95 (S.D.N.Y. 2005) (where aggregation would not displace an institutional investor as presumptive lead plaintiff, a small group of unrelated investors may serve as lead plaintiff). However, a number of courts have rejected lead plaintiff applications from large, lawyer-solicited aggregations of shareholders under the rationale that one of the primary purposes of the Reform Act was to eradicate “lawyer-driven” securities fraud litigation. See, e.g., In re Pfizer Inc. Sec. Litig., 233 F.R.D. 334, 337 (S.D.N.Y. 2005) (rejecting a proposed group of investors as lead plaintiff because they had been artificially grouped by their counsel in an attempt to create the “highest possible” financial interest figure under the PSLRA); In re Bally Total Fitness Sec. Litig., No. 04C3530, 2005 WL 627960, at *3 (N.D. Ill. Mar. 15, 2005) (rejecting group of investors “who have nothing in common with one another beyond their investment”); Bowman v. Legato Sys., Inc., 195 F.R.D. 655, 658 (N.D. Cal. 2000) (“[G]iven the Court’s conclusion that the Legato Group was solicited and created by the Milberg firm solely for the purpose of obtaining appointment as lead plaintiff – and thus allowing the Milberg firm to obtain appointment as lead plaintiff’s counsel – the Court remains convinced that the Legato Group is not within the definition of ‘group’ as that word is used in the Reform Act.”); Sakhrani v. Brightpoint, Inc., 78 F. Supp. 2d 845, 853 (S.D. Ind. 1999) (rejecting group of 118 individuals and businesses whose only connection was losing their investments); In re Donnkenny Inc. Sec. Litig., 171 F.R.D. 156, 157 (S.D.N.Y. 1997) (“To allow an aggregation of unrelated plaintiffs to serve as lead plaintiffs defeats the purpose of choosing a lead plaintiff.”); In re Gemstar-TV Guide Int’l., 209 F.R.D. at 451 (rejecting an unrelated group of three institutional investors and four individuals brought together “for the sole purpose of aggregating their claims in an effort to become the presumptive lead plaintiff”). See also Miller v. Ventro Corp., No. 01-CV-1287, 2001 WL 34497752, at *7-8 (N.D. Cal. Nov. 28, 2001) (taking the approach that the aggregation of a group of plaintiffs with no pre-litigation relationship is not dispositively allowed or disallowed, and opting for the application of a third option “that finds no single factor dispositive, but requires the group to justify and explain its composition and structure in terms of adequacy to represent the class”). In order to prevent “lawyer driven” litigation, some courts have adopted a “rule of reason” test in which the acceptability of the proposed group is tested against its ability to represent the interests of the class. The group is then allowed to proceed as a group only if the court determines that “lawyer driven” litigation is not likely to result. See, e.g., Barnet v. Elan Corp., 05 CIV. 2860 (RJH), 2005 WL 1902855 (S.D.N.Y. Aug. 8, 2005); In re Baan Co. Sec. Litig., 186 F.R.D. 214, 218-35 (D.D.C. 1999); Chill v. Green Tree Fin. Corp., 181 F.R.D. 398 (D. Minn. 1998). In making this determination, courts have considered several factors, including: (1) the size of the class, (2) any evidence that the group was formed in bad faith, and (3) the relationship between parties. In re Cendant Corp. Litig., 264 F.3d 201, 266-67 (3d Cir. 2001). See also Barnet, 2005 WL 1902855, at *4; Iron Workers Local No. 25 Pension Fund v. Credit-Based Asset Servicing and Securitization, LLC, 616 F. Supp. 2d 461, 464 (S.D.N.Y. 2009) (rejecting as lead plaintiff a pension fund which rewarded its counsel for uncovering

fraud in its investments by retaining him to prosecute the fraud on its behalf; the court noted that this gave counsel a “clear incentive” to discover “fraud” in the investments). e. Institutional Investors Immediately following passage of the Reform Act, non-institutional investors continued to dominate as lead plaintiffs in post-Reform Act cases. See P. Saparoff et al., “The Role of the Institutional Investors Class Actions Under the PSLRA-Are They Walking on a Slippery Slope? One Year Later,” Securities Reform Act Litigation Reporter, Vol. 5 No. 3 (June 1998) (“Of the 105 cases filed during the first year after the enactment of the PSLRA, institutional investors appear to have moved to become lead plaintiffs in only eight cases. Not surprisingly, institutional investors have identified the costs associated with fighting off other plaintiffs during the lead plaintiff appointment process as a substantial disincentive for seeking such an appointment.”). This has changed in the post-Enron environment. Now, institutional investors have shown increasing willingness and desire to serve as lead plaintiffs, even where they did not suffer the largest loss during the class period. See In re Enron Corp. Sec. Litig., 206 F.R.D. 427 (S.D. Tex. 2002). In Malasky v. IAC/Interactivecorp, 04 Civ. 7447 (RJH), 2004 U.S. Dist. LEXIS 25832, at *9-14 (S.D.N.Y. Dec. 20, 2004), the court appointed an institutional investor as a co-plaintiff, because the institutional investor did not appear to have the largest financial loss. The court reasoned that the co-plaintiffs could “pool financial resources, knowledge and experiences,” and could also reap the “benefits of joint decision-making” when pressed with difficult choices that may arise.” Id. at *13-14 (quoting In re Oxford Health Plans, Inc. Sec. Litig., 182 F.R.D. 42, 45 (S.D.N.Y. 1998)). Today, institutional investors are dominant in the lead plaintiff role, particularly in cases alleging large losses, and have become the favorite business development target of the major plaintiff’s class action firms. f. Investment Advisors Because investment advisors lack a proprietary interest in their clients’ funds, they generally lack standing to serve as lead plaintiff unless the client has assigned its claims to the investment advisor. In W.R. Huff Asset Mgmt. v. Deloitte & Touche LLP, 549 F.3d 100, 107 (2d Cir. 2008), the Second Circuit held that an investment advisor did not have standing to serve as lead plaintiff because it had not obtained legal title to its clients’ claims. The court expressly declined to decide whether an investment advisor could ever have standing to serve as lead plaintiff, but it emphasized that the named plaintiff in a class action “must allege and show that they personally have been injured.” Id. at 106 n.5. See also In re Herley Indus. Inc. Sec. Litig., No. 06-2596, 2009 WL 3169888 at *8-9 (E.D. Pa. Sept. 30, 2009) (investment advisor did not have standing until client validly assigned its claims); In re SLM Corp. Sec. Litig., 258 F.R.D. 112 (S.D.N.Y. 2009) (investment advisor did not have standing). Cf. In re Bard Assocs., Inc., No. 09-6243, 2009 WL 4350780, at *2 (10th Cir. 1009) (district court did not err in finding that assignment of claim after inception of lawsuit was insufficient to give institutional investor standing). g. Discovery Related To Purported Most Adequate Plaintiff A competing plaintiff may conduct discovery regarding the adequacy of a class plaintiff by initially demonstrating a reasonable basis for a finding that the presumptively most adequate plaintiff will inadequately represent the class. 15 U.S.C. § 77z-1(a)(3)(B)(iv); 15 U.S.C. § 78u-4(a)(3)(B)(iv). h. Restrictions On Professional Plaintiffs Under the Reform Act, no party may serve as lead plaintiff, or as an officer, director, or fiduciary of a lead plaintiff, in more than 5 class actions during any 3-year period, “[e]xcept as the court may otherwise permit, consistent with the purposes of this section.” 15 U.S.C. § 77z-1(a)(3)(B)(vi); 15 U.S.C. § 78u-4(a)(3)(B)(vi).

See also In re Enron Corp. Sec. Litig., 206 F.R.D. 427, 456-57 (S.D. Tex. 2002) (denying motion to be appointed lead plaintiff by institutional investor who had been lead plaintiff in nine other securities fraud class actions in five prior years). Many courts, however, find that “experienced” lead plaintiffs, particularly institutional plaintiffs with interest in pursuing class litigation, may benefit the class, even if there are concerns over the number of prior lead plaintiff positions. See, e.g., In re Cree, Inc. Sec. Litig., 219 F.R.D. 369 (M.D.N.C. 2003) (granting motion for appointment of lead plaintiff despite “concern” regarding movant’s involvement in 14 other pending securities cases). i. Filing Requirements The Reform Act also requires that each plaintiff seeking to serve as a lead plaintiff file a sworn certificate with his or her complaint that, in pertinent part: (1) sets forth all of the transactions of the plaintiff in the security that is the subject of the complaint during the class period specified in the complaint; and (2) identifies any other action under the Securities Act or the Exchange Act in which the plaintiff has sought to serve or served as a class representative during the three years preceding the date of the certification. 15 U.S.C. § 77z-1(a)(2)(A) (iv-v); 15 U.S.C. § 78u-4(a)(2)(A) (iv-v). 2. Selection Of Lead Class Counsel The Reform Act provides that, “[t]he most adequate plaintiff shall, subject to the approval of the court, select and retain counsel to represent the class.” 15 U.S.C. § 77z-1(a)(3)(B)(v); 15 U.S.C. § 78u-4(a)(3)(B)(v). Courts have interpreted the Reform Act to allow various procedures for the selection of lead counsel, including sealed bid auction (see, e.g., In re Bank One Shareholders Class Actions, 96 F. Supp. 2d 780, 784-85 (N.D. Ill. 2000), and Wenderhold v. Cylink Corp., 188 F.R.D. 577, 586-87 (N.D. Cal. 1999)); competitive bidding (see, e.g., In re Lucent Techs. Inc. Sec. Litig., 194 F.R.D. 137, 156 (D.N.J. 2000), and In re Network Assocs., Inc. Sec. Litig., 76 F. Supp. 2d 1017 (N.D. Cal. 1999)); and selection by lead plaintiff with some court oversight (see, e.g., Sakhrani v. Brightpoint, Inc., 78 F. Supp. 2d 845 (S.D. Ind. 1999)). The SEC has suggested that parties seeking lead plaintiff status should address the following five questions: a. What procedures did the lead plaintiff follow to identify a reasonable number of counsel with the skill and ability necessary to represent the class in the pending matter? b. What procedures did the lead plaintiff follow in inviting competent counsel to compete for the right to represent the class? c. What procedures did lead plaintiff follow to negotiate a fee and expense reimbursement arrangement that promotes the best interests of the class? d. On what basis can lead plaintiff reasonably conclude that it has canvassed and actively negotiated with a sufficient number of counsel and obtained the most qualified representation at the lowest cost? e. Did the lead plaintiff make inquiries into the full set of relationships between the proposed lead counsel, and the lead plaintiff and other members of the class, and did the lead plaintiff reasonably conclude either that there are no such relationships or that they do not affect the exercise of plaintiffs’ fiduciary obligations to the class? Brief of the S.E.C. as Amicus Curiae In Support of Appellants on the Issues Presented at 11-12, In re Cendant Corp. Litig., 264 F.3d 201 (3d Cir. 2001), noted in Craig v. Sears Roebuck & Co., 253 F. Supp. 2d 1046, 1049 (N.D. Ill. 2003). The lead plaintiff selection process has engendered some interesting rulings in district courts, as judges attempt to balance the best interests of the class against lead plaintiffs’ ability to choose their own lawyers. For

example, in In re Quintus Sec. Litig., 201 F.R.D. 475 (N.D. Cal. 2001), Judge Walker refused to appoint the nominal lead plaintiff’s choice of counsel and instead called upon interested firms to submit proposals setting forth such information as the firm’s experience with securities litigation cases, malpractice coverage, fee structure, and preliminary factual investigation of the case. Judge Walker later evaluated proposals from five firms and chose the firm he thought would charge the lowest fee and provide the best result to the class. In re Quintus Sec. Litig., 148 F. Supp. 2d 967 (N.D. Cal. 2001). See also Mayo v. Apropos Tech., Inc., No. 01 C 8406, 2002 WL 193393, at *5 (N.D. Ill. Feb. 7, 2002) (requiring proposed lead counsel to submit evidence of past experience, agreed fees, hourly rates, anticipated staffing and ability to carry forward the efforts of any potential class). The Ninth Circuit reversed Judge Walker’s ruling and use of the auction process in In re Cavanaugh, 306 F.3d 726 (9th Cir. 2002). The Ninth Circuit held that the district court erred in appointing lead counsel based on the fact that it was the cheapest in the field and the belief that “lawyers don’t make much difference in securities class actions.” Id. at 735. The Ninth Circuit further held that the role of the district courts is to apply the Reform Act, not to reduce the costs of securities class actions. Id. at 736. Further, according to the Ninth Circuit in Cavanaugh, the selection of lead counsel, unless plainly inadequate, should not affect the court’s decision in appointing a lead plaintiff. Id. at 732-33. See also Cendant, 264 F.3d at 266 (acknowledging that, generally, selection of lead counsel should be distinct from the court’s appointment of lead plaintiff); Craig, 253 F. Supp. 2d at 1051-52 (concluding that the Ninth Circuit’s minimal scrutiny of the lead plaintiff’s choice for counsel “more efficiently protect[s] the class” than an auction process or other court-directed procedure). 3. Legal Fees For Non-Lead Counsel Simply doing work on behalf of the class does not create a right to compensation. The focus is on whether that work provided a benefit to the class. In most cases, the work that lead counsel does will ordinarily benefit and advance the class’s interests. However, when dealing with non-lead counsel, the inquiry has to be more detailed. Non-lead counsel will have to demonstrate that their work conferred a benefit on the class beyond the benefit conferred by lead counsel. Work that is simply duplicative of the efforts of lead counsel will not ordinarily be compensated. Further, the court – not the lead plaintiff – must decide what firms/counsel deserve compensation for work done on behalf of the class prior to the appointment of the lead plaintiff. In re Cendant Corp. Sec. Litig., 404 F.3d 173 (3d Cir. 2005). a. Pre-appointment Work Before lead counsel is appointed, if an attorney discovers grounds for a suit based on his/her own investigation and legitimately creates a benefit for the class, the attorney should be compensated out of the class’s recovery, even if the lead plaintiff does not choose the attorney to represent the class. In addition, any attorneys whose complaints contain factual research or legal theories that lead counsel did not discover, and upon which lead counsel later relies, will have a claim for a share of the class’s recovery. In re Cedant Corp. Sec. Litig., 404 F.3d at 194-96. b. After Appointment Of Lead Counsel After lead counsel is appointed, the primary responsibility for compensation shifts from the court to the lead plaintiff (subject to ultimate court approval). Under the PSLRA, the lead plaintiff is the decision-maker for the class and has the responsibility of deciding which lawyers will represent the class and how they will be paid. There is a presumption of correctness afforded to lead plaintiff’s denial of fees to non-lead counsel. This presumption can be rebutted in two general ways. First, non-lead counsel can refute the presumption by showing some failure in lead plaintiff’s fiduciary representation of the class. A fiduciary generally owes to its principal the duty of loyalty and duty of due care. Thus, non-lead counsel can rebut this presumption by demonstrating a failure in either duty: (1) by demonstrating that the lead plaintiff’s denial of fees was

motivated by some factor other than the best interest of the class, or (2) by showing that the lead plaintiff did not carefully consider and reasonably investigate non-lead counsel’s request for fees. If non-lead counsel can rebut the presumption in this way, then the lead plaintiff is not entitled to any deference in the determination of counsel fees. At this point however, non-lead counsel will still have to demonstrate to the court that the work conferred a substantial benefit to the class. Id. at 197-200. Second, non-lead counsel can refute the presumption by a showing that lead plaintiff’s denial of fees was erroneous. This can be done by proving that non-lead counsel performed work that independently benefited the class. This standard is high, and non-lead counsel will need to prove by clear evidence that (1) they performed work on behalf of the entire class; (2) they did so with some reasonable expectation of being compensated out of the class’s common-fund recovery; and (3) their work led to identifiable and substantial benefits to the class that would not have been obtained by the work of lead counsel. Id. c. Representation Of Individual Class Members Non-lead counsel will not be compensated out of the class’s recovery solely for keeping abreast of the case on behalf of their individual clients, or by duplicating the efforts of lead counsel. To be eligible for compensation, non-lead counsel’s work must improve the class’s recovery. Otherwise, if individual class members wish to have the service of individual counsel, they should bear the expense themselves. See also In re Auction Houses Antitrust Litig., No. 00 Civ. 0648, 2001 WL 210697 (S.D.N.Y. Feb. 26, 2001). d. Representation of Uncertified Subclasses When non-designated counsel act on behalf of a putative but uncertified subclass (rather than an individual client or an identifiable group of clients), the issue of this counsel’s compensation arises. In In re Cendant, the Third Circuit concluded that non-lead counsel deserved no special consideration for advocating for the interests of an uncertified subclass. 404 F.3d at 182 (“[T]he presumption of correctness that [the court] awards to [the lead plaintiff’s] decision not to compensate an attorney will also extend to a decision not to compensate proposed counsel for an uncertified subclass.”). The court noted, however, that the presumption can be rebutted if non-lead counsel can prove that the lead plaintiff violated its fiduciary duties by unfairly favoring some class members over others or if the non-lead counsel succeeds in effecting a significant change in the allocation of damages. Id. 4. Other Responsibilities And Rights Of Lead Plaintiff While the PSLRA is explicit on the lead plaintiff’s authority to select and retain counsel, “it is silent on the other responsibilities and rights that lead plaintiffs have to control, direct, and manage class action securities litigation.” In re BankAmerica Corp. Sec. Litig., 350 F.3d 747, 751 (8th Cir. 2003). The Act does not address whether a lead plaintiff must approve a settlement, whether a lead plaintiff must be replaced before a district court may review and approve a proposed settlement, or how a district court should deal with a fractured lead plaintiff group. Id. at 751. Therefore, the district court’s decisions in these matters will be reviewed only for abuse of discretion. Id. at 752. See also Feder v. Elec. Data Sys. Corp., 429 F.3d 125, 132 (5th Cir. 2005) (proposed class representative could hire outside attorney to oversee proposed class counsel). 5. Defendants’ Role In Appointment Of Lead Plaintiff A defendant may have standing to object to certain issues on a motion for appointment of lead plaintiff. A defendant can challenge the plaintiff’s motion to be appointed lead plaintiff if a named plaintiff fails to file the required certification or to provide notice to the class as required by 15 U.S.C. § 78u-4(a)(3)(A), or if the notice served is inadequate. Greebel v. FTP Software, Inc., 939 F. Supp. 57, 60 (D. Mass. 1996). But see Bell v. Ascendant Solutions, Inc., No. CIV. A. 3:01-CV-0166, 2002 WL 638571, at *2 (N.D. Tex. Apr. 17, 2002)

(holding that a defendant does not have standing to object to a lead plaintiff’s appointment pursuant to the express terms of the PSLRA). a. Multiple Lead Plaintiffs Defendants have also objected that the appointment of multiple lead plaintiffs vitiates the Reform Act’s intent to place greater control of the litigation in the hands of investors, rather than those of plaintiffs’ counsel, despite the fact that the “principal responsibility” for challenging the qualifications of proposed lead plaintiffs rests with other class members. D’Hondt v. Digi Int’l, Inc., No. CIV 97-5 JRT RLE, 1997 WL 405668, at *3-4 (D. Minn. Apr. 3, 1997). But see Gluck v. CellStar Corp., 976 F. Supp. 542, 549 (N.D. Tex. 1997) (holding only class members, not defendants, have standing to challenge putative lead plaintiffs); In re Donnkenny Inc. Sec. Litig., 171 F.R.D. 156, 157-58 (S.D.N.Y. 1997) (same). b. Statutory Criteria Some courts have held that defendants lack standing to challenge whether a particular class member moving for appointment as lead plaintiff satisfies the criteria set forth in 15 U.S.C. § 78u-4(a)(3)(B)(iii)(I), at least at the lead plaintiff appointment stage. Greebel, 939 F. Supp. at 60. However, this question can be revisited on a motion for class certification. Id. The Reform Act’s language of 15 U.S.C. § 78u-4(a)(3)(D)(iii) regarding “the most adequate plaintiff” also helps underscore other objections defendants frequently raise concerning proposed class representatives including:

1) The Representative Should Not Be Subject To Unique Defenses In re Terayon Commc’ns Sys., Inc., No. C 00-01967 MHP, 2004 WL 413277, at *8 (N.D. Cal. Feb. 23, 2004) (holding that while a short-seller is not per se disqualified from being a lead plaintiff, a short seller who engages in a pattern of affirmative efforts to lower the stock prices is an inadequate class representative); In re ML-Lee Acquisition Fund II, L.P. & ML-Lee Acquisition Fund (Ret. Accounts) II, L.P. Sec. Litig., 149 F.R.D. 506 (D. Del. 1993) (finding plaintiff’s investment history relevant to determination as a “sophisticated investor” who could be subject to unique defenses); In re Harcourt Brace Jovanovich, Inc. Sec. Litig., 838 F. Supp. 109 (S.D.N.Y. 1993) (finding plaintiff’s investment history relevant to determination of typicality); McNichols v. Loeb Rhoades & Co., Inc., 97 F.R.D. 331, 335 (N.D. Ill. 1982) (finding plaintiff, subject to unique defense of non-reliance on market integrity, atypical and declining to certify class). But see Langner v. Brown, No. 95 CIV. 1981 (LBS), 1996 WL 709757 (S.D.N.Y. Dec. 10, 1996) (certifying a major shareholder and former insider as the class representative even though he might be subject to some unique defenses); and 2) The Lead Plaintiff Should Not Be A Professional Plaintiff Greebel, 939 F. Supp. at 60 (recognizing Congress’ “concern” regarding the “problem” of a professional plaintiff); In re K Mart Corp. Sec. Litig., No. 95-CS-75584-DT, 1996 WL 924811 (E.D. Mich. Dec. 16, 1996) (holding that named plaintiff who participated in dozens of other actions could not represent the class but that a plaintiff who had been a class representative twice before could represent the class). Since the Reform Act specifically raises the issues of sufficiency of financial interest, prior experience as a

class representative, and vulnerability to unique defenses in reaching a determination of who shall serve as class representative, these issues should be considered when the defendant is evaluating the proposed class representative as lead plaintiff. C. Motion To Dismiss Cases not dismissed at the pleadings stage require defendants to face a long and expensive discovery process. Given the breadth of the issues in complex business litigation and its high dollar stake, cases that are not dismissed on their pleadings almost inevitably require large document productions and distract senior management with internal fact investigations and depositions. Plaintiffs rely on these expenses and distractions, in fact, to broker settlements. Dismissing the case at the outset is thus essential if defendants are to maintain the upper hand. Of course, the PSLRA does not affect all securities litigation equally. By its terms, the Reform Act applies its pleading requirements only to claims under the 1934 Act. 15 U.S.C. § 78u-4(a)(1) (limiting applicability of Act’s provisions to private class actions “arising under this chapter”); In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d 281, 337-38 (S.D.N.Y. 2003) (holding that Congress intended the heightened pleading requirements of the PSLRA to apply to securities fraud claims only under the 1934 Act). Therefore, while the heart of this section focuses on the Reform Act’s innovations — and the courts’ interpretations of those innovations — it also addresses pleading standards required for all civil actions, including those under the 1933 Act. 1. Pleading Requirements For All Civil Actions This section traces the development of pleading standards under Federal Rule 8(a), covering first the noticepleading standard that applied up to the Supreme Court’s recent decisions in Bell Atlantic v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 556 U.S. __, 129 S. Ct. 1937 (2009). It then touches on how the new factbased pleading standard announced in these cases likely affects securities litigation practice. a. Pleading Requirements Before Twombly And Iqbal Since its adoption in 1937, Federal Rule of Civil Procedure 8(a) has required a pleading to contain a “short and plain statement of the claim showing that the pleader is entitled to relief.” Following its adoption and consistent with the liberalization of the Federal Rules, the Supreme Court read 8(a) merely to require “notice pleading.” Under that standard, the complaint simply had to give the defendant fair notice of what law had been violated and how the defendant was connected to the violation. See Conley v. Gibson, 355 U.S. 41, 47-48 (1957); Brownlee v. Conine, 957 F.2d 353, 354 (7th Cir. 1992). See generally 2 JEFFREY A. PARNESS & JERRY E. SMITH, MOORE’S FEDERAL PRACTICE § 8.04[1], at 8-21 to 8-24 (3d ed. 2009) (outlining development of notice pleading and its standards and purposes). Notice pleading was a distinct departure from 19th and early 20th century “code pleading” — technical standards where one misstep could be fatal to the claim. Conley, 355 U.S. at 48. “The Federal Rules of Civil Procedure do not require a claimant to set out in detail the facts upon which he bases his claim.” Id. at 47. A complaint should be dismissed for failure to state a claim only if “it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” Id. at 45-46. At bottom, the purpose of this more liberal pleading standard was to use the discovery process, rather than the motion to dismiss, to ferret out unmeritorious claims. Swierkiewicz v. Sorema N.A., 534 U.S. 506, 512 (2002). But as the nature of litigation changed over the latter half of the 20th century, and as discovery became more exhaustive, expensive and sometimes abusive, the costs of allowing unmeritorious claims to proceed past the motion to dismiss stage cut against the benefits of giving every litigant his day in court. Over time, the courts added layers to the civil pleading standard without expressly raising it. They did so by, for example, requiring

more facts in complex cases, e.g., Desai v. Tire Kingdom, Inc., 944 F. Supp. 876, 879 (M.D. Fla. 1996) and requiring plaintiffs to plead sufficient factual allegations to meet certain elements of a claim, Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 346-48 (2005). These developments presaged a wholesale change to the pleading standard. b. Twombly And Iqbal: To Survive A Motion To Dismiss, The Complaint Must Be “Plausible On Its Face” That change finally came in the form of Bell Atlantic v. Twombly, an antitrust case brought under § 1 of the Sherman Act. 550 U.S. 544, 570 (2007). Reversing the Second Circuit, the Court held the plaintiff’s complaint failed to contain “enough facts to state a claim to relief that is plausible on its face.” Id. “Because plaintiffs here have not nudged their claims across the line from conceivable to plausible, their complaint must be dismissed.” Id. In expressing the new “plausibility” pleading standard, the Court rejected Conley’s famous formulation, produced above, that a complaint should be dismissed for failure to state a claim only if “it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief.” Id. at 561 (quoting Conley, 355 U.S. at 45-46). Conley, the Court held, described the “breadth of opportunity to prove what an adequate complaint claims, not the minimum standard of adequate pleading to govern a complaint’s survival.” Twombly, 550 U.S. at 562-63. The Court did not make clear, however, whether Twombly’s new plausibility pleading standard applied (1) to only antitrust actions, (2) to a broader subset of civil actions that were more complex in nature or involved expensive discovery, or (3) to all civil actions. The Court answered this question in Ashcroft v. Iqbal, extending the Twombly plausibility standard to all civil actions. 556 U.S. __, 129 S. Ct. 1937, 1953 (2009). Starting with Rule 8(a)(2), which requires pleadings to contain a “short and plain statement of the claim showing that the pleader is entitled to relief” (Id. at 1949), the Court set forth a two-step analysis for district courts to determine whether Rule 8(a)(2) has been met. Id. at 1949-50. First, while a court must accept as true all the allegations contained in a complaint, courts should disregard conclusory allegations. Id. at 1949-50 (“[T]he tenet that a court must accept as true all of the allegations contained in a complaint is inapplicable to legal conclusions.”). Thus, a “threadbare” or “formulaic recitation of the elements” of a claim will not suffice. Id. at 1949. Second, taking into account only those factual allegations surviving the first step, the court must then determine whether the complaint states a claim for relief that is plausible on its face. Id. at 1950. Whether a claim is plausible is a “context-specific task that requires the reviewing court to draw on its judicial experience and common sense.” Id. The court advised that “[a] claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged. The plausibility standard is not akin to a ‘probability requirement,’ but it asks for more than a sheer possibility that a defendant has acted unlawfully.” Id. at 1949. The court also addressed the interplay between Rule 8 and Rule 9(b), which permits a plaintiff to plead conditions of a person’s mind “generally.” While the court acknowledged that plaintiff need only plead “malice, intent, knowledge and other conditions of a person’s mind” generally, and not with particularity, that “does not give him license to evade the less rigid — though still operative — strictures of Rule 8.” Id. at 1954. “Rule 8 does not empower respondent to plead the bare elements of his cause of action, affix the label ‘general allegation,’ and expect his complaint to survive a motion to dismiss.” Id. Rule 8 therefore stands as a floor for pleading requirements above which all complaints must rest.

c. Application to Securities Cases Because the Iqbal standard applies to all civil actions, it necessarily applies to civil securities actions, including federal derivative actions. Commentators have identified three major ways in which Iqbal is likely to shift the landscape of litigation at the motion to dismiss stage.

1) Iqbal Raises The Pleading Standards For SEC Civil Enforcement Actions Iqbal’s biggest effect will be on the pleading standards in SEC civil enforcement actions. Because the PSLRA does not apply to SEC civil actions, the Commission has frequently relied on Rule 9(b)’s language permitting a plaintiff to plead state of mind generally. The SEC’s complaints often include threadbare and conclusory assertions that the defendant acted with the requisite scienter. Two of Iqbal’s holdings — (1) that courts must disregard conclusory assertions and (2) that general allegations as to state of mind under Rule 9 cannot circumvent Rule 8’s requirement that factual allegations be plausible — operate together to raise the SEC’s pleading obligations in civil enforcement actions.

2) Iqbal May Give Courts Greater Latitude To Dismiss Securities Claims Outside The PSLRA’s Ambit For claims subject to the PSLRA, see infra Subsection 3, Iqbal is unlikely to have any effect because the PSLRA raises pleading standards above those of Rule 8. Likewise, insofar as Rule 9(b) already applies to securities fraud actions, the particularity standard plaintiff’s allegations must satisfy is already higher than that of the newly ratcheted up Rule 8. Where Iqbal discussed Rule 9(b), the discussion was limited to a plaintiff’s ability to plead malice, intent, knowledge, or other conditions of the mind generally. The case should thus not be read to disturb the higher pleading standards for scienter established under the PSLRA, 15 U.S.C. § 78u-4(b)(2), or the Court’s interpretation of that standard in Tellabs v. Makor Issues & Rights, Ltd., 551 U.S. 338 (2007). However, Iqbal may give defendants greater latitude to attack pleadings as to misstatement or omission, materiality, reliance and loss causation. Previously, when plaintiffs’ founded their case on a fraud on the market theory, courts would often deny a motion to dismiss without regard to whether the complaint sufficiently alleged reliance. Now, after Iqbal, defendants will be able to better target implausible theories of reliance, using judicially noticeable documents and other materials to show, for example, that the market for the defendant’s securities was inefficient. Iqbal will likewise buttress the Court’s prior holding in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), enabling defendants to better attack plaintiffs’ allegations regarding loss causation. Iqbal will also affect cases that fall outside the PSLRA’s ambit. Courts are split as to whether Rule 9(b)’s particularity standard applies to Section 11 claims sounding in fraud. See infra Subsection 2. In circuits that have held Rule 9(b) does not apply to Section 11 claims, Iqbal now heightens plaintiffs’ pleading standards.

3) Iqbal Raises Pleading Standards For Federal Derivative Actions Finally, Iqbal applies to derivative lawsuits filed in federal court. This has at least three implications. First, Iqbal affects plaintiffs’ ability to meet the threshold requirements for a derivative action. Although Federal Rule of Civil Procedure 23.1 sets forth specific pleading requirements for stock ownership requirements and demand futility, it does not address the pleading standards for those requirements. Iqbal sets a pleading “bottom” of plausibility.

Second, Iqbal applies with equal force to the underlying substantive claims brought on behalf of the corporation. Third, Iqbal’s elevated pleading standard brings the federal standard in line with many state standards, which require a plaintiff to plead with particularly concrete facts demonstrating that tendering a demand would have been futile. E.g., Del. Ch. Ct. R. 23.1; Cal. Corp. Code § 800(b)(2) (West 2009); see infra Section V.C.2.b.2. 2. Pleading Requirements For Claims Sounding In Fraud While Iqbal applies to civil actions generally, parties have long had to meet higher pleading standards when alleging fraud. Federal Rule of Civil Procedure 9(b) requires that “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9(b) (as amended, December 1, 2007). Rule 9(b) clearly applies to claims under section 10(b) and Rule 10b-5. Tellabs v. Makor Issues & Rights, Ltd., 551 U.S. 308, 320 (2007) (citing Greenstone v. Cambrex Corp., 975 F.2d 22, 25 (1st Cir. 1992)). Less clear is whether Rule 9(b) applies to claims in which scienter is not an element of the claim. Thus, the circuits are split as to whether plaintiffs must meet 9(b) standards in pleading a section 11 or 12 claim. Compare ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 69 (1st Cir. 2008) (applying Rule 9(b)’s heightened pleading standards to section 11 and 12 claims that “sound in fraud”) with In re NationsMart Corp. Sec. Litig., 130 F.3d 309, 315 (8th Cir. 1997) (holding that Rule 9(b) does not apply to section 11 and 12 claims because proof of fraud or mistake is not a prerequisite to liability). Although the Seventh Circuit has not conclusively decided the issue, at least one district court in that circuit has found that Rule 9(b) does not apply to section 11 or 12 claims, reasoning that requiring a plaintiff to plead fraud and scienter with particularity is illogical when neither is an element of the claim. In re Ulta Salon, Cosmetics & Fragrance, Inc. Sec. Litig., 604 F. Supp. 2d 1188, 1193 (N.D. Ill. 2009). Courts have also held that Rule 9(b) applies to claims under section 14(a) and Rule 14a-9, at least when they sound in fraud. See, e.g., Cal. Pub. Employees’ Retirement Sys. v. Chubb Corp., 394 F.3d 126, 144 (3d Cir. 2004); Yourish v. Cal. Amplifier, 191 F.3d 983, 993 (9th Cir. 1999); In re JP Morgan Chase Sec. Litig., 363 F. Supp. 2d 595, 636 (S.D.N.Y. 2005). 3. Claims To Which The PSLRA Applies Because the PSLRA applies to private class actions arising under the 1934 Act, courts have primarily applied its pleading standards to claims under section 10(b) and Rule 10b-5. However, courts have also applied its standards to claims under sections 14(a), 14(d), and 14(e). See infra Section III.D.1.e, III.D.2.e, and III.D.3.e, respectively. Finally, most circuit courts have also applied its standards to claims under section 18(a). See, e.g., Teachers’ Retirement Sys. v. Hunter, 477 F.3d 162, 188 (4th Cir. 2007); Deephaven Private Placement Trading, Ltd. v. Grant Thornton & Co., 454 F.3d 1168, 1172 (10th Cir. 2006); In re Stone & Webster, Inc. Sec. Litig., 414 F.3d 187, 194 (1st Cir. 2005); see infra Section III.F. Because the lion’s share of securities class action practice is devoted to defending 10(b) and 10b-5 claims, the remainder of this section focuses on the application of the PSLRA to those claims. 4. The Reform Act’s Effect On Pleadings Standards One of the Reforms Act’s principal aims was to heighten pleading standards for securities fraud claims. As they were designed to do, these heightened pleading requirements — and the circuit courts’ subsequent interpretation of those requirements — give defendants a better chance of dismissing cases on the pleadings in a securities fraud claim.

The discussion below addresses issues that routinely arise in a defendant’s motion to dismiss a securities class action. It first addresses the Reform Act’s four major innovations with respect to pleading and the motion to dismiss stage of litigation. It then focuses on the two requirements that have most often occupied the courts: increased specificity as to misstatements or omissions and particularity as to scienter. a. The Reform Act’s Innovations The Reform Act features four innovations that have significantly altered securities fraud pleadings and the landscape of litigation at the motion to dismiss stage. These innovations are: (1) heightened pleading as to the defendant’s allegedly misleading statement or omission; (2) heightened pleading of scienter; (3) stay of discovery and proceedings during the motion to dismiss phase; and (4) mandatory consideration of Rule 11 sanctions. 15 U.S.C. § 78u-4(b)(1)(B); id. § 78u-4(b)(2); id. § 78u-4(b)(3)(B); id. § 78u-4(c). In addition, the Reform Act largely codified the federal common law doctrine of “bespeaks caution,” through safe harbor provisions for forward-looking statements.

1) Heightened Standard As To Statements And Omissions With respect to heightened standards for misstatements or omissions, the Reform Act requires the complaint to set forth “each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” Id. § 78u-4(b) (1)(B). Even under the pre-PSLRA pleading standard, courts agreed that bare allegations of fraud were insufficient to support a securities fraud complaint. See, e.g., In re Navarre Corp. Sec. Litig., 299 F.3d 735, 742 (8th Cir. 2002) (citing Parnes v. Gateway 2000, Inc., 122 F.3d 539, 549 (8th Cir. 1997)). Since the enactment of the PSLRA, the Circuits have differed on the degree of specificity they require and their interpretation of the “all facts” requirement in the statute’s language.

2) Heightened Standard As To Scienter As to heightened standards for scienter, the Reform Act requires the complaint to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b) (2). This requirement applies to “each act or omission alleged to violate this chapter.” Id. § 78u-4(b)(2). The Reform Act mandates dismissal, upon the defendant’s motion, if the complaint fails to meet either of these requirements. Id. § 78u-4(b)(3)(A). Much of the debate surrounding the Reform Act was its intended interplay with Rule 9(b) of the Federal Rules of Civil Procedure. Prior to the Reform Act, plaintiffs filing securities fraud lawsuits needed only to satisfy Rule 9(b)’s particularity requirement. Fed. R. Civ. P. 9(b) (as amended, December 1, 2007); see supra Subsection 2. Because the Reform Act required plaintiffs “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind,” courts wrestled with whether this standard was coextensive with Rule 9(b) or had in fact supplanted it with a more stringent standard. 15 U.S.C. § 78u4(b)(2) (emphasis added). This debate led to a circuit split over what was required under the PSLRA to adequately plead a “strong inference” of scienter. Although most courts found that Congress intended for the Reform Act to heighten the pleading requirements in securities fraud cases above the Rule 9(b) standard, exactly what was required was a subject of some dispute. Compare Adams v. Kinder-Morgan, Inc., 340 F.3d 1083, 1096 (10th Cir. 2003) (“The

PSLRA supersedes . . . Rule 9(b), imposing a more stringent rule for pleading scienter.”) with Greebel v. FTP Software, Inc., 194 F.3d 185, 193 (1st Cir. 1999) (“The effect of [the PSLRA] is to embody in the Act itself at least the standards of Rule 9(b) . . . .”). As Subsection 7.c discusses infra, the Supreme Court eventually resolved this split in Tellabs.

3) Stay Of All Proceedings Another significant innovation of the PSLRA is the automatic stay on discovery and other proceedings before a court has ruled on a motion to dismiss. The Reform Act provides: “In any private action arising under this chapter, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.” 15 U.S.C. § 78u-4(b)(3)(B). This is meant, in part, to prohibit plaintiffs from first suing without the requisite information to satisfy the Reform Act’s heightened pleading requirements and then using discovery to acquire information to “resuscitate an otherwise dismissible complaint.” In re Comdisco Sec. Litig., 166 F. Supp. 2d 1260, 1263 (N.D. Ill. 2001). For a more complete discussion, see infra at Section II.E.2.

4) Mandatory Sanctions For Frivolous Securities Fraud Claims The PSLRA’s final major innovation with respect to pleadings was to make frivolous securities law claims sanctionable. The PSLRA requires the court to make findings with respect to each party and attorney and must impose sanctions for violations of Rule 11. 15 U.S.C. § 78u-4(c). See infra at Subsection 9.b for a more complete discussion of the PSLRA’s sanction regime. 5. The PSLRA’s Pleading Requirements With Respect To Statements And Omissions The Reform Act introduced two major innovations with respect to statements and omissions. First, it elevated the degree of factual specificity and analysis required for each alleged misstatement or omission. Second, it carved out an entire category of statements — forward-looking statements — that are not actionable. These statements fall under the PSLRA’s safe harbor, discussed infra at Subsection 6. For now, we start with the PSLRA’s increased specificity for those statements that are actionable. a. Increased Factual Specificity And Analysis Required To determine whether facts plead in a complaint alleging securities fraud are adequate, a court must review them in light of the PSLRA’s pleading standards. E.g., In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d 281, 337-38 (S.D.N.Y. 2003). In In re IPO, Judge Scheindlin parsed 15 U.S.C. § 78u-4(b)(1)(B), explaining that “[a]ny claim that falls under paragraph (b)(1)’s purview must: [1] specify each statement alleged to have been misleading; [2] [specify] the reason or reasons why the statement is misleading; and [3] if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” 241 F. Supp. 2d at 329 (alterations in original).

Together, these requirements prohibit plaintiffs from either “generally aver[ring] that the defendant made a material misstatement or omission” or “merely copy[ing] the language of the statute.” Id. b. Specification Of Each Allegedly Misleading Statement As to the first requirement, plaintiff must identify specific statements or omissions that give rise to her cause of action. Id. Because the “pleadings . . . serve as binding judicial admissions that control the plaintiff’s case throughout the course of the proceedings” and give defendants “fair notice of what the claim is and the grounds upon which it rests,” both the court and defendants must know what specific statements are at issue. Id.; Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). Thus, courts have found that simply copying press releases, SEC filings, or transcripts from conferences calls into the complaint is insufficient. E.g., In re 2007 Novastar Fin. Inc., Sec. Litig., 579 F.3d 878, 882-83 (8th Cir. 2009). Instead, the plaintiff must identify what statements within those communications were misleading. Id.; Tripp v. IndyMac Fin. Inc., No. CV-07-1635 GW (VBKx), 2007 WL 4591930, *6 (C.D. Cal. Nov. 29, 2007) (granting defendants’ motion to dismiss with leave to amend, noting that plaintiff pled insufficiently particularized allegations, and requiring any amended complaint to “identify[] only those statements that are alleged to be false or misleading and (briefly, but specifically), stat[e] why”); Havenick v. Network Express, 981 F. Supp. 480, 526 (E.D. Mich. 1997) (“Nowhere in the Complaint do plaintiffs specify each statement that is allegedly false nor do they give a particular reason why a particular statement is false. Rather, they have simply compiled a long list of block quotes, many of which contain statements that cannot seriously be regarded as false or misleading, and they line these statements up against a conclusory list of omissions and pronounce that fraud exists.”). Although plaintiffs generally must tie a statement to a specific defendant, that is not always true when an affirmative statement and omission occur simultaneously. Thus, if a two defendants participated in a conference call with analysts, with one making an allegedly false statement and another failing to correct it, plaintiffs have sufficiently pleaded the fraud as to each defendant even if they do not identify which of the two spoke and which remained silent. Barrie v. Intervoice-Brite, Inc., 409 F.3d 653, 655-56 (5th Cir. 2005). c. The Reason Or Reasons Why The Statement Is Misleading As to the second requirement, plaintiffs must then analyze each specific statement or omission by explaining why it is misleading. Simply reciting a laundry list of general reasons without an explanation as to why a particular statement is misleading is not sufficient. Wenger v. Lumisys, Inc., 2 F. Supp. 2d 1231, 1243 (N.D. Cal. 1998) (“In violation of the Reform Act . . . the Complaint lumps all alleged misrepresentations together . . . and then follows that catalog with a three-page laundry list of reasons why all the statements were allegedly false when made.”). In this regard, courts can be exacting in the degree of analysis required. See, e.g., In re CP Ships, Ltd., Sec. Litig., 506 F. Supp. 2d 1161, 1167 (M.D. Fla. 2007) (dismissing a claim regarding cost underaccruals because plaintiffs failed to allege facts regarding the subject matter of the under-accruals, the manner in which they were accomplished, the timing, who directed them and how they were directed). Courts will not let plaintiffs “place the burden on the reader to sort out the statements and match them with the corresponding adverse facts.” In re Wash. Mut., Inc. Sec., Derivative & ERISA Litig., 259 F.R.D. 490, 502 (W.D. Wash. 2009) (granting motion to dismiss because plaintiff’s “puzzle pleading” failed to present allegations clearly and with enough specificity to give defendants notice of the claims against them). d. “All Facts” Forming Basis For “Information And Belief” The Federal Rules of Civil Procedure recognize two types of allegations ¾ those made with personal knowledge or those made on information and belief. Fed. R. Civ. P. 11(b). With respect to every allegation made on information and belief, the PSLRA requires that a plaintiff must “state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1)(B). This requirement has proved a fertile ground for

pleading challenges. Interpreting this language, the Ninth Circuit has held that a plaintiff must include in the complaint literally all sources of information upon which the fraud allegations are based. In In re Silicon Graphics Inc., Securities Litigation, 183 F.3d 970, 988 (9th Cir. 1999), the court found that it is not sufficient to allege the presumed existence of “negative internal reports” and presumed “knowledge” of these reports by defendants simply because “every sophisticated corporation uses some kind of internal reporting system.” Rather, plaintiffs must plead “the titles of the reports, when they were prepared, who prepared them, to whom they were directed, their content, and the sources from which plaintiffs obtained this information.” In re Silicon Graphics Inc., Sec. Litig., 970 F. Supp. 746, 767 (N.D. Cal. 1997); see also In re Silicon Storage Tech., Inc. Sec. Litig., No. C-050295, 2006 WL 648683, at *10-11 (N.D. Cal. Mar. 10, 2006) (dismissing complaint in part for failure to plead with particularity that each confidential informant occupied a position such that he/she would possess the information alleged; because none of the informants was employed at the company during the alleged class period; and because uncorroborated internal reports were insufficiently reliable); Fla. State Bd. of Admin. v. Bay Networks, Inc., No. 97-CV-2347, 1998 WL 34187566 (N.D. Cal. Sept. 15, 1998), cited with approval in Silicon Graphics, 183 F.3d at 988 n.19. With respect to a complaint’s “sources,” the PSLRA’s requirements create special issues for both the: (1) use of experts or consultants in support of allegations, and (2) use of unnamed confidential witnesses.

1) Use Of Experts Or Consultants In Support Of Allegations See In re Silicon Storage Tech., Inc., No. C-05-0295 PJH, 2007 WL 760535 (N.D. Cal. Mar. 9, 2007) (data and information obtained from “experts” are subject to the same stringent particularity requirements of the Reform Act as are facts alleged to have originated from confidential informants or other witnesses); plaintiff must specifically allege the expert’s qualifications, how his analysis was performed and/or upon what data he relied. (In re Textainer P’ship Sec. Litig., No. C-05-0969 MMC, 2006 WL 1328851, at *5 (N.D. Cal. May 15, 2006).

2) Use Of Unnamed Confidential Witnesses Most courts allow claims to be founded on the testimony of confidential witnesses, if the witnesses are sufficiently identified. Prior to the Supreme Court’s decision in Tellabs, see infra Subsection 7.c, the Second Circuit’s influential decision in Novak v. Kasaks, 216 F.3d 300, 313-14 (2d Cir. 2000) held that the Reform Act did not require plaintiffs to identify all sources of information in the complaint as a general matter. Id. The court explained: [i]n our view, notwithstanding the use of the word ‘all,’ [the Reform Act] does not require that plaintiffs plead with particularity every single fact upon which their beliefs concerning false or misleading statements are based. Rather, plaintiffs need only plead with particularity ‘sufficient’ facts to support those beliefs. Accordingly, where plaintiffs rely on confidential personal sources but also on other facts, they need not name their sources as long as the latter facts provide an adequate basis for believing that the defendants’ statements were false. Id. Moreover, even if confidential sources must be identified, the Second Circuit did not require “that they be named, provided they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” Id. Thus, according to the Second Circuit, a complaint could meet the Reform Act’s pleading requirement “by providing documentary

evidence and/or a sufficient general description of the personal sources of the plaintiffs’ beliefs.” Id. The Ninth Circuit also adopted a similar stance. In In re Daou Sys., Inc., 411 F.3d 1006, 1015-16 (9th Cir. 2005), it applied the standards set forth by the Second Circuit, in conjunction with factors applied by the First Circuit, to assess the reliability of confidential witnesses. It held that naming sources is unnecessary so long as the sources are described with sufficient particularity and the complaint contains “adequate corroborating details.” Id. (citing Nursing Home Pension Fund, Local 144. v. Oracle Corp., 380 F.3d 1226, 1233 (9th Cir. 2004) and In re Silicon Graphics Inc., Sec. Litig., 183 F.3d 970, 985 (9th Cir. 1999)); In re Metawave Commc’ns Corp. Sec. Litig., 298 F. Supp. 2d 1056, 1068 (W.D. Wash. 2003) (allowing confidential witnesses to go unnamed but requiring enough particularity for the court to determine “how confidential witnesses ‘came to learn of the information they provide in the complaint’ … The Court must be able to tell whether a confidential witness is speaking from personal knowledge, or ‘merely regurgitating gossip and innuendo’” (citations omitted)). Many other courts followed Novak’s approach to confidential witnesses. See, e.g., Adams v. Kinder-Morgan, Inc., 340 F.3d 1083, 1098-99 (10th Cir. 2003) (“[W]e agree with the courts that have concluded that ‘notwithstanding the use of the word “all,” paragraph (b)(1) does not require that plaintiffs plead with particularity every single fact upon which their beliefs concerning false or misleading statements are based.’” (quoting Novak, 216 F.3d at 313-14)); ABC Arbitrage Plaintiffs Group v. Tchuruk, 291 F.3d 336, 352 (5th Cir. 2002) (“[The PSLRA] does not require that plaintiffs plead with particularity every single fact upon which their beliefs concerning false or misleading statements are based. Rather, plaintiffs need only plead with particularity sufficient facts to support those beliefs.”); In re Cabletron Sys., Inc., 311 F.3d 11, 30-31 (1st Cir. 2002) (determining whether an adequate basis exists for believing defendants’ statements were false by evaluating all facts alleged, including the level of detail provided by confidential sources, the corroborative nature of the other facts alleged, the coherence and plausibility of the allegations, the number of sources, and the reliability of sources). The Third Circuit also adopted the Novak standard, finding that as long as plaintiffs supplied sufficient facts to support their allegations, there is no reason to divulge confidential sources. Cal. Pub. Employees’ Ret. Sys. v. Chubb Corp., 394 F.3d 126, 146-47 (3d Cir. 2004); see In re Cigna Corp. Sec. Litig., No. Civ.A. 02-8088, 2006 WL 263631, at *3 (E.D. Pa. Jan. 21, 2006) (reasoning that “requiring specific identification (to the defendant) of confidential sources . . . would chill informants from providing critical information”). The court required consideration of “the detail provided by the confidential sources, the sources’ basis of knowledge, the corroborative nature of other facts alleged, including from other sources, the coherence and plausibility of the allegations, and similar indicia.” Chubb, 394 F.3d at 146; see also Freed v. Universal Health Serv., Inc., No. 04-1233, 2005 U.S. Dist. LEXIS 7789 (E.D. Pa. May 3, 2005) (holding that the complaint, which relied heavily on confidential sources, must contain information describing when confidential source worked for defendant corporation, dates on which information was acquired, and how they had access to that information). Following the Supreme Court’s decision in Tellabs, see infra Subsection 7.c, the circuit courts had to decide whether the Novak standard could survive that decision. The Seventh Circuit was the first appellate court to consider the weight confidential witnesses’ statements should receive after Tellabs. In Higginbotham v. Baxter Int’l, Inc., 495 F.3d 753 (7th Cir. 2007), it held that anonymity frustrates courts’ abilities to weigh plaintiffs’ favorable inferences against competing inferences. Id. at 757. Because plaintiffs must eventually provide defendants with the identity of persons with relevant information, see Fed. R. Civ. P. 26(a)(1)(A), concealing names at the complaint stage “does nothing but obstruct the judiciary’s ability to implement the PSLRA.” Higginbotham, 495 F.3d at 757. Although the court refrained from completely ignoring allegations based on information provided by confidential witnesses, it held that such allegations must usually be steeply discounted in weighing competing inferences. Id. (“It is hard to see how information from anonymous sources could be deemed ‘compelling’ or how we could take account of plausible opposing inferences. Perhaps these confidential sources have axes to grind. Perhaps they are lying. Perhaps they don’t even exist.”). But see In re NPS Pharms., Inc. Sec. Litig., No. 2:06-cv-00570, 2007 WL 1976589, at *5 (D. Utah July 3, 2007) (refusing to evaluate credibility of confidential witnesses on motion to dismiss).

Subsequent case law suggests, however, that courts must consider the context when determining how much weight to accord confidential witnesses, paying special attention to the level of detail provided. The Seventh Circuit itself qualified Higginbotham when Judge Posner ruled on the remand of Tellabs. In Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702 (7th Cir. 2008), the court acknowledged the difficulties of assessing allegations based on anonymous sources but noted that the confidential sources listed in the complaint “are numerous and consist of persons who from the description of their jobs were in a position to know at first hand the facts to which they are prepared to testify . . . . The information that the confidential informants are reported to have obtained is set forth in convincing detail, with some of the information . . . corroborated by multiple sources.” Id. at 712. Most circuit courts to consider the issue since Tellabs have adopted a similar stance. See, e.g., Institutional Investors Group v. Avaya, Inc., 564 F.3d 242, 261 (3d Cir. 2009) (summarizing pre- and post-Tellabs case law and ultimately approving of the factors set forth in its earlier opinion, Cal. Pub. Employees’ Ret. Sys. v. Chubb Corp., 394 F.3d 126, 146-47 (3d Cir. 2004)); Ley v. Visteon Corp., 543 F.3d 801, 811 (6th Cir. 2008) (noting that “anonymous sources are not altogether irrelevant to the scienter analysis” but applying Higginbotham’s steep discount when plaintiffs not only withheld the names of employees who knew of defendant’s “alleged accounting improprieties,” but also failed to allege “what, when, where, and how” the employees knew of that information); Mizzaro v. Home Depot, Inc., 544 F.3d 1230, 1240 (11th Cir. 2008) (“[Although there are] reasons why courts may be skeptical of confidential sources cited in securities fraud complaints . . . , [c]onfidentiality . . . should not eviscerate the weight given [to these sources] if the complaint otherwise fully describes the foundation or basis of the confidential witness’s knowledge, including the position(s) held, the proximity to the offending conduct, and the relevant time frame.”). Still, some courts remain skeptical as to the vitality of confidential witness allegations after Tellabs. For example, the Ninth Circuit rejected fairly detailed confidential witness statements for failure to allege personal knowledge. Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 996 (9th Cir. 2009). Applying In re Daou, discussed supra, the court identified two hurdles plaintiffs must clear: (1) “the confidential witnesses whose statements are introduced to establish scienter must be described with sufficient particularity to establish their reliability and personal knowledge” and (2) “those statements which are reported by confidential witnesses with sufficient reliability and personal knowledge must themselves be indicative of scienter.” Id. at 995. Although it questioned whether Tellabs requires a stricter standard for evaluating the sufficiency of securities fraud complaints relying on confidential witnesses, it left that question open, finding that the complaint failed even under In re Daou’s standards. Id. at 995 & n.2. See also Konkol v. Diebold, Inc., 590 F.3d 390, 399 (6th Cir. 2009) (applying Higgenbotham’s “steep discount”); Campo v. Sears Holding Corp., 371 Fed. Appx. 212 (2d Cir. 2010) (summary opinion – citable but without precedential effect – rejecting plaintiffs’ challenge to district court’s allowing depositions to be taken of confidential witnesses to test good-faith basis for plaintiffs’ compliance with Tellabs where witnesses on being deposed had disowned or contradicted many of the statements attributed to them, since the anonymity of confidential witnesses frustrates the weighing of competing inferences required by Tellabs). Despite this uncertainty, complaints relying on confidential witnesses continue to survive the motion to dismiss stage. E.g., In re Gilead Sciences Sec. Litig., 2009 WL 3320492, at *2 (N.D. Cal. Oct. 13, 2009) (finding a confidential witness’s allegations sufficient as a pleading matter even though witness changed his story because the change in the allegations was “plausible,” supported by other confidential witnesses; “while the Court must determine that confidential witness allegations are reliable as required by Zucco Partners . . . the Court does not find it appropriate to engage in a more searching assessment of CW2’s credibility at this stage”); but see In re Accuray, Inc. Sec. Litig., 2010 WL 3447588 (N.D. Cal. Aug. 31, 2010) (dismissing complaint founded on CW allegations that lacked specific facts about specific contracts included in allegedly misstated backlog, were based on opinion and hindsight and lacked personal knowledge or connection with the defendants). Courts have rejected some plaintiffs’ attempts to have courts view information about confidential witnesses in camera rather than having to plead it. See, e.g., City of Livonia Emp. Ret. Sys. v. Boeing Co., 2010 U.S. Dist. LEXIS 52271 (N.D. Ill. May 26, 2010); Hubbard v. BankAtlantic Bancorp, Inc., 625 F. Supp. 2d 1267, 1284 n. 13 (S.D. Fla. 2008); In re DOT Hill Syst. Corp. Sec. Litig., 594 F. Supp. 2d 1150, 1162 (S.D. Cal. 2008).

6. The Safe Harbor For Forward-Looking Statements The Reform Act also sought to curb abusive private securities litigation through its “safe harbor” for “forwardlooking statements.” Under the Safe Harbor, certain forward-looking statements are not actionable. See 15 U.S.C. § 77z-2; id. § 78u-5; see also Harris v. Ivax, 182 F.3d 799, 803 (11th Cir. 1999). Congress’s intent behind the safe harbor provision was “to loosen the ‘muzzling effect’ of potential liability for forward-looking statements, which often kept investors in the dark about what management foresaw for the company.” Id. at 806 (citing H.R. Conf. Rep. 104-369, at 42 (1995)); see also Employers Teamsters Local Nos. 175 & 505 Pension Trust Fund v. Clorox Co., 353 F.3d 1125, 1131 (9th Cir. 2004). However, even if the forward-looking aspect of a statement is not actionable, that very same statement may be actionable because of other misleading content. S. Ferry LP #2 v. Killinger, 399 F. Supp. 2d 1121 (W.D. Wash. 2005), vacated on other grounds, 542 F.3d 176 (9th Cir. 2008). a. Forward-Looking Statements The Reform Act defines a forward-looking statement as follows: 1) a statement containing a projection of revenues, income (including income loss), earnings (including earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items; 2) a statement of plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer; 3) a statement of future economic performance, including any such statement contained in a discussion and analysis of financial condition by the management or in the results of operations included pursuant to the rules and regulations of the Commission; 4) any statement of the assumptions underlying or relating to any statement described above in subparagraph [(1), (2) or (3)]; 5) any report issued by an outside reviewer retained by an issuer, to the extent that the report assesses a forward-looking statement made by the issuer; or 6) a statement containing a projection or estimate of such other items as may be specified by rule or regulation of the Commission. 15 U.S.C. § 77z-2(i)(1); id. § 78u-5(i)(1). Words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” and “estimate” are examples of forward-looking language. Baron v. Smith, 380 F.3d 49, 53-54 (1st Cir. 2004). Courts have also held that a present-tense statement can qualify as a forward-looking statement as long as the truth or falsity of the statement cannot be discerned until some point in time after the statement is made. Harris, 182 F.3d at 803; In re Aetna, Inc. Sec. Litig., 2009 WL 1619636, at *22-23 (E.D. Pa. June 9, 2009) (finding that the defendantinsurer’s statement that it practices “disciplined pricing” — meaning that defendant “expects that its pricing will be in lined with its projected medical cost trend” — is a statement of future performance despite being stated in the present tense, and therefore falls within the safe harbor); In re Kindred Healthcare, Inc. Sec. Litig., 299 F. Supp. 2d 724, 738 (W.D. Ky. 2004) (holding that management’s statements indicating a belief in the adequacy of current reserves and liability coverage of the health care company were necessarily predicated on projections of future events that could only be verified when liability claims were actually filed, and therefore considered forward looking under PSLRA). b. Applicability Of The Safe Harbor

The safe harbor applies when a forward-looking statement is (1) identified as such and accompanied by “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement”; or (2) not material, without regard to the “actual knowledge” or state of mind of the issuer or executive. See 15 U.S.C. § 77z-2(c)(1)(A-B); id. § 78u-5(c)(1) (A-B). The Reform Act differentiates forward-looking statements made by natural persons from those made by business entities. See id. § 77z-2(c)(1)(B); id. § 78u-5(c)(1)(B). Natural persons are insulated from liability when the plaintiff fails to prove the defendants actually knew the forward-looking statement was false or misleading; business entities are insulated from liability where the plaintiff fails to prove that the forwardlooking statement was “(I) made by or with the approval of an executive officer of that entity, and (II) made or approved by such officer with actual knowledge by that officer that the statement was false or misleading.” Id. § 77z-2(c)(1)(B); id. § 78u-5(c)(1)(B). Subsection (A)’s safe harbor for forward looking-statements accompanied by meaningful cautionary language operates independently of subsection (B)’s requirement that plaintiff prove that the defendant communicated the forward-looking statement with actual knowledge that the statement was false or misleading. See In re Cutera Sec. Litig., 610 F.3d 1102 (9th Cir. 2010) (the two subsections must be read in the disjunctive, such that defendant’s state of mind is irrelevant if statements identified as forward-looking are accompanied by meaningful cautionary language); Miller v. Champion Enters. Inc., 346 F.3d 660, 672 (6th Cir. 2003); Harris v. Ivax Corp., 182 F.3d 799, 803 (11th Cir. 1999); see also In re See Beyond Techs. Corp. Sec. Litig., 266 F. Supp. 2d 1150, 1164 (C.D. Cal. 2003) (“The statute, legislative history and courts interpreting the statute indicate that if a defendant shows that a forward-looking statement is accompanied by meaningful cautionary language, a court need not turn to subsection (B) and examine whether the plaintiff, nevertheless, has sufficiently alleged actual knowledge. In other words, these two prongs of the safe harbor provision are taken to be independent, alternative means by which a defendant may insulate itself from liability; the first prong, which comes into play when meaningful cautionary language is present, does not require looking at the defendant’s state of mind, while the second prong provides additional protection for a defendant where sufficient cautionary language is absent.”); In re Midway Games, Inc. Sec. Litig., 332 F. Supp. 2d 1152, 1168 (N.D. Ill. 2004) (“For purposes of § 78u-5(c)(1)(A), proof of knowledge of the falsity of a forward-looking statement is ‘irrelevant’ when the statement is accompanied by meaningful cautionary language.”). But see Lormand v. U.S. Unwired, Inc., 565 F.3d 228, 244 (5th Cir. 2009) (holding that the PSLRA’s safe harbor provision is not available to defendants who have actual knowledge that their forward-looking statements are false at the time they are made). The safe harbor does not protect statements that are no longer forward looking in character because they are already known to be false when made. See, e.g., Rombach v. Chang, 355 F.3d 164, 173 (2d Cir. 2004) (“Cautionary words about future risk cannot insulate from liability the failure to disclose that the risk has transpired.”); In re Nash Finch Co., Sec. Litig., 502 F. Supp. 2d 861, 873 (D. Minn. 2007) (finding defendants’ “cautionary language” was not meaningful because they had actual knowledge that the potential risks identified had in fact already occurred and thus the safe harbor rule did not apply); In re Sepracor, Inc. Sec. Litig., 308 F. Supp. 2d 20, 28, 31-34 (D. Mass. 2004) (holding that the safe-harbor provision does not apply to statements which were fact rather than conjecture at the time they were made and that cautionary statements cannot insulate defendants from liability where plaintiff’s complaints raise a strong inference that defendants were aware of, or recklessly disregarded, undisclosed material facts). The mere fact that a statement contains some reference to projected future events does not bring the statement within the safe harbor if the alleged falsity relates to non-forward-looking aspects of the statement. In re Stone & Webster, Inc., Sec. Litig., 414 F.3d 187 (1st Cir. 2005). The safe harbor provision is intended to apply only to allegations of falsity relating to the forward-looking aspects of the statement. Id. c. No Duty To Update The safe harbor provisions in both the Securities Act and the Exchange Act specifically provide that neither provision imposes a duty to update a forward-looking statement. See 15 U.S.C. § 77z-2(d); id. § 78u-5(d).

d. Effect On Bespeaks Caution Doctrine The safe harbor provisions of the Reform Act largely adopt the bespeaks caution doctrine. The Joint Explanatory Statement of the Committee of Conference on the Private Securities Litigation Reform Act of 1995, 27 Sec. Reg. & L. Rep. (BNA) 1894 (Dec. 1, 1995), specifically provides that the safe harbor provisions are not intended to replace the bespeaks caution doctrine or further judicial development of the doctrine. Id. at 1895. Therefore, in situations where the safe harbor does not grant protection, defendants subject to securities fraud lawsuits based on materially “misleading” forward-looking statements may continue to invoke the “bespeaks caution” doctrine in attempting to have such suits dismissed as a matter of law. See P. Stolz Family P’ship v. Daum, 355 F.3d 92, 96-97 (2d Cir. 2004); see also Lin v. Interactive Brokers Group, 574 F. Supp. 2d 408 (S.D.N.Y. 2008) (applying the common-law “bespeaks caution” doctrine to hold that optimistic statements about the potential of the offering company’s technology were accompanied by cautionary language disclosing possible risks sufficient to put a reasonable investor on notice and making the offering document not materially false or misleading). The Ninth Circuit has applied the bespeaks caution doctrine in situations where “optimistic projections coupled with cautionary language . . . affect the reasonableness of reliance on and the materiality of those projections.” Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 940, 947 (9th Cir. 2005) (quoting In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1414 (9th Cir. 1994)). The Ninth Circuit notes, however, that dismissal on the pleadings under the bespeaks caution doctrine requires a stringent showing: “[t]here must be sufficient ‘cautionary language or risk disclosure such that reasonable minds could not disagree that the challenged statements were not misleading.’” Id. (quoting In re Stac Elec. Sec. Litig., 89 F.3d 1399, 1409 (9th Cir. 1996) (alterations in original)). 7. The PSLRA’s Pleading Requirements With Respect To Scienter In addition to the PSLRA’s heightened pleading standard for statements and omissions, it also introduced heightened standards with respect to scienter. Much of the litigation following the PSLRA’s enactment focused on its requirements for pleading scienter. This section first discusses the circuit split that developed over those requirements and the Supreme Court’s ultimate resolution of the issue. It then focuses on attempts to plead scienter through different means, including Sarbanes-Oxley certifications and GAAP violations. See also, Section III.A.12 below for related discussion. a. Heightened Pleading Standard The Reform Act requires the complaint to “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2) (emphasis added). This requirement applies to “each act or omission alleged to violate this chapter.” Id. § 78u-4(b)(2). b. Following The PSLRA, The Circuits Split As To The Stringency Of The “Strong Inference” Standard Following the passage of the Reform Act in 1995, the Circuits interpreted the pleading requirements of the PSLRA in different ways. The Ninth Circuit adopted the strictest pleading requirements of the circuits, holding that the Reform Act significantly raised the pleading standards in securities fraud lawsuits both as to the specificity required of fraud allegations and as to the scienter requirement. In In re Silicon Graphics Inc, Securities Litigation, 183 F.3d 970, 974 (9th Cir. 1999), the Ninth Circuit held that plaintiffs “must plead, in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious

misconduct” to satisfy the PSLRA. See also In re Read-Rite Corp., 335 F.3d 843, 846, 848 n.1 (9th Cir. 2003) (noting the Ninth Circuit’s continuing adherence to the pleading standards of In re Silicon Graphics Inc.). By contrast, the Second Circuit took a more lenient approach, finding that the Reform Act’s scienter pleading standard simply codified the Second Circuit’s “motive and opportunity” standard used prior to the Reform Act. Levitt v. Bear Stearns & Co., Inc., 340 F.3d 94, 104 (2d Cir. 2003) (stating that the PSLRA scienter pleading requirement “is essentially a codification of [the Second Circuit’s] decisions interpreting Rule 9(b)”); Novak v. Kasaks, 216 F.3d 300, 313-14 (2d Cir. 2000). The Third Circuit followed this approach, finding that the “strong inference” language in the statute suggested that Congress intended to codify the Second Circuit’s approach. In re Advanta Corp. Sec. Litig., 180 F.3d 525 (3d Cir. 1999). The other circuits followed a middle ground – adopting stricter pleading requirements than those required by the Second and Third Circuits but less strict than required by the Ninth Circuit. See, e.g., Greebel, 194 F.3d 185; Nathenson v. Zonagen, Inc., 267 F.3d 400, 409-11 (5th Cir. 2001); Helwig v. Vencor, Inc., 251 F.3d 540, 550 (6th Cir. 2001); Makor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588 (7th Cir. 2006), vacated by 551 U.S. 308 (2007); In re Navarre Corp. Sec. Litig., 299 F.3d 735, 745 (8th Cir. 2002); City of Philadelphia v. Fleming Cos. Inc., 264 F.3d 1245, 1262 (10th Cir. 2001); Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1283 (11th Cir. 1999), rev’d sub nom., Bryant v. Dupree, 252 F.3d 1161 (11th Cir. 2001). Notably, courts in these circuits often found that what constitutes a “strong inference” of scienter depends on the facts and circumstances of each case and thus emphasized the need to examine the “totality of the pleadings.” See, e.g., Abrams v. Baker Hughes, Inc., 292 F.3d 424, 431 (5th Cir. 2002) (“The appropriate analysis . . . is to consider whether all facts and circumstances ‘taken together’ are sufficient to support the necessary strong inference of scienter on the part of the plaintiffs.”); Navarre, 299 F.3d at 745 (“[The scienter] standard is not satisfied by any one particular method, such as the motive and opportunity formulation adopted by the Second Circuit, but rather through various criteria developed throughout the circuits that look for badges of fraud” (citations omitted)). Even the courts following this “middle ground” disagreed with each other as to whether plaintiffs were entitled to the most plausible of competing inferences available from the facts in the complaint (see, for example, Helwig) or, in the alternative, whether a court should allow the complaint to survive if it alleges facts raising merely a reasonable inference of fraudulent intent. c. The Supreme Court Resolves The Split In Tellabs The Supreme Court addressed the heightened standard for pleading scienter under the Reform Act and the split that had developed among the circuits in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007). The Court laid out a three-step approach that should be followed in considering a motion to dismiss in a securities class action case. First, a court must accept all factual allegations in the complaint as true. Id. at 322. Second, the court must consider the complaint in its entirety, as well as other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions. “The inquiry is whether . . . all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard.” Id. at 322-23. Third, “in determining whether the pleaded facts give rise to a ‘strong’ inference of scienter, the court must take into account plausible opposing inferences.” Id. at 323. As to this third requirement, “[t]o determine whether the plaintiff has alleged facts that give rise to the requisite ‘strong inference,’ a court must consider plausible nonculpable explanations for the defendant’s conduct, as well as inferences favoring the plaintiff.” Id. at 323-24. “The inference that the defendant acted with scienter need not be irrefutable, . . . but it must be more than merely ‘reasonable’ or ‘permissible’ — it must be cogent and compelling, thus strong in light of other explanations.” Id. at 324. “A complaint will survive only if a

reasonable person would deem the inference of scienter cogent and at least as compelling as any plausible opposing inference one could draw from the facts alleged.” Id. Recent decisions applying Tellabs at both the district and appellate court levels suggest that pleading scienter will be harder for plaintiffs in some circuits while potentially easier in others. The question of the proper pleading standard for scienter post-Tellabs is discussed in detail at Section III.A.7, infra. d. Statements Of Present Or Historical Fact Plaintiffs must allege that defendants had the requisite scienter at the same time they made an allegedly false or misleading statement or failed to disclose something material. GSC Partners CDO Funds v. Washington, 368 F.3d 228, 239 (3d Cir. 2004); In re Navarre Corp. Sec. Litig., 299 F.3d 735, 743 (8th Cir. 2002) (explaining that plaintiffs’ amended complaint failed to indicate why statements about a planned initial public offering would have been false or misleading when allegedly made); In re Sofamor Danek Group, Inc., 123 F.3d 394, 401 n.3 (6th Cir. 1997) (noting that a violation of the federal securities laws cannot be premised upon a company’s disclosure of accurate historical data); In re Vertex Pharms. Inc., Sec. Litig., 357 F. Supp. 2d 343 (D. Mass. 2005) (holding that while motive evidence alone is insufficient to satisfy the scienter requirement, unusually strong financial incentives may be relevant when considered in combination with other factors to show scienter); Menkes v. Stolt-Nielsen S.A., 2005 WL 3050970, at *11 (D. Conn. Nov. 10, 2005) (explaining that without facts that show a flow of information from subsidiary to parent corporation or how parent monitored subsidiary, plaintiffs cannot establish the requisite scienter of parent for subsidiary’s alleged fraud). Moreover, the accurate reporting of historic successes does not give rise to a duty to further disclose contingencies that might alter the revenue picture in the future. McDonald v. Kinder-Morgan, Inc., 287 F.3d 992, 998 (10th Cir. 2002). e. Heightened Scienter Standard For Forward-Looking Statements Even when a forward-looking statement lacks sufficient cautionary language to place it within the Reform Act’s safe harbor, the statement will still receive the benefit of a heightened pleading standard. In such a case, unless a plaintiff pleads specific facts demonstrating that defendants had actual knowledge of the falsity of challenged statements, there is no liability as a matter of law. See 15 U.S.C. § 78u-5(c)(1)(B); id. § 77z-2(c)(1)(B) (finding no liability for any forward-looking statement “if … plaintiff fails to prove that [it] was made with actual knowledge … that the statement was false or misleading”); Johnson v. Tellabs, Inc., 303 F. Supp. 2d 941, 955 (N.D. Ill. 2004) (stating that a forward-looking statement will be actionable against a corporation only if plaintiffs plead with particularity facts that strongly indicate that defendants had actual knowledge that their statements were false or misleading when made); In re Globalstar Sec. Litig., No. 01 CIV. 1748 (SHS), 2003 WL 22953163, at *9 (S.D.N.Y. Dec. 15, 2003) (finding the safe harbor inapplicable to projections of future performance that were not believed to be true by the speaker at the time they were made). f. Use Of Sarbanes-Oxley Certifications To Plead Scienter Because the Sarbanes-Oxley Act requires certification of financial statements and internal controls, such certifications provide convenient grounds for plaintiffs to allege that a given defendant must have known of an alleged financial fraud. This has become an active area of litigation at the motion to dismiss stage. Thus far, these allegations have not fared well. See Cent. Laborers’ Pension Fund v. Integrated Elec. Servs. Inc., 497 F.3d 546, 555 (5th Cir. 2007) (mere fact that officers signed a Sarbanes-Oxley Act certification did not establish a strong inference of scienter, “otherwise scienter would be established in every case where there was an accounting error or an auditing mistake made by a publicly traded company, which would eviscerate the [PSLRA’s] pleading requirements for scienter”); Deephaven Private Placement Trading, Ltd. v. Grant Thornton & Co., 454 F.3d 1168 (10th Cir. 2006) (holding that mere certification of financial statements is not a

material misstatement under 18(a) rendering an independent auditor liable); In re BearingPoint, Inc. Sec. Litig., 525 F. Supp. 2d 759 (E.D. Va. 2007) (explaining knowingly or recklessly signing Sarbanes-Oxley Certifications attesting to accuracy of information in SEC filings is not enough to demonstrate scienter; there must be “other alleged facts establishing that the signor recklessly ignored ‘red flags’ that the attested-to financial statements contained material falsities”). But see In re Lattice Semiconductor Corp. Sec. Litig., No. CV04-1255-AA, 2006 U.S. Dist. LEXIS 262, *50-51 (D. Or. Jan. 3, 2006) (“Sarbanes-Oxley certifications, in combination with plaintiffs’ allegations of regular finance meetings, extensive access to databases, period reports and special reports, and the allegations they were micromanagers, are sufficient to create a strong inference of actual knowledge or of deliberate recklessness.”). g. Use Of GAAP Violations To Plead Scienter Financial statements made in violation of GAAP may be found to be misleading or inaccurate under the federal securities laws. See In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006 (9th Cir. 2005). However, where alleged GAAP violations are the premise of a claimed violation of Rule 10b-5, plaintiffs must clear significant pleading hurdles. In most circuits, “allegations of GAAP violations or accounting irregularities, standing alone, are insufficient to state a securities fraud claim. Only where such allegations are coupled with evidence that the violations or irregularities were the result of the defendant’s fraudulent intent to mislead investors may they be sufficient to state a claim.” City of Phila. v. Fleming Cos., 264 F.3d 1245, 1261 (10th Cir. 2001) (citing Novak v. Kasaks, 216 F.3d 300, 309 (2d Cir. 2000)); see also Stevelman v. Alias Research, Inc., 174 F.3d 79, 84 (2d Cir. 1999); Chill v. Gen. Elec. Co., 101 F.3d 263, 270 (2d Cir. 1996); Abrams v. Baker Hughes, Inc., 292 F.3d 424, 430 (5th Cir. 2002); Melder v. Morris, 27 F.3d 1097, 1103 (5th Cir. 1994); Kushner v. Beverly Enter., Inc., 317 F.3d 820, 831 (8th Cir. 2003); In re K-Tel Int’l, Inc. Sec. Litig., 300 F.3d 881 (8th Cir. 2002); In re Navarre Corp. Sec. Litig., 299 F.3d 735, 745 (8th Cir. 2002); In re FVC.com Sec. Litig., 32 F. App’x 338, 341 (9th Cir. 2002); Colin v. Onyx Acceptance Corp., 31 F. App’x 359, 361 (9th Cir. 2002); In re Software Toolworks Inc., 50 F.3d 615, 627-28 (9th Cir. 1994); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir. 1994). Various courts have elaborated on what is required to show scienter based on violations of GAAP.

1) Misapplication Of Accounting Principles The Ninth Circuit has held: Scienter requires more than a misapplication of accounting principles. The plaintiff must prove that the accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious or to investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts. DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 390 (9th Cir. 2002) (citing In re Software Toolworks Inc., 50 F.3d 615, 627-28 (9th Cir. 1994)); see also S.E.C. v. Sandifur, No. C05-1631C, 2006 WL 538210 (W.D. Wash. Mar. 2, 2006) (holding that although violations of GAAP alone are insufficient to show scienter, the complaint satisfactorily alleged that, based on defendant’s training and position in the company, he knew or was reckless in not knowing of improper revenue recognition); Hughes v. Huron Consulting Group, Inc., 2010 U.S. Dist. LEXIS 100561 (N.D. Ill. Aug. 6, 2010) (scienter could be inferred as to allegations of improper accounting for goodwill where defendants were expert accountants and allegedly knew of side letters regarding reallocations of goodwill disproportionate to ownership).

2) Red Flags The Sixth Circuit held in In re Comshare Inc. Sec. Litig. that, to create a strong inference of recklessness, plaintiffs must allege “specific facts that illustrate ‘red flags’ that should have put Defendants on notice” of accounting errors. 183 F.3d 542, 553 (6th Cir. 1999). Other courts, however, have rejected the sufficiency of such “red flags” in pleading scienter. See DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 389-91 (9th Cir. 2002) (although “red flags” should have put defendant on notice, allegations insufficient to establish strong inference of deliberate recklessness); Chill v. Gen. Elec. Co., 101 F.3d 263, 266, 269-70 (2d Cir. 1996) (alleged red flags may have been warnings to internal auditors or outside accountants but do not constitute intentional, knowing or reckless activity); In re US Aggregates, Inc. Sec. Litig., 235 F. Supp. 2d 1063, 1073 (N.D. Cal. 2002) (citing DSAM, 288 F.3d at 389) (“[E]ven an obvious failure to follow GAAP does not give rise to an inference of scienter. Appellants [must] allege … facts to establish that [the defendant] knew or must have been aware of the improper revenue recognition, intentionally or knowingly falsified the financial statements, or that the audit was such an extreme departure from reasonable accounting practice that [the defendant] knew or had to have known that its conclusions would mislead investors.”); Reiger v. PriceWaterhouseCoopers LLP, 117 F. Supp. 2d 1003 (S.D. Cal. 2000), aff’d, 288 F.3d 385 (9th Cir. 2002) (finding red flag allegations insufficient to raise an inference of scienter).

3) Magnitude Of The Restatement Despite the rejection of “red flag” pleading by some courts, others have found that truly egregious GAAP violations may compel an inference of scienter. See, e.g., In re MicroStrategy, Inc. Sec. Litig., 115 F. Supp. 2d 620, 636-37 (E.D. Va. 2000) (“[T]he greater the magnitude of a restatement or violation of GAAP, the more likely it is that such … violation was made consciously or recklessly … [S]ome violations of GAAP and some restatements of financials are so significant that they, at the very least, support the inference that conscious fraud or recklessness as to the danger of misleading the investing public was present.”); In re The Baan Co. Sec. Litig., 103 F. Supp. 2d 1, 21 (D.D.C. 2000); Chalverus v. Pegasys., Inc., 59 F. Supp. 2d 226, 233-36 (D. Mass. 1999). Other courts have declined to find that a strong inference of scienter can be alleged through the magnitude of the restatement. See, e.g., Fidel v. Farley, 392 F.3d 220, 231 (6th Cir. 2004) (declining to follow cases which hold that magnitude of accounting violations contributes to strong inference of auditor’s scienter; doing so “would eviscerate the principle that accounting errors alone cannot justify a finding of scienter”); In re Ramp Networks, Inc. Sec., 201 F. Supp. 2d 1051, 1071-72 (N.D. Cal. 2002) (dismissing without leave to amend for failure to establish scienter, despite plaintiff’s reliance on “indicia of scienter,” including the magnitude of the accounting error at issue); Svezzese v. Duratek, Inc., No. 01-CV-1830, 2002 WL 1012967, at *7 (D. Md. Apr. 30, 2002), aff’d, 67 F. App’x 169 (4th Cir. 2003) (“[The company] did not disguise a failing company or wipe years’ worth of reported profits. Even after being restated, Duratek’s financials showed a profit during each of the three quarters at issue.”).

4) Misstated Earnings Figures Some courts have distinguished GAAP violations where the allegations consist “merely of questionable bookkeeping practices” from inaccuracies in earnings figures, which “are vital aspects of ‘the total mix of information’ [that] investors would consult.” In re Cabletron Sys., Inc., 311 F.3d 11, 35 (1st Cir. 2002). Specifically, some courts have found that significant overstatements in revenue provide the requisite inference of scienter. See, e.g., Malone v. Microdyne Corp., 26 F.3d 471, 478 (4th Cir. 1994); Chalverus v. Pegasys., Inc., 59 F. Supp. 2d 226, 234 (D. Mass. 1999); Marksman Partners v. Chantal Pharm. Corp., 927 F. Supp. 1297, 1314 (C.D. Cal. 1996).

5) Simplicity Of Accounting Rules Violated The court in MicroStrategy also looked to the complexity of the accounting policies allegedly violated. The court noted that misstated financials and repetitive GAAP violations “take[] on added significance if . . . the violated GAAP rules are . . . relatively simple.” In re MicroStrategy, Inc. Sec. Litig., 115 F. Supp. 2d 620, 638 (E.D. Va. 2000). In other words, “violations of simple rules are obvious, and an inference of scienter becomes more probable as the violations become more obvious.” Id. But see, e.g., Svezzese v. Duratek, Inc., No. CIV. A. MJG-01-CV-1830, 2002 WL 1012967, at *5 (D. Md. Apr. 3, 2002) (distinguishing MicroStrategy because it involved insider trading allegations, which are highly probative of motive); In re Ramp Networks, Inc. Sec., 201 F. Supp. 2d 1051, 1071-72 (N.D. Cal. 2002) (dismissing complaint with prejudice even though plaintiff had argued that the accounting principle at issue was simple).

6) Indicia Of Fraudulent Intent In General Generally, GAAP violations alone are not sufficient to raise an inference of scienter. See, e.g., In re Ceridian Corp. Sec. Litig., 542 F.3d 240 (8th Cir. 2008); DSAM Global Value Fund v. Altris Software, Inc., 288 F.3d 385, 387 (9th Cir. 2002) (even an obvious failure to follow GAAP insufficient to raise scienter). Consequently, the admission of a failure to follow GAAP, usually in the form of a restatement of financials, is alone insufficient to raise the requisite inference of scienter. See Chill v. Gen. Elec. Co., 101 F.3d 263, 270 (2d Cir. 1996); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1426 (9th Cir. 1994); In re Peritus Software Servs., Inc. Sec. Litig., 52 F. Supp. 2d 211, 223 (D. Mass. 1999); In re Orbital Scis. Corp. Sec. Litig., 58 F. Supp. 2d 682, 687 (E.D. Va. 1999). 8. Non-Speaking Defendants And Group Pleading a. Overview Of Tactics And the Doctrine One goal of a motion to dismiss should be to narrow the number of individual defendants in the lawsuit. Plaintiffs typically name numerous officers and directors as defendants – including outside directors and less senior officers – simply because they sold stock during the alleged class period, in order to plead the greatest possible amount of insider trading. To the extent that certain individual defendants did not make any of the alleged false or misleading statements in the complaint, defendants should consider moving to dismiss these “non-speaking” defendants. However, winning these dismissals can prove difficult. Consider In re Salomon Analyst AT&T Litig., 350 F. Supp. 2d 455 (S.D.N.Y. 2004), where the CEO of Central Bank was held primarily liable for misrepresentations even though he made no statement, but “orchestrated and directly ordered a false representation.” Id. at 474. Plaintiffs usually rely on the traditional “group pleading” doctrine to argue that all defendants — including nonspeaking defendants — are liable for all of the corporate statements made. This doctrine presumes that corporate publications are the result of collective action, so that, at the pleading stage, a plaintiff may allege that misstatements in a group-published document, e.g., an SEC filing or press release, are attributable to the entire group of defendants. This doctrine is alternatively called the group published doctrine. In re Intelligroup Sec. Litig., 527 F. Supp. 2d 262, 281 n.8 (D.N.J. 2007). As discussed below, the Reform Act is in tension with the “group pleading” notion and arguably abolished it. The group pleading doctrine was first established in the Ninth Circuit in Wool v. Tandem Computers, Inc., which allowed plaintiffs to allege liability against several defendants based on group-published documents as long as plaintiffs allege, “where possible[,] the roles of the individual defendants in the misrepresentation.” 818 F.2d 1433, 1440 (9th Cir. 1987). Therefore, allegations that individuals signed a corporate statement may be

sufficient. See also In re GlenFed, Inc. Sec. Litig., 60 F.3d 591, 593 (9th Cir. 1995) (requiring complaint to sufficiently allege that outside directors or underwriters “either participated in the day-to-day corporate activities, or had a special relationship with the corporation, such as participation in preparing or communicating group information at particular times”); S.E.C. v. Yuen, 221 F.R.D. 631, 637 (C.D. Cal. 2004) (because the group pleading doctrine is grounded in reasonableness, a court will consider the day-to-day involvement of each defendant); Irvine v. ImClone Sys. Inc., No. 02 CIV 109 RO, 2003 WL 21297285, at *2 (S.D.N.Y. June 4, 2003) (“This doctrine ‘is extremely limited in scope. And courts in the Second Circuit and elsewhere have construed the doctrine as applying only to clearly cognizable corporate insiders with active daily roles in the relevant companies or transactions.’” (quoting Jordan (Bermuda) Inv. Co., Ltd. v. Hunter Green Inv. Ltd., 205 F. Supp. 2d 243, 253 (S.D.N.Y. 2002)). A narrow exception to the group pleading doctrine “exists where the information necessary is uniquely within the defendants’ knowledge.” In re Marsh & McLennan Cos., Inc. Sec. Litig., 501 F. Supp. 2d 452 (S.D.N.Y. 2006) (discussing what actions and statements can be attributed to the company based on actions of employees, and what actions and statements can be attributed to management based on actions of employees and subsidiaries). It should also be noted that at least some courts do not apply the group pleading doctrine in certain circumstances. One involves distinct corporate entities. Thus, courts have rejected attempts to impute the knowledge of a subsidiary to its parent corporation or to aggregate the knowledge of two subsidiaries by virtue of common ownership. Defer LP v. Raymond James Fin., Inc., 654 F. Supp. 2d 204, 218-19 (S.D.N.Y. 2009); cf. Kahn v. Ran, 2009 WL 1138504, at *7 (E.D. Mich. Apr. 27, 2009) (finding plaintiffs pled sufficient particularity in part because “even where group pleading is not permitted, it only applies to individuals, not to multiple entities controlled by the same individual”). Courts will not usually apply the group pleading doctrine with respect to an oral statement. Defer, 654 F. Supp. 2d at 213-14; In re Vivendi Universal, S.A. Sec. Litig., 381 F. Supp. 2d 158, 191 (S.D.N.Y. 2003). Instead, courts have limited the doctrine’s application to “prospectuses, registration statements, annual reports, press releases, or other group-published information that may be presumed to be the collective work of corporate insiders.” Id.; Elliot Assocs., LP v. Covance, Inc., 2000 WL 1752848, at *12 (S.D.N.Y. Nov. 28, 2000). Finally, the group pleading doctrine is just that: a doctrine for determining the sufficiency of a plaintiff’s pleading. Courts have almost unanimously rejected its application at the summary judgment phase. By then plaintiffs will have had the opportunity to discover which specific defendants were liable for the alleged misstatements. Bains v. Moores, 172 Cal. App. 4th 445, 474-76 (2009). Courts that have turned the doctrine into substantive law, Golden v. Terre Linda Corp., 1996 WL 426760, at *6 (N.D. Ill. 1996), or an evidentiary presumption, In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746, 759 (N.D. Cal. 1997), have been roundly criticized. Bains, 172 Cal. App. 4th at 475-76. b. Did The Reform Act Abolish Group Pleading? The Reform Act heightened the pleading standards for scienter, such that plaintiffs must now plead “with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2) (emphasis added). By focusing on each defendant’s intent, the Reform Act appears to override the group pleading presumption. But whether it did so went unanswered in most jurisdictions for many years. E.g., Selbst v. McDonald’s Corp., No. 04 C 2422, 2005 WL 2319936, at *5 (N.D. Ill. Sept 21, 2005) (explaining that while the Seventh Circuit has not ruled on whether the group pleading doctrine survives the enactment of the PSLRA, the court is “unwilling to hold that the PSLRA abolished it”); In re AFC Enter. Inc. Sec. Litig., 348 F. Supp. 2d 1363, 1371 (N.D. Ga. 2004) (“The Eleventh Circuit has yet to take a firm position on the continued vitality of the doctrine, [which] remains persuasive provided that application of the doctrine is kept within proper bounds.”); In re Aetna Inc. Sec. Litig., 34 F. Supp. 2d 935, 949 n.7 (E.D. Pa. 1999) (“[I]t is unclear whether the group pleading doctrine survives under the PSLRA.”). But see In re Pfizer Inc. Sec. Litig., 584 F. Supp. 2d 621, 641 (S.D.N.Y 2008) (holding that group pleading survived the PSLRA

despite the lack of a definitive Second Circuit decision on the issue). The Fifth Circuit was the first federal appeals court to expressly reject the “group pleading doctrine” in light of the Reform Act. In Southland Securities Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353 (5th Cir. 2004), the court stated that: The “Group Pleading” doctrine conflicts with the scienter requirements of the PSLRA . . . . [T]he PSLRA requires the plaintiffs to “distinguish among those they sue and enlighten each defendant as to his or her particular part in the alleged fraud.” As such, corporate officers may not be held responsible for unattributed corporate statements solely on the basis of their titles, even if their general level of dayto-day involvement in the corporation’s affairs is pleaded. Id. at 363-65; see also Fin. Acquisition Partners L.P. v. Blackwell, 440 F.3d 278 (5th Cir. 2006) (applying Southland to uphold dismissal of complaint); This decision followed a number of district court decisions reaching the same conclusion. See In re Enron Corp. Sec. Deriv. & ERISA Litig., No. MDL-1446, 2003 WL 230688, at *7 (S.D. Tex. Jan. 28, 2003) (rejecting group pleading doctrine); Schiller v. Physicians Res. Group, Inc., No. CIV. A. 3:97-CV-3158-L, 2002 WL 318441, at *5 (N.D. Tex. Feb. 26, 2002), aff’d, 342 F.3d 563 (5th Cir. 2003) (same). The Third Circuit has also rejected the doctrine. It recently considered the group pleading doctrine in Winer Family Trust v. Queen, 503 F.3d 319, 336-37 (3d Cir. 2007). Noting that “[t]he only courts of appeals to have directly addressed the survival of the group pleading doctrine post-PSLRA have abolished the doctrine,” the court expressly stated “[w]e agree and hold the group pleading doctrine is no longer viable in private securities actions after the enactment of the PSLRA.” Id. The court also pointed out that although the Supreme Court had not addressed the group pleading doctrine in Tellabs, neither did it “disturb” the Seventh Circuit’s holding that “the group pleading doctrine did not survive the enactment of the PSLRA.” Id. at 335 (citing Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 326 n.6 (2007)). But see Silverman v. Motorola, Inc., 2008 WL 4360648, at *14 (N.D. Ill. Sept. 23, 2008) (finding a “strong inference” of scienter where plaintiffs pled that based on defendants’ high-ranking positions within the company, they “should have known” about delays and setbacks associated with new product rollout, as it was “almost inconceivable these defendants were not aware of the production problems”). Outside of these circuits, a majority of post-Reform Act district court cases appears to have rejected group pleading. For example, courts in the Ninth Circuit have rejected the doctrine in light of the PSLRA. In Allison v. Brooktree Corp., 999 F. Supp. 1342, 1350 (S.D. Cal. 1998), the court stated that “the continued vitality of the judicially created group-published doctrine is suspect since the PSLRA specifically requires that untrue statements or omissions be set forth with particularity as to ‘the defendant’ and that scienter be plead in regards to ‘each act or omission’ sufficient to give ‘rise to a strong inference that the defendant acted with the required state of mind.’” Id. (citing 15 U.S.C. § 78u-4(b)). The court stated further that “[t]o permit a judicial presumption as to particularity simply cannot be reconciled with the statutory mandate that plaintiffs must plead specific facts as to each act or omission by the defendant.” Id. Thus, the court directed that should the plaintiff decide to file an amended complaint, he or she must plead specific facts regarding misleading statements and omissions by each defendant. Id. Similarly, in In re Dura Pharmaceuticals, Inc. Securities Litigation, 452 F. Supp. 2d 1005 (S.D. Cal. 2006), the court observed that, although the Ninth Circuit has not opined on the issue, courts in California have held that the group pleading doctrine does not survive the PSLRA. See also In re Marvell Tech. Group Ltd. Sec. Litig., 2008 WL 4544439, at *3 (N.D. Cal. Sept. 29, 2008) (following lines of cases holding that “the group pleading doctrine can no longer be used in cases under the PSLRA”); In re Nextcard, Inc. Sec. Litig., No. C 01-21029, 2006 WL 708663, at *3 (N.D. Cal Mar. 20, 2006) (holding that group published pleading doctrine is no longer viable after the PSLRA and that it appears to be “totally inconsistent with the particularity requirements of the PSLRA” (citing Southland Sec. Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353, 365 (5th Cir. 2004)). Several district courts in other circuits have also rejected the doctrine. See, e.g., In re Huffy Corp. Sec. Litig.,

577 F. Supp. 2d 968, 986 (S.D. Ohio 2008) (group pleading doctrine is “antithetical” to the pleading requirements of the PSLRA); In re Cross Media Marketing Corp. Sec. Litig., 314 F. Supp. 2d 256, 262 (S.D.N.Y. 2004) (“The [PSLRA’s] use of the singular ‘defendant’ counsels against group pleading in actions arising in securities fraud cases since the enactment of the PSLRA.”); Bond Opportunity Fund v. Unilab Corp., No. 99 CIV. 11074 (JSM), 2003 WL 21058251, at *4 (S.D.N.Y. May 9, 2003), aff’d, 87 F. App’x 772 (2d Cir. 2004) (“[W]ith respect to the individual directors, the PSLRA has eliminated the ‘group pleading’ doctrine. Therefore, Plaintiffs may not impute knowledge to the individual Defendants solely on the basis of the positions they held.”); In re Cable & Wireless, PLC, Sec. Litig., 321 F. Supp. 2d 749, 773 (E.D. Va. 2004) (noting that the Fourth Circuit has held the group pleading doctrine goes against the grain of the particularity requirement of the PSLRA). In courts that continue to allow group pleading, defendants can argue that plaintiffs must plead with greater specificity facts supporting application of the doctrine. See Molinari v. Symantec Corp., No. C-97-20021-JW, 1998 WL 78120, at *11 (N.D. Cal. Feb. 17, 1998) (“Because Plaintiffs cannot satisfy even the presumptively lower group pleading standard the Court need not consider at this time whether Congress implicitly rejected the group pleading standard by passing the Reform Act.”); see also In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1411 (9th Cir. 1996) (finding factual allegations insufficient to support application of the group pleading doctrine); In re Spiegel, Inc. Sec. Litig., 382 F. Supp. 2d 989, 1018 (N.D. Ill. 2004) (“Group pleading may be appropriate in certain circumstances notwithstanding the PSLRA, as long as the complaint sets forth facts demonstrating that each defendant may be responsible for the fraudulent statements.”); Johnson v. Tellabs, Inc., 262 F. Supp. 2d 937, 946-47 (N.D. Ill. 2003) (“Even if the group pleading doctrine survives the PSLRA in some form[,] . . . plaintiff is . . . required at least to include allegations in the complaint relating to an individual defendant’s duties or legal obligations that create a presumption that the company’s statement was somehow caused by or attributable to an individual defendant.”). Despite what appears to be a consensus towards rejecting group pleading, some cases have nonetheless allowed it. In In re Sensormatic Electronics Corp. Sec. Litig., No. 018346, 2002 WL 1352427, at *4 (S.D. Fla. June 10, 2002), the court held that, under the group pleading doctrine, a securities fraud plaintiff may impute false and misleading statements appearing in annual reports, quarterly reports, press releases, or other “group published” information to all inside corporate officers and directors who are presumed to have knowledge of and involvement in the day-to-day affairs of the company. Id. (noting that the Eleventh Circuit has not yet addressed whether the group pleading doctrine is viable under the PSLRA); In re Pegasus Wireless Corp. Sec. Litig., 657 F. Supp. 2d 1320, 1325 (S.D. Fla. 2009) (allowing group pleading doctrine provided “[p]laintiffs make the specific factual allegation that [defendant], due to his high ranking position and direct involvement in the everyday business of the Company, was directly involved in controlling the content of the statements at issue”); see also In re Take-Two Interactive Sec. Litig., 551 F. Supp. 2d 247, 267 n.10 (S.D.N.Y. 2008) (noting that while the validity of the group pleading doctrine after the PSLRA has been questioned, “the majority of courts in this District has determined that the doctrine survived the PSLRA’s enactment”); McGuire v. Dendreon Corp., 2008 U.S. Dist. LEXIS 65436, at *6 (W.D. Wash. April 18, 2008) (reaffirming that the group pleading doctrine survived enactment of the PSLRA); In re NPS Pharms., Inc. Sec. Litig., No. 2:06-cv-00570, 2007 WL 1976589, at *5 (D. Utah July 3, 2007) (finding allegations sufficient under the “group-published” doctrine where plaintiff claimed all defendants had power to control the contents of market statements); Grubka v. WebAccess Int’l, 445 F. Supp. 2d 1259 (D. Colo. 2006); In re McLeodUSA, Inc., No. C02-001-MWB, 2004 WL 1070570, at *4 (N.D. Iowa Mar. 31, 2004) (“The court concurs with the majority of courts that have held that the rationale behind the group pleading doctrine remains sound in the wake of the passage of the Reform Act.”); Schnall v. Annuity & Life re (Holdings), Ltd., No. 3:02 CV 2133 (GLG), 2004 WL 515150, at *4 (D. Conn. Mar. 9, 2004) (noting that the PSLRA does not affect the vitality of the group pleading doctrine); In re Sprint Corp. Sec. Litig., 232 F. Supp. 2d 1193, 1225 (D. Kan. 2002) (noting that the Tenth Circuit recognizes the group pleading doctrine); Benedict v. Cooperstock, 23 F. Supp. 2d 754, 763 (E.D. Mich. 1998) (noting that the group pleading doctrine applies only to official documents such as registration statements and prospectuses); Powers v. Eichen, 977 F. Supp. 1031, 1041 (S.D. Cal. 1997) (applying the group pleading presumption without discussion of the Reform Act); In re Health Mgm’t, Inc. Sec. Litig., 970 F. Supp. 192, 208 (E.D.N.Y. 1997) (same).

9. Other Procedural Considerations At The Motion To Dismiss Stage a. Documents The Court May Consider On A Motion to Dismiss Courts will generally consider documents beyond the complaint in deciding motions to dismiss in securities cases. For example, several circuits permit defendants to raise and rely on statements in a prospectus or offering memorandum even if the plaintiff did not incorporate or annex the documents to the complaint. See Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47 (2d Cir. 1991); Kramer v. Time Warner Inc., 937 F.2d 767, 774 (2d Cir. 1991) (stating that, in merger litigation, the court could judicially notice an Offer to Purchase and Joint Proxy Statement because under the circumstances such documents, which are required to be filed with the SEC, are “capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned” (citing Fed. R. Evid. 201(b)(2))); Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1276 (11th Cir. 1999), rev’d sub nom., Bryant v. Dupree, 252 F.3d 1161 (11th Cir. 2001) (approving of Cortec and Kramer and taking judicial notice of SEC filings); In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1405 n.4 (9th Cir. 1996) (“The district court considered the full text of the Prospectus, including portions which were not mentioned in the complaints. We note that such consideration is appropriate in the context of a motion to dismiss.”); I. Meyer Pincus & Assocs., P.C. v. Oppenheimer & Co., 936 F.2d 759 (2d Cir. 1991). Other SEC filings, including Forms 3 and 4, are common subjects of judicial notice. See In re Silicon Graphics Inc. Sec. Litig., 970 F. Supp. 746, 768 (N.D. Cal. 1997) (taking judicial notice of Forms 3 and 4); Plevy v. Haggerty, 38 F. Supp. 2d 816, 821 (C.D. Cal. 1998) (taking judicial notice of SEC filings). Judicial notice in securities class actions often extends far beyond public filings. For example, the Ninth Circuit has held, on a motion for judgment on the pleadings, that a court may “take judicial notice that the market was aware of the information contained in news articles submitted by the defendants.” Heliotrope Gen., Inc. v. Ford Motor Co., 189 F.3d 971, 980-81 & n.18 (9th Cir. 1999). Also, if plaintiff clearly based its allegation on materials not cited in the complaint, then judicial notice of the materials may be available. See Iron Workers Loc. 16 Pens. v. Hilb Rogal & Hobbs, 432 F. Supp. 2d 571 (E.D. Va. 2006) (finding it proper to consider analyst reports in considering motion to dismiss because plaintiff clearly based allegations found in complaint on a review of press releases, media reports, and general insider knowledge). But see Faulkner v. Beer, 463 F.3d 130 (2d Cir. 2006) (vacating district court’s dismissal of complaint because court had considered documents outside the complaint that involved disputed issues of material fact). b. Mandatory Sanctions Under PSLRA For Frivolous Securities Fraud Claims Frivolous securities law claims are sanctionable under the PSLRA. See 15 U.S.C. § 78u-4(c). Following final adjudication of the action, the district court must “record specific findings” regarding each party’s and each attorney’s compliance with Rule 11(b). Id. § 78u-4(c)(1). “If the court makes a finding . . . that a party or attorney violated any requirement of Rule 11(b) . . . as to any complaint, responsive pleading, or dispositive motion, the court shall impose sanctions . . . in accordance with Rule 11.” Id. § 78u-4(c)(2); see, e.g., De La Fuente v. DCI Telecomms., Inc., 82 F. App’x 723 (2d Cir. 2003) (sanctioning under PSLRA plaintiff’s frivolous arguments against defendant’s assertion of time-barred defense). But see Khan v. Park Capital Sec., LLC, No. C 03 00574, 2004 WL 1753385 (N.D. Cal. Aug. 5, 2004) (finding Rule 11 and Reform Act sanctions against plaintiff’s counsel inappropriate notwithstanding dismissal of complaint completely devoid of any factual allegations). The Second Circuit has held that the standard for determining sanctions under the PSLRA is one of “objective unreasonableness on the part of the attorney or client signing the papers.” ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 579 F.3d 143, 150-52 (2d Cir. 2009). The court need not find subjective bad faith. Id. at 52. c. Leave To Amend Federal Rule of Civil Procedure 15(a) provides that after a party has amended a pleading once as a matter of

course, it may amend further only by leave of court or consent of the adversary, but that “leave shall be freely given when justice so requires.” Foman v. Davis, 371 U.S. 178 (1962) is typically cited as guidance regarding the factors a district court should consider in deciding whether to grant leave to amend. In securities cases, both district courts and courts of appeal have created a broad spectrum of decisions on the question whether leave to amend should be granted or a denial of leave to amend should be affirmed. For example, the Ninth Circuit in Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048 (9th Cir. 2003) said that a district court’s failure to consider the Foman factors and articulate why dismissal should be with prejudice may constitute an abuse of discretion (id. at 1052) and that adherence to the principle of liberal amendment is especially important in the context of the Reform Act because meeting the Act’s exacting pleading standards “can be a matter of trial and error.” Id. Interestingly, plaintiff in Aspeon was not ultimately helped by the opportunity to practice trial and error, inasmuch as the dismissal of its amended complaint on remand was affirmed by the memorandum opinion of a different Ninth Circuit panel. 168 Fed. Appx. 836. Other courts, however, have held plaintiffs to a higher standard. In In re Novastar Financial Inc. Sec. Litig., 579 F.3d 878, 884-85 (8th Cir. 2009), for example, the court affirmed dismissal with prejudice of plaintiffs’ initial complaint, on the ground that a party seeking leave to amend must offer a proposed amended complaint to the district court, since the district court is not required to engage in a “guessing game” as a result of the plaintiff’s failure to specify proposed new allegations. In the wake of the Reform Act, dismissals with prejudice have become far more commonplace when securities plaintiffs have failed to persuade the court that amendment would not be futile. D. Motions For Class Certification To limit potential damages, defendants should challenge the size and definition of a class early and often. If a defendant is able to limit the size of the class (for example, by rebutting the presumption of reliance for one or more subsets of the class or by shortening the class period), the damages – and the settlement value – of the case may be dramatically reduced. Accordingly, class certification can be a critical battleground for securities litigation defendants. See Coopers & Lybrand v. Livesay, 437 U.S. 463, 476 (1978) (“Certification of a large class may so increase the defendant’s potential damages liability and litigation costs that he may find it economically prudent to settle and to abandon a meritorious defense.”). Until fairly recently, class certification was rarely defeated in its entirety in a securities action. Certain class certification rulings, however, suggest that going forward there may be more pressure on plaintiffs at the class certification stage of the litigation. These recent rulings have: (1) increased the amount of evidence plaintiffs must put forth to establish each Rule 23 factor, In re Initial Public Offering Sec. Litig., 471 F.3d 24, 42-43 (2d Cir. 2006) (reversing district court’s order certifying class because it did not have sufficient evidence to determine whether market for securities was efficient and thereby determine whether common questions predominate over individual questions of reliance); (2) required plaintiffs to establish each Rule 23 requirement by a preponderance of the evidence, e.g., Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc., 546 F.3d 196, 202 (2d Cir. 2008); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261, 269 (5th Cir. 2007); (3) allowed courts to resolve factual disputes even if that requires some overlap with the merits, In re IPO, 471 F.3d at 41; and (4) allowed defendants to rebut presumptions of reliance, Oscar Private Equity, 487 F.3d at 269; Regents v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372, 385 (5th Cir. 2007) (reversing district court’s certification of class because defendants owed no duty to plaintiffs and therefore Affiliated Ute presumption could not lie). Together, these class certification decisions may signal a trend towards increasing difficulty for plaintiffs in certifying classes, particularly if any facts call presumptions of reliance into question. But see Bombardier, 546 F.3d at 202 (declining to require district court to conduct a full evidentiary hearing at the class certification stage, emphasizing that class certification motion should not “become a pretext for a partial trial of the merits”).

1. Timing Of Certification Motion And Decision Defendants should consider seeking an early deadline for plaintiff’s class certification motion. See, e.g., In re System Software Assoc., Inc., No. 97 C 177, 2000 WL 283099, at *17 (N.D. Ill. Mar. 8, 2000) (instructing plaintiffs to promptly file motion for class certification). Local rules govern and may require that the party bringing the class action seek certification within a fixed time period. See, e.g., Model Stipulation, N.D. Cal. Rule 23-1 (“Plaintiffs shall file a motion for class certification within thirty (30) days after service of the consolidated complaint.”). However, class certification may conflict with the Reform Act’s stay of proceedings pending a motion to dismiss. (See discussion at Section II.E.2, “Reform Act’s Discovery Stay,” infra). Additionally, defendants should consider limiting pre-class certification discovery to class-related issues in order to avoid the expenses associated with merits discovery, which may become moot should defendants successfully oppose class certification. See, e.g., Krim v. BancTexas Group, Inc., 99 F.3d 775, 777-78 (5th Cir. 1996). a. Dispositive Motions A defendant should take into account the status of class certification in conjunction with the filing of dispositive motions. Rulings prior to class certification bind only the named plaintiffs, at least under pre-Reform Act law. Compare Wright v. Schock, 742 F.2d 541, 544 (9th Cir. 1984) with Frank v. United Airlines, Inc., 216 F.3d 845, 853 & n.6 (9th Cir. 2000) (holding judgment on behalf of class binds those who subsequently come into class if included in certified class, unless not adequately represented); see also Schwarzschild v. Tse, 69 F.3d 293 (9th Cir. 1995) (holding obtaining summary judgment prior to sending class notice waives defendant’s right to compel the class representative to send notice to the absent class members and finding absent class members were not bound by summary judgment). b. Impact Of The Reform Act’s Stay Of Discovery The Reform Act’s stay of “all discovery and other proceedings … during the pendency of any motion to dismiss” could be read to preclude class certification during the pendency of a motion to dismiss. See 15 U.S.C. § 78u-4(b)(3)(B). However, one court has held that this language does not bar certification of a class prior to the determination of a motion to dismiss. In re Diamond Multimedia Sys., Inc., Sec. Litig., No. C 962644 SBA, 1997 WL 773733 (N.D. Cal. Oct. 14, 1997). The Diamond court construed the statutory language “other proceedings” to refer in context only to other discovery-related proceedings and not to “all aspects of the litigation.” Id. at *3 (citing Medhekar v. Dist. Court, 99 F.3d 325, 328 (9th Cir. 1996)). The court had to determine class certification prior to ruling on the motion to dismiss to prevent prejudice to the defendants and the inefficient use of judicial resources from serial lawsuits. Id. 2. The Lead Plaintiff And Class Must Have Article III And Statutory Standing As a threshold inquiry, the plaintiffs must establish that the proposed class has both constitutional and statutory standing to sue. As to Article III standing, the plaintiff must show, among other requirements, that the class has suffered an injury in fact. Elk Grove Unified Sch. Dist. v. Newdow, 542 U.S. 1, 12 (2004). “[A] class will often include persons who have not been injured by the defendant’s conduct; indeed this is almost inevitable because at the outset of the case many of the members of the class may be unknown, or if they are known still the facts bearing on their claims may be unknown. Such a possibility or indeed inevitability does not preclude class certification.” Kohen v. Pac. Inv. Mgm’t Co., 571 F.3d 672, 677 (7th Cir. 2009). Courts have found that a class should not be certified for reasons of standing if (1) the class definition “is so broad that it sweeps within it persons who could not have been injured by the defendant’s conduct” or (2) the class “contains a great many persons who have suffered no injury at the hands of the defendant.” Id. In Kohen,

the court found that the class did have standing because it had no reason to believe that many of the class members were net gainers from the defendant’s alleged market manipulation and because the defendant had not sampled the class to prove that a high percentage were in fact net gainers. Id. at 678-79. Likewise, the class must have express or implied standing under the securities laws. For more on statutory standing, see, for example, infra Section III.A.4. The lead plaintiff or other named plaintiffs may not rely on the standing of absent class members to bootstrap standing for themselves that they otherwise lack. See, e.g., General Tel. Co. of the Southwest v. Falcon, 457 U.S. 147, 156 (1982) (plaintiff must be a member of the class he seeks to represent, i.e., have the same interest and suffer the same injury); Warth v. Seldin, 422 U.S. 490, 502 (1975) (named plaintiffs in a class action must show that they personally have been injured, “not that injury has been suffered by other, unidentified members of the class to which they belong and which they purport to represent”). 3. Required Elements: Federal Rule Of Civil Procedure 23 In addition to standing, the plaintiffs must satisfy all four of Rule 23(a)’s prerequisites for class action suits: One or more members of a class may sue or be sued as representative parties on behalf of all only if: (1) the class is so numerous that joinder of all members is impracticable, (2) there are questions of law or fact common to the class, (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class; and (4) the representative parties will fairly and adequately protect the interests of the class. (emphasis added). Rule 23(b), concerning types of class actions, provides in pertinent part that: A class action may be maintained if Rule 23(a) is satisfied and if ... (3) the court finds that the questions of law or fact common to class members predominate over any questions affecting only individual members, and that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy. (emphasis added). The party seeking class certification bears the burden of demonstrating that each of the four requirements of Rule 23(a) is met in addition to at least one Rule 23(b) requirement. For each of the four elements of Rule 23(a), there must be more than “some showing” of their existence. In re Initial Pub. Offering Sec. Litig., 471 F.3d 24 (2d Cir. 2006); see also Zinser v. Accufix Research Inst., Inc., 253 F.3d 1180, 1186, amended on other grounds, 273 F.3d 1266 (9th Cir. 2001) (citing Hanon v. Dataproducts Corp., 976 F.2d 497, 508 (9th Cir. 1992)); Applewhite v. Reichhold Chemicals, Inc., 67 F.3d 571, 573 (5th Cir. 1995); Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 903 F.2d 176 (2d Cir. 1990); Scholes v. Tomlinson, 145 F.R.D. 485 (N.D. Ill. 1992). The court must conduct a “rigorous analysis” to determine whether the party seeking certification has met the prerequisites of Rule 23. Zinser, 253 F.3d 1180 (citing Valentino v. CarterWallace, Inc., 97 F.3d 1227, 1233 (9th Cir. 1996)).

The standard of proof for each element is generally preponderance of the evidence. Alaska Elec. Pension Fund v. Flowserve Corp., 572 F.3d 221, 228 (5th Cir. 2009) (finding that plaintiffs must prove loss causation as an issue of predominance by a preponderance of the evidence); In re Hydrogen Peroxide Antitrust Litig., 552 F.3d 305, 320 (3d Cir. 2008); Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc., 546 F.3d 196, 202 (2d Cir. 2008). Finally, although the court may not decide the merits of plaintiffs’ claims at the class certification stage, it may address issues that overlap with the merits if necessary for the class certification analysis. Vega v. T-Mobile USA, Inc., 564 F.3d 1256, 1266 (11th Cir. 2009); Vallario v. Vandehey, 554 F.3d 1259, 1265-67 (10th Cir. 2009); In re Hydrogen Peroxide Antitrust Litig., 552 F.3d 305, 316-18 (3d Cir. 2008); Teamsters Local 445 Freight Div. Pension Fund v. Bombardier Inc., 546 F.3d 196, 201-04 (2d Cir. 2008); In re New Motor Vehicles Can. Exp. Antitrust Litig., 522 F.3d 6, 17, 24-26 (1st Cir. 2008); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261, 267-69 (5th Cir. 2007); Blades v. Monsanto Co., 400 F.3d 562, 566-67 (8th Cir. 2005); Gariety v. Grant Thornton, 368 F.3d 356, 364-65 (4th Cir. 2004); Szabo v. Bridgeport Machs., Inc., 249 F.3d 672, 676-78 (7th Cir. 2001). What degree of overlap is allowed has generated debate in the area of loss causation. Many courts have criticized the Fifth Circuit’s decision in Oscar Private Equity Investments. v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007), which held that plaintiffs must prove at the class certification stage “that the defendant’s non-disclosure materially affected the market price of the security.” Id. at 265. Because this “essentially injects what is fundamentally a merits inquiry into the class certification inquiry through the back door” by requiring “the plaintiff to prove loss causation . . . to avail itself of the . . . fraud-on-the-market presumption” many courts have declined to follow Oscar. In re LDK Solar Sec. Litig., 255 F.R.D. 519, 530-31 & n.6 (N.D. Cal. 2009) (declining to require proof of loss certification as a prerequisite to Rule 23 class certification, noting Oscar’s “striking breadth,” and citing numerous cases outside of the Fifth Circuit to reject it); Ross v. Abercrombie & Fitch Co., 257 F.R.D. 435, 454-55 (S.D. Ohio 2009) (refusing to follow Oscar’s requirement that plaintiffs prove loss causation at the class certification stage to plead the fraud-on-the-market theory because loss causation is a “merits inquiry”); In re Micro Techs., Inc. Sec. Litig., 247 F.R.D. 627, 633-34 (D. Idaho 2007) (“It is unlikely that [Oscar] would be adopted in this Circuit because it misreads Basic”). Not persuaded, the Fifth Circuit has maintained its position. Fener v. Operating Eng’rs Constr. Indus. & Misc. Pension Fund (Local 66), 579 F.3d 401, 408-11 (5th Cir. 2009) (affirming that an inquiry into loss causation is appropriate at the class certification stage); Alaska Elec. Pension Fund v. Flowserve Corp., 572 F.3d 221, 228 (5th Cir. 2009) (same). 4. Class Certification – Prerequisites Of Rule 23(a) a. Numerosity This element is not frequently the subject of class certification motions in securities class actions, and courts rarely deny certification on this basis. See In re First Capital Holdings Corp. Fin. Prods. Sec. Litig., No. MDL 901, 1993 WL 144861, at *5 (C.D. Cal. Feb. 26, 1993) (holding failure to allege number of individuals in class does not defeat numerosity when millions of shares were outstanding); Farley v. Baird, Patrick & Co., Inc., No. 90 CIV. 2168 (MBM), 1992 WL 321632 (S.D.N.Y. Oct. 28, 1992) (finding numerosity requirement met by fifty members whose identities were known); Scholes v. Tomlinson, 145 F.R.D. 485 (N.D. Ill. 1992) (holding 129 to 300 geographically dispersed individuals met numerosity requirement). But see Griffin v. GK Intelligent Sys., Inc., 196 F.R.D. 298, 301 (S.D. Tex. 2000) (finding plaintiffs did not satisfy the numerosity requirement by merely alleging the existence of 458 shareholders of record); Schwartz v. Upper Deck Co., 183 F.R.D. 672 (S.D. Cal. 1999) (finding too speculative plaintiffs’ assertion that the numerosity requirement was met based on sales records of the defendant’s trading cards showing thousands of people bought the cards); Primavera Familienstiftung v. Askin, 178 F.R.D. 405 (S.D.N.Y. 1998) (finding joinder of parties superior to certifying a class of approximately 125 plaintiffs who were sophisticated investors with adequate financial resources to maintain their own actions and whose identity and whereabouts were known).

b. Commonality And Predominance As a precondition to certification, Rules 23(a)(2) and 23(b)(3), when read together, require “one or more questions of law or fact common to the class [to] predominate over any questions affecting only individual members.” One method of showing commonality is to allege a “common course of conduct” indicating common questions of law or fact. Harris v. Palm Springs Alpine Estates, Inc., 329 F.2d 909, 914 (9th Cir. 1964). In a fraud on the market case, a course of repeated misrepresentations will satisfy this requirement. Hoxworth v. Blinder, Robinson & Co., Inc., 980 F.2d 912 (3d Cir. 1992) (finding allegation that securities dealer charged its customers more than the NASD maximum markup on customers’ trades and failed to disclose the markups satisfied the commonality requirement); Blackie v. Barrack, 524 F.2d 891, 902 (9th Cir. 1975). However, some courts have rejected class certification in fraud cases alleging oral misrepresentations because of the predominance of individual reliance issues. See Gibbs Props. Corp. v. CIGNA Corp., 196 F.R.D. 430, 440 (M.D. Fla. 2000) (citations omitted); In re GenesisIntermedia, Inc. Sec. Litig., 232 F.R.D. 321 (D. Minn. 2005) (holding fact that some plaintiffs seemed to be relying on fraud on the market theory while others did not rely on market efficiency was fatal to motion for class certification because there was no basis for class-wide presumption of reliance). Commonality is not required as to every issue raised in a securities class action. Realmonte v. Reeves, 169 F.3d 1280, 1285 (10th Cir. 1999); In re Visa Check/Mastermoney Antitrust Litig., 280 F.3d 124, 140 (2d Cir. 2001) (“The predominance requirement calls only for predominance, not exclusivity, of common questions.” (citations omitted)); see also Hanlon v. Chrysler Corp., 150 F.3d 1011, 1019 (9th Cir. 1998). Rule 23 is satisfied when the legal question linking the class members is substantially related to the resolution of the litigation. Id.; DeBoer v. Mellon Mortgage Co., 64 F.3d 1171, 1174 (8th Cir. 1995). Some courts have held that the commonality requirement is satisfied if the complaint pleads at least one question of fact or law common to the class. Mathews v. Kidder, Peabody & Co., 947 F. Supp. 180 (W.D. Pa. 1996), aff’d, 161 F.3d 156 (3d Cir. 1998). If issues common to the class do not predominate over issues not common to the class, certification is properly denied. Mayer v. Mylod, 988 F.2d 635, 640 (6th Cir. 1993); Schwartz v. Upper Deck Co., 183 F.R.D. 672 (S.D. Cal. 1999) (finding no commonality where individual questions of fact exist and the court must apply different law from each state). Although plaintiffs regularly establish the predominance requirement in securities cases, there is no presumption of predominance. In re Constar Int’l Inc. Sec. Litig., 585 F.3d 774, 781-82 (3d Cir. 2009) (noting that while the Supreme Court has suggested that the predominance requirement of Rule 23(b) is “readily met in certain cases alleging consumer or securities fraud,” the district court should not relax its certification analysis or presume a requirement for certification is met merely because the claim is a securities claim). Rather than denying certification, the court may exclude certain members from the class if the presence of a particular group in a class would make issues not common to the rest of the class predominant. Once the court determines that common issues predominate, the plaintiff still must show that a class action is a superior method of proceeding with the litigation. Infra at Subsection 4.e. If a large number of individual issues appears to affect the manageability of the class action — such as requiring the application of multiple state laws — the burden is on the plaintiff to present a manageable trial plan. Zinser v. Accufix Research Inst., Inc., 253 F.3d 1180, 1189 (9th Cir. 2001), amended on other grounds, 273 F.3d 1266 (9th Cir. 2001). But see Visa Check/Mastermoney, 280 F.3d at 140 (“[F]ailure to certify an action under Rule 23(b)(3) on the sole ground that it would be unmanageable is disfavored.”); In re Initial Pub. Offering, 399 F. Supp. 2d 261 (S.D.N.Y. 2004) (holding in a section 11 claim, a class must be restricted to those periods prior to the release of unregistered shares). c. Adequacy Of Representation For lead plaintiffs and their counsel to be adequate class representatives, they must “not have interests antagonistic to those of the class”; the plaintiffs must “vigorously pursue the litigation on behalf of the class”;

and “their chosen attorney must be qualified, experienced, and able to conduct the litigation.” Scholes v. Tomlinson, 145 F.R.D. 485, 490 (N.D. Ill. 1992); see also Hanlon v. Chrysler Corp., 150 F.3d 1011, 1020 (9th Cir. 1998); In re Initial Public Offering Sec. Litig., No. 21 MC 92 (SAS), 2008 U.S. Dist. LEXIS 38768, at *13 (S.D.N.Y. May 13, 2008) (dismissing claims because the plaintiffs failed to identify a class representative who was actually part of the alleged class after being given years to locate an appropriate representative); Griffin v. GK Intelligent Sys., Inc., 196 F.R.D. 298, 301 (S.D. Tex. 2000) (finding plaintiffs failed to carry the burden of showing they were adequate representatives of the class); In re United Telecomms., Inc. Sec. Litig., No. CIV. A 90-2251-O, 1992 WL 309884 (D. Kan. Sept. 15, 1992) (noting that neither the allegedly excessive number of attorneys nor the alleged failure of plaintiff’s counsel to conduct pre-filing investigation bears on the adequacy of representation). Factors to consider in determining the adequacy of a proposed representative include the putative plaintiff’s: (1) knowledge of the case, (2) ability to supervise counsel, (3) credibility, and (4) resources to finance the litigation. See Berger v. Compaq Computer Corp., 257 F.3d 475, 481-83 (5th Cir. 2001) (requiring plaintiffs to be highly knowledgeable about claims because of “Congress’s emphatic command that competent plaintiffs, rather than lawyers, direct such cases”); In re Vivendi Universal, S.A., 242 F.R.D. 76, 88 (S.D.N.Y. 2007) (finding class representative adequate because he understood his obligations to represent the class and supervise the class counsel, knew the claims and nature of the action, and expressed desire to “vigorously” pursue the case); cf. In re Monster Worldwide Inc. Sec. Litig., 251 F.R.D. 132, 135-36 (S.D.N.Y. 2008) (finding a proposed lead plaintiff’s lack of knowledge about basic case facts, such as the defendants’ names, illustrated “an inadequate familiarity with, and concern for, the litigation” on the part of the representative and rendered him unfit to be a class representative); Shiring v. Tier Techs., Inc., 244 F.R.D. 307, 313-17 (E.D. Va. 2007) (finding plaintiff inadequate because he (1) lacked credibility by virtue of his erroneous sworn certifications, (2) allowed counsel to control the litigation, and (3) was unfamiliar with basic aspects of the litigation); In re Theragenics Corp. Sec. Litig., 205 F.R.D. 687, 696 (N.D. Ga. 2002) (holding “the alleged deficiencies of the proposed class representative are irrelevant in a fraud on the market case such as this which is prosecuted by able and experienced counsel”); Zemel Family Trust v. Philips Int’l Realty Corp., 205 F.R.D. 434 (S.D.N.Y. 2002) (holding that plaintiff could not be designated as class representative because he “lacked honesty and trustworthiness” by falsely representing himself to be CFO, which made him an unacceptable candidate as a fiduciary who would adequately represent the class); In re THQ Inc. Sec. Litig., No. CV 00-1783AHM(EX), 2002 WL 1832145, at *7 (C.D. Cal. Mar. 22, 2002) (holding that although some representatives were unfamiliar with some details of the case and were unaware that they might be liable for costs and fees if the claim was unsuccessful, their level of unfamiliarity with the class action was not sufficient to defeat class certification). If a conflict exists between class members on the issue of damages or appropriate relief, it may preclude certification on the basis of adequacy. Morris v. Wachovia Sec., Inc., 223 F.R.D. 284, 299 (E.D. Va. 2004) (“Because the conflict of interests over appropriate relief in this case is fundamental, it defeats the adequacy of representation requirement.”); cf. LaGrasta v. First Union Sec., Inc., No. 2:01-cv-251-FTM-29DNF, 2005 WL 1875469, at *7 (M.D. Fla. Aug. 8, 2005) (holding evidence of direct reliance by plaintiffs on oral representations made by the First Union broker “does not destroy typicality or commonality [and] . . . does not render the named plaintiffs unqualified to serve as class representatives,” because the complaint pleaded fraud on the market). Persuading courts that a conflict should preclude certification, however, can be difficult. In many cases, a perceived conflict can arguably be addressed by the use of subclasses or other methods. E.g., In re Flag Telecom Holdings, Ltd. Sec. Litig., 574 F.3d 29, 35-37 (2d Cir. 2009) (affirming class certification because potential conflict between ‘34 Act and ‘33 Act plaintiffs as to whether defendant’s deceptive acts caused both groups’ losses would not become an actual conflict until the jury awarded damages, at which point district court’s case management tools, including subclasses, could protect each class’s interests); Kohen v. Pac. Inv. Mgm’t Co. LLC, 571 F.3d 672, 679-80 (7th Cir. 2009) (in a Commodity Exchange Act case involving shortseller plaintiffs, affirming class certification in relevant part because intra-class conflict between plaintiffs as to when defendant’s alleged acts artificially bid up prices was merely hypothetical and could be dealt with at a later stage through subclasses); In re Tyco Int’l, Ltd., 236 F.R.D. 62, 68-70 (D.N.H. 2006) (finding that conflict

between “equity holders” and “non-equity holders” can be addressed in ways other than denial of certification, including use of subclasses, exercise of opt-out right or divestiture of stock by class members). d. Typicality Typicality requires that the class representatives’ interests be aligned with those of the class so that the named plaintiffs’ claim truly represents those of absent class members. The individual circumstances, claims, and defenses of the class representative should not differ significantly from the class as a whole, but the claims need not be identical. Realmonte v. Reeves, 169 F.3d 1280, 1286-87 (10th Cir. 1999) (finding differences in method and timing of stock acquisition do not preclude class certification, where allegedly fraudulent statements were made in common to all class members); Hanon v. Dataproducts Corp., 976 F.2d 497, 508 (9th Cir. 1992); Weiss v. York Hosp., 745 F.2d 786, 809 (3d Cir. 1984); Lapin v. Goldman Sachs & Co., 254 F.R.D. 168 (S.D.N.Y. 2008) (certifying a major shareholder and former insider as the class representative even though he might be subject to some unique defenses); In re Vivendi Universal, S.A., 242 F.R.D. 76, 85-86 (S.D.N.Y. 2007) (allowing a class representative who did not trade shares based on alleged misstatements but rather, obtained shares through a merger); Schlagel v. Learning Tree Int’l, No. CIV 98-6384 ABC, 1999 WL 672306 (C.D. Cal. Feb. 23, 1999) (holding that in the securities context, the fact that class representatives may have reviewed different documents or purchased different amounts of stock than other members of the class does not mean that claims are not typical of the class); Mathews v. Kidder, Peabody & Co., 947 F. Supp. 180 (W.D. Pa. 1996) (finding that plaintiff meets typicality requirement even though he owned only one of three funds at issue).

1) Damages Uniformity of damages is not required to establish typicality. See In re Scorpion Techs. Inc., C 93-20333 RPA, 1994 WL 774029, at *4 (N.D. Cal. Aug. 10, 1994) (citing Blackie v. Barrack, 524 F.2d 891, 902 (9th Cir. 1975)).

2) Reliance Similarity of reliance on the part of the class representative and class members is not necessary to establish typicality. Thus, a plaintiff who purchased stock after adverse news and a stock price decline as part of an investment strategy may serve as a class representative. See Yamner v. Boich, No. C-92-20597 RPA, 1994 WL 514035, at *6 (N.D. Cal. Sept. 15, 1994) (citing Blackie v. Barrack, 524 F.2d 891, 905-06 (9th Cir. 1975)); see also In re Technical Equities Fed. Sec. Litig., No. C-86-20157(A) WAI, 1988 WL 147607, at *4 (N.D. Cal. Oct. 3, 1988).

3) Time Of Purchase A majority of courts have declined to find a conflict between a plaintiff and the class sufficient to deny class certification simply because some class members purchased after the date of plaintiff’s purchase. Searls v. Glasser, No. 91 C 6796, 1993 WL 28746, at *5 (N.D. Ill. Feb. 3, 1993).

4) Unique Defenses A court can deny class certification if defenses unique to the class representative will become the focus of the

litigation to the detriment of the class members. Hanon, 976 F.2d at 508; Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 903 F.2d 176, 179-80 (2d Cir. 1990); Zemel Family Trust v. Philips Int’l Realty Corp., 205 F.R.D. 434 (S.D.N.Y. 2002) (finding unique defenses available to plaintiff because he had been subject to SEC investigations resulting from failure to disseminate material information); Schaefer v. Overland Express Family of Funds, 169 F.R.D. 124, 128 (S.D. Cal. 1996) (holding it is appropriate to deny class certification if defendants show that unique defenses will shape litigation in a way that may harm class). The focus of the inquiry is not whether the defense will ultimately be successful but rather whether the plaintiff will have to devote considerable time to rebut the claimed defense. Beach v. Healthways, Inc., 2009 WL 3245393, at *4 (M.D. Tenn. Oct. 5, 2009). Even so, the appearance of a unique defense may not be sufficient to deny a motion for class certification. See In re Vivendi Universal, S.A., 242 F.R.D. 76, 89-90 (S.D.N.Y. 2007) (finding that a familial relationship with a director and majority shareholder of defendant company, without more, is insufficient to conclude that the class representative would be subject to unique defenses); In re THQ Inc. Sec. Litig., No. CV 00-1783AHM(EX), 2002 WL 1832145, at *5 (C.D. Cal. Mar. 22, 2002) (finding typicality where the “unusually speculative investments” of the putative class representatives were insufficient to raise a unique defense with the potential to become the center of litigation); Neuberger v. Shapiro, No. CIV. A. 97-7947, 1998 WL 826980, at *2 n.7 (E.D. Pa. Nov. 25, 1998) (holding that unique defenses which go to the merits are not properly addressed in a motion for class certification but may be sufficient to subdivide or modify the class). Several particular situations may give rise to unique defenses:

(a) In-And-Out Traders In In re Organogenesis Sec. Litig., 241 F.R.D. 397 (D. Mass. 2007), the court found that during the class period one of the proposed class representatives “sold almost six times as many shares as he purchased.” Under the last-in, first out (“LIFO”) methodology of assessing damages adopted by the court, these trades resulted in the investor making a profit on his trading during the class period and rendered him an unsuitable class representative. But see Serafimov v. Netopia, Inc., No. C-04-03364 RMW, 2004 U.S. Dist. LEXIS 25184, at *19-20 (N.D. Cal. Dec. 3, 2004) (finding plaintiff’s status as a combination in-and-out and retention trader minimized the impact of potential unique defenses on the other class members); In re Scott Paper Co. Sec. Litig., 142 F.R.D. 611, 615 (E.D. Pa. 1992) (holding in-and-out trades met typicality requirement). But see Dura v. Broudo Pharmaceuticals, discussed in Section III.A.10.c below (suggesting that in-and-out traders should be excluded from class because of inability to prove loss causation).

(b) Professional Plaintiffs Courts have also denied class certification because the proposed class representative was found to be a “professional plaintiff” and therefore atypical. Shields v. Smith, No. C-90-0349 FMS, 1991 WL 319032, at *4 (N.D. Cal. Nov. 4, 1991) (“Plaintiff’s purchasing of stock in troubled companies … to possibly pursue litigation, is a serious defense likely to become the focus of the litigation to the detriment of the class.”). A professional plaintiff may be subject to a unique defense because the presumption of reliance on the integrity of the market is rebutted; neither the misrepresentation nor the price of the stock affected that individual’s decision to buy. See Hanon v. Dataproducts Corp., 976 F.2d 497, 508 (9th Cir. 1992) (“Hanon’s reliance on the integrity of the market would be subject to serious dispute as a result of his extensive experience in prior securities litigation, his relationship with his lawyers, his practice of buying a minimal number shares of stock in various companies, and his uneconomical purchase of only ten shares of stock in Dataproducts.”); Schaefer v. Overland Express Family of Funds, 169 F.R.D. 124, 129 (S.D. Cal. 1996) (recognizing professional plaintiffs

may hurt class); Greebel v. FTP Software, Inc., 939 F. Supp. 57, 61 (D. Mass. 1996) (recognizing Congress’ “concern[]” regarding the “problem” of a professional plaintiff); Kline v. Wolf, 88 F.R.D. 696, 699 (S.D.N.Y. 1981), aff’d, 702 F.2d 400 (2d Cir. 1983) (finding stock speculator plaintiff would be subject to unique defenses on issue of reliance). Thus, the number of times a plaintiff has been involved in other class actions may be important. In re K Mart Corp. Sec. Litig., No. 95-CS-75584-DT, 1996 WL 924811 (E.D. Mich. Dec. 16, 1996) (holding named plaintiff who participated in dozens of other actions could not represent the class but that a plaintiff who had been a class representative twice before could represent the class).

(c) Impact Of “Fraud On The Market” Theory Plaintiffs frequently argue that by asserting the “fraud on the market” theory, they obviate any need to inquire into defenses unique to the named class representative. (For a detailed discussion of fraud on the market theory, see infra Section III.A.6.a., “Fraud on the Market Presumption of Reliance.”) This argument fails, however, because defendants can rebut the presumption. The fraud on the market presumption involves plaintiffs’ reliance on the false or misleading statements alleged in the complaint. The theory is that “in an open and developed securities market the price of a company’s stock is determined by the available material information regarding the company and its business,” and that investors rely on “the integrity of [the market] price.” Basic Inc. v. Levinson, 485 U.S. 224, 241, 247 (1988). In Basic, the Court concluded “[m]isleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.” Id. at 241-42; accord Blackie v. Barrack, 524 F.2d 891, 906 (9th Cir. 1975) (finding individual questions of reliance did not deter class certification in a 10b-5 action because “proof of subjective reliance on particular misrepresentations is unnecessary to establish a 10b-5 claim for a deception inflating the price of stock traded in the open market”). But see West v. Prudential Sec., Inc., 282 F.3d 935, 938 (7th Cir. 2002) (holding plaintiffs must show a causal link between non-public statements and securities prices prior to certification of a class that includes purchasers who did not personally hear misrepresentations, and the mere fact that both sides have support of reputable financial economists does not establish the causal link). Most courts have permitted inquiry into reliance on the integrity of the market at the class certification stage. The Second Circuit requires courts to determine the issue. In re Initial Pub. Offering Sec. Litig., 471 F.3d 24 (2d Cir. 2006); accord Luskin v. Intervoice-Brite Inc., 261 F. App’x 697 (5th Cir. 2008) (vacating the district court’s class certification on the basis that Fed. R. Civ. P. 23 mandates a complete analysis of fraud-on-themarket indicators, including loss causation, prior to class certification). See also Section II.D.7 below. Although the fraud on the market presumption applies to plaintiffs in Rule 10b-5 actions, this presumption is rebuttable. Blackie, 524 F.2d at 906. Rebutting the presumption requires an evidentiary showing. Basic, 485 U.S. at 241, 247; Hanon v. Dataproducts Corp., 976 F.2d 497, 508 (9th Cir. 1992); McNichols v. Loeb Rhoades & Co., 97 F.R.D. 331 (N.D. Ill. 1982). Because a defendant must make an “evidentiary” showing to rebut the fraud-on-the-market presumption, discovery into the class representative’s trading history in general and purchases of the stock of the defendant company in particular is essential. See Hanon, 976 F.2d at 508-09 (analyzing plaintiffs’ entire investment history to determine propriety as class representative); In re Fed. Nat’l Mortgage Ass’n, 247 F.R.D. 32, 42 (D.D.C. 2008) (noting option traders are afforded the rebuttable fraud-onthe-market presumption because “trading on the belief that the stock price will fluctuate does not necessarily mean that option traders do not rely on the integrity of the market information to predict those fluctuations”); Shields v. Smith, No. C-90-0349 FMS, 1991 WL 319032, at *4 (N.D. Cal. Nov. 4, 1991) (same); see also Degulis v. LXR Biotechnology, Inc., 176 F.R.D. 123, 125-27 (S.D.N.Y. 1997) (granting motion to compel production of plaintiff’s brokerage statements and investment records in part because evidence of a speculative investment strategy would be relevant to a pending class certification motion); In re ML-LEE Acquisition Fund II, L.P. & ML-LEE Acquisition Fund (Retirement Accounts) II, L.P. Sec. Litig., 149 F.R.D. 506, 508 (D. Del.

1993) (finding that information concerning plaintiffs’ entire investment history is “relevant to the Court’s determination of whether Plaintiffs satisfy the typicality requirement of Fed. R. Civ. P. 23(a)(3)”); In re SciMed Life Sec. Litig., CIV. No. 3-91-575, 1992 WL 413867, at *3 (D. Minn. Nov. 20, 1992) (recognizing “the importance of the Defendant’s need to conduct discovery concerning plaintiffs entire investment history and background” for class certification issues). The defendant need not show that he will be able to rebut the presumption at trial. Indeed, even if the defendant can show the potential to rebut the presumption, this alone may be sufficient to find the plaintiff atypical. For example, if the defendant can show that the plaintiff may have relied on non-market information that was unavailable to other class members, the potential for factual issues — such as whether plaintiff did rely on that information — to dominate the litigation may support a finding that lead plaintiff is atypical. Beach v. Healthways, Inc., 2009 WL 3245393, at *5-6 (M.D. Tenn. Oct. 5, 2009). Finally, when plaintiffs rely on the Affiliate Ute presumption to establish class-wide reliance, plaintiffs must establish the defendants owed a duty to the named class representative. Otherwise, the presumption does not apply, and certification may be unavailable. Newby v. Enron Corp., 446 F.3d 585 (5th Cir. 2006). Although courts have generally applied the fraud-on-the-market presumption to issuers, it is not limited to those types of cases. In In re Salomon Analyst Metromedia Litig., 544 F.3d 474 (2d Cir. 2008), the Second Circuit concluded that no bright-line rule bars application of the doctrine to suits involving third-party misrepresentations, such as those in analyst reports. Thus, plaintiffs are not required to make a heightened showing in analyst report cases. Id. at 480. Just as in issuer cases, however, defendants are entitled to present evidence rebutting the presumption at the class certification stage. Id. at 484-85.

(d) The La Mar Doctrine Generally, class representatives must have claims against the same defendants as other members of the class. In the seminal case of La Mar v. H & B Novelty & Loan Co., 489 F.2d 461, 465 (9th Cir. 1973), the Ninth Circuit held typicality is “lacking when the plaintiff’s cause of action, although similar to that of other members of the class, is against a defendant with respect to whom the class members have no cause of action.” La Mar has been followed by other courts in various contexts. See, e.g., Thompson v. Bd. of Educ., 709 F.2d 1200, 1204-05 (6th Cir. 1983); Barker v. FSC Sec. Corp., 133 F.R.D. 548 (W.D. Ark. 1989); Vulcan Soc. of Westchester County, Inc. v. Fire Dep’t of White Plains, 82 F.R.D. 379, 399 (S.D.N.Y. 1979). Exceptions to La Mar. The La Mar Court recognized two exceptions to its requirement that the class representatives and class members have claims against the same defendants: (A) The La Mar rule does not apply when “all injuries are the result of a conspiracy or concerted schemes between the defendants.” La Mar, 489 F.2d at 465; see also Brown v. Cameron-Brown Co., 92 F.R.D. 32, 3940 (E.D. Va. 1981). (B) The La Mar rule does not apply when “all defendants are juridically related in a manner that suggests a single resolution of the dispute would be expeditious.” La Mar, 489 F.2d at 466; see also In re Itel Sec. Litig., 89 F.R.D. 104, 121-23 (N.D. Cal. 1981) (applying the “juridical link” exception to justify class certification in securities action against underwriters who sold securities using identical documents); Barker v. FSC Sec. Corp., 133 F.R.D. at 553; State ex rel. Erie Fire Ins. Co. v. Madden, 515 S.E.2d 351 (W. Va. 1998) (reversing the trial court’s application of the “juridical link” doctrine, finding that insurance companies did not have the common scheme required).

5) Limiting The Class In A Multiple Offering Case In Hudson v. Capital Management, International, Inc., 565 F. Supp. 615 (N.D. Cal. 1983), the court applied La Mar to limit the scope and size of a class certified against attorney, accountant, broker, issuer, and officer and director defendants. In that case, plaintiffs alleged an integrated scheme of intrastate and private placement offerings to thousands of investors over several years. The offering materials varied by partnership and included expertized materials from different attorneys and accountants. The court held: the Rule 23(b)(3) requirement that questions of law or fact predominate over questions affecting only individual members of the class is met only if the class is limited to those who invested in the same partnerships as the named plaintiffs, because the representations varied from partnership to partnership. Similarly, the requirement that the claims of the representative parties be typical of the claims of the class, Fed. R. Civ. P. 23(a), permits plaintiffs to represent only those who invested in the same partnerships as plaintiffs did. Id. at 629. The Hudson Court relied on the Advisory Committee’s Note to Rule 23(b)(3). That note observed: “a fraud perpetrated on numerous persons by the use of similar misrepresentations may be an appealing situation for a class action, and it may remain so despite the need, if liability is found, for a separate determination of the damages suffered by individuals within the class. On the other hand, although having some common core, a fraud case may be unsuited for treatment as a class action if there was material variation in the representations made or in the kinds or degrees of reliance by the persons to whom they were addressed.” Id. at 629; Advisory Committee’s Note, Proposed Amendments to the Rules of Civil Procedure for the United States District Court, 39 F.R.D. 69, 103 (1966). But see Blackie v. Barrack, 524 F.2d 891, 904 (9th Cir. 1975) (holding commonality and typicality requirements met despite multiple offering documents when each contained similar misrepresentation concerning improper reserve accounts); In re W. Union Sec. Litig., 120 F.R.D. 629 (D.N.J. 1988) (finding stock purchasers allegedly defrauded over a period of time by similar misrepresentations were united by common interest which was not defeated by slight differences in class members’ position and holding it is not fatal to class certification that plaintiffs may have actually relied on many documents spread out over a period of time). e. Superiority Of Class Action Treatment The superiority requirement requires courts to balance the advantages of class action treatment against those of alternative methods of adjudication. SEE Fed. R. Civ. P. 23(b)(3) Advisory Committee Notes, 1966 Amendment. In considering whether a class action is “superior to other available methods for the fair and efficient adjudication of the controversy,” courts should examine several factors: (A) the interest of members of the class in individually controlling the prosecution or defense of separate actions; (B) the extent and nature of any litigation concerning the controversy already commenced by or against members of the class; (C) the desirability or undesirability of concentrating the litigation of the claims in the particular forum; (D) the difficulties likely to be encountered in the management of a class action. Fed. R. Civ. P. 23(b)(3); see, e.g., In re Genesisintermedia, Inc. Sec. Litig., No. CV 01-9024-SVW, 2007 WL 1953475, at *14 (C.D. Cal. June 28, 2007) (“A class action is not a superior method of resolving a securities fraud action where individual issues of reliance predominate [over] any common issues.”); Siemers v. Wells Fargo & Co., 243 F.R.D. 369, 376 (N.D. Cal. June 1, 2007) (finding a class that included all purchasers over a five year period in over one hundred mutual funds to be unmanageable). One particular application of the superiority requirement is noteworthy in light of the increased globalization of securities class action litigation. In weighing the factors, although the defendant may already be defending

shareholder suits in another country, the advantages of class certification may still outweigh shareholder interests in conducting separate lawsuits. See In re Vivendi Universal, S.A. Sec. Litig., 242 F.R.D. 76, 92 (S.D.N.Y. 2007). If there is a possibility of foreign suits, courts should consider the res judicata effects in the foreign countries when evaluating the superiority requirement. “Where plaintiffs are able to establish a probability that a foreign court will recognize the res judicata effect of a U.S. class action judgment, plaintiffs will have established this aspect of the superiority requirement.” Id. at 95. However, if plaintiffs are unable to show that recognition in a foreign court is more likely than not, that factor weighs against finding superiority and may lead to the exclusion of foreign claimants. Id. at 95-106 (analyzing probability of recognition of judgment in France, England, Germany, Austria, and the Netherlands and concluding that plaintiffs failed to establish that Germany and Austria would probably grant res judicata effect to judgment). 5. Alternatives To Denial When Prerequisites Are Not Met a. Subclasses If a court finds it cannot certify a single class in an action, it may certify multiple subclasses for particular issues or claims. Harden v. Raffensperger, Hughes & Co., Inc., 933 F. Supp. 763 (S.D. Ind. 1996); In re LILCO Sec. Litig., 111 F.R.D. 663, 670 (E.D.N.Y. 1986) (certifying eight different subclasses based on the different securities at issue); Wolfson v Solomon, 54 F.R.D. 584, 588 (S.D.N.Y. 1972) (allowing class action of two classes of plaintiffs pursuing different claims). But see In re Celaphon Sec. Litig., No. CIV. A. 96-0633, 1998 WL 470160, at *5 (E.D. Pa. Aug. 12, 1998) (refusing to create subclasses where the class members were not shown to have antagonistic or divergent interests); In re Cendant Corp. Litig., 182 F.R.D. 476, 480 (D.N.J. 1998) (refusing plaintiff’s request to create a subclass because it would detract from the Reform Act’s goal of client control by delegating more control to the attorneys for each class); In re Vivendi Universal, S.A. Sec. Litig., 242 F.R.D. 76, 109 (S.D.N.Y. 2007) (refusing to create subclasses to determine domestic and foreign damages where foreign market for shares was “highly integrated” with NYSE and the prices were “almost always effectively equivalent”). A number of cases have discussed the possibility of certifying subclasses in cases involving a series of partial curative disclosures. See Blackie v. Barrack, 524 F.2d 891, 911 (9th Cir. 1975); In re Unioil Sec. Litig., 107 F.R.D. 615, 622 (C.D. Cal. 1985); Koenig v. Smith, 88 F.R.D. 604 (E.D.N.Y. 1980); see also Section II.D.5.b(1), “Length of Class Period: Partial Curative Disclosures,” infra (discussing partial curative disclosures). However, as discussed in detail in In re Seagate Technology II Securities Litigation, 843 F. Supp. 1341 (N.D. Cal. 1994), if the court also accounts for the divergent interests of in-and-out trading (shareholders who buy and sell the stock), an average of two subclasses a day could be required, thus making the concept of subclasses unworkable. Id. at 1361. Faced with the question of class certification when there had been a series of partial curative disclosures, the court in Seagate II ordered the plaintiffs to provide evidence that the conflicts were not so serious as to preclude certification. Id. at 1365. As a result, plaintiffs voluntarily limited the class to those persons who purchased stock before the first partial curative disclosure. In re Seagate Tech. II Sec. Litig., 156 F.R.D. 229, 230 (N.D. Cal. 1994). b. Length Of Class Period 1) Court’s Discretion A court has discretion to modify the class period alleged in the complaint in deciding a class certification motion. Schaefer v. Overland Express Family of Funds, 169 F.R.D. 124, 131 (S.D. Cal. 1996).

2) Variance In Factual Issues Variance in factual issues and distinctive time periods within the class period can defeat typicality. As discussed below, purchasers after a curative public announcement are subject to unique factual defenses and therefore are not typical of purchasers prior to such an announcement. In re LTV Sec. Litig., 88 F.R.D. 134, 148 (N.D. Tex. 1980). Differing issues of proof over time can also defeat certification. J.H. Cohn & Co. v. Am. Appraisal Assocs., Inc., 628 F.2d 994, 998 (7th Cir. 1980) (refusing to certify a class because of “different proof [at different times] concerning the defendants’ willfulness or recklessness in issuing or omitting to issue material information”); Katz v. Comdisco, Inc., 117 F.R.D. 403, 411 (N.D. Ill. 1987) (“[D]ue to the shifting factual scenarios [over time], each class member will face different issues of proof.”); Kohntopp v. Butcher, 98 F.R.D. 551, 553 (E.D. Tenn. 1983) (denying certification where plaintiffs made purchases over time, in different amounts, and based upon a variety of information).

3) Curative Disclosures The timing of the disclosure of curative information may determine the end of the class period. Once allegedly false or misleading statements are made to the public, the ability of a class of purchasers to claim that they did not know the true facts is limited. Liability under the federal securities laws is terminated when “curative information is publicly announced or otherwise effectively disseminated.” In re Sun Microsystems, Inc. Sec. Litig., No. C-89-20351-RPA, 1990 WL 169140, at *8 (N.D. Cal. Aug. 20, 1990); see also Klein v. A.G. Becker Paribas, Inc., 109 F.R.D. 646, 652-53 (S.D.N.Y. 1986) (denying certification of a proposed extended class for non-typicality where named plaintiffs, unlike members of proposed extended class, purchased securities before news reports and a press release revealed compatibility, workforce and financial problems). But see Feldman v. Motorola, No. CIV. A. 90 C 5887, 1993 WL 497228, at *5 (N.D. Ill. Oct. 14, 1993) (declining to limit the class period at the certification stage based on timing of curative announcement because “there are fact questions as to the appropriate limits of the class period”). Sections 11(a) and 12(2) impose liability in favor of purchasers who did not know of the alleged misstatement or omission in the registration statement. Section 10(b) and Rule 10b-5 require proof of reliance. Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 180 (1994). If “curative information” has been disseminated, a purchaser may have actual knowledge of the false or misleading nature of prior information.

(a) Partial Curative Disclosures After a defendant publicly announces information that “cures” deficiencies in prior public statements, subsequent purchasers are not properly included within the class. McFarland, 96 F.R.D. at 364-65; see Gen. Tel. Co. of Sw. v. Falcon, 457 U.S. 147, 152-53 (1982) (holding typicality requirement only met if class representatives and class members suffered same injury under similar circumstances); see also In re Cypress Semiconductor Sec. Litig., No. C-92-20048-RMW, 1992 WL 394927 (N.D. Cal. Sept. 23, 1992). Cases involving a series of partial curative disclosures have created particularly difficult class certification problems. A number of decisions have discussed the possibility of the certification of subclasses. (See discussion supra at Subsection 5.a, “Alternatives to Denial When Prerequisites Are Not Met: Subclasses”) In addition, if a substantial question of fact exists as to whether the release cured the misrepresentation or was itself misleading, then the broader time period may be certified; however, if facts are uncovered in the course of discovery suggesting that the curative disclosure had been assimilated by the market, defendants may move to decertify the appropriate portion of the class. In re Sunrise Sec. Litig., No. MDL 655, 1987 WL 19343, at *3 (E.D. Pa. July 7, 1987).

(b) Effectiveness Of Curative Statements An announcement can effectively cure the alleged earlier misrepresentations. This issue involves consideration of the type and extent of alleged misrepresentations and the character of information said to cure such misrepresentations. In re Unioil Sec. Litig., 107 F.R.D. 615, 621 (C.D. Cal. 1985) (holding court could not determine on class certification motion whether wide range of allegedly fraudulent information was cured by a series of public disclosures by defendant); In re Memorex Sec. Cases, 61 F.R.D. 88, 97 (N.D. Cal. 1973) (finding curative statement candidly explained prior misleading statements); In re Sunrise, 1987 WL 19343, at *3 (noting that in analyzing whether the disclosure of the information was curative, the court should consider the content of the disclosures in question and their effect on the market price). If the curative statement is itself ambiguous, a court may be reluctant to find that it has cured earlier misrepresentations. In re AM Int’l Inc. Sec. Litig., 108 F.R.D. 190, 193 (S.D.N.Y. 1985); see S.E.C. v. Rana Research Inc., 8 F.3d 1358, 1362-63 (9th Cir. 1993) (noting that curative press releases containing a “grain of truth” are insufficient); Marksman Partners, L.P. v. Chantal Pharms. Corp., 927 F. Supp. 1297, 1307 (C.D. Cal. 1996) (holding that an appendix attached to Form 10-K is not a disclosure sufficient to neutralize allegedly misleading effect of accounting statements especially if unclear that addendum directly addresses the misleading information).

(c) Whether Statement Was Curative May Merit Inquiry Some courts have held that an inquiry into whether and when public announcements cured prior misstatements is a determination of the merits of the case, which is impermissible at the class certification stage. In re Seagate Tech. II Sec. Litig., 843 F. Supp. 1341, 1345, 1365 (N.D. Cal. 1994) (requiring “detailed factual analysis” to determine whether Rule 23 prerequisites have been satisfied); In re Victor Techs. Sec. Litig., 102 F.R.D. 53, 58 (N.D. Cal. 1984), aff’d, 792 F.2d 862 (9th Cir. 1986) (explaining whether announcement of the company’s expectation of quarterly loss, rather than later announcement of actual loss, effectively cured omissions in registration statement is a merits decision); see Morse v. Abbott Labs., 756 F. Supp. 1108 (N.D. Ill. 1991). Several circuits, however, have permitted inquiry into the merits where such an inquiry is relevant to determining the sufficiency of class allegations. Hanon v. Dataproducts Corp., 976 F.2d 497, 509 (9th Cir. 1992) (“[The court is] at liberty to consider evidence which goes to the requirements of Rule 23 even though the evidence may also relate to the underlying merits of the case.”). Many courts, including the Supreme Court, have approved the examination of facts beyond the “four corners of the complaint” when considering class certification and definition. See, e.g., Gen. Tel. Co. v. Falcon, 457 U.S. 147, 160 (1982) (explaining “it may be necessary for the court to probe behind the pleadings” to resolve class certification issues); In re Initial Pub. Offering Sec. Litig., 421 F.3d 24, 42 (2d Cir. 2006) (analyzing facts from discovery as well as complaint); Sirota v. Solitron Devices, Inc., 673 F.2d 566, 571 (2d Cir. 1982) (noting that a court should allow discovery on class certification issues and hold a hearing to determine whether Rule 23 prerequisites met); Doctor v. Seaboard Coast Line R.R. Co., 540 F.2d 699, 707-09 (4th Cir. 1976) (holding that in conducting class certification analysis, court must go beyond the complaint and consider the character or type of each representative plaintiff’s claim); In re Vivendi Universal, S.A. Sec. Litig., 242 F.R.D. 76, 92 (S.D.N.Y. 2007); Schaefer v. Overland Express Family of Funds, 169 F.R.D. 124, 127 (S.D. Cal. 1996) (finding that a court can consider evidence relevant to a class certification motion even if it is also related to the action’s merits); Friedlander v. Barnes, 104 F.R.D. 417, 420 (S.D.N.Y. 1984). Defendants should consider both pressing for consideration of curative statements at the early phase of class certification and re-opening the question of the class period if it is possible to subsequently argue a curative announcement has cut off the scope of the class as previously defined.

6. Statute Of Limitations Considerations On Dismissal Under the American Pipe tolling doctrine, “filing a class action tolls the statute of limitations as to all asserted members of the class.” Crown, Cork & Seal Co., Inc. v. Parker, 462 U.S. 345, 350 (1983) (clarifying the scope of American Pipe’s holding); Am. Pipe & Constr. Co. v. Utah, 414 U.S. 538, 552-53 (1974). The Supreme Court explained that efficiency and economy are the primary purpose of the class action procedure. Am. Pipe, 414 U.S. at 553. In the absence of a tolling doctrine, litigants would be forced to file duplicative motions to guard against the risk that the class might not be certified. The Court considered such a result undesirable because it would defeat the purpose of the class action procedure. Id. at 553-54; see also Catholic Social Servs., Inc. v. I.N.S., 232 F.3d 1139, 1147 (9th Cir. 2000) (en banc) (allowing plaintiffs to aggregate their claims in a subsequent class action if their individual claims would be timely under American Pipe). However, “no court of appeals has yet applied tolling to subsequent class claims where certification in the prior class action had been denied on the basis of the lead plaintiffs’ deficiencies as class representatives, [although] a number of district courts have done so.” Yang v. Odom, 392 F.3d 97, 107 n.7 (3d Cir. 2004) (collecting cases). In Yang v. Odom, the Third Circuit addressed this very issue, and held the American Pipe tolling applies to the filing of a new class action where the certification was denied by the prior suit based on the lead plaintiff’s deficiencies as class representatives. Id. at 104. However, the tolling doctrine will not apply if the court denied certification based on deficiencies in the purported class itself. Id. at 104-06 (citing Korwek v. Hunt, 827 F.2d 874, 876 (2d Cir. 1987); Basch v. Ground Round, Inc., 139 F.3d 6, 8 n.4 (1st Cir. 1998); Andrews v. Orr, 851 F.2d 146, 149 (6th Cir. 1988); Salazar-Calderon v. Presidio Valley Farmers Ass’n, 765 F.2d 1334, 1350 (5th Cir. 1985)); see also In re Tyco Int’l, Ltd., MDL No. 02-1335-B, 2007 WL 1703023, at *3 (D.N.H. June 11, 2007) (dismissing claims brought after the statute of repose period that did not share facts of prior class action). 7. Rule 23(f) Interlocutory Appeal Rule 23(f) of the Federal Rules of Civil Procedure, adopted in 1998, permits the appellate courts to grant discretionary review of district court orders granting or denying class certification under Rule 23. With increasing regularity, defendants have used Rule 23(f) to seek interlocutory review of class certification decisions, often on the ground that plaintiffs cannot meet the reliance or loss causation requirements of a 10b-5 claim on a classwide basis. Historically, plaintiffs have urged that these questions must be left for merits determinations that are inappropriate at the class certification stage. Recent decisions, however, have clearly established that courts must look at merits-related issues that are relevant to plaintiffs’ meeting their burden of establishing each of Rule 23’s requirements. The most frequent argument raised in Rule 23(f) petitions is that plaintiffs will be unable to meet the predominance requirement because the absence of an efficient market prevents them from being able to take advantage of the “fraud on the market” presumption of reliance, with the result that individual issues of reliance will predominate. Cases in which courts have either reversed class certification or affirmed a denial of class certification on this basis in Rule 23(f) appeals include In re Polymedica Corp. Sec. Litig., 432 F. 3d 1 (1st Cir. 2005); In re Initial Public Offering Sec. Litig., 471 F. 3d 24 (2d Cir. 2006); Hevesi v. Citigroup, Inc., 366 F. 3d 70 (2d Cir. 2004); In re Salomon Analyst Metromedia Litig., 544 F.3d 474 (2d Cir. 2008) (defendants must have opportunity to rebut FOM presumption prior to class certification); West v. Prudential Securities, Inc., 282 F.3d 935 (7th Cir. 2002); Teamsters Local etc. Pension Fund v. Bombardier Inc., 546 F.3d 196 (2d Cir. 2008); Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 259 F. 3d 154 (3d Cir. 2001); Gariety v. Advanta Mortgage Corp. USA, 368 F. 3d 356 (4th Cir. 2004); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F. 3d 261 (5th Cir. 2007); Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA), Inc., 482 F. 3d 372 (5th Cir. 2007); Bell v. Ascendant Solutions, Inc., 422 F. 3d 307 (5th Cir. 2005); Unger v. Amedisys, Inc., 401 F. 3d 316 (5th Cir. 2005); West v. Prudential Securities, Inc., 282 F. 3d 935 (7th Cir. 2002). In a related vein, the court in Malack v. BDO Seidman, LLP, 617 F.3d 743 (3d Cir. 2010) affirmed a denial of class certification based on the district court’s rejection of the “fraud created the market” theory for presuming reliance.

The court in Oscar Private Equity also rested its vacation of class certification on Rule 23(f) appeal on the plaintiff’s failure to establish loss causation. Similarly, the Second Circuit in In re Flag Telecom Holdings, Ltd. Sec. Litig., 574 F.3d 29 (2d Cir. 2009) reversed a class certification insofar as the class included “in and out” traders who could not prove loss causation. But see Alaska Elec. Pension Fund v. Flowserve Corp., 572 F.3d 221 (5th Cir. 2009) (vacating denial of class certification on Rule 23(f) review and remanding for a new class certification hearing where the district court had applied the wrong standard for assessing loss causation); Schleicher v. Wendt, 618 F.3d 679 (7th Cir. 2010) (rejecting Oscar and affirming class certification). See also Archidiocese of Milwaukee Supporting Fund v. Halliburton Co., 597 F.3d 330 (5th Cir. 2010) (although not expressly referencing Rule 23(f), court affirmed denial of class certification, presumably under that rule, for failure to show loss causation; court reconciled Oscar and Flowserve). E. Class And Merits Discovery Issues 1. Class Discovery To test a plaintiff’s assertions concerning the propriety of class certification, defendants should seek discovery from the representative plaintiff to see whether Rule 23 requirements will be met. Hanon v. Dataproducts Corp., 976 F.2d 497, 508-09 (9th Cir. 1992) (analyzing named plaintiff’s investment history to determine propriety as a named plaintiff in a securities case); Degulis v. LRX Biotechnology, Inc., 176 F.R.D. 123 (S.D.N.Y. 1997) (finding discovery of named plaintiff’s investment records, sophistication and trading strategies was relevant to pending class certification motions); In re SciMed Life Sec. Litig, CIV. No. 3-91-575, 1992 WL 413867, at *3 (D. Minn. Nov. 20, 1992) (“This Court recognizes the importance of the Defendant’s need to conduct discovery concerning Plaintiffs’ entire investment history.”); Feldman v. Motorola, Inc., No. 90 C 5887, 1992 WL 137163 (N.D. Ill. June 9, 1992) (permitting discovery of plaintiffs’ brokerage account statements for past four years as relevant to the class certification inquiry); Shields v. Smith, No. C-90-0349 FMS, 1991 WL 319032 (N.D. Cal. Nov. 4, 1991) (allowing review of plaintiff’s investment history in ruling on motion for class certification). Expert discovery may also be permitted where appropriate. Fogarazzo v. Lehman Bros., Inc., No. 03 CIV. 5194 (SAS), 2005 WL 361205 (S.D.N.Y. Feb. 16, 2005) (allowing use of “class certification” expert “to describe and explain a methodology that the ultimate fact-finder can use to determine central factual issues on a common basis” such as “whether the plaintiff’s purported class satisfies Rule 23 requirements,” and allowing defendants to depose expert regarding inquiries “bearing directly on the propriety of class certification”). Defendants should also seek a stay of merits discovery in appropriate cases while class discovery proceeds, inasmuch as a denial of class certification may well end the case as a practical matter. 2. The Reform Act’s Discovery Stay a. Automatic Stay Of Discovery The Reform Act provides: In any private action arising under this chapter, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party. 15 U.S.C. § 78u-4(b)(3)(B). The Reform Act thus provides for an automatic stay of discovery pending a defendant’s motion to dismiss. This stay is available to both parties and non-parties. See In re Carnegie Int’l Corp. Sec. Litig., 107 F. Supp. 2d

676, 679 (D. Md. 2000) (holding non-party accounting firm could invoke protection under the stay provisions of the Reform Act); see also In re Adelphia Commc’ns Corp., 294 B.R. 39, 43-44 (S.D.N.Y. 2003) (applying Carnegie International in holding a non-party non-subpoenaed witness who is a prospective target in state court proceedings has standing to seek the PSLRA automatic stay of discovery). If defendants are unable to prevail on the pleadings, the Reform Act discovery stay will be lifted and plaintiffs will begin pursuing discovery, especially the production of documents. Once the stay is lifted, plaintiffs may seek documents under the initial disclosure provisions of Federal Rule of Civil Procedure 26(a), which eliminated local deviations from the Rule. For example, in the Northern District of California, local rules previously exempted securities class actions from initial disclosures. Once plaintiffs have obtained initial disclosures, they will seek production of a wide array of documents and then begin taking depositions of senior management and other employees or former employees. Some issues that arise during the discovery process are discussed below. Congress enacted the automatic stay provision of the PSLRA to address concerns that plaintiffs would use discovery to find new claims or to coerce a settlement from defendants seeking to avoid the high cost of discovery. H.R. Conf. Rep. No. 104-369, at 37 (1995); S. Rep. No. 104-98, at 14 (1995). While the Second Circuit has not directly spoken to the issue, its district courts have suggested that the stay should only be lifted in cases “where defendants might be shielded from liability in the absence of the requested discovery.” For example, in one decision, the court denied the plaintiff’s motion to lift the stay of discovery because plaintiffs had failed to establish they suffered undue prejudice from the discovery stay. Taft v. Ackermans, No. 02 CIV. 7951 (PKL), 2005 WL 850916 (S.D.N.Y. Apr. 13, 2005); see also In re Worldcom, Inc. Sec. Litig., No. 02 CIV 3288 (DLC), 2002 WL 31628566, *4 (S.D.N.Y. Nov. 21, 2002) (permitting discovery before motion to dismiss was decided under “unique circumstances” where documents had already been produced in other litigation and complaint was “clearly not” a fishing expedition). b. Cases Interpreting The Discovery Stay In SG Cowen Securities Corp. v. District Court, 189 F.3d 909 (9th Cir. 1999), the Ninth Circuit held the Reform Act’s discovery stay provision was “intended to prevent unnecessary imposition of discovery costs on defendants.” Id. at 911. Addressing the propriety of relief from the discovery stay, the court held the district court had improperly “granted plaintiffs leave to conduct discovery so that they might uncover facts sufficient to satisfy the [Reform] Act’s pleading requirements.” Id. at 912. The Ninth Circuit found that lifting of the discovery stay was not proper “unless exceptional circumstances exist.” Id. In Medhekar v. District Court, 99 F.3d 325, 328 (9th Cir. 1996), the Ninth Circuit reviewed the question whether the initial disclosures required by Federal Rule of Civil Procedure 26(a)(1) and the accompanying local rules constitute “discovery” or “other proceedings” for purposes of the Reform Act’s stay provisions. The Ninth Circuit held the initial disclosures are a subset of discovery and, as such, are included in the Reform Act’s discovery stay. Id. at 328. The court noted “Congress clearly intended that complaints in these securities actions should stand or fall based on the actual knowledge of the plaintiffs rather than information produced by the defendants after the action has been filed.” Id. In dicta, the Medhekar court interpreted the term “other proceeding” to include “litigation activity related to discovery.” Id. At least one district court has disagreed with the Ninth Circuit’s holding in Medhekar regarding initial disclosures. In In re Comdisco Securities Litigation, 166 F. Supp. 2d. 1260, 1261-62 (N.D. Ill. 2001), the Northern District of Illinois, following the distinction made in Rule 26, distinguished between “disclosure” and “discovery.” In that case, the court granted plaintiffs’ motion to compel production of defendant directors’ and officers’ insurance policies because such policies are expressly provided for under the mandatory initial disclosures of Rule 26(a)(1)(D). Id. Courts also disagree as to whether a motion for class certification falls within the purview of “other proceedings.” A ruling on a motion to dismiss prior to a class certification would bind only the named plaintiffs; defendants, therefore, sometimes prefer to have a class certified before a ruling on the motion to dismiss to prevent other members of a putative class from refiling identical claims in the event that the motion to dismiss is granted. The court in In re Diamond Multimedia Systems, Inc., No. C 96-2644 SBA, 1997 WL 773733, at *3 (N.D. Cal. Oct. 14, 1997), relying on the Ninth Circuit’s language in Medhekar, held that a

motion for class certification does not fall into the category of “other proceedings” because it does not relate to discovery matters. The court rejected plaintiffs’ contention that they were barred from seeking class certification prior to resolution of defendants’ motion to dismiss. Id. In contrast, other courts have found that ruling on a motion to dismiss prior to considering class certification is appropriate. See Abrams v. Van Kampen Funds, Inc., No. 01 C 7538, 2002 WL 1989401, at *1 (N.D. Ill. Aug. 27, 2002), Winn v. Symons Int’l Group, Inc., No. IP 00-0310-C-B/S, 2001 WL 278113, at *2 (S.D. Ind. Mar. 21, 2001). Other district courts have provided context to the terms “discovery and other proceedings.” See In re JDS Uniphase Corp. Sec. Litig., 238 F. Supp. 2d 1127, 1134 (N.D. Cal. 2002) (finding plaintiffs’ proposed voluntary interviews with former employees did not fall within the scope of “discovery”). c. Exceptions To The Discovery Stay The statutory language provides that the discovery stay will not be in effect if discovery is necessary to “preserve evidence or to prevent undue prejudice” to a party. 15 U.S.C. § 78u-4(b)(3)(B). The Southern District of New York has defined “undue prejudice” as “improper or unfair treatment amounting to something less than irreparable harm.” See In re Bank of America Corp. Sec., Derivative, and ERISA Litig., No. 09 MDL 2058(DC), 2009 WL 4796169, at *2 (S.D.N.Y. Nov. 19, 2009) (citing Brigham v. Royal Bank of Canada, No. 08 Civ. 4331(WHP), 2009 WL 935684, at *1 (S.D.N.Y. Apr. 7, 2009)). In In re WorldCom, Inc. Securities Litigation, 234 F. Supp. 2d 301 (S.D.N.Y. 2002), a district court lifted the discovery stay, ordering defendant WorldCom to produce documents to a group of plaintiffs. The court held that plaintiffs would be unduly prejudiced if they were denied access to documents that had already been made available to public authorities and defendant WorldCom’s creditor committee. Id.; see also In re LaBranche Sec. Litig., 333 F. Supp. 2d 178, 184 (S.D.N.Y. 2004) (“The requested discovery is essential to determine [the plaintiff’s] strategy and to assist in formulating an appropriate settlement demand . . . . The Defendants have not demonstrated any burden imposed by complying now with the inevitable discovery.”); In re Royal Ahold N.V. Sec. & ERISA Litig., 220 F.R.D. 246, 251-2 (D. Md. 2004) (lifting discovery stay to preserve evidence and prevent undue prejudice because volume of request was not unreasonable, corporate reorganization and divesture of subsidiaries by defendant could lead to loss of documents, and separate civil and criminal actions regarding the same issue were not subject to the same discovery stay). But see In re Asyst Techs., Inc. Derivative Litig., No. C-06-04669 EDL, 2008 WL 916883, at *2 (N.D. Cal. Apr. 3, 2008) (denying request to lift discovery stay where plaintiffs claimed “undue prejudice” simply because they lacked access to documents which the DOJ and SEC already possessed). In Canada, Inc. v. Aspen Technology, Inc., No. 07 CIV 1204, 2007 WL 2049738 (S.D.N.Y. July 18, 2007), the court refused to lift the PSLRA’s discovery stay, stating that the “unique circumstances” of WorldCom were not present because here plaintiffs were not “competing with non-PSLRA plaintiffs for the limited assets of insolvent defendants.” Id. at *4. The court noted “courts have refused to lift the discovery stay if the narrow statutory exceptions of evidence preservation or undue prejudice have not been met.” Id. at *2 (citing In re Vivendi Universal S.A. Sec. Litig., 381 F. Supp. 2d 129, 129 (S.D.N.Y. 2003)). The decision in In re American Funds Securities Litigation, 493 F. Supp. 2d 1103 (C.D. Cal. 2007), also distinguished WorldCom on the basis that WorldCom involved court ordered global settlement discussions. Id. at 1106 (denying plaintiffs’ motion to lift stay because government’s possession of documents did not create undue prejudice against plaintiffs). While no circuit courts have specifically addressed the scope of the discovery stay, several district courts have rejected attempts to carve out exceptions to the discovery stay. See, e.g., In re CFS-Related Sec. Fraud Litig., 179 F. Supp. 2d 1260 (N.D. Okla. 2001), motion granted in part by 213 F.R.D. 435 (N.D. Okla. 2003) (denying a plaintiff’s motion to compel discovery against a non-moving defendant while another defendant made a motion to dismiss); In re Carnegie Int’l Corp. Sec. Litig., 107 F. Supp. 2d 676 (D.Md. 2000) (granting third party accountant’s motion to quash a defendant’s subpoena duces tecum because the defendant had not yet filed a motion to dismiss nor had the time to file a motion to dismiss run; noting that the PSLRA intended to stay discovery until the sufficiency of the complaint had been tested by a motion to dismiss or unless a party would

be unduly burdened by a discovery stay); In re Tyco Int’l, Ltd. Sec. Litig., No. 00MD1335, 2000 WL 33654141 (D.N.H. July 27, 2000) (denying plaintiff’s request for preservation order directed at defendants after the implementation of stay of discovery pursuant to the PSLRA because defendants were already on notice of the types of documents plaintiffs would seek during discovery). During a concurrent investigation, the stay of discovery does not apply to documents the government did not originally produce. Seippel v. Sidley, Austin, Brown & Wood, No. 03 CIV. 6942 (SAS), 2005 WL 388561 (S.D.N.Y. Feb. 17, 2005). d. Applicability Of The Discovery Stay On Renewed Motions To Dismiss A denial of a defendant’s motion to dismiss does not automatically and indefinitely lift the discovery stay. For example, in In re Salomon Analyst Litigation, 373 F. Supp. 2d 252 (S.D.N.Y. 2005), the district court reimposed the automatic stay for renewed motions to dismiss, even after the first motion was denied, because the second motion was clearly not frivolous but was prompted by a recent decision that might impact the validity of the case. Similarly, in Selbst v. McDonald’s Corp., No 04 C 2422, 2006 WL 566450 (N.D. Ill. Mar. 1, 2006), the district court re-imposed the discovery stay, even though plaintiff’s original complaint survived a motion to dismiss, because plaintiff chose to file an amended complaint, which defendants moved to dismiss. e. The Discovery Stay And Related State Actions 1) Motions To Stay Discovery Brought In Federal Court Plaintiffs sometimes seek to skirt the constraints of the Reform Act’s discovery stay by filing one or more parallel actions in state court, either as shareholder derivative actions or as individual actions. To prevent plaintiffs from such improper circumvention, defendants should bring a motion to stay discovery in federal court pursuant to the Securities Litigation Uniform Standards Act of 1998 (the “Uniform Standards Act”). The Uniform Standards Act expressly provides that, upon a proper showing, a court may stay discovery proceedings in any private action in state court “as necessary in aid of its jurisdiction, or to protect or effectuate its judgments.” 15 U.S.C. § 78u-4(b)(3)(D); see also Angell Inv. v. Purizer Corp., No. 01 C 6359, 2001 WL 1345996 (N.D. Ill. Oct. 31, 2001) (granting defendants’ motion to stay discovery of both federal securities claims and related state law claims, prior to the outcome of the defendant’s motion to dismiss); Newby v. Enron Corp., 338 F.3d 467, 473 (5th Cir. 2003) (holding the discovery stay provisions of the Reform Act “apply to stays of discovery in any private, class or nonclass, action in state court”); In re Countrywide Fin. Corp. Derivative Litig., 524 F. Supp. 2d 1160, 1179 (C.D. Cal. 2008) (holding Reform Act’s discovery stay applied to derivative actions arising under the Securities and Exchange Act of 1934). But see Tobias Holdings, Inc. v. Bank United Corp., 177 F. Supp. 2d 162, 169 (S.D.N.Y. 2001) (holding automatic discovery stay does not prohibit discovery on non-fraud common law claims arising under court’s diversity jurisdiction). At least one court has held that the procedural safeguards created by the Reform Act are so important that efforts by state court plaintiffs to circumvent its protections could be enjoined by a federal court even in cases where the Uniform Standards Act does not apply. See In re BankAmerica Corp. Sec. Litig., 263 F.3d 795 (8th Cir. 2001). The Eighth Circuit upheld a ruling of the district court staying parallel state court proceedings in their entirety, reasoning that “the PSLRA expressly authorized an injunction against the state proceedings … based upon the tortuous path the state court litigation had taken, [it] was but an end run around the PSLRA.” Id. at 804.

2) Motions To Stay Discovery Brought In State Court

Defendants may find it necessary to file a motion to stay discovery in the related state court action or file a motion to coordinate discovery and pretrial proceedings with the federal litigation. Both federal and state courts are equipped to mitigate inefficiencies of parallel actions by coordinating discovery. See Carpenter v. Wichita Falls Indep. Sch. Dist., 44 F.3d 362, 371 (5th Cir. 1995). California courts have recognized that trial courts should play a larger role in managing modern discovery. See, e.g., Calcor Space Facility, Inc. v. Superior Court, 53 Cal. App. 4th 216, 221, 223, 225 (1997) (explaining California Code of Civil Procedure vests the court with authority to craft reasonable discovery procedures, forestall unnecessary discovery, and impose reasoned case management objectives). Coordination of state and federal actions falls within statutory authority and the court’s inherent power to control its docket and regulate proceedings. See, e.g., Lewis v. County of Sacramento, 218 Cal. App. 3d 214 (1990). But see David v. Wolfen, Minute Order, No. 01 CC0390 (Cal. Super. Ct. Dec. 12, 2001) (denying defendants’ motion to stay discovery in a state derivative action pending defendants’ challenge to plaintiffs’ standing and pending resolution of motion to dismiss in federal court).

3) Motions To Stay Proceedings Brought In State Court Defense counsel may also find it necessary to file a motion to stay the entire proceedings in the related state court action. In such cases, state law may provide ample support. For example, in California, courts have broad discretion to stay a state court proceeding to “avoid a multiplicity of suits and prevent vexatious litigation, conflicting judgments, confusion and unseemly controversy between litigants and courts.” Simmons v. Superior Court, 96 Cal. App. 2d 119, 125 (1950). In California, when an earlier action, including a federal action, has been filed covering the same subject matter, the relevant factors for issuing a stay are: (1) “the importance of discouraging multiple litigation designed solely to harass an adverse party;” (2) the importance “of avoiding unseemly conflicts with the courts of other jurisdictions;” (3) “whether the rights of the parties can best be determined by the court of the other jurisdiction because of the nature of the subject matter, the availability of witnesses, or the stage to which the proceedings in the other court have already advanced;” and (4) whether “the federal action is pending in California not some other state.” Caiafa Prof. Law Corp. v. State Farm Fire & Cas. Co., 15 Cal. App. 4th 800, 804 (1993) (quoting Farmland Irr. Co., Inc. v. Dopplmaier, 48 Cal. 2d 208, 215 (1957)); see also Schimmel Family Trust v. Morgenthaler, No. 842137 (Cal. Super. Ct. Nov. 7, 2001) (following Caiafa and granting defendants’ motion to stay the entire proceedings in a consolidated derivative action until the earlier of the filing of an answer by defendants in the federal action or dismissal of that action “because the damages, if any, to the corporation are to be determined in the federal action”). California courts have also recognized that it is “unreasonable and illogical” to litigate the same issues simultaneously in two separate forums. See Bancomer, S.A. v. Superior Court, 44 Cal. App. 4th 1450, 1462 (1996); see also Schneider v. Vennard, 183 Cal. App. 3d 1340, 1348 (1986) (dismissing state class action in favor of federal class action because principles of “[j]udicial economy and efficiency” are violated when the resources of two already “overtaxed” courts are devoted to the resolution of a single dispute). To avoid this waste of judicial resources, California courts have held that an action should be stayed if the parties and issues involved are “substantially identical” to those in another action. Thomson v. Cont’l Ins. Co., 66 Cal. 2d 738, 746 (1967); see also Berg v. MTC Elec. Techs., 61 Cal. App. 4th 349, 356 (1998) (granting stay in favor of federal cases where both actions were based on allegations of fraud and misrepresentations in connection with the sale of securities). A stay “conserve[s] judicial and other resources which would otherwise be consumed in litigation of some issues which will likely be resolved by [the federal court].” Pac. Bell v. Superior Court, 187 Cal. App. 3d 137, 140 (1986). In determining the appropriate length of the stay, at least one court looked to effectuate the purposes of the Reform Act and the Uniform Standards Act by staying proceedings in a state derivative action until the resolution of a motion to dismiss a previously filed federal securities action. See Schimmel Family Trust v.

Morgenthaler, No. 842137 (Cal. Super. Ct., Nov. 7, 2001). 3. Depositions Much of the early discovery period in securities class actions will focus on defendants’ production of documents, often involving motion practice regarding the proper scope of relevant documents in light of the allegations in the case. Plaintiffs will typically wait until after they have received the majority of defendants’ production before noticing the depositions of defendants and company employees. However, plaintiffs may depose (and seek documents from) third parties such as analysts, customers, suppliers or competitors in the interim. Plaintiffs may also use corporate depositions under Rule 30(b)(6) to obtain testimony on specific substantive areas when they are not sure who might have the requisite information and when they do not feel compelled to have all the relevant documents prior to obtaining testimony. Plaintiffs will often seek to expand the statutory limit of ten depositions per side early in the case so that they will not be constrained in scheduling depositions. Defendants should seek to limit the number of depositions allowed at the outset. a. Ten Deposition Statutory Limit Fed. R. Civ. P. 30(a)(2)(A)(i) imposes a ten-deposition limit on parties in federal court. A party seeking to exceed the statutory limit must seek leave of court and justify its request “consistent with the principles stated in Rule 26(b)(2).” Rule 26(b)(2) requires inquiry into three factors: (1) whether the discovery sought is cumulative or duplicative or is obtainable from another source that is more convenient, less burdensome, or less expensive; (2) whether the party seeking discovery has had ample opportunity to obtain the information sought; and (3) whether the burden or expense of the proposed discovery outweighs its likely benefit given the context of the case. See Bell v. Fowler, 99 F.3d 262, 271 (8th Cir. 1996) (upholding denial of plaintiff’s request to take additional depositions because plaintiff failed to justify why additional depositions were necessary and not cumulative); Siegel v. Truett-McConnell Coll., Inc., 13 F. Supp. 2d 1335, 1338 (N.D. Ga. 1994), aff’d, 73 F.3d 1108 (11th Cir. 1995) (finding plaintiff’s request to take additional depositions that were unnecessary to resolve litigation burdensome); Archer Daniels Midland Co. v. Aon Risk Servs., Inc. of Minn., 187 F.R.D. 578, 587 (D. Minn. 1999) (denying a motion to expand the permissible number of depositions from twenty to forty-seven because “[a]t a minimum, Aon should appropriately exhaust its current quota of depositions, in order to make an informed request for an opportunity to depose more witnesses, before seeking leave to depose a legion of others”); Barrow v. Greenville Indep. Sch. Dist., 202 F.R.D. 480, 483 (N.D. Tex. 2001) (finding positing in general and conclusory terms the materiality of a desired deponent is insufficient); DiBartolo v. City of Philadelphia, No. CIV. A. 99-1734, 2001 WL 872835, at *1-2 (E.D. Pa. June 26, 2001) (finding plaintiff’s request for additional depositions premature because it could not be known at the early stages of discovery whether additional discovery was necessary). b. Rule 30(b)(6) Depositions Rule 30(b)(6) states that: [a] party may in the party’s notice and in a subpoena name as the deponent a public or private corporation . . . and describe with reasonable particularity the matters on which examination is requested. In that event, the organization so named shall designate one or more officers, directors, or managing agents, or other persons who consent to testify on its behalf, and may set forth, for each person designated, the matters on which the person will testify. . . . The persons so designated shall testify as to matters known or reasonably available to the organization.

1) Speaking For The Corporation The testimony elicited at the Rule 30(b)(6) deposition represents the knowledge of the corporation, not of the individual deponent. The designated witness is “speaking for the corporation,” and this testimony must be distinguished from that of a “mere corporate employee” whose deposition is not considered that of the corporation and whose presence must be obtained by subpoena. 8A Charles Alan Wright, Arthur R. Miller & Richard L. Marcus, Federal Practice & Procedure § 2103, at 36-37 (West 2007); Lapenna v. Upjohn Co., 110 F.R.D. 15, 21 (E.D. Pa. 1986); Toys “R” Us, Inc. v. N.B.D. Trust Co., No. 88 C 10349, 1993 WL 543027, at *2 (N.D. Ill. Sept. 29, 1993); United States v. Mass. Indus. Fin. Agency, 162 F.R.D. 410, 412 (D. Mass. 1995). Moreover, the designee must not only testify about facts within the corporation’s knowledge, but also about its subjective beliefs and opinions. Lapenna, 110 F.R.D. at 20. The corporation must provide its interpretation of documents and events. Ierardi v. Lorillard, Inc., No. CIV. A. 90-7049, 1991 WL 158911 (E.D. Pa. Aug. 13, 1991). Testimony by a Rule 30(b)(6) designee, although binding on the corporation, is not tantamount to a judicial admission. As with deposition testimony of individuals, Rule 30(b)(6) testimony is only a statement of the corporate person which, if altered, may be explained and explored through cross-examination as to why the opinion or statement was altered. W.R. Grace & Co. v. Viskase Corp., No. 90 C 5383, 1991 WL 211647 (N.D. Ill. Oct. 15, 1991). However, defense counsel should be aware that the designee can make an admission against interest which, under Federal Rule of Evidence 804(b)(3), is binding on the corporation. Ierardi, 1991 WL 158911, at *3.

2) Designation Of Knowledgeable Persons A corporation must “make a conscientious good-faith endeavor to designate the persons having knowledge of matter sought by [the discovering party] and to prepare those persons in order that they could answer fully, completely, and unevasively, the questions posed by [the discovering party] as to the relevant subject matter.” Mitsui & Co. v. P.R. Water Res. Auth., 93 F.R.D. 62, 67 (D.P.R. 1981); see also F.D.I.C. v. Butcher, 116 F.R.D. 196 (E.D. Tenn. 1986) (explaining corporation must not only produce such number of persons as will satisfy the request, but more importantly, prepare them so that they may give complete, knowledgeable, and binding answers on behalf of the corporation), aff’d, 116 F.R.D. 203 (E.D. Tenn. 1987). If no current employee has sufficient knowledge to provide the requested information, the party is obligated to prepare one or more witnesses, to the extent possible, so that they may give complete, knowledgeable, and binding answers on behalf of the corporation. Also, if during the course of a deposition the designee becomes obviously deficient, the corporation is obligated to provide a substitute. See Dravo Corp. v. Liberty Mut. Ins. Co., 164 F.R.D. 70 (D. Neb. 1995). F. Privilege Considerations 1. Public Policies Supporting The Attorney-Client Privilege And Work Product Doctrine A plaintiff is likely to argue that a court should grant a motion to compel production of privileged material because of policies supporting discovery of relevant information concerning the facts in dispute. In response, a defendant should emphasize the important public policy considerations underlying the attorney-client privilege. See, e.g., Trammel v. United States, 445 U.S. 40, 51 (1980) (“The lawyer-client privilege rests on the need for the advocate and counselor to know all that relates to the client’s reasons for seeking representation if the professional mission is to be carried out.”); Upjohn Co. v. United States, 449 U.S. 383, 389 (1981) (noting that as the “oldest of the privileges for confidential communications known to the common law,” the attorney-client privilege aims “to encourage full and frank communication between attorneys and their clients” and “thereby to

promote broader public interests in the observance of law and administration of justice”); Saito v. McKesson HBOC, Inc., No. CIV. A. 18553, 2002 WL 31657622, at *6 (Del. Ch. Nov. 13, 2002) (“[P]ublic policy seems to mandate that courts continue to protect the confidentially disclosed work product in order to encourage corporations to comply with law enforcement agencies.”). 2. Attorney-Client Privilege Issues One of the most important issues during discovery for defendants is preserving the attorney-client privilege and any attorney work product from discovery by plaintiffs. Both in producing documents and in preparing witnesses for depositions, counsel should be acutely aware of any potential attorney-client privilege issues that may arise with in-house or outside counsel and the names of those lawyers. a. Immunity From Disclosure It is well settled under both state and federal law that confidential attorney-client communications are immune from discovery by an adverse party. See, e.g., In re Grand Jury Subpoena Duces Tecum, 731 F.2d 1032, 1036 (2d Cir. 1984) (setting forth elements of attorney-client privilege). b. Relevance Of Communications And Challenges To Privilege Confidential attorney communications with a client may be relevant to discovering the accuracy of information in an offering document, the results of due diligence investigations, the exercise of reasonable care under Sections 11 or 12(2), the existence of scienter under Rule 10b-5, the absence of culpable knowledge or participation under Section 15, and good faith under Section 20(a). Therefore, these privileges may not survive in public offering litigation. Maintenance of the privilege can be tested when: (1) a client asserts a reliance-oncounsel defense; (2) privileged communications or work product of an attorney are disseminated to third persons (e.g., a tax opinion included in offering materials); or (3) a plaintiff asserts a right to the privileged material under the “crime-fraud” exception to the attorney-client privilege and succeeds in making the requisite showing. 3. Reliance On Counsel Defense a. Asserting Defense Waives Privilege Several courts have held that asserting a reliance-on-counsel defense waives the attorney-client privilege as to communications on which the defense is based. See, e.g., In re von Bulow, 828 F.2d 94, 103 (2d Cir. 1987) (ruling attorney-client privilege cannot be used as both “a sword and a shield”); Joy v. North, 692 F.2d 880, 893-94 (2d Cir. 1982) (holding that party waived the attorney-client privilege over a committee report when it used the report as the basis for a motion for summary judgment); Multiform Dessicants, Inc. v. Stanhope Prods. Co., Inc., 930 F. Supp. 45, 47 (W.D.N.Y. 1996) (“[D]eliberate injection of the advice of counsel into a case waives the attorney-client privilege.”); Connell v. Bernstein-Macaulay, Inc., 407 F. Supp. 420, 423 (S.D.N.Y. 1976) (ruling that the attorney-client privilege is waived when a litigant seeks to avoid a statutory protection which has been established for his adversary’s benefit by a claim that his adversary is estopped to assert the protection, and where there is a good-faith basis for believing that waiving the privilege would reveal the validity of the estoppel claim); Hearn v. Rhay, 68 F.R.D. 574, 581 (E.D. Wash. 1975) (noting assertion of good faith defense based on advice of counsel in a civil rights action impliedly waived the attorney-client privilege because “party asserting the privilege placed information protected by it in issue through some affirmative act for his own benefit, and to allow the privilege to protect against disclosure of such information would have been manifestly unfair to the opposing party”); Garfinkle v. Arcata Nat’l Corp., 64 F.R.D. 688, 689 (S.D.N.Y. 1974)

(holding defendant waived privilege when he asserted as a defense that he had relied on an opinion of counsel that securities need not be registered despite contractual agreement to do so). b. Limitation Of Implied Waiver The Sixth Circuit in In re Grand Jury Proceedings, 78 F.3d 251 (6th Cir. 1996), rejected the argument that the assertion of a reliance on counsel defense resulted in a broad waiver of the attorney-client privilege. Rather, the court held that fairness required that the waiver be limited to communications on the same subject matter. The case was remanded to the district court with instructions to determine the scope of the waiver on a question-byquestion basis. Id. at 256. Many courts have similarly taken a limited view of “implied waivers” in other courts, including inadvertent disclosure. In Weil v. Investment/Indicators, Research & Management, Inc., 647 F.2d 18 (9th Cir. 1981), the court refused to hold that a single, inadvertent disclosure of attorney-client communications – that defendant had been advised by its Blue Sky counsel to register certain securities – waived the privilege as to all attorney-client communications. Instead, the court held that because the disclosure occurred early in the case, was made to opposing counsel rather than the court, and did not prejudice plaintiff, defendant “waived its privilege only as to communications about the matter actually disclosed.” Id. at 25. c. Assertion Of Defense Waives Accountant-Client Privilege Several courts have held that by asserting reliance on a public accountant’s audit report as a defense in litigation, a defendant waives the right to insist that the audit report was privileged and not subject to discovery. See, e.g., Nashville City Bank & Trust Co. v. Reliable Tractor, Inc., 90 F.R.D. 709, 712 (M.D. Ga. 1981); Savino v Luciano, 92 So. 2d 817 (Fla. 1957). 4. Dissemination Of Information To Third Parties a. No Privilege, Or Implied Waiver Several courts have held that the attorney-client privilege does not protect communications concerning materials disseminated or proposed to be disseminated to third persons. However, when considering whether the privilege was waived, courts have found that revealing the general topic of discussion between an attorney and client does not waive the privilege, unless the revelation also reveals the substance of the protected communication. See New Jersey v Sprint Corp., 258 F.R.D. 421, 426 (D. Kan. 2009) (finding that individual class action defendants did not waive the attorney-client privilege by partially disclosing legal advice during their deposition because individuals did not testify as to the substance of any legal advice). While some courts treat third party communications as an implied waiver of otherwise privileged information, others held that no privilege attaches to the communications at all. In In re Grand Jury Proceedings, the Fourth Circuit held that the attorney-client privilege did not extend to the communication of information intended to be used in preparing a prospectus that “was to be published to others and was not intended to be kept in confidence.” 727 F.2d 1352, 1358 (4th Cir. 1984). The court therefore held that the privilege never attached to such communications in the first place. The court reasoned that privileged communications were limited to those that the client expressly made confidential or would reasonably assume under the circumstances would be understood by the attorney as so intended. Id. at 1355-56. In United States v. Jones, the Fourth Circuit held that the attorney-client privilege did not apply to “correspondence and instructions or directions, written or verbal … [and] any documents and research notes used in preparation of [tax law opinions]” where:

[t]he success of appellants’ business venture depended upon convincing potential investors that purported tax benefits existed in fact, and this rested on interpretations of the tax laws. The appellants not only obtained the tax law opinions for the ultimate use of persons other than themselves, but also publicized portions of the legal opinions in brochures and other printed material. They cannot now assert a right to quash the subpoenas (1) to block the grand jury’s access to documents substantial portions of which the appellants have published to the public at large, or (2) to prevent the revelation of the factual communications between the appellants and their attorneys underlying the published opinion letters. 696 F.2d 1069, 1071, 1073 (4th Cir. 1982). In United States v. Cote, the Eighth Circuit held that the attorney-client privilege was waived as to accountant work papers prepared at the direction of counsel, which reflected the entries later appearing in a nonconfidential tax return. 456 F.2d 142 (8th Cir. 1972). The court observed that any dispute “as to whether particular work papers contain detail of unpublished expressions which are not part of the data revealed on the tax returns, should be submitted to the district court for an in camera ruling.” Id. at 145 n.4 (emphasis added). The Eighth Circuit treated the issue as one of waiver of privilege. In Ryan v. Gifford, No. Civ. A. 2213-CC, 2007 WL 4259557 (Del. Ch. Nov. 30, 2007), the Delaware Court of Chancery held that the defendant company’s special committee – i.e., not a special litigation committee under Zapata – waived the attorney-client privilege as to all communications between the special committee and its counsel by making a presentation at a meeting for the board of directors where some of the board members present were individual defendants “whose interests are not common with the client.” Id. at *3. The court ordered that the company, its special committee and the committee’s counsel produce to plaintiffs all material related to the committee’s options backdating investigation that was previously withheld on the basis of attorney-client privilege. See id. at * 2-3. The company subsequently sought certification for interlocutory appeal of the Chancery Court’s order to produce all communications between the special committee and its counsel. In Ryan v. Gifford, No. Civ. A. 2213-CC, 2008 WL 43699 (Del. Ch. Jan. 2, 2008), the Chancery Court denied the application. The court emphasized that the work product of the special committee’s counsel had been used by defendant directors to defend themselves, the directors obtained the information in their individual as opposed to fiduciary capacities, and the special committee lacked the power to act independently, but was required to report back to the full board. See id. at *5-7. b. No Implied Waiver Other courts have looked closely at the substance and circumstances of the information shown to third parties and concluded that dissemination of such information did not constitute a waiver of confidential communications. In In re Grand Jury Subpoena Duces Tecum, the Second Circuit rejected the proposition that disclosure to a third person of documents prepared by an attorney for his client destroys the confidentiality of all other attorney-client communications relating to the same subject matter. 731 F.2d 1032 (2d Cir. 1984). The court held that documents relating to a company’s request for tax advice were covered by the attorney-client privilege even though some of the information contained in the documents might be given to non-control group employees or to outsiders. Id. at 1037. The court observed that: the attorney-client privilege protects communications rather than information; the privilege does not impede disclosure of information except to the extent that the disclosure would reveal confidential communications. Thus, the fact that certain information in the documents might ultimately be disclosed to AG employees did not mean that the communications to [the company’s attorney] were foreclosed from protection by the privilege as a matter of law. Nor did the fact that certain

information might later be disclosed to others create the factual inference that the communications were not intended to be confidential at the time they were made. Id. The court stressed that the privilege analysis must focus on the communication rather than the subject matter: For example, although some of the documents appear to be drafts of communications … which might eventually be sent to other persons, and as distributed would not be privileged, we see no basis in the record for inferring that AG did not intend that the drafts – which reflect its confidential requests for legal advice and were not distributed – to be confidential. Id.; see also United States v. Ackert, 169 F.3d 136, 139 (2d Cir. 1999) (holding that attorney-client privilege can protect communications with a third party only where the third party assists in translating or interpreting information between the attorney and client). In Sylgab Steel & Wire Corp. v. Imoco-Gateway Corp., the court rejected the argument that, because plaintiff’s attorney in a patent infringement action had sent an “opinion letter” to the defendant stating that the plaintiff’s patent was valid, the attorney-client privilege as to all confidential communications concerning the subject matter of the opinion letter was waived. 62 F.R.D. 454 (N.D. Ill. 1974), aff’d, 534 F.2d 330 (7th Cir. 1976). The court observed: a party cannot waive its privilege merely if its lawyer, bargaining on its behalf, contends vigorously and even in some detail that the law favors his client’s position on a point in issue – whether that point is the contested validity of a patent or the contested validity of a contract or some other matter.… Clients and lawyers should not have to fear that positions on legal issues taken during negotiations waive the attorney-client privilege so that the confidential facts communicated to the attorney and the private opinions and reports drafted by an attorney for his client become discoverable. Id. at 458. The court noted that the specifics of the confidential communications were not disclosed in the opinion letter. Id. As such, the attorney-client privilege was not waived. Id. In Merrill Lynch & Co., Inc. v. Allegheny Energy, Inc., 229 F.R.D. 441, 458 (S.D.N.Y. 2004), the court held that the reports of an investigation conducted by counsel did not lose work product protection simply because their contents had been disclosed to the company’s independent auditors. The court observed: any tension between an auditor and a corporation that arises from an auditor’s need to scrutinize and investigate a corporation’s records and book-keeping practices simply is not the equivalent of an adversarial relationship contemplated by the work product doctrine. [T]o construe a company’s auditor as an adversary and find a blanket rule of waiver of the applicable work product privilege under these circumstances could very well discourage corporations from conducting a critical selfanalysis and sharing the fruits of such an inquiry with the appropriate actors. Id. at *6-7. But see United States v. Ruehle, 83 F.3d 600 (9th Cir. 2009) (ruling that statements made by the CFO to attorneys conducting an internal investigation on option backdating were not privileged because the CFO failed to establish that the statements were “made in confidence.” In Duplan Corp. v. Deering Milliken, Inc., 397 F. Supp. 1146, 1191 (D.S.C. 1974), the court observed “[t]he voluntary waiver by a client, even without limitation, of one or more nonprivileged documents passing between the same attorney and the same client discussing the same subject does not waive the privileged communications between the same attorney and the same client on the same subject.” Id (emphasis added); accord Champion Int’l Corp. v. Int’l Paper Co., 486 F. Supp. 1328, 1330 n.2 (N.D. Ga. 1980). In Chase Manhattan Bank N.A. v. Drysdale Sec. Corp., 587 F. Supp. 57 (S.D.N.Y. 1984), the court rejected the argument that an implied waiver of the attorney-client privilege occurs whenever protected confidential

communications relate to an issue in litigation. The court denied defendant’s motion to compel discovery of privileged, confidential communications between plaintiff and its counsel concerning a securities transaction even though “justifiable reliance” by plaintiff was an issue in the litigation. The court dismissed defendant’s contention that by filing a securities fraud action, plaintiff placed all communications relating to the reliance question in issue and subject to discovery: “While it may be useful [for defendant] to know the substance of the advice [plaintiff] received concerning its liability on the transaction, I do not believe that the communications are essential to establish of what a reasonably prudent bank should have known and should have done under the circumstances.” Id. at 58; accord Tribune Co. v. Purcigliotti, No. 93 CIV. 7222 LAP THK, 1997 WL 10924 (S.D.N.Y. Jan. 10, 1997), modified, 1998 WL 175933 (S.D.N.Y. Apr. 14, 1998). c. Prejudice Several courts have refused to find an implied waiver unless a party is able to show prejudice resulting from the assertion of the privilege. S.E.C. v. Lewis, No. CIV-2-83-228, 1984 WL 2451 (E.D. Tenn. May 31, 1984); accord Champion Int’l, 486 F. Supp. at 1333; Hearn v. Rhay, 68 F.R.D. 574, 581 (E.D. Wash. 1975). d. Joint Defense Privilege Courts will extend the attorney-client privilege to legal communications with third parties where a community of interests exists between the parties. See, e.g., United States v. Aramony, 88 F.3d 1369, 1391 (4th Cir. 1996); United States v. Bergonzi, 214 F.R.D. 563 (N.D. Cal. 2003), amended on other grounds, 216 F.R.D. 487 (N.D. Cal. 2003) (holding the claimed common interest between company and the government to determine if company’s employees violated securities laws was not the same as the common interest shared by allied lawyers and clients who are working together); See also Louisiana Mun. Police Employees Ret. Sys. v. Sealed Air Corp., 253 F.R.D. 300, 310 (D.N.J. 2008) (holding although “parties were on adverse sides of a business deal” the common interest doctrine still protects their communications because “the weight of case law suggests that, as a general matter, privileged information exchanged during a merger between two unaffiliated businesses would fall within the common-interest doctrine”) (internal citations omitted). e. Dissemination To Regulatory Agencies Defense attorneys in securities litigation often find themselves dealing with regulatory agencies and criminal authorities as well as with civil plaintiffs. An issue often arises as to whether responses to informal investigative requests by regulatory agencies will be subsequently discoverable by plaintiffs.

1) Waiver Of Privilege? In In re Steinhardt Partners, L.P., the Second Circuit held that the voluntary submission of material to the SEC waived the protection of the work-product doctrine. 9 F.3d 230 (2d Cir. 1993). The Court of Appeals upheld the finding of the lower court that the SEC stood in an adversarial position, and thus no common interest existed. Id. at 234. Any material handed over to the SEC could be obtained by private litigants. Id. at 236; see also In re Initial Pub. Offering Sec. Litig., No. 21 MC 92 (SAS), 2004 WL 60290 (S.D.N.Y. Jan. 12, 2004) (concluding Wells submissions to the SEC are not protected from discovery merely because they may contain an offer of settlement and that the discovery of settlement materials is not governed by a different standard than other documents under the Federal Rules of Civil Procedure). The Second Circuit noted, however, that rules relating to privilege in government investigations must be crafted on a case-by-case basis, and that privilege might not be waived where the disclosing party and the government share a common interest or the SEC and the disclosing party have entered into a confidentiality agreement. See

id. at 235. Other circuits have also found such a waiver. See Westinghouse Elec. Corp. v. Republic of Philippines, 951 F.2d 1414 (3d Cir. 1991) (finding party waived work product and attorney-client privilege upon voluntary disclosure of information to SEC and Department of Justice); In re Subpoenas Duces Tecum, 738 F.2d 1367 (D.C. Cir. 1984) (same); In re Initial Pub. Offering Sec. Litig., 249 F.R.D. 457 (S.D.N.Y. 2008) (rejecting the selective waiver theory and ordering defendant to turn over internal investigation documents to plaintiffs due to voluntary disclosure of the documents to the SEC and Department of Justice, despite the existence of a confidentiality agreement); United States v. Bergonzi, 214 F.R.D. 563 (N.D. Cal. 2003) (holding company’s disclosure of documents to the government waives the attorney-client privilege and work product doctrine even if a confidentiality agreement exists between the company and the government); In re Kidder Peabody Sec. Litig., 168 F.R.D. 459, 470 (S.D.N.Y. 1996) (disclosing report to SEC in litigation results in waiver of work product and attorney-client privilege). The California Court of Appeals in McKesson HBOC v. Superior Court, 115 Cal. App. 4th 1229 (2004), affirmed that attorney-client and work product privileges are waived (and the relevant documents are discoverable to plaintiffs in civil litigation) by disclosure of counsel’s investigation to government agencies, despite the claim of a common interest and the existence of a “confidentiality agreement.” The court joined others rejecting the “selective waiver” doctrine urged by the SEC and SIA as amici.

2) Selective Waiver Theory In Diversified Industries v. Meredith, the Eighth Circuit sitting en banc held that the voluntary disclosure of material to the SEC does not constitute a waiver. 572 F.2d 596 (8th Cir. 1977). The disclosure was in “a separate and nonpublic SEC investigation” and, as such, only a limited waiver applied. Id. at 611. Subsequent courts have described the DIVERSIFIED rule as one of “selective waiver.” See Steinhardt, 9 F.3d at 235. In Saito v. McKesson HBOC, Inc., the chancellor held that voluntary disclosure to the SEC pursuant to a confidentiality agreement does not constitute a waiver. No. CIV. A. 18553, 2002 WL 31657622 (Del. Ch. Nov. 13, 2002). A reasonable expectation exists that such documents submitted “to the SEC under a confidentiality agreement would not reach the hands of its other adversaries.” Id. at *7. Other courts have also applied the selective waiver theory when a confidentiality agreement between the company and the regulatory agency exists. See Permian Corp. v. United States, 665 F.2d 1214, 1218 (D.C. Cir. 1981) (upholding trial court’s conclusion that a confidentiality agreement was in place before disclosures were made to the SEC and that this agreement prevented waiver of the work product privilege as to those documents). Despite the above authorities, significant risk of a waiver occurs upon voluntary disclosure of materials to regulators, as many courts have rejected the doctrine of selective waiver. For example, in In re Qwest Communications International Inc., 450 F.3d 1179 (10th Cir. 2006), the Tenth Circuit refused to adopt the “selective waiver” or “limited waiver” approach, under which a cooperating company could produce attorneyclient privileged and work-product protected documents to the DOJ or SEC without waiver of further protection for those materials. See also Westinghouse Elec. Corp., 951 F.2d at 1431 (finding waiver of privilege despite confidentiality agreement). f. Federal Rule Of Evidence 502 A new rule addressing the issues of attorney-client privilege and work product waiver was enacted in September 2008. FRE 502(a) limits subject matter waivers in instances of intentional disclosure, providing that the waiver extends to undisclosed privileged or protected communications on the “same subject matter” only if “they ought in fairness to be considered together.” Fed. R. Evid. 502(a) (2009). FRE 502(b) goes on to address inadvertent disclosures and bars a waiver finding in certain instances. Fed. R. Evid. 502(b) (2009). It remains

to be seen how these and other subsections of Rule 502 will be interpreted by the courts. g. Sarbanes-Oxley “Professional Responsibility” Dissemination On January 23, 2003, the SEC adopted final rules to implement Section 307 of the Sarbanes-Oxley Act and thus set standards of professional conduct for attorneys appearing and practicing before the SEC in the representation of an issuer. These rules became effective August 5, 2003, 180 days after they were published in the Federal Register. The rules mandate, under certain circumstances, the upward dissemination of information within a company.

1) Duty To Report Evidence Of A Material Violation If an attorney becomes aware of evidence of, or has reason to suspect, a material violation by the company or any of its directors, officers or employees, such attorney is required to notify (1) the Chief Legal Officer (“CLO”) or (2) the CLO and Chief Executive Officer (“CEO”). 17 C.F.R. § 205.3(b)(1). A material violation is defined as “a material violation of an applicable US federal or state securities law, a material breach of fiduciary duty arising under US federal or state law, or similar material violation of any US federal or state law.” 17 C.F.R. § 205.2(h)(i). If the attorney does not receive an “appropriate response” (as defined in 17 C.F.R. § 205.2(b)) from the CLO or CEO, the attorney is required to report “up the ladder” to the audit committee, another committee comprising of completely independent directors, or the entire board of directors if the company does not have a committee consisting of independent directors. 17 C.F.R. § 205.3(b)(3)(i)-(iii). Alternatively, in lieu of reporting to the CLO or CLO & CEO, the attorney may report evidence of the material violation to a qualified legal compliance committee (“QLCC”) – a committee comprised of independent members of the board of directors established primarily to handle reports of such violations. 17 C.F.R. § 205.3(c). The SEC has confirmed that by communicating to the company’s officers or directors, the attorney is not waiving the attorney-client privilege with regard to such information. 17 C.F.R. § 205.3(b)(1).

2) Disclosure Of Confidential Information An attorney who fails to report a material violation may be subject to civil penalties or remedies, as well as disciplinary action by the SEC. 17 C.F.R. § 205.(6)(a)-(b). Therefore, an attorney is allowed to use any report of a material violation or any response thereto in connection with any investigation, proceeding, or litigation in which the attorney’s compliance is an issue. 17 C.F.R. § 205.3(d)(1). Furthermore, an attorney “may reveal to the SEC, without the issuer’s consent,” confidential information related to the representation to the extent the attorney reasonably believes it necessary: (a) to prevent the [company] from committing a material violation that is likely to cause substantial injury to the financial interest or property of the company or investors; (b) to prevent the [company in an SEC] investigation or administrative proceeding from committing perjury, suborning perjury, or committing any act that is likely to perpetrate a fraud upon the [SEC]; or (c) to rectify the consequences of a material violation by the [company] that caused, or may cause, substantial injury to the financial interest of the [company] or investors in the furtherance of which the attorney’s services were used. 17 C.F.R. § 205.3(d)(2) (emphasis added). The final rules do not state whether revealing such confidential information to the SEC will result in the waiver of any attorney-client privilege or work product.

5. Crime-Fraud Exception Attorney-client communications in furtherance of criminal or fraudulent acts are not protected from disclosure. See In re Richard Roe, Inc., 68 F.3d 38, 40 (2d Cir. 1995). A communication is in furtherance of criminal or fraudulent acts when it facilitates or conceals the wrongful acts. Id. at 40. In order to gain an in camera review of the attorney-client communications by the court to determine the applicability of the crime-fraud exception, the party seeking discovery must make a threshold showing sufficient to support a reasonable belief that a crime or fraud was planned or committed. United States v. Zolin, 491 U.S. 554, 563 (1989); see also In re Nat’l Mortgage Equity Corp. Mortgage Pool Certificates Litig., 116 F.R.D. 297 (C.D. Cal. 1987). In addition, the crime-fraud exception, if applicable, can also be used to abrogate attorney work-product protection. Id. 6. The Accountant-Client Privilege a. No Federal Accountant-Client Privilege The absence of a federal common law accountant-client privilege is well settled. See United States v. Arthur Young & Co., 465 U.S. 805 (1984); Couch v. United States, 409 U.S. 322, 335 (1973). b. State Statutory Privilege Several states have an established statutory accountant-client privilege protecting confidential communications between accountant and client. See Wright & Miller, Accountant’s Privilege, 23 Fed. Prac. & Proc. Evid. § 5427 (R 501); see, e.g., Ariz. Rev. Stat. Ann. § 32-749; Colo. Rev. Stat. Ann. § 154-1-7(7); Fla. Stat. Ann. § 473.141; Ga. Code Ann. § 84-216; Ida. R. Ev. 515; Ill. Rev. Stat. Ch. 110 1/2, § 51; Ind. Code § 25-2.1-14-2; Iowa Code § 116.15; Ky. Rev. Stat. § 325.440; La. Rev. Stat. Ann. § 37.85; Md. Ann. Code, art. 75A, § 20; Mich. Comp. Laws § 338.523; Miss. Code § 73-33-16(2); Mo. Rev. Stat. § 326.151; Mont. Code Ann 37-50402; Nev. Rev. Stat. §§ 49. 125-.205; N.M. Stat. Ann. § 36-6-6(c); Pa. Stat. Ann., tit. 63, § 911a; P.R. Laws Ann., tit. 20, § 790; Tenn. Code Ann. § 61-1-116; Tex. Rev. Civ. Stats., Art. 41a-1, sec. 26. c. Federal Court – Federal Rules Of Evidence Apply Rule 501 of the Federal Rules of Evidence provides in pertinent part: the privilege of a witness … shall be governed by the principles of the common law as they may be interpreted by the courts of the United States in the light of reason and experience. However, in civil actions and proceedings, with respect to an element or defense as to which State law supplies the rule of decision, the privilege of a witness … shall be determined in accordance with state law. d. Federal Court – No Privilege If Both Federal And State Claims In an action arising under federal question jurisdiction, but involving both federal and state causes of action, courts have held that a state statutory accountant-client privilege does not apply to any of the claims in the litigation. See, e.g., F.D.I.C. v. Mercantile Nat’l Bank of Chicago, 84 F.R.D. 345 (N.D. Ill. 1979). Counsel for accountant defendants nevertheless should consider either asserting the privilege or requesting a court order on the privilege issue because accountants often are under a statutory duty to protect the confidential communications of their clients or else risk disciplinary proceedings. See, e.g., Fla. Stat. Ann. § 473.323 (providing that a breach of an accountant’s obligation to protect privileged materials could subject the

accountant to disciplinary action); Ross v. Popper, 9 B.R. 485 (S.D.N.Y. 1980) (noting that attorneys “quite properly” followed considerations of professional ethics by asserting attorney-client privilege in response to purported waiver by bankruptcy trustee). e. Federal Court – Diversity Action A state statutory accountant-client privilege may be asserted in a diversity case. See, e.g., Commercial Union Ins. Co. of Am. v. Talisman, Inc., 69 F.R.D. 490 (E.D. Mo. 1975) (noting that state-based accountant-client privilege could successfully be asserted by defendant-accountant in diversity action). Accordingly, in a federal diversity or state court action, counsel for an accountant should pay close attention to choice of law issues. 7. Fifth Amendment Privilege Due to the increased interest of the United States Attorney’s Office in securities fraud cases, one must consider instructing a client to assert his or her Fifth Amendment privilege against self-incrimination in civil class actions. The Fifth Amendment to the U.S. Constitution provides in part that, “[n]o person … shall be compelled in any criminal case to be a witness against himself.” U.S. Const. amend. V. Of course, such a strategy may have serious ramifications in the civil proceeding. The following are a few issues to consider when advising a client to assert his or her Fifth Amendment privilege. a. Corporations The Fifth Amendment privilege against self-incrimination applies only to individuals and does not apply to corporations, partnerships or other entities. See, e.g., United States v. Doe, 465 U.S. 605, 608 (1984); Bellis v. United States, 417 U.S. 85, 94 (1974); Hale v. Henkel, 201 U.S. 43, 69-70 (1906), overruled in part on other grounds, Murphy v. Waterfront Comm’n of N.Y. Harbor, 378 U.S. 52 (1964). b. Producing Documents The privilege generally does not apply to the production of incriminatory documents. See United States v. Doe, 465 U.S. 605, 610 (1984); S.E.C. v. First Jersey Sec., Inc., 843 F.2d 74, 76-77 (2d Cir. 1988). However, the privilege may apply where the act of producing documents itself is a “testimonial act,” i.e., where by producing the documents the party effectively admits their existence and authenticates them as its own. See Doe, 465 U.S. at 612; In re DG Acquisition Corp., 151 F.3d 75, 79-80 (2d Cir. 1998); In re Three Grand Jury Subpoenas Duces Tecum Dated January 29, 1999, 191 F.3d 173, 178 (2d Cir. 1999). The issue may turn on whether the individual is a current or former employee. If the individual is a current employee of the corporation, the individual holds the documents as a representative of the corporation and thus cannot assert the privilege even if the documents would incriminate the individual personally. See Braswell v. United States, 487 U.S. 99, 108-09 (1988); In re Grand Jury Witnesses, 92 F.3d 710, 712 (8th Cir. 1996). On the other hand, if the individual is no longer an employee, several courts have held that the individual may assert the Fifth Amendment privilege because the individual is no longer acting on behalf of the corporation. In re Grand Jury Proceedings, 71 F.3d 723, 724 (9th Cir. 1995); Three Grand Jury Subpoenas, 191 F.3d at 183. But see In re Grand Jury Subpoena Dated November 12, 1991, 957 F.2d 807, 812 (11th Cir. 1992) (holding that a corporate custodian of records continues to hold documents in a representative capacity even after his or her employment is terminated and therefore may be compelled to produce them regardless of his or her Fifth Amendment right); In re Sealed Case (Gov’t Records), 950 F.2d 736, 740 (D.C. Cir. 1991) (same). c. Adverse Inference

In a criminal proceeding, there can be no adverse comment on an individual’s decision to assert the Fifth Amendment privilege. See, e.g., Baxter v. Palmigiano, 425 U.S. 308, 317 (1976); Griffin v. California, 380 U.S. 609, 612 (1965). A defendant may also assert his or her Fifth Amendment privilege regarding any matter in a civil proceeding that may incriminate the individual criminally, but the court or jury may draw an adverse inference from the individual’s invocation of the privilege. See, e.g., Baxter, 425 U.S. at 318; Doe ex rel. RudyGlanzer v. Glanzer, 232 F.3d 1258, 1264 (9th Cir. 2000); S.E.C. v. Musella, 578 F. Supp. 425, 429-30 (S.D.N.Y. 1984) (holding that the SEC can infer from an individual’s assertion of the Fifth Amendment privilege that the individual willfully violated the federal securities laws). Further, one court has even held that an adverse inference may be drawn against a corporation from an employee’s assertion of the Fifth Amendment. Brink’s, Inc. v. City of New York, 717 F.2d 700, 707-10 (2d Cir. 1983). However, a finding of liability cannot be based solely on the adverse inference. See Curtis v. M&S Petroleum, Inc., 174 F.3d 661, 675 (5th Cir. 1999); Daniels v. Pipefitters’ Ass’n Local Union No. 597, 983 F.2d 800, 802 (7th Cir. 1993); United States v. Premises Located at Route 13, 946 F.2d 749, 756 (11th Cir. 1991). d. Preclusion Of Evidence When an individual asserts his or her Fifth Amendment privilege against self-incrimination, a court may preclude the individual from offering evidence on that issue at trial or allow the party to be impeached with his or her silence on those matters. See, e.g., Harris v. City of Chicago, 266 F.3d 750, 753-54 (7th Cir. 2001); In re Edmond, 934 F.2d 1304, 1308-09 (4th Cir. 1991) (sustaining district court order striking affidavits opposing summary judgment after parties refused to answer questions at depositions); Traficant v. C.I.R., 884 F.2d 258, 265 (6th Cir. 1989) (upholding trial court’s order barring the defendant from introducing evidence on the authenticity of his own statement and of tape recordings because he had invoked the Fifth Amendment and had refused to respond to discovery on those points); Gutierrez-Rodriguez v. Cartagena, 882 F.2d 553, 577 (1st Cir. 1989) (“A defendant may not use the fifth amendment to shield herself from the opposition’s inquiries during discovery only to impale her accusers with surprise testimony at trial.”). But see S.E.C. v. Greystone Nash, Inc., 25 F.3d 187, 192-94 (3d Cir. 1994) (holding that a party invoking the privilege is not prevented from presenting evidence to the fact-finder to support his own position). 8. Assertion Of “Work Product” Protection Over Identities Of Confidential Witnesses The majority of district courts will reject a plaintiff’s effort to withhold the identities of confidential witnesses referenced in the complaint. See Miller v. Ventro Corp., No. C01-01287SBA, 2004 WL 868202, at *2 (N.D. Cal. Apr. 21, 2004) (holding that a plaintiff must answer interrogatories seeking identity of confidential witnesses referred to in its complaint and thus rejecting plaintiff’s arguments that the identities of the confidential witnesses constituted undiscoverable work product or that disclosure is unnecessary since the confidential witnesses were presumably identified as part of its initial disclosures). G. Motions For Summary Judgment 1. Legal Standard Summary judgment is appropriate when “the pleadings, depositions, answers to interrogatories, and admissions on file, together with affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.” Fed. R. Civ. P. 56(c); Celotex Corp. v. Catrett, 477 U.S. 317, 325-26 (1986). A genuine issue is one where “the evidence is such that a reasonable jury could return a verdict for the nonmoving party.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). When ruling on a summary judgment motion, courts have refused to consider new theories and material

misstatements not previously included in a securities fraud complaint, reasoning that PSLRA’s deliberate scheme is thrown into disarray if new theories are permitted to be produced in response to a motion to dismiss. See In re St. Jude Medical, Inc., Sec. Litig., 629 F. Supp. 2d 915, 921 (D. Minn. 2009) (citing several cases). a. Burden On Moving Party The moving party bears the initial burden of identifying evidence that demonstrates the absence of a genuine issue of material fact. Celotex, 477 U.S. at 323; see also Devereaux v. Abbey, 263 F.3d 1070, 1076 (9th Cir. 2001) (en banc) (“The Celotex ‘showing’ can be made by pointing out through argument the absence of evidence to support plaintiff’s claim.”). Inferences that arise from direct evidence may constitute proof provided they are “specific and substantial,” not merely speculative. See Bergene v. Salt River Project Agric. Imp. & Power Dist., 272 F.3d 1136, 1142 (9th Cir. 2001). b. Opposing Party Once this burden is satisfied, the opposing party must “set forth specific facts showing that there is a genuine issue of material fact in dispute.” In re Silicon Graphics Inc., Sec. Litig., 970 F. Supp. 746, 752 (N.D. Cal. 1997); see also Celotex, 477 U.S. at 324. The court should view the evidence and any inferences that may be drawn in a light most favorable to the nonmovant. See Adickes v. S.H. Kress & Co., 398 U.S. 144, 158-59 (1970). Once the moving party has met that burden, the opposing party “may not rest upon the mere allegations or denials of the adverse party’s pleading, but … must set forth specific facts showing that there is a genuine issue for trial.” Fed. R. Civ. P. 56(c); Anderson, 477 U.S. at 248. “To defeat a motion for summary judgment, the nonmoving party … must raise ‘significant probative evidence’ that would be sufficient for a jury to find for that party.” LaChance v. Duffy’s Draft House, Inc., 146 F.3d 832, 835 (11th Cir. 1998) (quoting Anderson, 477 U.S. at 249). If the evidence adduced by the nonmovant is “merely colorable” or “not significantly probative,” summary judgment is appropriate. Anderson, 477 U.S. at 249-50. Defendants typically move for summary judgment in Section 10(b) and Rule 10b-5 cases on the basis that no genuine issue of material fact exists with regard to: (1) scienter; (2) false or misleading statements or omissions; (3) the materiality of defendants’ alleged misrepresentations or omissions; (4) reliance; and/or (5) loss causation. 2. Scienter Defendants often move for summary judgment on the grounds that there is insufficient evidence that defendants acted with scienter. See, e.g., Geffon v. Micrion Corp., 249 F.3d 29, 36 (1st Cir. 2001) (affirming grant of summary judgment on ground that plaintiffs introduced insufficient evidence of scienter); Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266, 274-75 (3d Cir. 1998) (finding factual dispute where defendant broker-dealers represented that they would execute the plaintiffs’ orders to maximize plaintiffs’ economic gain while “[knowing] that they intended to execute the plaintiffs’ orders at [one] price even if better prices were reasonably available”); RMED Int’l, Inc. v. Sloan’s Supermarkets, Inc., 185 F. Supp. 2d 389, 403-04 (S.D.N.Y. 2002) (genuine issue existed as to scienter because plaintiffs offered evidence of defendants’ motive and opportunity to commit fraud and knowledge of undisclosed antitrust investigation); Freedman v. Value Health, Inc., 135 F. Supp. 2d 317 (D. Conn. 2001) (granting defendants’ motion for summary judgment because, among other things, no genuine issue of material fact regarding defendants’ intent to deceive existed), aff’d, 34 F. App’x 408 (2d Cir. 2002); Tse v. Ventana Med. Sys., Inc., 123 F. Supp. 2d 213, 225 (D. Del. 2000) (granting defendants’ motion for summary judgment because incentive compensation is insufficient evidence of scienter), aff’d, 297 F.3d 210 (3d Cir. 2002); Marucci v. Overland Data, Inc., No. 97 CV 0833-TW (JFS), 1999 WL 1027053, at *8 (S.D. Cal. Aug. 2, 1999) (genuine issue existed as to whether “[d]efendants acted with at least deliberate recklessness in failing to properly disclose” company’s supply problems); Carlson v. Xerox Corp., 392 F. Supp. 2d 267 (D. Conn. 2005) (finding false exculpatory statements and a failure to comply with

an SEC investigation are both evidence of fraudulent intent). “On a motion for summary judgment … the issue is whether the evidence, taken as a whole, could support a finding by a reasonable juror that defendants acted with the intent to deceive, manipulate or defraud investors.” In re N. Telecom Ltd. Sec. Litig., 116 F. Supp. 2d 446, 462-63 (S.D.N.Y. 2000) (finding no genuine issue as to scienter where facts did not show that company’s accounting practices were “inherently fraudulent or deceptive”). The following issues relating to scienter frequently arise in motions for summary judgment: a. Insider Trading Courts often grant motions for summary judgment where there is an absence of insider trading during the class period. Schuster v. Symmetricon, Inc., No. C94 20024 RMW, 2000 WL 33115909, at *8 (N.D. Cal. Aug. 1, 2000) (granting defendants’ summary judgment motion on the issue of scienter where defendants who had made allegedly false or misleading statements had not made insider sales during the period and evidence demonstrated that they believed their optimistic statements and acted in good faith); N. Telecom, 116 F. Supp. 2d at 462-63 (finding insufficient evidence to enable reasonable juror to conclude that defendants acted with scienter where insiders sold no stock and derived no other concrete benefit from the alleged fraud); In re Oracle Corp., 867 A.2d 904, 906 (Del. Ch. 2004) (“[N]o rational trier of fact could find that … Ellison or Henley possessed material, nonpublic financial information as of the time of their trades.”), aff’d, 872 A.2d 960 (Del. 2005). By contrast, suspicious trading during the class period may preclude summary judgment. See Provenz v. Miller, 102 F.3d 1478, 1491 (9th Cir. 1996); Marksman Partners, L.P. v. Chantal Pharms. Corp., 46 F. Supp. 2d 1042 (C.D. Cal. 1999) (finding genuine issue of material fact existed regarding scienter when defendant engaged in insider sales), aff’d, 234 F.3d 1277 (9th Cir. 2000). b. Inconsistencies Between Internal Documents And Public Statements Conflicts between internal documents and public statements often lead courts to conclude that there is a genuine issue of material fact regarding scienter. See In re Reliance Sec. Litig., 135 F. Supp. 2d 480, 508 (D. Del. 2001) (finding genuine issue of material fact existed where outside directors signed allegedly fraudulent SEC filings after receiving reports of company’s deteriorating financial condition); Kaufman v. Motorola, Inc., No. 95 CV 1069, 1999 WL 688780, at *11, *13 (N.D. Ill. Apr. 16, 1999) (finding adverse undisclosed information in internal documents, combined with evidence of company’s extensive internal reporting system, created genuine issue as to whether the defendants “knew or recklessly disregarded the high levels of inventory excess”); Marucci v. Overland Data, Inc., No. 97 CV 0833-TW (JFS), 1999 WL 1027053, at *8 (S.D. Cal. Aug. 2, 1999) (finding issue regarding scienter existed where internal reports indicated that defendants had knowledge of supply problems that they failed to disclose in prospectus). Courts such as the First Circuit have further found that the absence of inconsistencies between internal documents and public statements can rebut claims of scienter. Geffon v. Micrion Corp., 249 F.3d 29, 36-37 (1st Cir. 2001) (affirming grant of summary judgment on ground that plaintiffs introduced insufficient evidence of scienter where they offered no internal documents or other evidence to support their assertion that internal company documents defined terms differently than how the terms were used in public statements); see also N. Telecom, 116 F. Supp. 2d at 462-63 (finding no genuine issue regarding scienter where company’s public statements accurately reflected its internal forecasts); Freedman v. Value Health, Inc., 135 F. Supp. 2d 317, 342 (D. Conn. 2001) (finding no genuine issue of material fact regarding defendant’s scienter because, among other things, his statement was “consistent with reasonably available data”), aff’d, 34 F. App’x 408 (2d Cir. 2002). c. Liability Of Outside Directors An outside director’s awareness of potential fraud and failure to investigate it may constitute sufficient evidence

of scienter to preclude summary judgment. See, e.g., Stat-Tech Liquidating Trust v. Fenster, 981 F. Supp. 1325, 1342 (D. Colo. 1997) (finding genuine issue of material fact regarding scienter existed where “evidence support[ed] an inference that [director] was on notice concerning problems in the company’s SEC compliance, its accounting department, and its auditors, and … did not undertake any investigation or analysis of these matters because his sole interest was in disposing of his stock at a substantial profit”). If plaintiffs fail to demonstrate that an outside director was aware of possible improprieties, the outside director may prevail on a summary judgment motion based on the absence of scienter. Kaufman, 1999 WL 688780, at *11, *13 (finding no genuine issue regarding scienter of outside director where plaintiffs failed to show that he was put on “notice of a possible material failure of disclosure” that he should have investigated). d. Liability Of Auditors Auditors may prevail on a summary judgment motion with regard to scienter if plaintiffs fail to put forth evidence demonstrating that the auditors acted in bad faith or recklessly. For example, in In re Ikon Office Solutions, Inc., 277 F.3d 658, 668 (3d Cir. 2002), the Third Circuit affirmed summary judgment where no triable issue of fact existed as to whether auditors acted with scienter in performing an audit. The court found that the auditors “took appropriate steps to determine whether allegations [of accounting fraud against the company] had any merit,” and nothing in the record showed that the auditors’ “judgment – at the moment exercised – was sufficiently egregious such that a reasonable accountant reviewing the facts and figures should have concluded that Ikon financial statements were misstated and that as a result the public was likely to be misled.” Id. at 673. The court also noted “[t]he mere fact that [the auditors] did not conduct [their] own fraud investigation or alert [their] field auditors to the allegations of fraud [was] not probative, as the relevant inquiry is bad faith, not bad judgment.” Id. at 670. Thus, the plaintiffs could not make the minimal showing of highly unreasonable conduct, involving an extreme departure from the standards of ordinary care that presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it. Id. at 667; see also Marksman Partners, L.P. v. Chantal Pharm. Corp., 46 F. Supp. 2d 1042, 1046-50 (C.D. Cal. 1999) (granting defendant auditor’s motion for summary judgment because plaintiffs failed to raise a genuine issue that the auditor’s accounting decisions and auditing procedures were so deficient that the audit amounted to no audit at all, or that the accounting judgments that were made were such that no reasonable accountant would have made them if confronted with the same facts). But see In re Reliance Sec. Litig., 135 F. Supp. 2d 480, 510 (D. Del. 2001) (finding genuine issue of material fact existed regarding scienter of independent auditors because a reasonable juror could determine that, given the information available to them, the “auditors did not believe that the [company’s] loan loss reserves were adequate”); In re Worldcom, Inc. Sec. Litig., 352 F. Supp. 2d 472 (S.D.N.Y. 2005) (finding that principles of collective knowledge and intent could apply to establish scienter in securities fraud action against an accounting firm, and plaintiffs were not required to show that at least one employee of the firm acted with scienter). 3. False Or Misleading Statement Of Material Fact a. False Or Misleading Statement Defendants’ motions for summary judgment often contend that the statements alleged in the complaint were not false or misleading. Courts have usually denied summary judgment, though, where adverse internal documents and other evidence raise a dispute as to the falsity of the statements. Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266, 273 (3d Cir. 1998) (reversing summary judgment where genuine issue of material fact existed over defendant broker-dealers’ implied misrepresentation that they would execute plaintiffs’ orders in manner calculated to maximize plaintiffs’ gain); Marucci v. Overland Data, Inc., No. 97 CV 0833-TW (JFS), 1999 WL 1027053, at *8 (S.D. Cal. Aug. 2, 1999) (denying defendants’ motion for summary judgment because internal reports and deposition testimony demonstrated that genuine issue existed as to whether company’s prospectus contained false or misleading statements); Miller v. NTN Commc’ns, Inc., No. 97-CV-1116 TW JAH, 1999 WL 817217, at *8 (S.D. Cal. May 21, 1999) (denying defendants’ motion for summary judgment

where undisclosed agreements demonstrated that triable issue existed concerning false or misleading nature of statements); Kaufman v. Motorola, Inc., No. 95 CV 1069, 1999 WL 688780, at *11, 13 (N.D. Ill. Apr. 16, 1999) (internal documents demonstrated genuine issue as to whether defendants made false or misleading statements or omissions of material fact regarding inventory levels). Courts grant summary judgment when there is no evidence that the statements lacked a reasonable basis or were false when made. In re Sybase, Inc. Sec. Litig., 48 F. Supp. 2d 958, 963 (N.D. Cal. 1999) (granting defendants’ motion for summary judgment and concluding no reasonable jury could find a false or misleading statement where plaintiff failed to demonstrate that defendants’ “budget forecasts and general statements of optimism lacked a reasonable basis”); see also Binder v. Gillespie, 184 F.3d 1059, 1067 (9th Cir. 1999) (affirming summary judgment for auditor when there was insufficient evidence that auditor participated in preparation of allegedly false or misleading financial statements marked “unaudited”). b. Adopting Statements In Analyst Reports Defendants may also move for summary judgment on the basis that there is no genuine issue of fact as to whether defendants adopted the statements of analyst reports. In re Stratosphere Corp. Sec. Litig., 66 F. Supp. 2d 1182, 1200 (D. Nev. 1999) (finding defendants did not adopt statements in analyst reports because they presented sufficient evidence that they “never commented upon submitted draft reports, except to correct matters of public record” and rarely distributed analyst reports to investors); Schuster v. Symmetricon, Inc., No. C 94 20024 RMW, 2000 WL 33115909, at *2-3 (N.D. Cal. Aug. 1, 2000) (finding defendants were not liable for statements in analyst reports because plaintiff “failed to adduce any admissible evidence linking specific comments by defendants with specific statements in analysts’ reports”). c. Materiality A statement is material if there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). “Like scienter, materiality is [a] fact-specific element of a Rule 10b-5 claim which should normally be left to the trier of fact . . . . However, when no rational trier of fact can find that an alleged misrepresentation or omission was material, summary judgment may nevertheless be justified in appropriate cases.” Miller v. NTN Commc’ns, Inc., No. 97-CV-1116 TW (JAH), 1999 WL 817217, at *8-9 (S.D. Cal. May 21, 1999) (citations omitted) (finding genuine issue of fact existed as to whether alleged misrepresentations and omissions were material); S.E.C. v. Autocorp Equities, Inc., 292 F. Supp. 2d 1310, 1320 (D. Utah 2003) (holding that although materiality is a question of fact, summary judgment is proper where authenticity of an asset’s value is so obviously important to an investor). Interestingly, in Miller v. Thane International, Inc., 508 F.3d 910, 922 (9th Cir. 2007), the Ninth Circuit held “[t]he district court erred when it considered the movement in share price of a stock that did not trade on an efficient market to determine materiality,” even though the evidence showed “the shares had the ability to incorporate the obvious” misstatement. Id. at 919 (holding that a false promise to list shares on the NASDAQ NMS is material because “a reasonable . . . .shareholder would have wanted to know where [] new . . . .shares would be trading and would have viewed the fact of [the] nonlisting ‘as having significantly altered the total mix of information.’”). The Ninth Circuit in Thane remanded the action to the district court for a determination on loss causation, which that court found to be absent because even an inefficient market will impound material information, and the company’s stock price did not drop for 19 days after the failure to list on NMS. In Thane II, the Ninth Circuit affirmed the judgment for defendants, noting that while materiality and loss causation are related inquiries, they are nonetheless distinct because materiality is an ex ante inquiry into whether a reasonable investor would consider a particular misstatement important, whereas loss causation is an ex post inquiry into whether the misstatement actually caused a loss. Miller v. Thane Int’l., Inc., 615 F.3d 1095 (9th Cir. 2010).

Courts have found summary judgment appropriate when plaintiffs fail to raise a triable issue of fact regarding the materiality of an alleged misrepresentation or omission. In re Int’l Bus. Mach. Corp. Sec. Litig., 163 F.3d 102, 109 (2d Cir. 1998) (affirming summary judgment where statements regarding company’s dividend were not material); In re Corning, Inc. Sec. Litig., 349 F. Supp. 2d 698, 720-22 (S.D.N.Y. 2004) (granting summary judgment for the defendants because the failure to disclose breast implant litigation over a ten-year period until a major verdict led to bankruptcy was immaterial, given that during the non-disclosure period, the facts about breast implant suits and claims were highly favorable to the companies); In re N. Telecom Ltd. Sec. Litig., 116 F. Supp. 2d 446, 462-63 (S.D.N.Y. 2000); In re Stratosphere Corp. Sec. Litig., 66 F. Supp. 2d 1182, 1200 (D. Nev. 1999) (dismissing claims relating to statements of general optimism or “vaguely positive statements that could not be relied upon by [the] reasonable investor”). But see Media Gen., Inc. v. Tomlin, 387 F.3d 865 (D.C. Cir. 2004) (reversing grant of summary judgment because there was a genuine issue of material fact whether a lawsuit brought by a former employee of the acquired company was a material contingency at the time of merger negotiations, even though it was immaterial for purposes of acquiring company’s post-merger Form 8-K filing); RMED Int’l, Inc. v. Sloan’s Supermarkets, Inc., 185 F. Supp. 2d 389, 401-02 (S.D.N.Y. 2002) (finding non-disclosure of FTC investigation threatening completion of acquisitions was material); Ostler v. Codman Research Group, Inc., No. 98-356-JD, 1999 WL 813889 (D.N.H. Aug. 12, 1999) (denying defendants’ motion for summary judgment because defendants failed to show that plaintiff, who let his stock options expire, allegedly as a result of defendants’ incomplete picture of the company’s financial status, would not be able to prove that the omitted information was material); Marucci v. Overland Data, Inc., No. 97 CV 0833-TW (JFS), 1999 WL 1027053, at *8 (S.D. Cal. Aug. 2, 1999) (finding “swift and severe drop in the share price” following disclosure of company’s supply problems supported materiality of defendants’ allegedly false or misleading statements regarding supply problems in prospectus). When statements are accompanied by appropriate cautionary language, courts may deem them immaterial. Gasner v. Bd. of Supervisors, 103 F.3d 351, 359 (4th Cir. 1996) (finding challenged misrepresentations and omissions were immaterial as a matter of law under the bespeaks caution doctrine, because they were accompanied by appropriate cautionary language); N. Telecom, 116 F. Supp. 2d at 462-63 (finding plaintiffs failed to establish defendants made material misrepresentations because the challenged statements “[w]hen viewed in their surrounding context … are either immaterial, cautionary, or have a reasonable basis in fact”). But see In re Reliance Sec. Litig., 135 F. Supp. 2d 480, 510 (D. Del. 2001) (holding genuine issue of material fact existed as to whether defendants’ statements were actionable because reserve estimates were not forwardlooking statements and thus were not rendered immaterial under the bespeaks caution doctrine or protected by the Safe Harbor provisions of the Reform Act); Stratosphere, 66 F. Supp. 2d at 1192-96 (finding, based on internal memoranda, triable issue of fact existed as to whether defendants had actual knowledge that statements were false, and thus as to whether the statements were protected by the Safe Harbor for forward-looking statements). In the Ninth Circuit, “[s]ummary judgment based on the ‘bespeaks caution’ doctrine is only appropriate when reasonable minds could not disagree as to whether the mix of information in the document is misleading.” Provenz v. Miller, 102 F.3d 1478, 1491 (9th Cir. 1996) (reversing summary judgment on basis of materiality where cautionary language was too general to render the challenged statements immaterial). Summary judgment is clearly appropriate where the allegedly actionable statements fall within the Reform Act’s safe harbor for forward looking statements. See Employers Teamsters Local Nos. 175 and 505 v. Clorox Co., 353 F.3d 1125, 1131 (9th Cir. 2004). 4. Reliance In a motion for summary judgment, defendants may also challenge plaintiffs’ claim of reliance by arguing that the evidence fails to show: (1) that plaintiffs relied on the alleged misrepresentations or omissions, (2) that the fraud on the market presumption of reliance applies, or (3) that plaintiffs’ reliance was reasonable. Poth v. Russey, 281 F. Supp. 2d 814, 821 (E.D. Va. 2003), aff’d, No. 03-1308, 2004 WL 614623 (4th Cir. Mar. 30, 2004) (granting summary judgment where plaintiffs unreasonably relied on unsubstantiated oral statements that contradicted written documentation plaintiff had already signed) (citing Foremost Guar. Corp. v. Meritor Sav. Bank, 910 F.2d 118, 123-24 (4th Cir. 1990) (providing eight factor test to determine if reliance is reasonable)); RMED Int’l, Inc. v. Sloan’s Supermarkets, Inc., 185 F. Supp. 2d 389, 405 (S.D.N.Y. 2002) (rejecting

defendants’ argument that the fraud on the market presumption was inapplicable where (1) the company’s stock was traded on AMEX, and (2) there was a plausible, market-based explanation for the decline in the stock prices); Gabriel Capital, L.P. v. NatWest Fin., Inc., 177 F. Supp. 2d 169 (S.D.N.Y. 2001) (denying summary judgment where genuine issue existed as to whether “the timely receipt of the [company’s] Offering Memorandum defeats plaintiff’s claim of reliance on material presented at the road show”); Steed Fin. LDC v. Nomura Sec. Int’l Inc., No. 00 CIV. 8058 (NRB), 2004 WL 2072536, at *8 (S.D.N.Y. Sept. 14, 2004) (granting summary judgment because reliance on the alleged misrepresentation was unreasonable where plaintiff had ample opportunity to investigate the many red flags contained in defendants’ disclosures), aff’d, 148 F. App’x 66 (2d Cir. 2005); Amendolia v. Rothman, No. CIV. A. 02-8065, 2003 WL 23162389 (E.D. Pa. Dec. 8, 2003) (holding plaintiff could not show reliance because she admittedly had no intention of changing financial advisors regardless of defendants’ alleged false statements). 5. Loss Causation Plaintiffs’ failure to prove loss causation is often raised at the summary judgment stage, though defendants must meet a “heavy burden of proof” to succeed in obtaining summary judgment. Provenz v. Miller, 102 F.3d 1478, 1491 (9th Cir. 1996). In the Ninth Circuit, “the defendants must prove, as a matter of law, that the depreciation of the value [of the investment] resulted from factors other than the alleged false and misleading statements.” Id. In contrast, “[t]o establish loss causation, plaintiffs must “simply alleg[e] that the false and misleading statements ‘touch[ed] upon the reasons for the investment’s decline in value.” Id. at 1492 (internal quotation marks omitted). Other courts similarly require plaintiffs to demonstrate that “[a] direct or proximate relationship between the loss and the [alleged] misrepresentation.” Gasner v. Bd. of Supervisors, 103 F.3d 351, 359 (4th Cir. 1996); Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 186 (2d Cir. 2001) (same). In Provenz, the Ninth Circuit affirmed the trial court’s rejection of defendants’ loss causation defense because plaintiffs offered evidence that the company’s revenue recognition practices “touched upon” the allegedly inflated stock price and that the company’s public disclosure of previously undisclosed information “touched upon” the decline in the stock price. 102 F.3d at 1491; see also Castellano, 257 F.3d at 186 (finding triable issue existed as to loss causation because “a jury could find that foreseeability link[ed] the omitted information and the [plaintiff’s] ultimate injury”); In re Reliance Sec. Litig., 135 F. Supp. 2d 480, 510 (D. Del. 2001) (disputed issue remained as to whether plaintiffs who purchased shares after director resigned from board relied on his alleged misrepresentations because “[director’s] resignation is not enough to break the chain of causation”); Miller v. NTN Commc’ns, Inc., No. 97-CV-1116-TW JAH, 1999 WL 817217, at *8 (S.D. Cal. May 21, 1999) (finding summary judgment was inappropriate where evidence that “honest representations regarding . . . .transactions would have shown that [the company’s] shares were over-inflated and would possibly have persuaded plaintiffs to refrain from investing in the company”). Nonetheless, courts have found that defendants are able to demonstrate the absence of loss causation and grant summary judgment on that basis. Heliotrope Gen., Inc. v. Ford Motor Co., 189 F.3d 971, 978 (9th Cir. 1999) (affirming grant of summary judgment where information undisclosed in prospectus had entered the market before plaintiff purchased its shares and thus could not have caused plaintiff’s loss); In re N. Telecom Ltd. Sec. Litig., 116 F. Supp. 2d 446, 462-63 (S.D.N.Y. 2000) (granting summary judgment where plaintiffs failed to raise a disputed issue as to whether defendants’ alleged accounting fraud and misrepresentations caused an inflation of the company’s stock price); Tse v. Ventana Med. Sys., Inc., 123 F. Supp. 2d 213, 223-25 (D. Del. 2000), aff’d, 297 F.3d 210 (3d Cir. 2002) (plaintiffs could not establish loss causation because their alleged loss of possible profits was “wholly speculative”); Shanahan v. Vallat, No. 03 Civ. 3496(PAC), 2008 WL 4525452, at *5 (S.D.N.Y. Oct. 3, 2008) (granting summary judgment for defendants where plaintiff’s loss was caused by “industry-wide phenomena” causing comparable losses to other investors and not by fraudulent misstatements or omissions); In re Retek Inc. Sec. Litig., 621 F. Supp. 2d 690 (D. Minn. 2009) (granting summary judgment because plaintiffs failed to establish that market became aware of corporation’s misrepresentations as to its true financial condition via corrective press release as required to establish loss causation); Alaska Elec. Pension Fund v. Flowserve Corp., 572 F.3d 221, 233-34 (5th Cir. 2009) (reversing grant of summary judgment because genuine of issue of material fact existed regarding whether company’s statement regarding prior projected earnings caused some portion of investors’ loss after the relevant truth began to leak out).

H. Trial Of Securities Class Actions While securities class action trials have been rare in the past, cases do go to trial. “[I]ncreasingly aggressive settlement postures now being taken by plaintiffs are decreasing the defendants’ relative risks of going to trial in many cases, and defendants are less likely to settle when they believe they have a defensible case.” Michael Tu, Trial’s Rewards Starting To Outweigh Its Risks, The National Law Journal, Oct. 10, 2005. Since 1996, only 22 securities class actions have gone to trial. RiskMetrics Group, Securities Class Action Trials in the Post-PSLRA Era (Jan. 2010), available at blog.riskmetrics.com/slw/SCAS%20Trials.pdf. Two recent securities class action trials include IN RE JDS UNIPHASE CORP. SECURITIES LITIGATION, No. CV 02-1486 CW (N.D. Cal. 2007) and IN RE APOLLO GROUP INC. SECURITIES LITIGATION, No. CV 04-2147PHX-JAT (D. Ariz. 2007). The IN RE JDS UNIPHASE trial involved allegations by investors that JDS Uniphase misrepresented the company’s financial health and resulted in a defense verdict after four weeks of trial. In IN RE APOLLO GROUP, shareholders alleged that the University of Phoenix committed securities fraud by failing to disclose that it paid the Department of Education $9.8 million to settle allegations that its recruiter’s compensation program violated the False Claims Act. The trial lasted two months and resulted in a $280 million jury verdict for the plaintiffs. The possibility of a securities class action going to trial requires counsel to prepare trial strategies from the moment the case is accepted. A comprehensive outline of essential trial tactics and strategies has been compiled by counsel in the Everex Securities Litigation, Howard v. Hui, No. C-92-3742 (N.D. Cal. 1992), after achieving a favorable directed verdict at trial. [1] See Robert P. Varian, et al., Winning Securities Class Actions at Trial: Lessons Learned, Securities Litigation: Planning and Strategies, SD79 ALI-ABA 295 (1999). The most salient points of the article are summarized below. 1. Jury Education While defense counsel in securities actions are aware of the particular role that plaintiffs’ firms play in the securities arena, jurors are not. Jurors imagine angry investors gelling to form a class, finding an attorney to accept the case, and hiring experts to aid them in pursuing their rights in the court system. This perception may foster the belief that even completely baseless suits have merit. Because most jurors will view the evidence through this filter, erasing this belief at the onset of the presentation of the case is paramount. An opening statement, which points out that the action was filed by one individual, rather than by a class of investors, and is being driven by the plaintiffs’ firms, rather than by the investors themselves, may aid this process. 2. Simple Strategy Complex securities arguments, appropriate in legal briefs, do not resonate well with jurors. Therefore, it is important to simplify the defense case and utilize timelines, graphics, and other visual aids to assimilate complex information and help jurors remember important facts and themes. Defense counsel must rise above the minutia of SEC filings, stock price movements, and accounting forecasts in order to focus the suit on the defendants and the fraud accusations they face. Accusing an individual of committing an intentional wrong is more troubling to jurors than claims brought against a faceless corporation. Counsel should therefore argue that the reputations of hard-working individuals are on the line, and not merely the losses incurred by investors while “playing” in the stock market. 3. Plaintiff Witnesses As plaintiff investors take the stand, defense counsel must respond with tempered and balanced questioning or otherwise risk alienating jurors. Often it appears that the only reason such witnesses are put on the stand is to garner jury sympathy by describing how they have been affected by the alleged misconduct. The impulse reaction to engage in blistering cross-examination must be controlled. Instead, defense counsel should use this

opportunity to inquire as to the amount of pre-purchase investigation the plaintiff investor conducted. Counsel must not appear to the jurors to be berating the witness for making a bad investment. Similarly, defense counsel should use tact when inquiring further about the witness’s participation in other class actions, lack of contact with other class members, plaintiff’s counsel or experts before filing the suit, and continued stock purchases in the face of price declines. 4. Pre-Trial Elimination Of Claims By narrowing the claims before trial, defense counsel reduces the risk that the jury will pick up on extraneous information. The more information the plaintiffs put into play, the less probable a favorable outcome. This increased risk disrupts any contemporaneous settlement discussions and may dismantle the simple format put forward by defense counsel. Therefore, while drafting pre-trial briefs such as motions to dismiss and requests for summary judgment, defense counsel should keep the possibility of trial in mind and aim to reduce the amount of claims, relevant facts, and issues. Early issue-elimination can later support trial motions, such as a motion in limine excluding harmful evidence. 5. Damages Plaintiff-style damage analysis has drawn academic criticism, prompting many defenders to pursue extended experts’ testimony dissecting the damage requests in great detail. To be successful in this endeavor, the defense should control its witness and avoid diluting points that might otherwise have a major impact. Importantly, the defense should also use this opportunity to underscore important trial themes, focus on major flaws in the analysis, and provide the jury with a defensible alternative damage number in the event liability is found. Defendants may request that damages be determined in one of two ways: (1) per-share, or (2) in gross. Relying on per-share basis limits the jury’s discretion but may not allow the jury to understand the magnitude of the ultimate award. The gross analysis is preferable in cases where the defense believes the jury is not inclined to make a large award. See Robert P. Varian, et al., Winning Securities Class Actions at Trial: Lessons Learned, 22 Bank and Corporate Governance Law Reporter 321-331 (1999). I. Settlement Considerations Settlement is strongly favored, particularly in complex class actions, to minimize potential litigation costs and reduce the strain on judicial resources. See, e.g., In re Gen. Motors Corp. Pick-Up Truck Fuel Tank Prods. Liab. Litig., 55 F.3d 768, 786 (3d Cir. 1995). 1. The Court’s Role In The Settlement Process a. Court Approval Or Disapproval Federal Rule of Civil Procedure 23(e) provides that “[t]he claims, issues, or defenses of a certified class may be settled, voluntarily dismissed, or compromised only with the court’s approval.” The court must therefore preliminarily approve or disapprove any settlement. See In re Warner Commc’ns Sec. Litig., 798 F.2d 35 (2d Cir. 1986) (stating that it is not the function of the court to modify the terms of settlement as proposed by the parties); In re United Energy Corp. Solar Power Modules Tax Shelter Inv. Sec. Litig., No. CV 87-3962 KN(GX), 1989 WL 73211, at *3 (C.D. Cal. Mar. 9, 1989) (noting that the court will not substitute its business judgment for that of the parties but will determine whether the proposed settlement is within a range of reasonableness); In re BankAmerica Corp. Sec. Litig., 350 F.3d 747, 752 (8th Cir. 2003) (holding that the Reform Act does not expressly divest the district court of its Rule 23 authority or discretion by explicitly granting veto power to lead plaintiffs; Congress did not intend to usurp the district court’s traditional

responsibility to guard the interests of absent class members). After examining the proposed settlement and reaching a decision, the court will pursue one of two courses: If the court disapproves the settlement, the court is required to notify the parties of the provisions to which it objects and instruct the parties on what must be done in order to gain court approval of the settlement. See Martens v. Thomann, 273 F.3d 159 (2d Cir. 2001) (reversing district court’s decision for failing to state reasons for denial of settlement agreement); In re Cal. Micro Devices Sec. Litig., 168 F.R.D. 257 (N.D. Cal. 1996). If the court preliminarily approves the settlement, the court will require that notice of the settlement be given to all class members pursuant to Federal Rules of Civil Procedure 23(e)(1). b. Notice 1) General Under Federal Rules of Civil Procedure 23(e)(1), if the court permits a Rule 23(b)(3) class action settlement to be maintained, “[t]he court must direct notice in a reasonable manner to all class members who would be bound by the proposal.” Rule 23(e)(4) provides that “[i]f the class action was previously certified under Rule 23(b)(3), the court may refuse to approve a settlement unless it affords a new opportunity to request exclusion to individual class members who had an earlier opportunity to request exclusion but did not do so.” Thus, a court may give members of a certified class a second opportunity to opt-out as part of the settlement process. The notice must inform the members (i) of their right to opt-out, (ii) that they will be bound by any judgment or settlement if they do not opt-out, and (iii) if they do not request to opt-out, they may enter an appearance through counsel. A class action settlement is binding on all members of the class, even absent class members who do not receive individual notice, if the notice is procedurally adequate. See Presidential Life Ins. Co. v. Milken, 946 F. Supp. 267 (S.D.N.Y. 1996). Thus, where class members choose to opt-out, the res judicata effect of settlement is impaired because they will not be bound by the settlement. The possibility of opt-outs can be an issue in any agreement to settle because, prior to executing a settlement agreement, knowing with certainty whether or how many class members may choose to opt-out is difficult. But see Biben v. Card, 789 F. Supp. 1001, 1004 (W.D. Mo. 1992) (noting its broad discretionary powers under Rule 23(d), court ordered early submission of proof-of-claims to assist in determination of damages and thus, inter alia, facilitate settlement); Robinson v. Union Carbide Corp., 544 F.2d 1258, 1263 (5th Cir. 1977) (Wisdom, J., concurring) (finding that “early identification” of damage information would “encourage accurate settlement discussions”); In re Storage Tech. Corp. Sec. Litig., No. 92-K-750, 1994 WL 1718450, at *1 (D. Colo. May 16, 1994) (requiring that a questionnaire accompany initial class notice, the court noted that a “questionnaire [would] assist the parties in determining damages and [might] facilitate settlement”). One way that this can be addressed in settlements is to give the defendant a negotiated right to terminate the settlement if there is more than an agreed upon level of opt outs.

2) Reform Act’s Settlement Notice Requirements Section 101 of the Reform Act amended both the Securities Act and the Exchange Act by adding new requirements for the contents of any settlement notice. 15 U.S.C. § 77z-1(a)(7); 15 U.S.C. § 78u-4(a)(7). These new sections require that any proposed or final settlement notice to the class contain the following: A “statement of plaintiff recovery,” including both the global and the per share amount of the settlement;

A “statement of potential outcome of case.” Two alternatives under this provision are available: (1) if the parties agree on the average amount of damages per share that would be recoverable if plaintiff prevailed, then this amount must be disclosed; (2) if the parties do not agree, then “a statement from each settling party concerning the issue or issues on which the parties disagree” is required. Notably, these statements “shall not be admissible in any Federal or State judicial action or administrative proceeding, other than an action or proceeding arising out of such statements;” A “statement of attorneys’ fees or costs sought” from any fund established as part of the settlement. The statement should indicate which parties or counsel intend to seek such fees or costs, the aggregate and per share amount, “and a brief explanation supporting the fees and costs sought;” An “identification of representatives of lawyers” for the plaintiff class “who will be reasonably available to answer questions from class members,” including their names, telephone numbers and addresses; “A brief statement explaining the reasons why the parties are proposing settlement;” and “Such other information as may be required by the court.” These statements must be summarized on the cover page of the notice. However, at least one district court has held that minor deviations from compliance with PSLRA requirements does not render the notice invalid. In re Indep. Energy Holdings PLC Sec. Litig., 302 F. Supp. 2d 180 (S.D.N.Y. 2003) (finding that if cover page of settlement does not have all the required information, it is not fatal, as long as the required information is readily ascertainable and understandable).

3) Case Law On Notice Abundant case authority describes the type of notice and service of notice necessary to satisfy statutory and constitutional requirements. In brief, the notice should include (a) the rights of the class members, including the manner in which objections could be lodged and the right to opt-out could be exercised; (b) the nature, history, and progress of the litigation; (c) the proposed settlement; (d) the method of allocating the proposed settlement; (e) the judgment to be entered; (f) the time and place of the fairness hearing before the court; and (g) the manner in which class members could gain access to court papers. Krangel v. Golden Rule Res., Ltd., 194 F.R.D. 501, 504-05 (E.D. Pa. 2000). The Ninth Circuit also requires that the “average recovery per share” is based on all of the shares in the class, as opposed to the estimated fraction of class members likely to file a claim. In re Veritas Software Corp. Sec. Litig., 496 F.3d 962, 971 (9th Cir. 2007). Although the representative plaintiffs are not required to exhaust every conceivable method of identifying potential class members, individual notice generally must be sent to all class members who can be identified with reasonable effort. See In re HPL Techs., Inc. Sec. Litig., No. C-02-3510 VRW (N.D. Cal. Nov. 5, 2004) (“[P]lain and full notice to the in-and-outs that [the] settlement extinguishes their claims for no consideration whatsoever is essential to a finding that the settlement is fair.”); Burns v. Elrod, 757 F.2d 151 (7th Cir. 1985); Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177 (1974). Special notice problems may arise when no class has been certified at the time the settlement is proposed. See In re Gen. Motors Corp. Pick-Up Truck Fuel Tank Prods. Liab. Litig., 55 F.3d 768, 800 (3d Cir. 1995) (warning that approval of settlement without certifying class would preclude res judicata effect with regard to absent class members); Woodall v. Drake Hotel, Inc., 913 F.2d 447, 451 (7th Cir. 1990) (holding, in an age discrimination class action, inadequate notice is prejudicial even though absent class members are not bound by the settlement because settlement “adversely affected [absent members’] ability to achieve redress”); Simer v. Rios, 661 F.2d 655 (7th Cir. 1981) (approval of a settlement prior to class certification and without notice to putative class members violated due process rights of absent class members). Clearly, notice to absent class

members is required where the settlement will have a preclusive effect on claims later asserted by them. c. Fairness Hearing Federal Rule of Civil Procedure 23(e) provides that “notice of the proposed dismissal or compromise shall be given to all members of the class in such manner as the court directs.” The court holds a “fairness hearing” to consider whether the proposed settlement is fair, reasonable, and adequate to all members of the class prior to approval of the settlement. See Neuberger v. Shapiro, 110 F. Supp. 2d 373, 377 (E.D. Pa. 2000) (“[I]n approving a settlement, the court acts as a fiduciary for absent class members.”); Moore v. Halliburton Co., No. 3:02-CV-1152-M, 2004 WL 2092019 at *3 (N.D. Tex. Sept. 9, 2004) (“The Court must protect the interests of the absent class members who would be bound by a settlement ... ‘As such, the Court owes a fiduciary duty to the class to ensure that the interests of every member of the class are adequately represented.’”) (quoting In re Quintus Sec. Litig., 148 F. Supp. 2d 967, 970 (N.D. Cal. 2001)). The most significant aspect of this provision is that once a settlement is approved, it serves as res judicata for all parties to all claims covered by the agreement. See Devlin v. Scardelletti, 536 U.S. 1, 10 (2002) (“[N]onnamed class members are parties to the proceedings in the sense of being bound by the settlement.”).

1) Burden Of Proof At the fairness hearing, the proponent of the settlement has the burden of “demonstrating 1) the settlement is not collusive but was reached after arm’s length negotiations; 2) the proponents are counsel experienced in similar cases; 3) there has been sufficient discovery to enable counsel to act intelligently; and 4) the number of objectors or their relative interests is small.” Schwartz v. Novo Industri A/S, 119 F.R.D. 359, 362 (S.D.N.Y. 1988); see also Neuberger, 110 F. Supp. at 377 (noting proponent has the burden of establishing the settlement is fair).

2) Objections Members of the proposed settlement class who object to the terms of the settlement are entitled to appear at the settlement hearing and submit their objections to the court without first intervening. See Devlin, 536 U.S. at 14. If no one in the class objects, the court may streamline the hearing. However, if objectors exist, they have the right to present evidence and argument at the hearing. The court may also permit them to conduct discovery on relevant issues if reasonable and requested in a timely manner. Girsh v. Jepson, 521 F.2d 153 (reversing approval of settlement agreement where district court denied objector the right to conduct discovery); Bell Atl. Corp. v. Bolger, 2 F.3d 1304, 1314-15. Objectors also have the right to bring an appeal if the court approves the settlement. See Devlin, 536 U.S. at 14.

3) Fairness Factors In In re Sterling Foster & Co., Inc. Sec. Litig., 238 F. Supp. 2d 480 (E.D.N.Y. 2002), the court identified several factors governing the fairness and adequacy of a proposed class action settlement, including the: (a) complexity, expense, and likely duration of the litigation; (b) reaction of the class to the settlement; (c) stage of the proceedings and the amount of discovery completed; (d) risks of establishing liability; (e) risks of establishing damages; (f) risks of maintaining the class action through the trial; (g) ability of the defendants to withstand a greater judgment; (h) range of reasonableness of the settlement fund in light of the best possible recovery; and (i) range of reasonableness of the settlement fund to a possible recovery in light of all the attendant risks of litigation. Id. at 484 (citing City of Detroit v. Grinnell Corp., 495 F.2d 448, 463 (2d Cir. 1974)); see also Hanlon v. Chrysler Corp., 150 F.3d 1011 (9th Cir. 1998); In re Gen. Motors Corp. Pick-Up

Truck Fuel Tank Prods. Liab. Litig., 55 F.3d 768, 805 (3d Cir. 1995); Newby v. Enron Corp., 394 F.3d 296, 301 (5th Cir. 2004) (applying a six-factor test, including examination of whether the settlement was obtained by fraud or collusion). At the hearing, the court cannot conduct a “mini trial” into the merits of the claims but may only examine the factors of fairness. Gen. Motors, 55 F.3d at 796. Whether the court is required to, or even allowed to, consider the fairness to parties other than members of the class is unclear. See, e.g., Eichenholtz v. Brennan, 52 F.3d 478, 481 (3d Cir. 1995). 2. Settlement Prior To Certification Of A Class a. Hesitancy Courts may be reluctant to approve a class action settlement before the class is certified because of uncertainty as to who represents the class and the possibility that defendants’ counsel will attempt to deal with the most easily swayed plaintiffs’ counsel. See Weinberger v. Kendrick, 698 F.2d 61, 72 (2d Cir. 1982) (voicing concern with the practice of bypassing formal class certification by sending notice of proposed settlement to prospective class members); In re Beef Indus. Antitrust Litig., 607 F.2d 167, 173 (5th Cir. 1979) (finding the practice controversial); Ace Heating & Plumbing Co. v. Crane Co., 453 F.2d 30 (3d Cir. 1971); see also Raymond A. Fylstra, Settlement of Class Action Cases Prior to Class Certification, 69 Ill. B.J. 24 (Sept. 1980). But see Presidential Life Ins. Co. v. Milken, 946 F. Supp. 267, 279 (S.D.N.Y. 1996) (“The fact that a suit is settled prior to class certification does not, in and of itself, demonstrate the existence of collusion.”). b. Court Approval Settlements that take place prior to formal class certification require a higher standard of fairness. See In re Mego Fin. Corp. Sec. Litig., 213 F.3d 454, 458 (9th Cir. 2000); In re Chiron Corp. Sec. Litig., 2007 WL 4249902 (N.D. Cal. 2007) (“Where approval for settlement and certification are sought simultaneously … district courts must be even more scrupulous than usual in examining the fairness of the proposed settlement.”) (citations omitted). Courts have routinely approved pre-certification settlements. See, e.g., Carlough v. Amchem Prods, Inc., 5 F.3d 707 (3d Cir. 1993) (approving settlement negotiated between certain plaintiffs and certain defendants for all claims that might be asserted in the future prior to certification); Brucker v. ThyssenBornemisza Europe, N.V., 424 F. Supp. 679 (S.D.N.Y. 1976), aff’d sub nom. Brucker v. Indian Head, Inc., 559 F.2d 1202 (2d Cir. 1977) (approved after considerable litigation “where there were not different counsel vying to be class representatives before the settlement agreement was reached and publicized”); Plummer v. Chemical Bank, 91 F.R.D. 434, 440 (S.D.N.Y. 1981), aff’d, 668 F.2d 654 (2d Cir. 1982) (stating that pre-certification settlement is appropriate in certain cases but inappropriate in this case where settlement was substantially formulated prior to commencement of the action); Weinberger v. Kendrick, 698 F.2d 61, 73 (2d Cir. 1982) (approving settlement because it met a clear showing of fairness and substantial discovery had been conducted); Polar Int’l Brokerage Corp. v. Reeve, 187 F.R.D. 108, 113 (S.D.N.Y. 1999) (“[W]hen a settlement class is certified after the terms of settlement have been reached, courts must require a ‘clearer showing of a settlement’s fairness, reasonableness and adequacy and the propriety of the negotiations leading to it.’”) (citations omitted). c. Temporary Class Courts often certify a temporary class for settlement purposes in cases where settlement is reached before regular class certification. In re Gen. Motors Corp. Pick-Up Truck Fuel Tank Prods. Liab. Litig., 55 F.3d 768, 786-97 (3d Cir. 1995) (holding that settlement classes are cognizable under Rule 23, and discussing the pros and cons of such classes); In re Joint E. & S. Dist. Asbestos Litig., 132 F.R.D. 332, 333 (E.D.N.Y. 1990)

(“[C]ourt has power to act prior to addressing the merits of the class certification motion [and] may appoint counsel to represent the proposed class.”); Harden v. Raffensperger Hughes & Co., Inc., 933 F. Supp. 763 (S.D. Ind. 1996) (noting that “it is not unusual for a court to recognize tentative classes or subclasses for purposes of settlement,” and such recognition usually occurs before certification of litigation class); In re Dennis Greenman Sec. Litig., 829 F.2d 1539 (11th Cir. 1987) (allowing certification solely for settlement purposes); In re Beef Indus. Antitrust Litig., 607 F.2d 167, 177-78 (5th Cir. 1979) (“[T]emporary settlement classes have proved to be quite useful in resolving major class actions disputes.”); see also H. Newberg, Newberg on Class Actions, §§ 11.27, 22.78 (2d ed. 1985). However, even if the court finds the settlement to be fair, it still may not approve the proposed settlement if class certification is improper. See Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 593-594 (1997) (“Federal courts, in any case, lack authority to substitute for Rule 23’s certification criteria a standard never adopted ... that if a settlement is ‘fair,’ then certification is proper.”). 3. Settlement Prior To Appointment Of Lead Counsel Attempts to settle prior to the appointment of class counsel may be problematic. For example, in In re California Micro Devices Securities Litigation, No. C-94-2817-VRW, 1995 WL 476625 (N.D. Cal. Aug. 4, 1995), the court ordered that class counsel be selected by a competitive bidding process described in In re Oracle Securities Litigation, 131 F.R.D. 688, modified, 132 F.R.D. 538 (N.D. Cal. 1990), and In re Wells Fargo Securities Litigation, 156 F.R.D. 223 (N.D. Cal. 1994). The court stated that such a bidding process, “or one that emulates the results of such a process” was necessary to ensure that the class representatives would fairly and adequately protect the interests of the class in accordance with Federal Rules of Civil Procedure 23(a)(4). In re Cal. Micro Devices, 1995 WL 476625, at *4. However, well before this process could be initiated, a settlement was negotiated between defense counsel and two of the three law firms that had been first to file actions. The court found that these negotiations undermined the competitive bidding process and, on that basis, denied motions both for preliminary approval of the settlement and the lead firm’s appointment as class counsel. In re Cal. Micro Devices, 168 F.R.D. 257 (N.D. Cal. 1996). 4. Settlement With Individual Class Members Once the plaintiff class is certified and the opt-out deadline has passed, an individual settlement with the named plaintiffs who are part of the certified class will not be permitted. See In re Painewebber Ltd. P’ship Litig., 147 F.3d 132 (2d Cir. 1998); H. Newberg, Newberg on Class Actions, § 11.75 (2d ed. 1985). Defendants are free, without court approval, to negotiate settlements – side settlements – with absent class members who opt out. See Duhaime v. John Hancock Mut. Life Ins. Co., 183 F.3d 1, 4 (1st Cir. 1999). Where the court has denied class certification, defendants are free to negotiate individual settlements with plaintiffs without court intervention. Fed. R. Civ. P. 41(a)(1); Painewebber, 147 F.3d at 138 (court approval not required for compromises with those outside of class). Furthermore, settlement does not bar the settling plaintiffs from appealing the denial of class certification. In re DES Litig., 7 F.3d 20, 25 n.5 (2d Cir. 1993) (recognizing Supreme Court’s holding in Deposit Guar. Nat’l Bank, Jackson, Miss. v. Roper, 445 U.S. 326 (1980), that denial of class certification may be appealed notwithstanding entry of judgment in plaintiffs’ favor); Montgomery Ward & Co. v. Warehouse, Mail Order, Office, Tech. and Prof’l Employees Union, 911 F. Supp. 1094, 1103 n.7 (N.D. Ill. 1995) (same). 5. Rule 23 And The “Opt-out” In Phillips Petroleum Co. v. Shutts, the Supreme Court held that in class suits “which seek to bind known [plaintiff class members] concerning claims wholly or predominantly for money judgments, … due process requires at a minimum that an absent plaintiff be provided with an opportunity to remove himself from the class by executing and returning an ‘opt-out’ or ‘request for exclusion’ form to the court.” 472 U.S. 797, 811-12

(1985). Opt-out settlements appear to be growing in significance. For instance, California’s teacher pension fund opted out of a $400 million class settlement with Qwest Communications and reached a $46.5 million settlement in December 2006 in its separate case against Qwest Communications, its accountants and investment banks, and certain former directors and officers. Similarly, the State of Alaska in December 2006 entered into a $50 million opt-out settlement disposing of its claims against AOL Time Warner, which had settled with the class for $300 million. In the same vein, five New York City public pension funds opted out of the 2005 $6.1 billion WorldCom class-action settlement and settled their own lawsuits for a total of $78.9 million. Such opt-out settlements may allow the opt out plaintiff to benefit from state blue sky laws and, if successful, may allow for a much larger recovery of claimed damages. The type of class action can impact the settlement process and the ability of absent class members to opt-out. Fed. R. Civ. P. 23(b) provides three sets of circumstances which may justify maintenance of a suit as a class action: (1) prosecution of separate actions creating the risk of inconsistent judgments or, as a practical matter, disposing of the interests of non-parties; (2) a party acting or refusing to act with respect to the class and injunctive or declaratory relief is sought; or (3) common questions of law or fact predominating and class action prosecution would be superior to other available methods for adjudicating the controversy. Generally speaking, (b)(1) and (b)(2) class actions are not “wholly or predominantly for money judgments,” and, therefore, providing absent members with an opportunity to opt-out is not necessary. See, e.g., In re Joint E. & S. Dist. Asbestos Litig., 78 F.3d 764, 777-78 (2d Cir. 1996) (denying class members’ motion to opt-out not an abuse of discretion); 1 Newberg on Class Actions § 1.18 (3d ed. 1992). The overwhelming majority of securities class actions are (b)(3) class actions, and therefore the opt-out is usually available. If a dispute arises about whether a class member has followed the appropriate opt-out procedures, the burden is on the class member to establish that he or she made a sufficient effort to communicate an intent to opt out through the appropriate channels. See, e.g., In re Worldcom, Inc. Sec. Litig., No. 02 CIV. 5288 (DLC), 2005 WL 1048073 (S.D.N.Y. May 5, 2005) (holding testimony alone, absent documentation, that individual mailed in class opt out form is insufficient to carry evidentiary burden). 6. Practical Considerations With Settlements Defense counsel should consider the following matters, among others, when structuring a settlement. a. Timing No clear-cut rule prescribes when the time is right to settle a case. The advantages of early settlement may include: (a) smaller settlement contribution; (b) reduction in litigation expenses; (c) avoidance of disruption to a company’s business or interference with its customers or clients; (d) early distribution to the class of settlement funds; (e) possible termination of the litigation before full liability is exposed; and (f) minimization of adverse publicity. See Schlusselberg v. Colonial Mgmt. Assocs., Inc., 389 F. Supp. 733 (D. Mass. 1974). However, the disadvantages of early settlement include: (a) lacking sufficient factual knowledge to make an accurate assessment of the case; (b) foregoing the opportunity to “win” the case; and (c) facing the uncertainty of final judgment for non-settling defendants, if only a partial settlement is reached. b. Parties Where possible, all parties to the case should be included in the settlement agreement; if one or more parties refuse to settle, steps should be taken to cut off by court order any and all claims that non-participating parties

might bring. c. Publicity Defendants, especially professionals, must consider the impact of adverse publicity from the settlement on their reputation and standing with peers, employees, and the community. Counsel may wish to negotiate an appropriate confidentiality requirement in the settlement agreement. The Reform Act makes such confidentiality agreements more difficult to effectuate as it prohibits the sealing of settlements, except where disclosure would cause direct and substantial harm to a party. 15 U.S.C. § 77z-l(a)(5); 15 U.S.C. § 78u-4(a) (5). d. Admissions The agreement should provide that no defendant admits any allegations of wrongdoing in the complaint (or, if applicable, any cross-complaints or cross-claims). e. Releases Defense counsel should ensure that the releases cover all claims raised or that could have been raised by the allegations in the complaint. Consider the degree to which claims that have not been asserted or that are as yet unknown may be compromised on behalf of a class. Releases of at least equal scope should be obtained from all co-defendants and third-party defendants participating in the settlement. The agreement should also provide a mechanism for obtaining releases from non-settling defendants who subsequently elect to settle. f. Scope Of The Class Consider the degree to which class members may be bound by the settlement. Unlike litigating a class action and seeking to narrow or defeat the plaintiff class, when settling a class action, defendants want to broaden the class as much as possible. Broadening the class also broadens the release of claims. Thus, to the extent possible, the class should be broadened by time period, type of securities (including options), and type of claim. If defendants have previously succeeded in limiting the class, counsel should consider stipulating to a broader class, e.g., the class described in the complaint, for purposes of settlement. If a class has not yet been certified, counsel should request that the court’s order approving the settlement contain a certification of the broadest class possible. g. Consideration Cash, of course, is always acceptable. Inasmuch as cash may not always be available, particularly for smaller start-up companies, parties may resort to other forms of consideration or injunctive relief to fashion a settlement advantageous to all concerned. See, e.g., In re Cal. Micro Devices Sec. Litig., 965 F. Supp. 1327, 1330 (N.D. Cal. 1997) (approving a settlement consisting of cash and non-cash consideration); In re MicroStrategy, Inc. Sec. Litig., 148 F. Supp. 2d 654 (E.D. Va. 2001) (approving a completely non-cash settlement). These cash substitutes are often in the form of:

1) Stock

The defendant may offer its own stock in settlement of the case. See MicroStrategy, 148 F. Supp. 2d at 659 (offering Class A common stock as part of settlement); In re Am. Bank Note Holographics, Inc., 127 F. Supp. 2d 418 (S.D.N.Y. 2001) (offering cash, stock and warrants); Greenfield v. Villager Indus., Inc., 483 F.2d 824, 827 (3d Cir. 1973) (offering unregistered shares of defendants’ stock).

2) Warrants A warrant is a certificate entitling the owner to purchase stock at a specified price, usually only for a specified time. A warrant differs from a stock option because a warrant is granted to shareholders, not employees. See In re MicroStrategy, 148 F. Supp. 2d at 659 (offering warrants as part of settlement); In re Am. Bank Note Holographics, Inc., 127 F. Supp. 2d 418 (S.D.N.Y. 2001) (same); In re Milken & Assocs. Sec. Litig., 150 F.R.D. 46, 50 (S.D.N.Y. 1993) (same). Class action settlements where the sole value exchanged is warrants have been approved even over the objections of class members. In re Brown Co. Sec. Litig., 355 F. Supp. 574 (S.D.N.Y. 1973) (approving shareholder class action settlement consisting of warrants worth $1.6 million). Interestingly, the Eleventh Circuit affirmed a dismissal of a complaint by the shareholders who initially settled their action for warrants and later alleged that misrepresentations by the company caused them to agree to accept the warrants in the settlement. Hall v. Coram Healthcare Corp., 157 F.3d 1286 (11th Cir. 1998).

3) Contingent Value Rights Frequently, stock or warrants are offered as consideration with a guarantee that the instrument will have a specific value. These guarantees are sometimes called Contingent Value Rights or CVR’s. See In re Cendant Corp. Prides Litig., 51 F. Supp. 2d 537, 541 (D.N.J. 1999), vacated in part, 243 F.3d 722 (3d Cir. 2001) (approving non-cash settlement consideration of convertible stock rights).

4) Waiver Of Rights As Consideration Relinquishing one party’s rights under collateral agreements has been used as consideration to settle cases. See In re Brown Co. Sec. Litig., 355 F. Supp. at 589-90 (involving waivers of claims for indemnity); White v. Auerbach, 363 F. Supp. 366 (S.D.N.Y. 1973), rev’d on other grounds, 500 F.2d 822 (2d Cir. 1974) (affirming surrender of rights under executive compensation agreement).

5) Corporate Restructuring In one case, the settlement consisted of a plan to realign corporate stock to alter control of the corporation. Cannon v. Tex. Gulf Sulphur Co., 55 F.R.D. 308, 325 (S.D.N.Y. 1972). In another case, the terms of a proposed merger were revised to increase the benefits distributed to minority shareholders. Oppenlander v. Standard Oil Co., 64 F.R.D. 597 (D. Colo. 1974). The parties can also agree to plans of divestiture of stock held by the corporation. See Wellman v. Dickinson, 497 F. Supp. 824, 828-29 (S.D.N.Y. 1980), aff’d, 647 F.2d 163 (2d Cir. 1981). Injunctions or agreements requiring the corporation to undertake certain reforms, or to refrain from certain actions, may also serve as effective settlement tools.

6) Corporate Governance Changes Sometimes changes in corporate governance procedures, e.g., narrowing the trading window during which

employees can buy and sell the corporation’s stock or changing accounting procedures, may serve as consideration. In re Caterpillar, Inc., 51 S.E.C. Docket 147 (Mar. 31, 1992) (reporting Caterpillar settled by agreeing to cease and desist from future violations of Exchange Act § 13(a) and to “implement and maintain procedures designed to ensure compliance with Item 303 of Regulation S-K.…”). This is especially common in settlement of derivative suits. h. Future Litigation Costs In rare instances, defense counsel may wish to negotiate for a separate fund from settlement proceeds providing indemnification for defense costs incurred in actions brought by opting-out class members, as well as indemnification for any breach by settling plaintiffs. The need for such an arrangement depends on the insurance coverage of the defendant. i. Effect On Other Litigation Special problems may arise where parties attempt to settle class and derivative actions simultaneously. “This stems in large measure from the inherent conflict between the interests supposedly protected by the class action and those benefitted by the derivative action.” In re Oracle Sec. Litig., 829 F. Supp. 1176, 1183 (N.D. Cal. 1993). Although both groups are largely made up of shareholders, they do not necessarily include the same shareholders. Thus, a favorable result in the class action may tend to transfer wealth from the plaintiffs in the derivative action to the plaintiffs in the class action and vice versa. Moreover, while the corporation will likely be named a defendant in the class action, it will be the party on whose behalf plaintiff is suing in the derivative action. The Oracle court denied approval of the settlement, finding that the settlement committee of independent board members relied on “inherently biased advice” and therefore, “their approval of the settlement [was] worthless for purposes of analyzing whether the settlement reasonably protect[ed] the interests of the corporation and its shareholders.” Id. at 1189. j. Appeal And Collateral Attack The settlement agreement should provide an express waiver of any right by plaintiff to appeal or attack collaterally a judgment of dismissal entered pursuant to the settlement. As is self-evident from the incessant fluctuations of the open market, the value of settlements involving stock or warrants as consideration can materially change after the settlement agreement concludes. A decline in the value of the stock-based portion of the settlement may present plaintiffs with an incentive to seek opportunities to renegotiate the consideration for the agreement. The Eleventh Circuit rejected such an attempt, shrouded in the guise of a motion to enforce the terms of the settlement agreement. In re T2 Med., Inc., 130 F.3d 990 (11th Cir. 1997). Plaintiffs brought a “motion to enforce stipulation of settlement” claiming fraud, mutual mistake, and breach of contract. Id. at 993. The district court rejected plaintiffs’ motion as beyond its jurisdiction, and the Eleventh Circuit agreed. Id. at 994-95. Plaintiffs’ motion to “enforce” the settlement agreement in reality was an attempt to renegotiate the agreement on grounds (subsequent events) that expressly had been waived in the stipulation of settlement. Id. at 993. 7. Partial Settlements a. Global Settlements Not Always Possible Global settlement of securities litigation is often desirable for both plaintiffs and defendants. From the defendant’s perspective, a global settlement terminates the litigation, permits the client to put the litigation behind it, and resolves questions of indemnity, contribution, and cross-actions. However, in large cases

involving multiple defendants, sub-classes or alleged wrongdoing over a long period of time, a consensus among defendants to settle may not be possible. Some defendants accordingly may enter into a partial settlement with the plaintiffs. Partial settlements present several legal and practical issues. b. Indemnity Arguably, indemnity is not available under the federal securities laws. See In re Cont’l Airlines, 203 F.3d 203, 215-16 (3d Cir. 2000); Baker, Watts & Co. v. Miles & Stockbridge, 876 F.2d 1101 (4th Cir. 1989); King v. Gibbs, 876 F.2d 1275, 1281 (7th Cir. 1989); Stowell v. Ted S. Finkel Inv. Servs. Inc., 641 F.2d 323, 325 (5th Cir. 1981); Laventhol, Krekstein, Horwath & Horwath v. Horwitch, 637 F.2d 672 (9th Cir. 1980); Globus v. Law Research Serv., Inc., 418 F.2d 1276 (2d Cir. 1969); South Carolina Nat’l Bank v. Stone, 749 F. Supp. 1419, 1429 (D.S.C. 1990) (finding it well settled that “one tortfeasor may not seek indemnification from another under Rule l0b-5”). The minority view disallows indemnification where scienter is involved, but allows it where one tortfeasor is guilty of negligence only, e.g., a Section 11 tortfeasor seeking indemnification from a Rule l0b-5 tortfeasor. See Adalman v. Baker, Watts & Co., 599 F. Supp. 752, 759 (D. Md. 1984); Muth v. Dechert, Price & Rhoads, 391 F. Supp. 935 (E.D. Pa. 1975). State law governs the availability of indemnity in respect of state law claims. See Lucas v. Hackett Assocs., Inc., 18 F. Supp. 2d 531, 535-36 (E.D. Pa. 1998) (holding that indemnity is not available for federal securities claims or for state law claims that seek “damages for what are essentially violations of the federal securities laws” but allowing indemnity for state claims that are not “de facto federal securities claims” to be determined by the state court). California Corporations Code Sections 25505 and 25510 limit the availability of indemnity to a corporation against its principal executive officers, directors, and controlling persons whose willful violations gave rise to corporate liability. The theory of indemnity – whether contractual, federal common law or implied right – will not change the result. See In re Olympia Brewing Co. Sec. Litig., 674 F. Supp. 597 (N.D. Ill. 1987). c. Contribution 1) General Congress has expressly conferred a right to contribution for actions brought under Sections 9 and 18 of the Exchange Act, 15 U.S.C. §§ 78i(e), 78r(b), as well as Section 11 of the Securities Act, 15 U.S.C. § 77k(f). For nearly a quarter century, an implied right to contribution has existed under Section 10(b). See Employers Ins. of Wausau v. Musick, Peeler & Garrett, 954 F.2d 575 (9th Cir. 1992), aff’d, 508 U.S. 286 (1993). Congress did not provide for an express right to contribution for Section 12 of the Securities Act, 15 U.S.C. § 771 (see Baker Watts & Co. v. Miles & Stockbridge, 876 F.2d 1101(4th Cir. 1989)), Section 15 of the Securities Act, 15 U.S.C. § 77o (see Premier Capital Mgmt., LLC v. Cohen, No. 02C5368, 2005 WL 1564926 (N.D. Ill. July 1, 2005)), Section 16 of the Exchange Act, 15 U.S.C. § 78p, or Section 20A of the Exchange Act, 15 U.S.C. § 78t-1. Contribution is available under the law of most states. See, e.g., N.Y.C.P.C.R. § 1401; Cal. Corp. Code § 25505; Am. Motorcycle Ass’n v. Superior Court, 20 Cal. 3d 578, 591-98 (1978). A right to contribution exists only among joint tortfeasors. See Laventhol, Krekstein, Horwath & Horwath v. Horwitch, 637 F.2d 672 (9th Cir. 1980); Am. Motorcycle, 20 Cal. 3d at 600; Steed Fin. LDC v. Laser Advisers, Inc., 258 F. Supp. 2d 272, 281-82 (S.D.N.Y. 2003) (holding that “joint tortfeasors” are only those who jointly participate in fraud, and that therefore independent, though concurrent, tortfeasors lack a right to contribution); Restatement (Second) of Torts, §§ 886A-886(B) (1979); Cal. Corp. Code § 25505; 15 U.S.C. § 77k (contribution under the Securities Act limited to “any person who, if sued separately, would have been liable to make the same payment”). The modern trend is toward equitable contribution based on relative culpability, rather than the pro-rata approach.

2) The Reform Act The Reform Act limits joint and several liability. One of the key purposes of the Reform Act was to discourage “the targeting of deep pocket defendants, including accountants, underwriters, and individuals who may be covered by insurance without regard to their actual culpability.” See Joint Explanatory Statement of the Committee on Conference on the Private Securities Reform Act of 1995, 27 Sec. Reg. & L. Rep. (BNA) 189091 (Dec. 1, 1995). Prior to the Reform Act, the existing “system of joint and several liability create[d] coercive pressure for entirely innocent parties to settle meritless claims rather than risk exposing themselves to liability for a grossly disproportionate share of the damages in the case.” H.R. Conf. Rep. 104-369, 1995 U.S.C.C.A.N. 730, 736-37 (Nov. 28, 1995). Subject to limited exceptions, the Reform Act abolishes joint and several liability for non-knowing violations of the securities laws. Thus, absent knowing violation of the securities laws, a defendant is typically liable only for the percentage of damages for which he is determined to be responsible. See Exchange Act Section 21D(f).

3) Settlement Bar Statutes

(a) General A plaintiff class will often be able to reach an accord with some, but not all, of the defendants. A defendant that is otherwise willing to settle may be faced with the threat of contribution claims by non-settling defendants. As a result, the defendant is unlikely to enter into a partial settlement. Several states have responded to this inhibiting effect on settlements by passing settlement bar statutes. These statutes bar non-settling defendants from seeking contribution from settling defendants in certain circumstances. See Nelson v. Bennett, 662 F. Supp. 1324, 1329 n.7 (E.D. Cal. 1987) (citing 19 different state statutes); S.C. Nat’l Bank v. Stone, 749 F. Supp. 1419, 1430 (D.S.C. 1990). Under most settlement bar statutes, if a judgment is later entered against the non-settling defendants, the non-settling defendants are entitled to an offset against the judgment in an amount proportionate to the amount of the settlement. See 2 H. Newberg, Newberg on Class Actions § l2.42A at 87 (Supp. 1988). The statutes require that the settlements be made in good faith. See In re Nucorp Energy Sec. Litig., 661 F. Supp. 1403, 1411-12 (S.D. Cal.1987).

(b) The Reform Act Settlement Bar The Reform Act provides for settlement bars for claims pursuant to the Exchange Act. The Exchange Act specifically provides that upon entry of a settlement by the court, the court shall issue an order barring any claims for contribution by or against the settling party. 15 U.S.C. § 78u-4(f)(7). Additionally, the final verdict or judgment shall be reduced by the percentage liability of the settling party or the amount of settlement, whichever is greater. Id.; see also In re Sterling Foster & Co. Sec. Litig., 238 F. Supp. 2d 480 (E.D.N.Y. 2002). This bar also applies to outside directors in Section 11 actions. See Lucas v. Hackett Assocs., Inc., 18 F. Supp. 2d 531, 534 (E.D. Pa. 1998) (applying 15 U.S.C. § 78u-4(f)(7) of the Reform Act contribution bar in favor of settling defendants, but holding that “the settling defendants will be estopped from contending in the future that viatical settlements are not securities”). However, the PSLRA settlement bar allows a settling defendant to seek contribution from a third party, if the

settlement agreement extinguishes that third party’s liability. 15 U.S.C. § 78u-4(f)(7)(A). See In re Cendant Corp. Sec. Litig., No. 98-CV-1664, 2007 WL 2164241, at *6 (D.N.J. July 25, 2007) (holding PSLRA settlement bar did not prevent settling defendant from seeking contribution against Ernst & Young because the settlement agreement, between plaintiff and settling defendant released Ernst & Young from liability to the plaintiff).

(c) Examples of State Good Faith Settlement Statutes California Code of Civil Procedure Section 877.6 provides, in pertinent part, that: [a]ny party to an action in which it is alleged that two or more parties are joint tortfeasors or joint co-obligors on a contract debt shall be entitled to a hearing on the issue of the good faith of a settlement entered into by the plaintiff or other claimant and one or more alleged tortfeasors …, [¶] (c) A determination by the court that the settlement was made in good faith shall bar any other joint tortfeasor or co-obligor from any further claims against the settling tortfeasor or co-obligor for equitable comparative contribution, or partial or comparative indemnity, based on comparative negligence or comparative fault. N.Y. Gen. Oblig. L. § 15-108 (b) provides that: A release given in good faith by the injured person to one tortfeasor are … relieves him from liability to any other person for contribution….

4) Judicial Approval Is Required Judicial approval of the fairness and adequacy of the settlement is required in some jurisdictions before the court will bar claims against settling defendants. See Nelson, 662 F. Supp. at 1338. Among the factors to be considered in determining whether the settlement is “fundamentally fair and equitable” are “the possible uncollectability of any larger judgment which might be entered against the settling defendants, the adequacy of the settlement amount in light of the comparative culpability of the settling defendants and the uncertainties of establishing such liability and the participation of a magistrate or judge in the settlement negotiations.” Nelson, 622 F. Supp. at 1338; see Tech-Bilt. Inc. v. Woodward-Clyde & Assoc., 38 Cal. 3d 488, 499-500 (1985) (discussing factors to be taken into account in determining if settlement is made in good faith); Harden v. Raffensperger, Hughes & Co., 933 F. Supp. 763 (S.D. Ind. 1996) (addressing court’s power to order a contribution bar); TBG, Inc. v. Bendis, 36 F.3d 916 (10th Cir. 1994).

5) Application Of Settlement Bars By Federal Courts Traditionally, a determination that a settlement by some defendants was entered into in good faith did not bar a right to contribution by non-settling defendants for federal securities claims. See Laventhol, Krekstein, Horwath & Horwath v. Horwitch, 637 F.2d 672 (9th Cir. 1980) (finding claims not cut off, but settling defendants did not pay “proper” or “fair” share, and suggesting in dictum that result might be different if defendants had done so); Harrison v. Sheats, 608 F. Supp. 502, 505-07 (E.D. Cal. 1985) (holding despite finding of good faith settlement under Section 877.6, non-settling defendant entitled to contribution on federal securities claims); Altman v. Liberty Equities Corp., 54 F.R.D. 620 (S.D.N.Y. 1972). However, even before the Reform Act, the trend was to cut off claims if a “fair” share is paid by a settling defendant. See Nelson v. Bennett, 662 F. Supp. 1324 (E.D. Cal. 1987) (implied rights of contribution in federal securities actions should be subject to implied settlement bar rule under federal common law); In re Nucorp Energy Sec. Litig., 661 F. Supp. 1403 (S.D. Cal. 1987) (rejecting argument that “fair” share can only be determined after trial);

Smith v. Mulvaney, No. 85-0688, 1985 WL 29953, at *4 (S.D. Cal. June 5, 1985) (holding non-settling defendant not entitled to contribution in case where court made finding of good faith settlement under Section 877.6); see also First Fed. Sav. & Loan Ass’n of Pittsburgh v. Oppenheim, Appel, Dixon & Co., 631 F. Supp. 1029, 1036 (S.D.N.Y. 1986) (holding “good faith” settlement under New York law barred contribution to non-settling defendant on federal securities claims and rejecting “fairness” approach).; Employers Ins. of Wausau v. Musick, Peeler & Garrett, 954 F.2d 575 (9th Cir. 1992), aff’d, 580 U.S. 286 (1993) (explaining contribution may be sought through a third party action). Furthermore, courts have held that nothing in the Reform Act divests a court of its power to fashion a bar order that is broader than that contemplated in the Reform Act. See Wisc. Inv. Bd. v. Ruttenberg, 300 F. Supp. 2d 1210 (N.D. Ala. 2004); In re Healthsouth Corp. Sec. Litig., 572 F.3d. 854 (11th Cir. 2009) (holding that PSLRA is not grounds for forbidding a district court from barring claims other than contribution claims). In other words, the Reform Act does not necessarily strip district courts of the power to enter settlement bar orders in securities fraud litigation that extinguish non-contribution claims in related cases. See id. However, other recent court decisions dealing with settlement bars have expressly refused to approve stipulations of settlement that contain proposed bar orders that deviate from the scope of §21D(f)(7)(B) of the 1934 Act. See In re Heritage Bond Litig., 546 F.3d 667, 671 (9th Cir. 2008) (holding that a district court’s approval of the securities class action settlement may bar only claims for contribution or indemnity “or disguised claims for such relief,” not independent claims against settling defendants); In re Global Crossing Sec. & ERISA Litig., 225 F.R.D. 436, 447 (S.D.N.Y. 2004) (approving settlement for D&O defendants only after settling defendants and plaintiffs agreed to adopt the non-settling defendants’ proposal for an alternate bar order, more limited than the original proposal); In re Worldcom, Inc. Sec. Litig., No. 02 CIV. 3288, 2005 WL 335201 (S.D.N.Y. Feb. 14, 2005) (refusing to approve partial settlement stipulation that contained bar order with judgment reduction provision that could reduce settling defendants’ contribution below that of §21D(f)(7) (B) of the 1934 Act); In re IPO Sec. Litig., 226 F.R.D. 186 (S.D.N.Y. 2005) (conditioning preliminary approval of settlement on revision of overly broad bar order that left final limitations to the trial court to a bar order “limited to the express wording of §78u-4(f)(7)(A)”). But see Denney v. Jenkins & Gilchrist, No. 03 CIV. 5460 (SAS), 2005 WL 388562 (S.D.N.Y. Feb. 18, 2005) (preliminarily approving bar order that left calculation of judgment credit to the jurisdictions in which a class member may bring a claim in case with multiple actions in multiple jurisdictions), vacated in part on other grounds, Denney v. Deutsche Bank AG, 443 F.3d 253 (2d Cir. 2006). Plaintiffs have argued that the Reform Act’s bar order provisions (reducing a verdict or judgment by the greater of (i) an amount that corresponds to the percentage of responsibility of that covered person; or (ii) the amount paid to the plaintiff by that covered person) act as a serious deterrent to partial settlement in cases with deep pocket non-settling defendants and potentially enormous exposure. Judge Cote in Worldcom even agreed, but ruled that “because the statutory language is clear, the remedy must be legislative.” See In re Worldcom, 2005 WL 335201 at *15. If the outside directors remain in an action where this imbalance of wealth is present, the plaintiff will be able to collect the entirety of judgment from other [] violators regardless of what percentage of responsibility the jury assigns to the outside directors. This is because the plaintiff can collect the entire judgment from a wealthy jointly and severally liable defendant (who will in turn be able to recover only what the outside director co-defendants are actually able to pay, up to the percentage of the final judgment for which the jury has deemed them responsible). On the other hand, if the outside directors settle, under the [Reform Act] formula, the outside directors’ assessed proportion of liability will be subtracted from the final judgment amount if it is greater than the actual settlement amount, reducing the plaintiff’s overall recovery by the difference between the proportion of liability and the settlement amount. As explained above, if the stakes in the case are high, even a relatively small percentage of outside-director liability can translate into a vast sum of money to which the plaintiff will have denied itself access by choosing to settle with the outside directors. As a result, if the “deep pockets” refuse to settle, it is likely that the plaintiff will refuse to settle with outside directors on terms they are able to meet.

Id. Apart from the Reform Act, some federal courts have refused to apply the forum state’s statute and have attempted instead to fashion a federal common law. See Nelson v. Bennett, 662 F. Supp. 1324, 1388 (E.D. Cal. 1987) (refusing to apply California’s settlement bar statute and instead fashioning a federal common law rule which arguably applied the same factors required under the California statute); Eichenholtz v. Brennan, 52 F.3d 478 (3d Cir. 1995); Franklin v. Kaypro Corp., 884 F.2d 1222 (9th Cir. 1989); In re Sunrise Sec. Litig., 698 F. Supp. 1256 (E.D. Pa. 1988). But see Langford v. Fox, No. 84 CIV. 5308 (LBS), 1988 WL 70351 (S.D.N.Y. Sept. 28, 1988) (“A ‘no-bar’ policy, then, would leave little incentive for one party in a multi-party litigation to settle, and public policy has long favored settlement, particularly in the case of complex securities actions.”).

6) Calculating Set-off Amounts For Non-Settling Defendants An issue in the federal settlement bar doctrine is the amount of setoff to which the non-settling defendants are entitled by virtue of the plaintiffs’ recovery from the settling defendants. When a settlement extinguishes the contribution rights of non-settling defendants, those non-settling defendants are entitled to a set-off against the judgment. See Franklin v. Kaypro Corp., 884 F.2d 1222, 1231 (9th Cir. 1989); In re Masters Mates & Pilots Pension Plan, 957 F.2d 1020, 1031 (2d Cir. 1992). Before the enactment of the Reform Act, courts were divided among three methods for calculating set-off amounts:

(a) The Pro Tanto Method Any judgment against the non-settling defendants is reduced by the amount paid in settlement. See, e.g., Harden v. Raffensperger, Hughes & Co., 933 F. Supp. 763 (S.D. Ind. 1996) (adopting pro tanto method for securities class action); Singer v. Olympia Brewing Co., 878 F.2d 596, 600 (2d Cir. 1989) (noting pro tanto method also called “one satisfaction rule”); In re Jiffy Lube Sec. Litig., 772 F. Supp. 890 (D. Md. 1991) (calling the pro tanto method the most equitable method to all parties).

(b) The Pro Rata Method Liability is divided into equal slices represented by the aggregate judgment; one slice is allocated to each defendant. See Herzfeld v. Laventhol, Krekstein, Horwath & Horwath, 540 F.2d 27, 38 (2d Cir. 1976);

(c) The Proportional Method The jury determines the relative culpability of each defendant, and the non-settling defendants are liable for their share of the judgment based on culpability; Franklin, 884 F.2d at 1231. The claims against non-settling defendants will be discounted by the amount that corresponds to that settling defendant’s percentage of responsibility.

7) The Reform Act Approach To Set-offs

The PSLRA incorporates aspects of the “proportionate share” approach employed by the Ninth Circuit in Franklin v. Kaypro prior to passage of the PSLRA, and the pro tanto approach favored by other circuits, such as the Second Circuit. See, e.g., Singer v. Olympia Brewing Co., 878 F.2d 596, 600 (2d Cir. 1989). According to the PSLRA: If a covered person enters into a settlement with the plaintiff prior to final verdict or judgment, the verdict or judgment shall be reduced by the greater of (i) an amount that corresponds to the percentage of responsibility of that covered person; or (ii) the amount paid to the plaintiff by that covered person. 15 U.S.C. § 78u-4(f)(7)(B). Thus, the proportionate method, or option (i), most likely will apply where a settlement is reached with a defendant facing potential liability for all or most of the damages, while the pro tanto method, or option (ii), most likely will apply where a settlement is reached with a defendant that pays more than its proportionate share of liability. See In re Worldcom, Inc. Sec. Litig., No. 02 Civ. 3288, 2005 U.S. Dist. LEXIS 1805 (S.D.N.Y. Feb. 10, 2005) (analyzing proportionate method); In re Initial Pub. Offering Sec. Litig., 226 F.R.D. 186, 192 (S.D.N.Y. 2005) (rejecting argument that plaintiffs must know the exact size of the pro tanto credit based on amount that would ultimately be received before a settlement could be approved); see also Gerber v. MTC Elec. Tech. Co., 329 F.3d 297, 304-305 (2d Cir. 2003) (discussing the difficulty in calculating proportionate damages in cases before the outcome of a trial on claims that are not common, such as section 10(b) and section 14 claims), cert. denied, 540 U.S. 966 (2003).

8) Parties Not In Suit Settlement agreements cannot bar contribution actions by settling defendants against individuals who were not parties to the original suit. See Employers Ins. of Wausau v. Musick, Peeler & Garrett, 954 F.2d 575, 579 (9th Cir. 1992), aff’d, 508 U.S. 286 (1993). The Ninth Circuit determined that the district court erred in failing to recognize that the “fair share” paid by the settling party depends “on the context in which it is used since the concept of fairness is inherently relational.” Id. at 579. The court noted that “an action for contribution is concerned with the [fair share] of the individual tortfeasor relative to all others jointly liable for the injury,” as opposed to the “fair share” of the settlement which is relative only to the other defendants. Id. The court concluded that “it is axiomatic that a defendant may pay her fair share relative to other parties in the suit and yet pay more than her fair share relative to the universe of all tortfeasors.” Id. This rule appears to remain in effect after the passage of the PSLRA, in light of the statute’s limitation of the contribution bar to settling defendants, the requirement that allocation of proportional liability determinations include non-parties, and § 21D(f)(8). However, no court has yet squarely addressed the issue. d. Cross-Actions Partial settlements present problems concerning cross-actions among co-defendants for primary wrongdoing, indemnity or contribution. Co-defendants may be under pressure to file a cross-action at the time of answering the complaint; any subsequent cross-action requires leave of court. Defense counsel must consider whether to file a cross-action early in the litigation and risk creating an adversarial relationship with both plaintiff and codefendants or wait until there is substantial exposure in the event of a partial settlement by some defendants, at which time a court may be unwilling to grant leave to file a late cross-action absent newly discovered facts. The Reform Act’s bar on contribution claims by or against a settling defendant greatly simplifies this analysis. e. Severance Of Claims In the event of a completed or proposed partial settlement, a plaintiff may elect to sever pendent state claims

from any remaining federal causes of action against the non-settling defendants. In California practice, if a plaintiff obtains a good faith determination pursuant to Section 877.6, a non-settling defendant faces increased pressure to settle because (a) a pendent claim for negligent misrepresentation will yield the same recovery as a Rule 10b-5 action but does not require proof of scienter, and (b) the non-settling defendant found liable under the pendent claim may not obtain contribution under Section 877.6. 8. Collateral Attack Of Settlement a. Potential Derivative Suits Counsel should attempt to protect settlements from derivative complaints challenging the terms of the settlement or alleging the same facts contained in the class action itself. Defendants in a federal securities class action who enter into a comprehensive settlement with class plaintiffs can be sued derivatively in state court by non-class member shareholders making virtually identical allegations and challenging the allocation of the settlement in the federal action as between the company’s officers and its insurer. Therefore, counsel may wish to negotiate releases not just between plaintiffs and defendants but between co-defendants as well – particularly as between the company and its management. b. Issue Preclusion Of Federal Claims A “global” settlement approved in a state court action may release related federal claims. In Epstein v. MCA, Inc., defendants opposed plaintiffs’ federal class certification motion on the grounds that the motion was barred by a Delaware state court action which purported to settle and release both pending state and federal law claims. 50 F.3d 644 (9th Cir. 1995). Plaintiffs filed a class action suit against Matsushita in the Delaware Court of Chancery after Matsushita acquired a Delaware corporation, MCA, Inc. While the Delaware action (which alleged only state law claims) was pending, the “Epstein” plaintiffs filed another class action in federal district court in California alleging violations of certain Exchange Act rules that are within the exclusive jurisdiction of the federal courts. The district court declined to certify the class, entered summary judgment for Matsushita, and dismissed the action. With the federal case on appeal, a settlement was negotiated in the state court action and entered as an order of the Delaware Court. This settlement included a global release of all claims arising out of the Matsushita-MCA acquisition. Matsushita then invoked the settlement to bar further prosecution of the federal court action under the Full Faith and Credit Act, 23 U.S.C. § 1738. The Ninth Circuit found that the state court plaintiffs could not release federal claims of absent class members in a state court action when the state court did not have jurisdiction to dispose of those federal claims. Id. at 665-66. The court therefore declined to give full faith and credit to the Delaware judgment because it purported to release federal claims based upon different underlying facts from those at issue in the state court action, even though the claims in both the federal and state action arose from the same transaction, namely, the merger. Id. at 668. The Supreme Court reversed the Ninth Circuit in Matsushita Electric Industrial Co. v. Epstein, 516 U.S. 367 (1996). The Full Faith and Credit Act, 28 U.S.C. § 1738, requires federal courts to give the judgments of state courts “the same full faith and credit … as they have by law or usage in the courts of such State … from which they are taken.” Nothing in the Act or the securities laws, the Supreme Court ruled, indicated that the Act did not apply to state court judgments voluntarily releasing exclusively federal claims. 516 U.S. at 381-84. Instead of judging the validity of the global settlement by the law of Delaware, however, as the Full Faith and Credit Act requires, the Ninth Circuit had fashioned its own test, under which the preclusive effect of the state court settlement judgment would be limited to claims that could have been extinguished by adjudication of the state claims. Id. at 372 (citing Epstein, 50 F.3d at 665). The Supreme Court then remanded the case to the Ninth Circuit.

On remand, the Ninth Circuit initially refused to find that the Epstein plaintiffs’ claims were barred by the Delaware judgment approving the settlement. The court denied full faith and credit to the Delaware judgment on the grounds that the decision had denied the absent members of the plaintiff class the due process rights to adequate representation. See Epstein v. MCA, Inc., 126 F.3d 1235 (9th Cir. 1997). A petition for rehearing was later granted and a reconstituted Ninth Circuit panel withdrew its initial decision and came to the opposite result. See Epstein v. MCA, Inc., 179 F.3d 641, 648 (9th Cir. 1999). The full court held that adequacy of representation as determined by the state court was not subject to broad collateral review. As long as procedural safeguards were employed, absent class members’ due process rights to adequate representation were protected by the certifying court and, if necessary, remedied on appeal within the forum state’s judicial system and by direct review in the United States Supreme Court. Id. 9. Insurance Issues a. Allocations Are Made From Time Of Settlement An insurer is responsible for covering costs incurred after settlement so long as potential liability exists based on facts known to the insured. See Luria Bros. & Co. v. Alliance Assurance Co. Inc., 780 F.2d 1082, 1091 (2d Cir. 1986). Courts will not permit insurers to re-litigate the underlying action in order to avoid their obligations. See Nodaway Valley Bank v. Cont’l Cas. Co., 715 F. Supp. 1458, 1465 (W.D. Mo. 1989), aff’d, 916 F.2d 1362 (8th Cir. 1990); Nordstrom, Inc. v. Chubb & Son, Inc., 820 F. Supp. 530 (W.D. Wash. 1992), aff’d, 54 F.3d 1424 (9th Cir. 1995). Instead, a court will allocate defense costs based on the court’s determination of what “reasonable allocations should have been made, considering uncertainties in both fact and law known at the time of the settlement.” Nodaway Valley Bank, 715 F. Supp. at 1465. b. An Insurer’s Ability To Allocate Generally, Director & Officer (“D&O”) Insurance coverage will not cover claims against uninsured individuals or entities. See PepsiCo, Inc. v. Cont’l Cas. Co., 640 F. Supp. 656 (S.D.N.Y. 1986); Fed. Realty Inv. Trust v. Pac. Ins. Co., 760 F. Supp. 533 (D. Md. 1991). However, unless the policy is exceptionally clear, allocating between insured and uninsured defendants and claims may be a major source of negotiation between the carrier and the insured. The question that typically arises is how to allocate when a case includes both covered and uncovered claims, individuals, or entities. See Level 3 Commc’n v. Fed. Ins. Co., 168 F.3d 956 (7th Cir. 1999) (applying “insured vs. insured” exclusion but requiring allocation as between “covered and uncovered” loss). An insurer providing D&O insurance may allocate defense costs according to covered and uncovered claims. See Okada v. MGIC Indem. Corp., 823 F.2d 276, 282 (9th Cir. 1986); Gon v. First State Ins. Co., 871 F.2d 863, 868-69 (9th Cir. 1989). However, no right of allocation exists if “there is no reasonable means of prorating.” Nordstrom, Inc. v. Chubb & Son, Inc., 54 F.3d 1424, n.5 (9th Cir. 1995) (en banc) (citations omitted); see also Fed. Realty Inv. Trust, 760 F. Supp. at 536-37. In Okada, the underlying complaint was found to govern the allocation allowance. 823 F.2d at 282. The insurer had to advance defense costs for all covered and potentially covered claims although the insurer could reserve its rights as to those claims that fell within the policy’s exceptions to coverage. Id. In Gon, the allocation between covered and uncovered claims could not be easily distinguished. 871 F.2d at 868-69. The insurer, however, was responsible for all legal expenses as incurred, subject to apportionment and reimbursement for defense of uncovered claims after settlement or judgment. Id. at 869. Theories of Allocation. The circuit courts currently disagree concerning the appropriate allocation theory to apply when considering an issuer’s responsibility for the reimbursement of defense costs and settlement payments. The Second Circuit looks at “the relative exposure of the respective parties.” PepsiCo, 640 F. Supp. at 662. The Seventh and Ninth Circuits apply the “larger settlement rule,” allocating as uncovered only those costs of litigation or settlement that were greater due to the inclusion of uninsured parties (or claims).

Caterpillar, Inc. v. Great Am. Ins. Co., 62 F.3d 955 (7th Cir. 1995); Harbor Ins. Co. v. Cont’l Bank Corp., 922 F.2d 357 (7th Cir. 1990); Nordstrom, Inc., 54 F.3d 1424; Safeway Stores, Inc. v. Nat’l Union Fire Ins. Co., 64 F.3d 1282 (9th Cir. 1995). Bankruptcy Preference. Where the insurer contributes to the settlement under a D&O policy and the corporation files for bankruptcy shortly thereafter, an issue can arise as to whether the funds contributed by the carrier may be withdrawn from the settlement as a voidable preference under Section 547 of the Bankruptcy Code, 11 U.S.C. § 547. This question was addressed in In re Imperial Corp. of America, 144 B.R. 115 (S.D. Cal. 1992). After securities class actions and derivative suits were filed against it, Imperial Corporation of America (“ICA”) negotiated a $13 million settlement with plaintiff shareholders. ICA’s insurer, American Casualty, transferred $12.5 million to the settlement fund pursuant to the terms of the D&O policy American Casualty had issued to ICA. Approximately one month later, ICA filed for Chapter 11 bankruptcy protection. Id. at 117. American Casualty instituted an action to recover the $12.5 million on the theory that the amount constituted a voidable transfer from ICA’s estate under Section 547. However, examining carefully the terms of the D&O policy, the court concluded that the policy provided for payment to ICA only for indemnification of its officers and directors. Because ICA could receive payment under the policy only on behalf of its employees, ICA could have no interest of its own in the proceeds. Therefore, since “the indemnification proceeds paid to the Settlement Fund … were not a transfer of an interest of the debtor in property,” American Casualty’s contribution to the settlement was not within the terms of Section 547, and American Casualty could not recover the $12.5 million on this basis. Id. at 120. 10. Attorneys’ Fees After Settlement When granting fee awards, district courts have broad discretion in determining what is reasonable under the circumstances. See Luciano v. Olsten Corp., 109 F.3d 111, 115 (2d Cir. 1997); In re Indep. Energy Holdings Sec. Litig., 302 F. Supp. 2d 180, 182 (S.D.N.Y. 2003). a. Lead Counsel Under the PSLRA, a fee agreement negotiated between a lead plaintiff and lead counsel as part of a retainer agreement enjoys a presumption of reasonableness. In re Lucent Techs. Inc., Sec. Litig., 327 F. Supp. 2d 426, 433 (D.N.J. 2004). Courts must determine whether this presumption is rebutted by a “prima facie showing that the retained agreement fee is clearly excessive.” Id. (quoting In re Cendant Corp. Litig., 264 F.3d 201, 283 (3d Cir. 2001)); see also, In re HPL Tech., Inc. Sec. Litig., 366 F. Supp. 2d 912, 917 (N.D. Cal. 2005) (noting while lead plaintiff’s negotiated fee arrangement with lead counsel is owed deference, the fees and expenses must still be objectively reasonable.) The Ninth Circuit held in In re Mercury Interactive Corp. Sec. Litig., 618 F.3d 988 (9th Cir. 2010) that, under the plain language of Rule 23(h), it was error for the district court to schedule the fee proceedings in such a manner that objections to the fee award had to be made prior to the filing of counsel’s fee petition and supporting papers. b. Reasonable Fee Circuit courts have enumerated different tests to evaluate the reasonableness of a fee award. For example, courts in the Second Circuit examine: (1) time and labor expended by counsel; (2) magnitude and complexity of the litigation; (3) litigation risks; (4) quality of the representation; (5) requested fee in relation to the settlement; and (6) public policy. Goldberger v. Integrated Res., Inc., 209 F.3d 43, 50 (2nd Cir. 2000). The Second Circuit permits both the lodestar and percentage-of-recovery methods for calculating reasonable attorney fees but

disfavors the lodestar method because the “lodestar creates an unanticipated disincentive to early settlements, tempts lawyers to run up their hours and compels district courts to engage in a gimlet-eyed review of line-item fee audits.” In re Merrill Lynch & Co., Inc. Research Reports Sec. Litig., No. 02 MDL 1484(JFK), 2007 WL 313474, at *12 (S.D.N.Y. Feb. 1, 2007) (employing the Goldberger factors to reduce lead counsel’s fee from 28% (lodestar multiplier of 2.43) to 22.5% (lodestar multiplier of 1.95)); see also In re Nortel Networks Corp. Sec. Litig., 539 F.3d 129 (2d Cir. 2008) (upholding district court’s reduction of a negotiated fee award from 8.5% to 3%, but noting 3% was at the lower-end of what was considered reasonable and that courts should give “serious consideration” to agreements between parties); In re NTL Inc. Sec. Litig., No. 02 Civ. 3013(LAK), 2007 WL 1294377, at *4 (S.D.N.Y. May 2, 2007) (applying the Goldberger factors and lode-star “cross-check” to find a 15% fee (negative lodestar multiplier of 0.42) reasonable because it provided sufficient incentive while avoiding a windfall to counsel at the expense of the plaintiff class); In re Merrill Lynch & Co., Inc. Research Reports Sec. Litig., 246 F.R.D 156 (S.D.N.Y. 2007) (applying Goldberger factors and lodestar method to determine that attorneys’ fees of 24% of a $125 million settlement fund were reasonable). In the Third Circuit, courts apply the factors established in Gunter v. Ridgewood Energy Corp.: (1) complexity and duration of litigation; (2) presence or absence of substantial objections; (3) skill and efficiency of counsel; (4) size of fund and number of persons benefited; (5) risk of nonpayment; (6) amount of time that counsel devoted to the case; and (7) awards in similar cases. 223 F.3d 190 (3d Cir. 2000). The Third Circuit also recognizes use of the lodestar method as a check on the percentage-of-recovery calculation. In re Rite Aid Corp. Securities Litigation, 396 F.3d 294, 300 (3d Cir. 2005). When performing the lodestar cross check, district courts should apply blended billing rates that approximate the fee structure of all attorneys who worked on the matter. Id. at 306 (holding failure to apply blended rate of partner and associate required vacating the award and remanding for further consideration); In re HPL Tech., Inc. Sec. Litig., 366 F. Supp. 2d at 918 (holding application of lodestar cross check which considered only percentage-based fees and failed to take into account the nature and amount of work put into case is insufficient to ensure a reasonable fee). The Sixth Circuit applies the factors set forth in Ramey v. Cincinnati Enquirer, Inc., 508 F.2d 1188, 1196 (6th Cir. 1974) to determine the reasonableness of fee awards. These relevant factors are: “(1) the value of the benefit rendered to the corporation to its stockholders, (2) society’s stake in rewarding attorneys who produce such benefits in order to maintain an incentive to others, (3) whether the services were undertaken on a contingent fee basis, (4) the value of the services on an hourly basis, (5) the complexity of the litigation, and (6) the professional skill and standing of the counsel involved on both sides.” Id.; see also In re Cardinal Health Inc. Sec. Litig., 528 F. Supp. 2d 752 (S.D. Ohio 2007) (discussing the weight afforded to each of the Ramey factors, including the lodestar cross-check). In the Seventh Circuit, attorneys’ fees are assessed by “estimating what the parties would have agreed to had negotiations occurred at the outset.” Sutton v. Bernard, 504 F.3d 688, 693 (7th Cir. 2007). The district court should apply a market-based approach and consider the risk of no recovery. Id. The court should not apply a “degree of success” calculation to determine a fee percentage rate in common fund cases. Id. c. Non-Lead Counsel Non-lead counsel are entitled to some compensation when they have conferred a benefit upon the class. Indep. Energy Holdings, 302 F. Supp. 2d at 182 (holding that fees incurred by non-lead counsel after the appointment of lead counsel are non-compensable); Gottlieb v. Barry, 43 F.3d 474, 490 (10th Cir. 1994) (“[W]e fail to see why the work of counsel later designated as class counsel should be fully compensated, while the work of counsel who were not later designated class counsel ... should be wholly uncompensated.”); In re Cendant Corp. Sec. Litig., 404 F.3d 173, 197 (3d Cir. 2005) (determining fees for the work of non-lead counsel preformed before the appointment of the lead plaintiff will rest in the first instance with the district court, whereas after a lead plaintiff has been appointed, the primary responsibility for compensation shifts to the lead plaintiff, subject to ultimate court approval).

III. ELEMENTS OF FEDERAL SECURITIES CLAIMS A. Section 10(b) Of The 1934 Act And Rule 10b-5 Section 10(b) of the 1934 Act, 15 U.S.C. § 78j, provides: a. 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 –

b. To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, 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. Rule 10b-5, 17 C.F.R. § 240.10b-5, 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, 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 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. 1. Definition Of Security In order to fall under the 1934 Act, the thing purchased or sold must be a “security” within the meaning of 15 U.S.C. § 78c(a)(10). The term “security” has been broadly defined to include “virtually any instrument that might be sold as an investment.” See, e.g., Reves v. Ernst & Young, 494 U.S. 56, 60 (1990), aff’d, 507 U.S. 170 (1993). “Stock” is “always an investment if it has the economic characteristics traditionally associated with stock.” Id. at 62 (citing Landreth Timber Co. v. Landreth, 471 U.S. 681, 687, 693 (1985)). Notes are presumed to be securities, a presumption that may be rebutted only by showing that the instrument falls into an exempted category or else bears a “family resemblance” to notes in those exempted categories. Id. at 64-65. Other instruments, such as partnership interests and time deposits, have been found to be securities based on the “economic realities” of the transaction. See S.E.C. v. W.J. Howey Co., 328 U.S. 293, 301 (1946). Under Howey, a security involves (i) an investment of money, (ii) in a common enterprise, (iii) with expectation of profits (iv) to come solely from efforts of others. Id. Significantly, the Supreme Court has stated “that Congress, in enacting the securities laws, did not intend to provide a broad federal remedy for all fraud.” Marine Bank v. Weaver, 455 U.S. 551, 556 (1982). Particularly where an alternative federal scheme exists to

protect individuals, the Court is more reluctant to find that an instrument is a security. Id. at 558-59 (holding certificate of deposit not a security because federal banking laws ensure that individuals are already “abundantly protected”); see also Int’l Bhd. of Teamsters, Chauffeurs, Warehouseman & Helpers of Am. v. Daniel, 439 U.S. 551 (1979) (“If any further evidence were needed to demonstrate that pension plans of the type involved are not subject to the Securities Acts, the enactment of ERISA in 1974 … would put the matter to rest.”). An investment contract will not be deemed a “security” absent an investment of money. Noncontributory pension plans, for example, are not securities because the plans do not require the employees to give up specific consideration in return for a separable financial interest with characteristics of a security. See Fishoff v. Coty Inc., No. 09 Civ. 628(SAS), 2009 WL 1585769 (S.D.N.Y. June 8, 2009) (finding that a corporation’s noncontributory incentive plan was not an investment contract and thereby could not be deemed to be a security). However, in S.E.C. v. Edwards, the Supreme Court held that a contributory investment scheme is always a security subject to federal securities laws, because regardless of whether an investor expects fixed returns or variable returns, “[i]n both cases, the investing public is attracted by representations of investment income.” 124 S. Ct. 892, 894 (2004). In regard to the “solely from the efforts of others” prong of Howey, the Court in S.E.C. v. Mutual Benefits Corp., 408 F.3d 737 (11th Cir. 2005), found that a distinction should not be made “between a promoter’s activities prior to his having use of an investor’s money and his activities thereafter.” Id. at 743; Wuliger v. Mann, No. 3:03 CV 1531, 2005 WL 1566751, at *12-13 (N.D. Ohio July 1, 2005) (finding that viatical settlements were securities, the court noted in regard to such pre/post-purchase distinctions, “economic realities dictate against a narrow approach since there will always be opportunistic entrepreneurs who attempt to evade liability based on those distinctions”). The Second Circuit has emphasized that courts, in evaluating the Howey factors, may look beyond the formal relationship and to the reality of the parties’ positions to determine whether the transaction is a “security.” U.S. v. Leonard, 529 F.3d 83, 85-88 (2d Cir. 2008) (holding that interests in film companies constitute securities because the investors’ role was passive). The Ninth Circuit has applied a “risk capital” subtext to determine whether an instrument satisfies Howey’s definition of an investment contract. See, e.g., Danner v. Himmelfarb, 858 F.2d 515, 519 (9th Cir. 1988) (under the risk capital standard the ultimate question is whether the funding party contributed risk capital subject to the entrepreneurial or managerial efforts of others). The “risk capital” test, however, was rejected by the Supreme Court as a means for determining whether an investment is a “note” under the Securities Acts. S.E.C. v. R.G. Reynolds Enters. Inc., 952 F.2d 1125, 1131 n.6 (9th Cir. 1991). Additionally, while adopted by some state courts in interpreting state “Blue Sky” legislation, the “risk capital” analysis is of limited use today in federal courts. 2. Private Right Of Action Section 10(b) does not expressly create a private right of action; however, the existence of an “implied remedy is simply beyond peradventure.” Herman & MacLean v. Huddleston, 459 U.S. 375, 380 (1983). And of course the Reform Act’s requirements for private securities litigation have now in effect given express Congressional approval to the private right of action. 3. Overview Of The Elements Of Rule 10b-5 In order to state a cause of action under Rule 10b-5, a private plaintiff must allege each of the following elements: (a) plaintiff is a purchaser or seller of a security; (b) defendant made a material misstatement or omission; (c) the misrepresentation or omission was “in connection with” the purchase or sale of the security; (d) defendant’s misrepresentation or omission caused plaintiff’s loss; (e) the plaintiff relied on defendant’s misrepresentation or omission; (f) defendant acted with the requisite scienter; and (g) plaintiff suffered damages from the harm. [2] Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005). These elements are discussed below. A plaintiff must allege the elements of a primary violation of 10b-5 with respect to each defendant. Central

Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191 (1994) (“Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under Rule 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met.”); see also Simpson v. AOL Time Warner, Inc., 452 F.3d 1040 (9th Cir. 2006), vacated by Simpson v. Homestore.com, Inc., 519 F.3d 1041 (9th Cir. Mar 26, 2008) (containing extensive discussion of what constitutes a primary violation (cited below)); In re Enron Corp. Sec., Derivative & ERISA Litig., 439 F. Supp. 2d 692, 707 (S.D. Tex. 2006) (noting that all 10(b)-5 elements must be satisfied as to each defendant). 4. Purchaser/Seller Requirement Plaintiff must be either an actual purchaser or an actual seller of securities, or must possess a contractual right to purchase or sell a security. Being a potential purchaser or seller is not enough. Thus, standing is absent where an individual (who lacks a contractual right to buy or sell) declines to buy or sell a security because of an alleged misstatement or omission. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). The Supreme Court grounded its decision in the language of section 10(b) of the Securities Exchange Act and Rule 10b-5, requiring that any alleged fraud be “in connection with the purchase or sale” of securities. See id. at 733-34, 755-60; see also Davidson v. Belcor, Inc., 933 F.2d 603, 606 (7th Cir. 1991) (holding ex-wife of purchaser who had beneficial interest in proceeds of stock sale or exchange had no standing under Section 10(b) or Rule 10b-5); Fraser v. Fiduciary Trust Co., 417 F. Supp. 2d 310 (S.D.N.Y. 2006) (finding officer of investment management company lacked standing to bring securities fraud suit against the company because the shares of the company earned as part of compensation did not satisfy the purchaser-seller requirement); Seippel v. Sidley, Austin, Brown & Wood, LLP, 399 F. Supp. 2d 283, 296 (S.D.N.Y. 2005) (denying motion to dismiss, court stated that wife may have standing to sue under 10b-5 ‘in connection with’ the exercise and sale of options granted to her husband by her former employer, as well as in the issuance of stock to her husband by the company he created); Griggs v. Pace Am. Group, Inc., 170 F.3d 877 (9th Cir. 1999) (holding plaintiff who received only a contingent contractual right to receive stock had standing as a “purchaser” under Section 10(b) and Rule 10b-5); In re Cendant Corp. Sec. Litig., 81 F. Supp. 2d 550, 557-58 (D.N.J. 2000) (holding absent some individual investment decision, employees who receive options or modifications to options under an Employee Option Stock Plan (“ESOP”) have no standing as purchasers or sellers of securities under Section 10(b) or Rule 10b-5); Kinsey v. Cendant Corp., No. 04 CIV. 0582 (RWS), 2004 WL 2591946, at *7 (S.D.N.Y. Nov. 16, 2004) (holding conversion of previously granted options of a target company into the right to buy shares of an acquiring company is not a “purchase” for purposes of federal securities laws); In re Adelphia Commc’ns Corp. Sec. & Derivative Litig., 398 F. Supp. 2d 244 (S.D.N.Y. 2005) (holding plaintiffs who received stock as a dividend did not engage in purchase within the scope of 10(b)); Ontario Pub. Serv. Employees Union Pension Trust Fund v. Nortel Networks Corp., 369 F.3d 27, 32 (2d Cir. 2004), cert. denied, 125 S. Ct. 919 (2005) (clarifying that to have standing, plaintiff must be a purchaser or seller of a security of the entity that made the alleged misrepresentation, not merely a purchaser or seller of a security of any company affected by the misrepresentation); Jayhawk Capital Mgmt., LLC v. LSB Indus., Inc., No. 08-2561-EFM, 2009 WL 3766371 at *8-9 (D. Kan. Nov. 10, 2009) (finding that plaintiffs had standing because “[l]ooking at the transaction realistically and as a whole, [the purchase and conversion of securities] involved the sale of securities” thereby rejecting defendant’s technical argument that the transaction was two separate transactions in which plaintiffs merely held securities and were unable to sell); Abbey v. 3F Therapeutics, Inc., No. 06 CV 409(KMW), 2009 WL 4333819 at *6-8 (S.D.N.Y. Dec. 2, 2009) (finding that plaintiff-investor in a shell holding company had standing under Blue Chip Stamps when that “holding company is created for the sole purpose of facilitating an individual’s investment in a single company”). Further, because the plaintiff must be an actual purchaser or seller of securities, a securities claim is not automatically assignable. Dobyns v. Trauter, 552 F. Supp. 2d 1150 (W.D. Wash. 2008) (dismissing 10b-5 claim brought by purported assignee due to suspicious timing and evidentiary problems). 5. The Materiality Requirement

A material misstatement is a misrepresentation of a material fact or an omission of a material fact necessary in order to make statements made, in light of the circumstances under which they were made, not misleading. 17 C.F.R. § 240.10b-5. Preliminarily, note that only subsection (b) of Rule 10b-5 makes reference to a material misstatement. While compliance with disclosure obligations may be sufficient to dismiss a claim based on Rule 10b-5(b), such compliance will not necessarily dispose of claims based upon Rules 10b-5(a) and (c) because violations of those sections are not limited to an untrue statement of material fact or an omission to state a material fact, and thus the materiality analysis may differ from that under Rule 10(b)-5(b). Benzon v. Morgan Stanley Distrib., Inc., 420 F.3d 598, 610 (6th Cir. 2005) (citing Affiliated Ute Citizens v. United States, 406 U.S. 128, 152-53 (1972)). a. Definition The basic definition of materiality is well-established. “An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision.” TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). “[T]o fulfill the materiality requirement there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) (citations omitted) (adopting TSC Industries materiality standard for Rule 10b-5 cases); Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824 (8th Cir. 2003) (materiality should be judged from perspective of reasonable investor at the time of misrepresentation, not from perspective of investor looking back); Acito v. IMCERA Group, Inc., 47 F.3d 47, 52 (2d Cir. 1995) (failure to report negative FDA inspections of manufacturing plant held immaterial where plant was only one of thirty and FDA took no materially adverse action against company); In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 369 (3d Cir. 1993) (finding optimistic statement couched amid numerous warnings in prospectus not material); Greenhouse v. MCG Capital Corp., 392 F.3d 650, 658 (4th Cir. 2004) (finding misrepresentation of an executive’s educational credentials in public filings immaterial where it serves as plaintiffs’ one and only allegation of fraud); Atlas v. Accredited Home Lenders Holding Co., et al., 556 F. Supp. 2d 1142 (S.D. Cal. 2008) (finding that public statements by defendant, a subprime mortgage lender, regarding underwriting standards were material to investors, as illustrated by the frequency with which defendants emphasized the standards in press releases and other public statements); Lapin v. Goldman Sachs Group, Inc., 506 F. Supp. 2d 221 (S.D.N.Y. 2006) (rejecting defendant’s “truth on the market” defense to materiality, finding that public reports of conflicts of interest were counteracted by contemporaneous statements by the defendant analyst firm that its research was objective); Davis v. SPSS, Inc., 431 F. Supp. 2d 823 (N.D. Ill. 2006) (dismissing complaint with prejudice because the allegations insufficiently alleged the amount, and hence the materiality, of the improper revenue recognition); In re Corning, Inc. Sec. Litig., 349 F. Supp. 2d 698, 720-22 (S.D.N.Y. 2004) (finding immaterial defendants’ failure to disclose breast implant litigation over a ten-year period until a major verdict led to bankruptcy, given that during the non-disclosure period, claims were relatively few, settlement amounts were a fraction of one percent of Dow Corning’s net income, and the company won most cases). b. Mixed Question Of Law And Fact Materiality is “a mixed question of law and fact, involving as it does the application of a legal standard to a particular set of facts.” TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). The materiality of an omission is a fact-specific determination that is often properly left to the jury. Fecht v. Price Co., 70 F.3d 1078, 1080-81 (9th Cir. 1995). Only in two situations should the court resolve this question as a matter of law: (1) if the immateriality of the statement or allegedly omitted fact is so obvious that reasonable minds could not differ (Id.; see also TSC Indus., 426 U.S. at 445, (quoting John Hopkins Univ. v. Hutton, 422 F.2d 1124, 1129 (4th Cir. 1970))); or, (2) “if the information is trivial or is ‘so basic that any investor could be expected to know it.’” Ganino v. Citizens Util. Co., 228 F.3d 154, 162 (2d Cir. 2000) (citation omitted); see also No. 84 EmployerTeamster Joint Council Pension Trust Fund v. Am. W. Holding Corp., 320 F.3d 920 (9th Cir. 2003) (rejecting

bright-line rule for materiality that would require an immediate market reaction in favor of fact-specific inquiry). c. Materiality Of Small Accounting Misstatements In accounting cases, courts will sometimes view materiality in terms of the percentage of a given misstatement measured against a given denominator, with amounts in the range of 2% being presumptively immaterial. See, e.g., Parnes v. Gateway 2000, Inc., 122 F.3d 539, 546 (8th Cir. 1997) (finding immaterial defendants’ alleged overstatement of assets by $6.8 million as a matter of law where this amount represented only 2% of the company’s total assets). But see S.E.C. v. Cohen, No. 4:05 CV 371 (DJS), 2006 WL 2225410, at *2 (E.D. Mo. Aug. 2, 2006) (citing SEC Staff Accounting Bulletin No. 99 and rejecting 2% litmus test because it failed to address the cumulative effect of several misstatements) d. Materiality Of Statements Concerning Medical Devices In Siracusano v. Matrixx Initiatives, Inc., the Ninth Circuit examined whether appellees’ failure to disclose information regarding the possible link between the medicine, Zicam, and anosmia constituted an omission of a material fact. 585 F.3d 1167, 1178-79 (9th Cir. 2009). Relying on the Second Circuit’s “statistical significance” standard of materialty, the lower court found the omission to be immaterial because the number of complaints that appellees were aware of were not “statistically significant.” The Ninth Circuit rejected this reasoning, ruling that the question of whether an event occurs frequently enough to be statistically significant is a question of fact, not of law. In contrast, a district court in Indiana granted defendant’s motion to dismiss because plaintiffs failed to adequately allege that defendants possessed material information regarding product recalls, the adverse action resulting from an FDA inspection, and the halt in production of certain medical devices at the time the alleged misstatements occurred. Plumbers and Pipefitters Local Union 719 Pension Fund v. Zimmer Holdings, Inc., No. 1:08-cv-1041-SEB-DML, 2009 WL 428940 (S.D. Ind. Dec. 1, 2009). e. Materiality Of Proposed Mergers Difficult materiality issues arise in connection with information regarding mergers, which is often speculative, yet which can have obvious significance to investors. In Basic Inc. v. Levinson, 485 U.S. 224 (1988), the Supreme Court held that public companies and their officials are liable for issuing misleading denials or incomplete statements regarding preliminary merger negotiations when that information is “material.” In Basic, the company was sued by former shareholders who alleged that it made misleading statements when it denied that it had been engaged in merger talks for more than a year. When the merger talks led to the takeover of the Company, the shareholders contended that they had suffered damages by selling their shares prior to the takeover at prices artificially depressed by Basic’s misstatements. Though the Court adopted the “reasonable investor” standard of materiality set forth in TSC Industries with regard to Section 10(b) and Rule 10b-5, it declined to adopt a bright-line rule regarding materiality. Instead, the Court noted the difficulty of assessing materiality with respect to contingent or speculative events and adopted the case-by-case approach set forth in S.E.C. v. Tex. Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) (en banc). Basic, 485 U.S. at 238-40 (holding “fact-specific inquiry” must be applied when judging the materiality of “contingent or speculative” information or events). Thus, “materiality [of forward-looking information] ‘will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.’” Basic, 485 U.S. at 238. The Court noted that companies did not necessarily have a blanket duty to disclose the existence of negotiations. Instead, they could choose to remain silent or adopt a “no

comment” posture provided they did not make inaccurate, incomplete or misleading statements in such circumstances. The Basic Court also rejected the Sixth Circuit’s rule that once a company denies the existence of merger discussions, even discussions that might not have been material are thereby rendered material. The Sixth Circuit’s approach, according to the Court, failed to recognize that to prevail on a Rule 10b-5 claim, “[a] plaintiff must show that the statements were misleading as to a material fact. It is not enough that a statement is false or incomplete, if the misrepresented fact is otherwise insignificant.” Id.; see also Weiner v. Quaker Oats Co., 129 F.3d 310 (3d Cir. 1997) (holding in light of potential acquisition, purchasers successfully stated securities fraud claim based on corporation’s failure to update information about its total debt-to-total capitalization ratio guideline). Taylor v. First Union Corp. of S.C., 857 F.2d 240 (4th Cir. 1988) (holding merger discussions were preliminary, contingent, and speculative, thus no duty to disclose existed); Grossman v. Novell, Inc., 909 F. Supp. 845 (D. Utah 1995), aff’d, 120 F.3d 1112 (10th Cir. 1997) (finding that company statements concerning merger were no more than vague declarations of corporate optimism and therefore immaterial); Panfil v. ACC Corp., 768 F. Supp. 54, 58 (W.D.N.Y.), aff’d, 952 F.2d 394 (2d Cir. 1991) (“The mere ‘intention’ to pursue a possible merger at some time in the future, without more, is simply not a material fact under rule 10b-5.”). f. The Level Of Detail The Court in Basic emphasized that the Exchange Act’s purpose is not “simply to bury the shareholders in an avalanche of trivial information – a result that is hardly conducive to informed decision making.” Basic, 485 U.S. at 231 (citing TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 448-49 (1976)); see also Ganino v. Citizens Util. Co., 228 F.3d 154, 161-62 (2d Cir. 2000) (“It is not sufficient to allege that the investor might have considered the misrepresentation or omission important. On the other hand, it is not necessary to assert that the investor would have acted differently if an accurate disclosure was made.”); In re VeriFone Sec. Litig., 784 F. Supp. 1471, 1480 (N.D. Cal. 1992), aff’d, 11 F.3d 865 (9th Cir. 1993) (finding no duty to disclose fact that customers listed in prospectus were not currently ordering from company because prospectus did not contain any representations about current or future orders from those customers); Gallagher v. Abbott Labs., 269 F.3d 806, 808 (7th Cir. 2001) (holding that companies do not have absolute duty to disclose all information material to stock prices as soon as news comes into their possession; “[w]e do not have a system of continuous disclosure. Instead firms are entitled to keep silent (about good news as well as bad news) unless positive law creates a duty to disclose”). g. Information Of Which The Market Is Already Aware Courts have ruled that it is not a material omission to fail to point out information of which the public is already aware. Baron v. Smith, 380 F.3d 49, 57 (1st Cir. 2004) (citing In re Donald Trump Casino Sec. Litig., 7 F.3d 357, 377 (3d Cir. 1993)) (no violation where investors were not informed of the weakened economic conditions in particular geographic areas); Iron Workers Loc. 16 Pens. v. Hilb Rogal & Hobbs, 432 F. Supp 2d. 571, 580 (E.D. Va. 2006) (explaining where information about a company was made available in any analyst report, or by newspaper articles, any withholding of information by the company is immaterial and any omissions by the company are cured). 6. Actionable Misstatements a. Accurate Statements Of Historical Fact Statements of historical fact that are accurate when made are not actionable. In re Ford Motor Co. Sec. Litig., 381 F.3d 563, 570 (6th Cir. 2004) (holding that the disclosure of accurate earnings data does not become

misleading even if the company might predict less favorable results in the future); In re Convergent Techs. Sec. Litig., 948 F.2d 507, 514 (9th Cir. 1991) (rejecting plaintiff’s contention that financial statements showing past growth misled investors by implying that the company expected its upward trend to continue); Rintel v. Wathen, 806 F. Supp. 1467, 1470 (C.D. Cal. 1992) (“[P]laintiffs must allege facts other than the disclosure of accurate historical data along with general statements of optimism … in order to state a cause of action.”); Anderson v. Abbott Labs., 140 F. Supp. 2d 894, 909 (N.D. Ill. 2001), aff’d, 269 F.3d 806 (7th Cir. 2001) (“Accurate statements of historical fact, such as past financial results, are not actionable.”). Furthermore, “it is well-established that the accurate reporting of historic successes does not give rise to a duty to further disclose contingencies that might alter the revenue picture in the future.” McDonald v. KinderMorgan, Inc., 287 F.3d 992, 998 (10th Cir. 2002) (citing In re Advanta Corp. Sec. Litig, 180 F.3d 525, 538 (3d Cir. 1999)). b. General Statements Of Optimism And Puffery Generalized statements of optimism (e.g., “we expect this to be a fine year for us”) and puffery are not actionable. See, e.g., In re Ford Motor, 381 F.3d at 570 (determining that statements regarding company’s commitment to safety and quality were immaterial because a reasonable investor would not view them as “significantly changing the general gist of available information”); Grossman v. Novell, Inc., 120 F.3d 1112, 1121 (10th Cir. 1997) (statements made by corporation regarding merger, that corporation had experienced “substantial success” in integrating sales forces, that merger was moving “faster than we thought,” and that merger presented “compelling set of opportunities” were immaterial statements of corporate optimism and would not support securities fraud claim); Parnes v. Gateway 2000, Inc., 122 F.3d 539, 547 (8th Cir. 1997) (“[S]oft, puffing statements generally lack materiality because the market price of a share is not inflated by vague statements predicting growth.”) (citation omitted); San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 811 (2d Cir. 1996) (holding no securities fraud where company made generally optimistic statements regarding its prospects and, a few months later, announced a price reduction in company’s premium brand of cigarette); Raab v. Gen. Physics Corp., 4 F.3d 286, 289 (4th Cir. 1993) (holding that statements in Annual Report lacked materiality “because the market price of a share is not inflated by vague statements of growth”); In re Cerner Corp. Sec. Litig., 425 F.3d 1079, 1083-84 (8th Cir. 2005) (holding that favorable statements regarding company’s growth, product demand, and future earnings were not materially false and misleading due to the company’s failure to disclose that it was losing deals due to increased competition, dissatisfied customers and an economic downturn, where no actual impact was shown.); In re Aetna Inc. Sec. Litig., 34 F. Supp. 2d 935, 945 (E.D. Pa. 1999) (“[V]ague expressions of corporate optimism and expectations about a company’s prospects are not actionable because reasonable investors do not rely on such statements in making investment decisions.”) (citing Lasker v. New York State Elec. & Gas Corp., 85 F.3d 55, 57-58 (2d Cir. 1996)); Jakobe v. Rawlings Sporting Goods Co., 943 F. Supp. 1143, 1157 (E.D. Mo. 1996) (holding CEO’s statement that “I’m confident that this business is sound and poised for growth” was a soft, puffing statement and immaterial as a matter of law); In re Foundry Networks, Inc. Sec. Litig., No. C 00-4823, 2003 WL 22077729 (N.D. Cal. Aug. 29, 2003) (company officials’ public statement that business “remains on track” was a statement of general optimism, and thus not sufficient to support a securities fraud claim); In re Clearly Canadian Sec. Litig., 875 F. Supp. 1410, 1419 (N.D. Cal. 1995) (statements that company “is wellpositioned for the future or that it will be a $1 billion dollar company … or … that the company’s distribution agreements are steps towards becoming a global leader” are not actionable as a matter of law); In re Vertex Pharm., Inc. Sec. Litig., 357 F. Supp. 2d 343, 351 (D. Mass. 2005) (general statements about company’s success not false or misleading where problems with specific product did not have “extensive company-wide effects”). Under certain circumstances, however, optimistic statements may be actionable where plaintiff makes sufficiently particularized allegations of falsity. See Warshaw v. Xoma Corp., 74 F.3d 955, 959 (9th Cir. 1996) (“even optimistic statements, when taken in context, might constitute a basis for a claim under Section 10(b) and Rule 10b-5”); Fecht v. Price Co., 70 F.3d 1078, 1083 (9th Cir. 1995) (holding allegations of specific

problems undermining defendants’ optimistic claims were sufficient to explain how they are false); In re InterMune, Inc. Sec. Litig., No. C 03-2954 SI, 2004 WL 1737264 (N.D. Cal. July 30, 2004) (finding plaintiffs made sufficiently detailed allegation of falsity regarding defendants’ statements regarding a marketed drug and, hence, statements were not mere “puffery”). c. Qualitative Statements Of Opinion The Supreme Court in Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991), held that knowingly false statements of opinion or belief contained in a proxy statement could be actionable, at the least to support a Rule 14a-9 claim. The proxy statement in Virginia Bankshares set forth the board’s recommendation that shareholders approve a merger because minority shareholders would receive a “high” value for their stock. The plaintiff shareholder alleged that the directors did not believe the price was high or the terms of the merger were fair but recommended the merger only because they wanted to remain on the board. In finding that knowingly false statements of reasons, opinions, or beliefs could be actionable even though conclusory in form, the Court stated that “a statement of belief by corporate directors about a recommended course of action, or an explanation of their reasons for recommending it,” may be material because “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” Id. at 1090-91. As to the term “high” value, the Court found “that such conclusory terms in a commercial context are reasonably understood to rest on a factual basis that justifies them as accurate, the absence of which renders them misleading.” Id. at 1093. The Court did say, however, that “proof of mere disbelief or belief undisclosed should not suffice for liability.” Id. at 1095-96; see also In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1409 (9th Cir. 1996) (finding that plaintiffs’ complaint failed to make any showing that any of the implied assertions arising from statements in Stac’s prospectus were inaccurate); In re Wells Fargo Sec. Litig., 12 F.3d 922, 930 (9th Cir. 1993) (determining that statements which imply factual assertions are actionable if one of three implied assertions is inaccurate: that the statement is genuinely believed, that there is a reasonable basis for that belief, and that the speaker is not aware of any undisclosed facts tending to seriously undermine the accuracy of the statement); Mayer v. Mylod, 988 F.2d 635, 639 (6th Cir. 1993) (“Material statements which contain the speaker’s opinion are actionable under Section 10(b) . . . if the speaker does not believe the opinion and the opinion is not factually well-grounded.”). The First Circuit in In re Credit Suisse First Boston, LLC, 431 F.3d 36 (1st Cir. 2005), affirmed the dismissal of securities fraud claims based on alleged false “buy” recommendations made by CSFB’s analysts with respect to a company’s stock. The Court reiterated that a plaintiff can challenge a statement of opinion by pleading facts sufficient to indicate that the speaker did not actually hold the opinion expressed, but to do this plaintiff must “point to provable facts that strongly suggest knowing falsity” and may not rely on “conclusory allegations regarding an analyst’s hidden beliefs.” Id. at 49 (emphasis added). Regarding this heightened “subjective falsity” standard, the Court reasoned that “[i]n cases premised on misstatements of opinion, [] the falsity element, at a minimum, entails an inquiry into whether the statement was subjectively false.... Accordingly, the subjective aspect of the falsity requirement and the scienter requirement essentially merge.” Id. at 48; accord In re Salomon Analyst Level 3 Litig., 350 F. Supp. 2d 477, 490 (S.D.N.Y. 2004). Thus, “if a plaintiff adequately pleads that a statement of opinion was subjectively false when made, the complaint will, ex proprio vigure, satisfy the pleading requirements of the PSLRA relative to scienter.” Credit Suisse First Boston, 431 F.3d at 48. Cases relating to the collapse of the subprime mortgage market have frequently focused on statements of opinion, particularly in a 1933 Act context. See, e.g., In re IndyMac Mortgage-Backed Sec. Litig., 2010 U.S. Dist. LEXIS 61458 (S.D.N.Y. June 21, 2010) (appraisals and credit ratings were non-actionable matters of opinion). d. Statements Rendered False Due To GAAP Violations

A statement made in violation of GAAP may be found to be misleading or inaccurate under the federal securities laws. See In re Daou Sys., Inc., 411 F.3d 1006 (9th Cir. 2005); S.E.C. v. Caserta, 75 F. Supp. 2d 79, 90 (E.D.N.Y. 1999); In re Physician Corp. of Am. Sec. Litig., 50 F. Supp. 2d 1304, 1317, n.17 (S.D. Fla. 1999) (“[B]ased on the particularities of the facts and circumstances alleged, facts demonstrating overstatement of revenues and income in violation of GAAP may constitute the false and misleading statements of material fact necessary for alleging a violation of Rule 10b-5.”); S.E.C. v. Reyes, 491 F. Supp. 2d 906, 913 (N.D. Cal. 2007) (finding GAAP violation even though defendants claimed that misstatements under APB 25’s treatment of compensation expenses were immaterial because defendant’s annual report footnotes adequately disclosed and documented expenses under FAS 123); In re Levi Strauss & Co. Sec. Litig., 527 F. Supp. 2d 965, 991 (N.D. Cal. 2007) (“[C]hanges in valuation allowances are to be recorded in the period in which the available facts and evidence indicate that it is more likely than not that the associated deferred tax assets will not be realized in future periods.”). But see In re Nat’l Century Fin. Enters., No. 2:03-MD-1565, 2007 WL 2331929, at *8 (S.D. Ohio Aug. 13, 2007) (dismissing complaint because allegations that auditors misapplied GAAS while conducting the audit and caused and made misstatements were not misleading public statements). The premise is simple: if a company’s accounting was improper under GAAP, then figures in reported financial statements arguably are misleading. In certain cases, however, plaintiffs may attempt to couch misleading business practices as accounting fraud. For example, in In re Marsh & Mclennan Cos., Inc. Securities Litigation, 501 F. Supp. 2d 452 (S.D.N.Y. 2006), the court rejected plaintiff’s attempt to allege GAAP violations, noting that the complaint simply recouched the allegations of misleading business practices as accounting fraud. The complaint failed to cite specific instances of fraudulent accounting practices and failed to cite to any GAAP provisions prohibiting the company’s accounting practices. Even though the court found that the complaint did allege misleading statements regarding the company’s business practices, it did not allege facts showing that the financial statements misstated the company’s financial condition. e. Statements Regarding Legal Compliance As a general matter, general statements regarding legal compliance are not actionable because companies have no duty to opine about the legality of their own actions. See, e.g., Ind. State Dist. Council of Laborers & Hod Carriers Pension & Welfare Fund v. Omnicare, Inc., 583 F.3d 935, 945 (6th Cir. 2009). Such information is considered “soft” and, therefore, disclosure is not required. Id. However, general statements regarding legal compliance are actionable if plaintiffs plead sufficient facts to establish that defendants actually knew they were false when made. Id. at 945-46; accord Kushner v. Beverly Enters., Inc., 317 F.3d 820, 831 (8th Cir. 2003) (holding that company’s general assertion that it complied with Medicare regulations was not actionable even though company was later embroiled in large Medicare fraud investigation, because complaint did not adequately allege defendants knew the statements were untruthful). f. Forward-Looking Statements And The Reform Act’s Safe Harbor The Reform Act carved out a “safe harbor” for certain forward-looking statements. 15 U.S.C. § 77z-2; 15 U.S.C. § 78u-5. The purpose of the Safe Harbor provision is to encourage disclosure of forward-looking information. H.R. Conf. Rep. No. 104-369, 104th Cong. 1st Sess. at 53 (1995). Specifically, Congress sought “to loosen the ‘muzzling effect’ of potential liability for forward-looking statements, which often kept investors in the dark about what management foresaw for the company.” Harris v. Ivax Corp., 182 F.3d 799, 806 (11th Cir. 1999) (citing H.R. Conf. Rep. 104-369, at 42), reh’g denied, 209 F.3d 1275 (11th Cir. 2000).

1) Covered Forward-Looking Statements A forward-looking statement is defined as a statement containing a projection of revenue, income or earnings

per share, management’s plans or objectives for future operations, and a prediction of future economic performance. 15 U.S.C. § 77z-2; 15 U.S.C. § 78u-5(I)(1)(A)-(C). Any statement of “the assumptions underlying or relating to” such forward-looking statements also qualifies as a forward-looking statement. 15 U.S.C. § 78u-5(I)(1)(D). Moreover, a present-tense statement may fall within the meaning of a forwardlooking statement if the truth or falsity of the statement cannot be discerned until some point after the statement is made. Harris, 182 F.3d at 805; Winick v. Pac. Gateway Exchange, Inc., 73 F. App’x 250, 252-53 (9th Cir. 2003); In re Splash Tech. Holdings, Inc. Sec. Litig., 160 F. Supp. 2d 1059, 1067-68 (N.D. Cal. 2001). However, the Reform Act’s safe harbor does not immunize an allegedly fraudulent statement of present or historical fact merely because a forward-looking statement is made along with it. Makor Issues & Rights, Ltd. v. Tellabs Inc., 513 F.3d 702, 705 (7th Cir. 2008) (“[A] mixed present/future statement is not entitled to the safe harbor with respect to the part of the statement that refers to the present.”); accord In re Stone & Webster, Inc. Sec. Litig., 414 F.3d 187, 213 (1st Cir. 2005) (“The mere fact that a statement contains some reference to a projection of future events cannot sensibly bring the statement within the safe harbor if the allegation of falsehood relates to non-forward-looking aspects of the statement.”); see also In re Nortel Networks Corp. Sec. Litig., 238 F. Supp. 2d 613, 629 (S.D.N.Y. 2003) (stating that “even when an allegedly false statement has both a forward-looking aspect and an aspect that encompasses a representation of present fact, the safe harbor provision of the PSLRA does not apply”) (internal quotations omitted). Nonetheless, even statements of present fact will be protected if they “are too vague” and, “when read in context, cannot meaningfully be distinguished from the future projection of which they are a part.” Institutional Investors Group v. Avaya, Inc., 564 F.3d 242, 255 (3rd Cir. 2009); cf. Ind. State Dist. Council of Laborers & Hod Carriers & Welfare Fund v. Omnicare, Inc., 583 F.3d 935, 943 (6th Cir. 2009) (CEO’s statement that “revenue and earnings growth outlook remains positive” fell within safe harbor because it included the predictive term “growth outlook”; the term “remains” was not enough of a “present circumstance” to take it out of the safe harbor).

2) Definition Of The Safe Harbor Under the Reform Act Safe Harbor, a forward-looking statement cannot as a matter of law be the basis for Section 10(b) liability IF EITHER: (a) the forward-looking statement is— identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement; or (b) the plaintiff fails to prove that the forward-looking statement – (i) if made by a natural person, was made with actual knowledge that the statement was false or misleading, or (ii) if made by a business entity, was made or approved by [an executive officer] with actual knowledge by that officer that the statement was false or misleading. 15 U.S.C. § 78u-5(c)(1) (emphasis added); Baron v. Smith, 380 F.3d 49, 53-54 (1st Cir. 2004); see also In re Splash Tech. Holdings, Inc. Sec. Litig., 160 F. Supp. 2d 1059, 1068 (N.D. Cal. 2001). In other words, “the statute provides that a forward-looking statement cannot be the basis for [section] 10b liability if either the forward-looking statement is accompanied by meaningful cautionary language, or the plaintiff fails to prove that the person making the statement made it with actual knowledge that the statement was false and misleading.” In re Boeing Sec. Litig., 40 F. Supp. 2d 1160, 1167 (W.D. Wash. 1998). In this way, the Reform Act not only codified but also expanded upon the “bespeaks caution” doctrine, see supra Part II.C.3.d, by precluding liability if plaintiff fails to prove “actual knowledge” that the forward-looking statement

was false or misleading. See In re Advanta Corp. Sec. Litig., 180 F.3d 525, 536 (3d Cir. 1999). Several courts hold that even forward-looking statements made with actual knowledge of their falsity are protected by the safe harbor so long as they are identified as forward-looking and accompanied by meaningful cautionary language. See, e.g., Harris v. Ivax Corp., 182 F.3d 799, 803 (11th Cir. 1999) (noting that “if a statement is accompanied by meaningful cautionary language, the defendants’ state of mind is irrelevant.”) (internal quotations omitted); In re Gilat Satellite Networks, Ltd., No. CV-02-1510 (CPS), 2005 WL 2277476, at *11-12 (E.D.N.Y. Sep. 19, 2005) (“[T]he first prong of the PSLRA safe harbor places a limit on materiality. Once a court determines that a forward-looking statement is accompanied by cautionary language sufficiently meaningful as to render it incapable of being reasonably relied upon, it is immaterial as a matter of law and the court need not consider the defendants’ state of mind. The second prong, subsection B, imposes a heightened scienter requirement for forward-looking statements not accompanied by cautionary language. Those false statements are immunized so long as they were not knowingly false.”). The Fifth Circuit has reached a contrary conclusion, holding that “the safe harbor provision is inapplicable to all alleged misrepresentations” where “the defendants actually knew that their statements were misleading at the time they were made.” Lormand v. U.S. Unwired, Inc., 565 F.3d 228, 244 (5th Cir. 2009).

3) The Safe Harbor Applies To Oral Statements The Safe Harbor also applies to oral statements if accompanied by (1) a statement identifying the projection as a forward-looking statement that cautions that actual results could differ materially; and (2) a reference to publicly available written materials which describe the necessary risk factors. See 15 U.S.C. § 77z-2(c)(1)(B) (2); 15 U.S.C. § 78u-5(c)(1)(B)(2); see also Constr. Laborers Pension Trust of Greater St. Louis v. Neurocrine Biosciences, Inc., 2008 WL 2053733, at *10-11 (S.D. Cal. May 13, 2008) (statements made during conference calls referring listeners to risk factors contained in SEC filings were sufficient to incorporate the risk factors by reference).

4) No Duty To Update Forward-Looking Statements Furthermore, the Safe Harbor provisions in both the Securities Act and the Exchange Act specifically provide that neither provision imposes a duty to update a forward-looking statement. See 15 U.S.C. § 77z-2(d); 15 U.S.C. § 78u-5(d).

5) Defining “Meaningful Cautionary Language” In determining whether forward-looking statements are accompanied by sufficient “meaningful cautionary language,” several courts have looked at what it means to identify “important factors that could cause actual results to differ materially.” Citing the language of the Reform Act, courts have held that defendants must identify such important factors but need not identify all such factors. Harris v. Ivax Corp., 182 F.3d 799, 807 (11th Cir. 1999) (“[F]ailure to include the particular factor that ultimately causes the forward-looking statement not to come true will not mean that the statement is not protected by the safe harbor.”) (quoting from the H.R. Conf. Rep. 104-369 at 44); see also Ehlert v. Singer, 85 F. Supp. 2d 1269, 1273 (M.D. Fla. 1999), aff’d and remanded, 245 F.3d 1313 (11th Cir. 2001) (explaining the Reform Act “does not require that the prospectus list all factors that might influence the company’s financial future”); Rasheedi v. Cree Research, Inc., No. 1:96 CV 00890, 1997 WL 785720, at *1 (M.D.N.C. Oct. 17, 1997) (quoting H.R. Conf. Rep. 104-369). Thus, defendants do not have to “caution against every conceivable factor that may cause results to differ.” Rasheedi, 1997 WL 785720, at *2; see also Wenger v. Lumisys, Inc., 2 F. Supp. 2d 1231, 1242 (N.D. Cal. 1998) (rejecting plaintiff’s argument that every oral forward-looking statement must be accompanied by a separate cautionary

statement to receive Safe Harbor protection). Courts will, however, evaluate the content of the cautionary language to make sure it is “meaningful.” See In re Compuware Sec. Litig., 301 F. Supp. 2d 672 (E.D. Mich. 2004) (determining that defendant’s warning of possible competition was not meaningful because it implied that competition was only a possibility, when defendant was aware that a competing business was a significant threat); In re Duane Reade Inc. Sec. Litig., No. 02- CIV. 6478, 2003 WL 22801416 (S.D.N.Y. Nov. 25, 2003), aff’d, 107 F. App’x 250 (2d Cir. 2004) (holding that cautionary language that is “too prominent and specific to be disregarded” will protect a company from liability for its forward-looking information) (citations omitted); Selbst v. McDonald’s Corp., No. 04C2422, 2005 WL 2319936, at *18 (N.D. Ill. Sept. 21, 2005) (holding vague and boilerplate cautionary language is not sufficient to bring projections within first prong of the safe harbor rule) (citing Asher v. Baxter Int’l Inc., 377 F.3d 727 (7th Cir. 2004)).

6) Some Forward-looking Statements Ineligible For The Safe Harbor The Reform Act’s Safe Harbor is subject to limitations and does not protect certain types of forward-looking statements, including statements: (1) included in financial statements prepared in accordance with GAAP, particularly those that purport to be forward-looking but fail to disclose existing material information (see, e.g., In re Home Health Corp. of Am. Sec. Litig., No. CIV. A. 98-834, 1999 WL 79057, at *10 (E.D. Pa. Jan. 29, 1999)); (2) contained in an IPO registration statement; (3) made in connection with a tender offer; (4) made in connection with a partnership, LLC or direct participation program offering; or (5) made in beneficial ownership disclosure statements filed with the SEC under Section 13(d) of the 1934 Act. See 15 U.S.C. § 77z-2(b)(2); 15 U.S.C. § 78u-5(b)(2); H.R. Conf. Rep. 104-369 at 46. Moreover, the Safe Harbor does not extend to an issuer who: (a) during the three year period preceding the date on which the statement was first made, has been convicted of a felony or misdemeanor under § 15(b)(4)(I)-(iv) or is the subject of a decree or order involving a violation of the securities laws; or (b) makes the statement in connection with a “blank check” securities offering, “rollup transaction,” or “going private” transaction; or (c) issues penny stock. See 15 U.S.C. § 77z-2(b)(1); 15 U.S.C. § 78u-5(b)(1); H.R. Conf. Rep. 104-369 at 46. g. Statements That “Bespeak Caution” Even if forward-looking statements fall outside the Reform Act’s Safe Harbor, the statements may still fall under the traditional “bespeaks caution” doctrine. Most circuit and district courts have declined to impose liability on the basis of forward-looking statements that “bespeak caution.” As explained by the Ninth Circuit: “[T]he ‘bespeaks caution’ doctrine has developed to address situations in which optimistic projections are coupled with cautionary language … affecting the reasonableness of reliance on and the materiality of those projections. To put it another way, the ‘bespeaks caution’ doctrine reflects the unremarkable proposition that statements must be analyzed in context.” In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1414 (9th Cir. 1994) (citation omitted). The doctrine holds that economic projections, estimates of future performance, and similar optimistic statements in a prospectus or other written document are not actionable when precise cautionary language elsewhere in the document adequately discloses the risks involved. Even if the optimistic statements are later found to have been based on erroneous or inaccurate assumptions when made, liability will not be imposed so long as the risk disclosure was conspicuous, specific, and adequately disclosed the assumptions upon which the optimistic language was based. Id. at 1413. But see In re NVE Corp. Sec. Litig., 551 F. Supp. 2d 871, 893 (D. Minn. 2007) (“Meaningful cautionary language need not explicitly mention the realized risk, as long as it warned of risks of similar significance ….”), aff’d, 527 F.3d 749 (8th Cir. 2008). The Safe Harbor provisions of the Reform Act largely adopt the “bespeaks caution” doctrine, but the Reform Act also protects statements without meaningful cautionary language where plaintiffs fail to show actual knowledge that the forward-looking statement was false or misleading. The Joint Explanatory Statement of the

Committee of Conference on the Private Securities Litigation Reform Act of 1995, 27 Sec. Reg. & L. Rep. (BNA) 1894 (Dec. 1, 1995), specifically provides that the Safe Harbor provisions are not intended to replace the bespeaks caution” doctrine or further judicial development of the doctrine. Id. at 1895; see also Little Gem Life Sciences LLC v. Orphan Medical, Inc., No. CIV. 06-1377 ADM/AJB, 2007 WL 541677 (D. Minn. Feb. 16, 2007) (noting bespeaks caution doctrine applies to “going private” mergers, though the Reform Act’s “Safe Harbor” provision does not, and finding the Reform Act has no preemptive effect on the bespeaks caution doctrine).

1) Evolution Of The “Bespeaks Caution” Doctrine And Its Application The “bespeaks caution” doctrine was first formulated in Polin v. Conductron Corp., 552 F.2d 797, 806 (8th Cir. 1977) (holding that economic projections are not actionable if they bespeak caution) and has been subsequently adopted by every circuit. The “bespeaks caution” doctrine allows courts to rule that a defendant’s forwardlooking representations contain enough cautionary language or risk disclosures to render the representation immaterial, and thereby protect against claims for securities fraud. See, e.g., San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., Inc., 75 F.3d 801, 811 (2d Cir. 1996); In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 364, 371-73 (3d Cir. 1993); Gasner v. Bd. of Supervisors, 103 F.3d 351, 358 (4th Cir. 1996); Rubinstein v. Collins, 20 F.3d 160, 166-68 (5th Cir. 1994); Sinay v. Lamson & Sessions Co., 948 F.2d 1037, 1040-41 (6th Cir. 1991); Harden v. Raffensperger, Hughes & Co., Inc., 65 F.3d 1392, 1404-06 (7th Cir. 1995) (noting that “bespeaks caution” is consistent with language of Virginia Bankshares); Moorhead v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 949 F.2d 243, 245 (8th Cir. 1991); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1413 (9th Cir. 1994) (noting, however, that by definition, the “bespeaks caution” doctrine applies only to affirmative, forward-looking statements); Grossman v. Novell, Inc., 120 F.3d 1112, 1120 (10th Cir. 1997); Saltzberg v. TM Sterling/Austin Assoc., Ltd., 45 F.3d 399, 400 (11th Cir. 1995) (per curiam); In re Baan Co. Sec. Litig., 103 F. Supp. 2d 1, 15 (D.D.C. 2000). In In re Stac Electronics Securities Litigation, 89 F.3d 1399, 1406 (9th Cir. 1996), the complaint alleged, among other things, that Stac went public knowing, but without disclosing, that Microsoft was about to release a competitive product. The Court found, however, that the company’s prospectus made detailed disclosures concerning the risks of competition, specifically stating that one developer had already licensed a competitive data compression product and that “[t]here can be no assurance that Microsoft … will not incorporate a competitive data compression technology in their products.” As the Court stated, the Stac prospectus “neither stints on warnings nor fails to disclose Stac’s practices, but ‘fairly overflows’ with specific and detailed cautionary language.” Id. The Court accordingly held that the district court properly dismissed plaintiffs’ prospectus-based claims. Id.; see also In re Syntex Corp. Sec. Litig., 95 F.3d 922, 929 (9th Cir. 1996) (finding no liability where annual report expressly acknowledged that the precise effect of a consent decree could not be known, and that the company was merely stating its opinion that the consent decree would not have any “material adverse effect”); Saltzberg, 45 F.3d at 400 (affirming summary judgment where cautionary language was not “boilerplate and was not buried among too many other things, but was explicit, repetitive and linked to the projections about which plaintiffs complain”); Barrios v. Paco Pharm. Servs., Inc., 816 F. Supp. 243, 250 (S.D.N.Y. 1993) (“[E]conomic projections were cloaked in express warnings that they were entirely speculative; they are not actionable because they bespeak caution in precise language and specifically disclose the nature and extent of the risks involved.”). But see Fecht v. Price Co., 70 F.3d 1078, 1082 (9th Cir. 1995) (reversing dismissal because cautionary language was inadequate; “[a] motion to dismiss for failure to state a claim will succeed only when the documents containing defendants’ challenged statements include ‘enough cautionary language or risk disclosure,’ that ‘reasonable minds’ could not disagree that the challenged statements were not misleading”). Where offering documents expressly warn investors not to rely on certain projections, reliance on those projections clearly is not justified. Friedman v. Ariz. World Nurseries Ltd. P’ship, 730 F. Supp. 521, 536-41 (S.D.N.Y. 1990), aff’d, 927 F.2d 594 (2d Cir. 1991); Brown v. E.F. Hutton Group, 735 F. Supp. 1196 (S.D.N.Y. 1990) (granting summary judgment to defendants on Section 10(b) claims because prospectus

included extensive discussion of risk factors of investment), aff’d, 991 F.2d 1020 (2d Cir. 1993).

2) Cautionary Language Need Not Necessarily Be In Same Document The “bespeaks caution” doctrine does not require the cautionary language to be contained in the same document as the purported false statements. See, e.g., Asher v. Baxter Int’l Inc., 377 F. 3d 727, 731 (7th Cir. 2004) (holding that cautionary language contained in the company’s Form 10-K brought allegedly misleading press releases and executives’ oral statements within the safe harbor, even though language in the 10-K did not accompany the press release or oral statements); In re AMDOCS Ltd. Sec. Litig., 390 F.3d 542, 548 (8th Cir. 2004) (finding cautionary statements regarding market erosion and softening customer demand sufficient to make prior statements hyping customer demand immaterial); EP Medsystems, Inc. v. EchoCath, Inc., 235 F.3d 865, 874 (3d Cir. 2000) (explaining cautionary language must be directly related to the alleged misrepresentations or omissions but does not need to actually accompany it); Grossman v. Novell, Inc., 120 F.3d 1112, 1122 (10th Cir. 1997); San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801 (2d Cir. 1996) (holding cautionary language in Annual Report “bespeaks caution” with regard to optimistic statements in press releases and newspaper articles); Raab v. Gen. Physics Corp., 4 F.3d 286 (4th Cir. 1993) (holding cautionary language in press release bespeaks caution with regard to optimistic statement in contemporaneous Annual Report). But see In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1413 (9th Cir. 1994) (stating in dicta that the “bespeaks caution” doctrine applies only when “precise cautionary language elsewhere in the document adequately discloses the risks involved”).

3) Limitations On The “Bespeaks Caution” Doctrine There are several significant limitations on the “bespeaks caution” doctrine. First, cautionary language cited to justify application of the doctrine must precisely address the substance of the specific statement or omission that is challenged. In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357 (3d Cir. 1993). Second, cautionary language does not protect material misrepresentations or omissions when defendants knew they were false when made. U.S. v. Carter, 355 F. 3d 920 (6th Cir. 2004) (“It would be perverse indeed if an offer or could knowingly misrepresent historical facts but at the same time disclaim those misrepresented facts with cautionary language.”); In re Westinghouse Sec. Litig., 90 F.3d 696, 705-10 (3d Cir. 1996) (finding that cautionary language did not sufficiently counter the alleged misrepresentations, i.e., that the defendants knowingly or recklessly misrepresented the adequacy of loan loss reserves and compliance with GAAP); Provenz v. Miller, 102 F.3d 1478 (9th Cir. 1996) (finding that the alleged cautionary statements were too general to trigger the “bespeaks caution” doctrine; defendant’s disclosure that it was having sourcing and cost problems with certain product line held insufficient where evidence suggested that the line was plagued with delays and performance problems so severe that the company was losing orders and constantly cutting sales forecasts); see also Harden v. Raffensperger, Hughes & Co., 65 F.3d 1392, 1404 (7th Cir. 1995) (same); Rubenstein v. Collins, 20 F.3d 160, 171 (5th Cir. 1994) (“[T]o warn that the untoward may occur when the event is contingent is prudent; to caution that it is only possible for the unfavorable events to happen when they have already occurred is deceit.”). Accordingly, courts may refuse to apply the doctrine at the pleading stage where defendants are alleged to have information that makes even the asserted cautionary statements fraudulent. See, e.g., Sides v. Simmons, No. 07-80347-CIV, 2007 WL 2819371, at *6 (S.D. Fla. Sept. 24, 2007) (finding that the bespeaks caution doctrine was not available as a defense in connection with a circular misrepresenting the ownership of real estate because language included in the disclaimer did not warn of dangers inherent in the investment, and the only cautionary language was designed to protect the distributor of document, not the public). h. Projections

Before Congress enacted the Reform Act, numerous circuits had addressed the materiality of earnings forecasts or projections. For example, the Ninth Circuit held that projections and general statements of optimism may be actionable under the federal securities laws because such statements contain “at least three implicit factual assertions: (1) that the statement is genuinely believed; (2) that there is a reasonable basis for that belief; and (3) that the speaker is not aware of any undisclosed facts tending to seriously undermine the accuracy of the statement.” In re Apple Computer Sec. Litig., 886 F.2d 1109, 1113 (9th Cir. 1989). To the extent that “one of these implied assertions is inaccurate,” a projection or statement of belief may be actionable. Id.; see also In re VeriFone Sec. Litig., 11 F.3d 865, 870 (9th Cir. 1993); Isquith v. Middle South Utils., Inc., 847 F.2d 186, 20304 (5th Cir. 1988) (liability depends on whether predictive statement was “false” when made, and “falsity is determined by examining the nature of the prediction”). The SEC’s policy of encouraging the disclosure of projections is currently set forth in 17 C.F.R. § 229.1(b) and has been further endorsed by the Safe Harbor provisions in the Reform Act which preclude liability for projections that are accompanied by meaningful cautionary language. See 15 U.S.C. § 78u-5(c)(1)(A). Under the standard articulated in Apple, even if projections are unaccompanied by meaningful cautionary language, they are not actionable, so long as they are genuinely believed by the speaker unless they lack any reasonable basis or unless the speaker was aware of undisclosed facts tending to seriously undermine the accuracy of the statement. See In re Convergent Techs. Sec. Litig., 948 F.2d 507, 516 (9th Cir. 1991) (holding defendants not obliged to disclose detailed internal projections that are not reasonably certain); In re Lyondell Petrochem. Co. Sec. Litig., 984 F.2d 1050, 1052-53 (9th Cir. 1993) (holding no duty to disclose projections indicating that 1989 income and revenues would be below 1988 levels, reasoning that “[a] corporation may be called upon to make confidential projections for a variety of sound purposes where public disclosure would be harmful”). As discussed supra, projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure, or other financial items are subject to the Reform Act’s Safe Harbor for forward-looking statements. Ronconi v. Larkin, 253 F. 3d 423 (9th Cir. 2001); Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir. 2001); In re Advanta Corp. Sec. Litig., 180 F.3d 525 (3d Cir. 1999) (citing 15 U.S.C. § 78u-5(i)(1)(A)). In Winer Family Trust v. Queen, 503 F.3d 319, 331-33 (3d Cir. 2007), the court found that flawed preliminary cost estimates for renovating a meat processing facility, which were made before acquisition of the facility was final and were subsequently revised, did not support a strong inference of scienter. Rather, the most plausible inference to be drawn was that the estimates were revised to reflect new information and subsequent negotiations. The court concluded that “[a] reasonable person would not deem the inference of scienter cogent and at least as compelling as any non-culpable inference,” as required under Tellabs. In In re Syntex Corp. Sec. Litig., 95 F.3d 922, 930 (9th Cir. 1996), the Court determined that a prediction that the over-the-counter product Naprosyn would be approved “well in advance of” the 1993 patent expiration was merely a forecast and plaintiffs failed to plead facts showing that the statement was false when made as required under Rule 9(b). The court distinguished Warshaw v. Xoma Corp., 74 F.3d 955 (9th Cir. 1996), noting that in Warshaw the company stated that approval of an E-5 drug was imminent when it knew that approval was unlikely. The Court concluded that any statements related to future sales of new products were merely forecasts. Quoting VeriFone, the court stated that “because defendants’ predictions proved to be wrong in hindsight does not render the statements untrue when made.” Syntex, 95 F.3d at 934; see also In re VeriFone Sec. Litig., 784 F. Supp. 1471, 1487 (N.D. Cal. 1992), aff’d, 11 F.3d 865 (9th Cir. 1993) (explaining “[p]laintiffs must show why the projection disclosed lacked a reasonable basis” and existence of contradictory internal projections will not support inference that disclosed projection was unreasonable); accord Steiner v. Tektronix, Inc., 817 F. Supp. 867, 878 (D. Or. 1992) (“[F]ailure to be clairvoyant is not a sign of Tek’s lack of sincerity.”). Cf. Provenz v. Miller, 102 F.3d 1478 (9th Cir. 1996) (reversing grant of summary judgment for defendants where company executive, disregarding reliable internal spreadsheet predicting a $4 million loss for the quarter, predicted quarterly earnings of approximately $624,000). Decisions in other circuits are consistent with the approach espoused by the Ninth Circuit and have generally required that a plaintiff allege that a projection was made without a reasonable basis. See, e.g., Searls v.

Glasser, 64 F.3d 1061, 1066-1067 (7th Cir. 1995) (summary judgment for defendants affirmed because “loose predictions” are “not actionable,” and CEO’s characterization of corporation as “recession resistant” was too vague to constitute material statement of fact); In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 368 (3d Cir. 1993) (characterizing forecasts as “soft information [which] may be actionable misrepresentations if the speaker does not genuinely and reasonably believe them”); Raab v. Gen. Physics Corp., 4 F.3d 286, 287-90 (4th Cir. 1993) (holding “prognostications [were] not the specific guarantees necessary to make such predictions material” and vague statements of opinion are not actionable because they are considered immaterial and discounted by the market as “puffing”); Arazie v. Mullane, 2 F.3d 1456, 1468 (7th Cir. 1993) (granting motion to dismiss where plaintiffs failed to allege adequately that projections lacked a “reasonable basis”); Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 515-16 (7th Cir. 1989) (granting summary judgment where defendant’s projections drastically underestimated certain operating costs because plaintiffs failed to demonstrate strong facts showing that there was no reasonable basis for the company’s predictions). i. Mosaic Misrepresentation Thesis Where statements in isolation appear accurate but collectively appear misleading, courts are in disagreement over how much context may appropriately be considered in determining whether a given statement is actionable. One view examines each statement in isolation without regard to other alleged misstatements. See generally In re Apple Computer Sec. Litig., 886 F.2d 1109, 1118 (9th Cir. 1989). At the other end of the spectrum is the “mosaic misrepresentation thesis.” In Isquith v. Middle South Utils., Inc., 847 F.2d 186 (5th Cir. 1988), the Fifth Circuit adopted a “mosaic misrepresentation thesis,” holding that a plaintiff need not link each and every alleged omission of material fact to an affirmative statement. Rather, accurate statements may be misleading if the statements, in the aggregate, create a misleading impression. “[C]ourts interpreting the securities laws have long recognized that reviewing the context in which a disclosure appears is an essential part of determining the disclosure’s adequacy.” Id. at 201; see also Fecht v. Price Co., 70 F.3d 1078, 1081 (9th Cir. 1995) (reversing dismissal because “the mix of information contained in the public documents issued by the Company does not clearly preclude ‘reasonable minds’ from differing on the question of whether they included misleading statements”); Warshaw v. Xoma Corp., 74 F.3d 955, 958-59 (9th Cir. 1996) (following Fecht); S.E.C. v. Fitzgerald, 135 F. Supp. 2d 992, 1028 (N.D. Cal. 2001) (“A defendant’s statements ‘must be viewed as part of a ‘mosaic’ to see if those statements, in the aggregate, created a misleading impression.’”) (quoting In re Genentech, Inc. Sec. Litig., No. C-88-4038DLJ, 1989 WL 106834, at *3 (N.D. Cal. July 7, 1989). Many courts have questioned the legitimacy of the mosaic thesis following passage of the Reform Act. See In re Harmonic, Inc. Sec. Litig., 163 F. Supp. 2d 1079, 1093 n.12 (N.D. Cal. 2001) (questioning whether the materiality standard in Isquith survived the passage of the Reform Act); see also In re Convergent Techs. Sec. Litig., 948 F.2d 507, 512 (9th Cir. 1991) (“[T]o prevail, the plaintiffs must demonstrate that a particular statement, when read in light of all the information then available to the market … conveyed a false or misleading impression.”). j. Statements In Analyst Reports In the absence of any statement on a subject by a given defendant, plaintiffs may attempt to attribute to defendants the statement of somebody else, generally an analyst. A defendant can be liable for the false or misleading statements of third parties, including analysts, if the defendant either (1) expressly or impliedly adopts or endorses the statements (the “adoption” or “entanglement” theory) (see In re Syntex Corp. Sec. Litig., 95 F.3d 922, 934 (9th Cir. 1996)), or (2) provides the analyst with false or misleading information with the intent that the analyst communicate that information to the market (the “conduit” theory). See Cooper v. Pickett, 137 F.3d 616, 624-25 (9th Cir. 1997); Warshaw v. Xoma Corp., 74 F.3d 955, 959 (9th Cir. 1996). These theories of liability are typically employed where defendants have not directly made misleading

statements to the market, but “put [their] imprimatur, express or implied” on the third-party’s statements. In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1410 (9th Cir. 1996) (quoting In re VeriFone Sec. Litig., 784 F. Supp. 1471, 1486 (N.D. Cal. 1992), aff’d, 11 F.3d 865 (9th Cir. 1993)); see also Nursing Home Pension Fund v. Oracle Corp., 380 F.3d 1226, 1234-35 (9th Cir. 2004) (“[W]hen statements in analysts’ reports clearly originated from the defendants, and do not represent a third party’s projection, interpretation, or impression, the statements may be held to be actionable even if they are not exact quotations.”).

1) The “Adoption” Or “Entanglement” Theory To succeed under the adoption theory of liability, plaintiffs must show that “the company adopted, endorsed or sufficiently entangled itself with the [analyst’s opinions] to render them attributable to [the company].” In re Syntex Corp. Sec. Litig., 855 F. Supp. 1086, 1097 (N.D. Cal. 1994), aff’d, 95 F.3d 922 (9th Cir. 1996). The complaint “should (1) identify specific forecasts and name the insider who adopted them; (2) point to specific interactions between the insider and the analyst which gave rise to the entanglement; and (3) state the dates on which the acts which allegedly gave rise to the entanglement occurred.” See In re Caere Corp. Sec. Litig., 837 F. Supp. 1054, 1059 (N.D. Cal. 1993). The complaint also “must allege a two-way flow of information between the analyst and the insider, such as review and approval of the report by the insider.” In re Harmonic Inc. Sec. Litig., 163 F. Supp. 2d 1079, 1095 (N.D. Cal. 2001). The policy behind the adoption or entanglement requirement is that a company should not be held responsible for the opinions of a third party over which it has no control. See In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446 (N.D. Cal. 1996) (granting summary judgment because no evidence that Cirrus adopted analyst reports at issue and the only corporate defendants permitted to speak with analysts never commented on analysts’ financial projections, nor provided internal earnings or revenue forecasts or other specific financial guidance); In re Seagate Tech. II Sec. Litig., No. C-89-2493(A)-VRW, 1995 WL 66841 (N.D. Cal. Feb. 8, 1995), aff’d, 98 F.3d 1346 (9th Cir. 1996) (holding corporation and its officers and directors could not be liable for projections made by securities analysts where the company had a strict policy not to comment upon analysts’ financial projections and plaintiff failed to offer any proof that defendant departed from this policy); Raab v. Gen. Physics Corp., 4 F.3d 286, 288 (4th Cir. 1993) (“The securities laws require General Physics to speak truthfully to investors; they do not require the company to police statements made by third parties for inaccuracies.”). Management’s statement of “comfort” with analyst predictions generally cannot be deemed actionable. See Malone v. Microdyne Corp., 26 F.3d 471, 479 (4th Cir. 1994).

2) The “Conduit” Theory A defendant is also liable for false or misleading statements made by a third-party analyst if the defendant provides the analyst with false or misleading information with the intent that the analyst will communicate that information to the market. See Cooper v. Pickett, 137 F.3d 616, 620 (9th Cir. 1997). In Cooper, the Court found that the complaint properly alleged that the defendant company “endorsed the reports by distributing them to potential investors” and that insiders faxed a specific internal forecast detailing specific earnings information to a specific analyst. Id.; see also In re Secure Computing Corp. Sec. Litig., 184 F. Supp. 2d 980, 990 (N.D. Cal. 2001) (finding that plaintiff had sufficiently pled conduit theory of liability where plaintiff alleged a specific false and misleading statement, directly communicated to analysts at a specific place and time, followed by analyst recommendations to buy stock, and which identified defendants’ specific statements, locations, speakers, content, and date of false or misleading statements, and contents and speakers of analysts’ statements). 7. Omissions An omission is actionable under the securities laws only when: (1) there is a duty to disclose the allegedly

omitted information (see, for example, Basic Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988)), or (2) the alleged omissions render an affirmative statement misleading. Glazer v. Formica Corp., 964 F.2d 149, 157 (2d Cir. 1992); Backman v. Polaroid Corp., 910 F.2d 10, 12-13 (1st Cir. 1990); see also In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1993); In re Seagate Tech. II Sec. Litig., No. C-89-2493(A) MHP, 1990 WL 134963 (N.D. Cal. June 19, 1990), aff’d, 98 F.3d 1346 (9th Cir. 1996). a. The Requirement Of Identifying A Duty To Disclose A material omission may be actionable under Rule 10-b-5 where defendants have a duty to disclose the information in question. Basic Inc. v. Levinson, 485 U.S. 224, 239, n.17 (1988). Silence, absent a duty to disclose, is not misleading under Rule 10b-5. For example, in In re Optionable Securities Litigation, 577 F. Supp. 2d 681, 692 (S.D.N.Y. 2008), defendants’ failure to disclose that the former CEO and company consultant had been convicted of credit card fraud and tax evasion was not an actionable omission because no regulations gave rise to a duty to disclose his crimes. Thus, “[t]he initial inquiry in each case is what duty of disclosure the law should impose upon the person being sued.” Chris-Craft Indus. Inc. v. Piper Aircraft Corp., 480 F.2d 341, 363 (2d Cir. 1973). A duty to disclose may arise in a number of ways. Under the securities laws, the duty to disclose is primarily statutory. See In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d 281, 381 (S.D.N.Y. 2003) (citing H.L. Federman & Co. v. Greenberg, 405 F. Supp. 1332, 1336 (S.D.N.Y. 1975)). A duty to disclose may also arise upon choosing to speak, for one has an obligation to be “both accurate and complete.” Caiola v. Citibank, N.A., New York, 295 F.3d 312, 331 (2nd Cir. 2000); Lormand v. U.S. Unwired, Inc., 565 F.3d 228, 248-49 (5th Cir. 2009) (noting that upon choosing to publicly discuss the prospective benefits from a future course of action, one has a duty to disclose all material risks that will affect the actual outcome of that course of action); In re Dynex Capital, Inc. Sec. Litig., No. 05 CIV. 1897 (HB), 2009 WL 3380621, at *9 (S.D.N.Y. Oct. 19, 2009) (stating that once defendant chose to speak about what caused losses in bond collateral, it had a duty to disclose all contributing causes). The duty to disclose can also arise under a fiduciary relationship between two parties to a securities transaction. See Chiarella v. United States, 445 U.S. 222, 227-29 (1980); see also R2 Investments v. Phillips, No. CIV. A. 302CV0323N, 2003 WL 22862762, at *5 (N. D. Tex. Dec. 3, 2003), aff’d, 401 F.3d 638 (5th Cir. 2005) (“In determining whether the duty to speak arises, we consider the relationship between the plaintiff and defendant, the parties’ relative access to the information to be disclosed, the benefit derived by the defendant from the purchase or sale, defendant’s awareness of plaintiff’s reliance on defendant in making its investment decisions, and defendant’s role in initiating the purchase or sale.”); Garvey v. Arkoosh, 354 F. Supp. 2d 73, 83 (D. Mass. 2005) (holding while there is a duty to disclose payments made by the issuer to analysts for favorable stock recommendations, such a duty falls on the one who publishes the analyst report, and not on the issuer who has paid for the puffery). b. Affirmative Misstatements May Trigger A Duty To Disclose A duty to disclose also exists “when disclosure is necessary to make prior statements not misleading.” Time Warner, 9 F.3d at 268. In such a case, “[t]he inquiries as to duty and materiality coalesce. The undisclosed information is material if there is ‘a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information available.’” Id. at 267-68 (citing TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). The duty to disclose arises “whenever secret information renders prior public statements materially misleading, not merely when that information completely negates the public statements.” Id. at 268; see In re Credit Suisse-AOL Sec. Litig., 465 F. Supp. 2d 34, 56 (D. Mass. 2006) (holding that analysts have a duty to disclose where they make material statements on the value of a company); Beleson v. Schwartz, 599 F. Supp. 2d 519, 525-26 (S.D.N.Y. 2009) (company’s failure to disclose its imminent bankruptcy planning did not render statements regarding its financial condition misleading as to its viability because enough information was available in the market to put investors on notice of its bankruptcy filing); cf. Higginbotham v. Baxter Int’l, Inc., 495 F.3d 753, 760-61 (7th

Cir. 2007) (finding no duty to disclose before managers had a reasonable time to investigate potential misstatement). Whether a public statement is misleading is a “mixed question to be decided by the trier of fact.” Freedman v. Louisiana Pac. Corp., 922 F. Supp. 377, 388 (D. Or. 1996) (citing Durning v. First Boston Corp., 815 F.2d 1265, 1268 (9th Cir. 1987)); see also TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 450 (1976). c. No Duty To Disclose Mismanagement The principle that corporate mismanagement, and the failure to disclose such mismanagement is not actionable under the securities laws if the alleged wrongdoing does not include “any deception, misrepresentation, or nondisclosure” of otherwise material facts is well established. Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 476 (1977); see also Galati v. Commerce Bancorp, Inc., 220 F. App’x 97, 101 (3d Cir. 2007) (finding general statements about company’s performance and growth did not give rise to duty to disclose criminal malfeasance of three senior officers); Garfield v. NDC Health Corp., 466 F.3d 1255 (11th Cir. 2006) (finding that allegations about misrepresentations in financial statements amounted to nothing more than corporate mismanagement); In re Marsh & McLennan Cos., Inc. Sec. Litig., 501 F. Supp. 2d 452 (S.D.N.Y. 2006) (finding that allegation that company misstated earnings merely by failing to disclose misconduct at its subsidiary is not actionable because there was no allegation that the company reported income it did not actually receive – misleading statements about the sources of revenue do not make the company’s statements of revenue figure misleading); In re Citigroup, Inc. Sec. Litig., 330 F. Supp. 2d 367, 375-77 (S.D.N.Y. 2004) (holding that corporation’s failure to disclose that its revenues were derived from illegitimate sources was not actionable, “for the federal securities laws do not require a company to accuse itself of wrongdoing”). But see In re Van der Moolen Holding, N.V. Sec. Litig., 405 F. Supp. 2d 388 (S.D.N.Y. 2005) (finding statements putting sources of defendant’s revenue at issue when revenue was generated, at least in part, by trading practices that violated NYSE rules, sufficient to give rise to 10(b) liability); In re Providian Fin. Corp. Sec. Litig., 152 F. Supp. 2d 814, 824-25 (E.D. Pa. 2001) (holding that although a defendant does not have a duty to speculate about the risk of future investigation or litigation, if it puts the topic of the cause of its financial success at issue, then it is “obligated to disclose information concerning the source of its success, since reasonable investors would find that such information would significantly alter the mix of available information.”) (citing Shapiro v. UJB Fin. Corp., 964 F.2d 272, 281-82 (3d Cir. 1992)). In In re Immucor Inc. Securities Litigation, No. 1:05-CV-2276-WSD, 2006 WL 3000133 (N.D. Ga. Oct. 4, 2006), the court allowed claims of misleading representations of foreign criminal investigations, where the statements made by the company omitted information about the significance of corruption at a foreign subsidiary and omitted potential criminal liability. d. Duty To Update And Duty To Correct The court in Backman v. Polaroid Corp., 910 F.2d 10 (1st Cir. 1990) (en banc), distinguished between disclosures that were misleading when made and disclosures that become misleading in light of subsequent events. With respect to statements that become misleading in light of subsequent events, the court opined that if there is a “forward intent and connotation” to the disclosure, further disclosure “may be called for.” Id. at 17. The Backman court found that the disclosure at issue had been and remained “precisely correct,” noting that to require corrections of statements which were correct when made may “inhibit disclosures altogether.” Id.; see also In re Time Warner, Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1993) (finding that disputed statements lacked “the sort of definite positive projections that might require later correction”). The Third Circuit in In re Burlington Coat Factory Securities Litigation, 114 F.3d 1410, 1431 (3d Cir. 1997), held that a voluntary disclosure of an earnings forecast does not trigger any duty to update. See also Stransky v. Cummins Engine Co., 51 F.3d 1329, 1331 (7th Cir. 1995) (rejecting the duty to update forward-looking statement; “mere silence about even material information is not fraudulent absent a duty to speak”); San

Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Cos., Inc., 75 F.3d 801, 811 (2d Cir. 1996) (finding no duty to update “subdued general comments” of optimism); In re Abbott Labs. Sec. Litig., 813 F. Supp. 1315, 1319 (N.D. Ill. 1992) (finding no duty to update statements that were not forward-looking and that were not false or misleading when made). But see Weiner v. Quaker Oats Co., 129 F.3d 310, 315 (3d Cir. 1997) (holding corporation had duty to update statements regarding its total debt-to-total capitalization ratio guideline when such statements became unreliable). The Reform Act specifically does not impose a duty to update forward-looking statements. 15 U.S.C. § 77z-2(d); 15 U.S.C. § 78u-5(d). The Third Circuit in U.S. v. Schiff, 602 F.3d 152 (3d Cir. 2010) dismissed criminal securities fraud claims, rejecting the government’s theory that an officer has a duty to correct misrepresentations by others. e. No Duty To Disclose Forecasts As a general rule, companies are not required to disclose internal forecasts. See Heliotrope Gen., Inc. v. Ford Motor Co., 189 F.3d 971, 980 (9th Cir. 1999) (holding no duty to disclose “internal financial projections regarding the expected dollar values of tax costs and benefits, the date on which the tax-strategy benefits were expected to be outweighed by its costs, or the date on which a merger was most likely”); In re VeriFone Sec. Litig., 11 F.3d 865, 869 (9th Cir. 1993) (“[A]bsent allegations that VeriFone withheld financial data or other existing facts from which forecasts are typically derived … the forecasts need not have been disclosed.”); see also In re Ford Motor Co. Sec. Litig., 381 F. 3d 563, 572 (6th Cir. 2004) (holding that the future recall costs that the defendant agreed to pay need not be disclosed in prior financial statements since no asset was diminished nor liability incurred at the date of the financial statements); In re Syntex Corp. Sec. Litig., 95 F.3d 922, 929-30 (9th Cir. 1996) (holding that statement in 1991 annual report about the effect of a consent decree on future sales for fiscal year 1992 was nothing more than a forecast on future sales and profits and, hence, was not actionable under VeriFone; similarly, prediction that over-the-counter Naprosyn would be approved “well in advance of” the 1993 patent expiration was merely a forecast, and plaintiffs failed to plead facts showing that the statement was false when made as required under Rule 9(b)); In re Convergent Tech. Sec. Litig., 948 F.2d 507, 516 (9th Cir. 1991) (holding company not required to disclose internal projections); In re Sybase, Inc. Sec. Litig., 48 F. Supp. 2d 958, 963 (N.D. Cal. 1999). In In re Verity, Inc. Securities Litigation, No. C 99-5337 CRB, 2000 WL 1175580 (N.D. Cal. Aug. 11, 2000), the court found that defendant had no duty to update financial forecasts, reasoning that a judicially-created duty of continuous disclosure of all material information every time a single specific earnings forecast is disclosed would likely result in a drastic reduction in the number of such projections made by companies. Because such a duty would thwart the type of disclosure encouraged by the Congress and the SEC, the court refused to find a duty to update. See also Grossman v. Novell, Inc., 120 F.3d 1112, 1124 (10th Cir. 1997) (holding defendant had no duty to disclose third quarter earnings forecasts prior to disclosure of actual third quarter earnings, which showed them to be disappointing); In re Lyondell Petrochemical Co. Sec. Litig., 984 F.2d 1050, 1052-53 (9th Cir. 1993) (finding no duty to disclose projections indicating that 1989 income and revenues would be below 1988 levels, reasoning that “[a] corporation may be called upon to make confidential projections for a variety of sound purposes where public disclosure would be harmful”); Grossman v. Novell, Inc., 120 F.3d 1112, 1124 (10th Cir. 1997) (holding defendant had no duty to disclose third quarter earnings forecasts prior to disclosure of actual third quarter earnings, which showed them to be disappointing). But see In re Netsmart Techs., Inc., 924 A.2d 171, 199-200 (Del. Ch. 2007) (finding material omission and breach of fiduciary duty of candor when proxy statement did not include financial projections used by the financial advisor to assess the fairness of deal, and instead used different projections not used by the financial advisor). Failure to disclose projected or potential changes in the company’s product market has been rejected as the basis for a 10b-5 claim. The court in In re VeriFone Sec. Litig., 11 F.3d 865, 869 (9th Cir. 1993), declared that such an allegation amounts to nothing more than a failure to disclose forecasts and the disclosure of forecasts is not required under the 1934 Act. Similarly, courts have held that there is no duty to predict future actions of

independent government agencies. See Epstein v. Wash. Energy Co., 83 F.3d 1136, 1142 (9th Cir. 1996) (finding no duty to predict action of public utility commission); In re Viropharma, Inc. Sec. Litig., No. CIV. A. 02-1627, 2003 WL 1824914 (E.D. Pa. Apr. 7, 2003) (suggesting that there was no duty to predict FDA approval of drug and that investors should not rely on a company’s prediction about the future actions of independent government agencies); Fanni v. Northrop Grumman Corp., No. CV98-6197 DT, 2000 U.S. Dist. LEXIS 21626, at *32-37 (C.D. Cal. Apr. 10, 2000) (finding no duty to predict whether Justice Department would approve merger). On the other hand, if companies disclose internal forecasts, they must have a reasonable basis for believing the forecasts to be accurate. See In re Convergent Tech. Sec. Litig., 948 F.2d 507, 516 (9th Cir. 1991); see also Provenz v. Miller, 95 F.3d 1376, 1386 (9th Cir. 1996) (reversing grant of summary judgment for defendants where company executive, disregarding reliable internal spreadsheet predicting $4 million loss for the quarter, predicted quarterly earnings of approximately $624,000). f. Duty To Disclose Triggered By Insider Trading “Insiders” may have a duty to disclose material non-public information prior to selling their stock. When seeking to trade in the company’s stock, even where a duty to disclose does not otherwise exist, an insider in possession of material non-public information is required to either “abstain or disclose.” That is, the insider must either abstain from trading in the stock or publicly disclose the material information that the insider possesses. Failure to do so may result in liability, in an action by the SEC, under Rule 10b-5. Dirks v. S.E.C., 463 U.S. 646, 654 (1983) (10b-5 liability requires a duty of disclosure arising from the relationship between the parties); Chiarella v. United States, 445 U.S. 222, 228 (1980) (10b-5 liability for silence “is premised upon a duty to disclose arising from a relationship of trust and confidence between the parties to a transaction”); see also Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299 (1985) (holding tippee using nonpublic information does not violate 10b-5 “unless the tippee owes a corresponding duty to disclose the information”); cf. United States v. O’Hagan, 521 U.S. 642 (1997) (holding criminal liability under Section 10(b) may be predicated on misappropriation theory, which permits imposition of liability on person who trades in securities for personal profit using material, confidential information without disclosing such use to the source of the information). Standing problems will often preclude class treatment of Section 10(b) claims premised on the argument that insider trading by executives created a broad duty to disclose. This is because standing to bring private insider trading claims is limited. In 1988, Congress enacted Section 20A of the Securities Exchange Act of 1934 to provide expressly for private suits against insiders who trade on non-public material information contemporaneously with private party plaintiffs. Section 20A does not preempt existing remedies such as Rule 10b-5. Neubronner v. Milken, 6 F.3d 666, 669-70 (9th Cir. 1993) (holding plaintiff may properly elect to proceed against insider trading defendant under Rule 10b-5 even though Section 20A remedy also available). Nevertheless, in order to establish a violation of Section 20A, a plaintiff must establish three elements: (1) a primary violation of the 1934 Act; (2) a contemporaneous trade with defendant; and (3) defendant’s possession of material nonpublic information. 15 U.S.C. § 78t-1(a); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 541 (3d Cir. 1999) (explaining Section 20A liability is predicated on showing of underlying independent securities violation); Wilson v. Bernstock, 195 F. Supp. 2d 619, 642 (D.N.J. 2002) (dismissing Section 20A claim where primary Rule 10b-5 violation could not be established); Manavazian v. Atec Group, Inc., 160 F. Supp. 2d 468, 485-86 (E.D.N.Y. 2001) (holding complaint satisfies requirements of Section 20A where underlying securities fraud claims do not warrant dismissal). Significantly, for an insider to be liable for trades under either Rule 10b-5 or Section 20A, the plaintiff must plead with specificity that he or she traded contemporaneously with defendants. Wilson v. Comtech Telecomms. Corp., 648 F.2d 88, 94-95 (2d Cir. 1981) (holding in Rule 10b-5 context that plaintiff could not bring claim

where he did not trade “contemporaneously with the insider,” reasoning that “non-contemporaneous traders do not require the protection of the ‘disclose or abstain’ rule because they do not suffer the disadvantage of trading with someone who has superior access to information”); Neubronner, 6 F.3d at 670 (requiring that in Rule 10b-5 context contemporaneous trading must be pled with particularity under Rule 9(b)). Courts agree that a plaintiff’s trade must have occurred after the wrongful insider transaction, although the exact contours of contemporaneous trading are not uniform from court to court. See id., 6 F.3d at 670. In establishing this rule, the Ninth Circuit adopted the Second Circuit’s reasoning in a case holding that trades occurring approximately a month apart were not contemporaneous. Id. at 669-70. In In re Silicon Graphics, Inc. Securities Litigation, No. C 96-0393, 1996 WL 664639 (N.D. Cal. Sept. 25, 1996), the court interpreted this requirement even more strictly, holding that only purchases within six days of insider sales are truly contemporaneous. Other courts in claims brought under Section 20A have held that plaintiffs’ trades must have occurred within one to five days after defendant’s trades. See, e.g., In re MicroStrategy, Inc. Sec. Litig., 115 F. Supp. 2d 620, 663-64 (E.D. Va. 2000) (finding in Section 20A claim that three days separation in trading is not contemporaneous and noting that “the growing trend among district courts in a number of circuits … is to adopt a restrictive reading of the term ‘contemporaneous’ at least with respect to shares heavily traded on a national exchange”); Feldman v. Motorola, Inc., No. CIV. A. 90 C 5887, 1993 WL 497228, at *14 (N.D. Ill. Oct. 14, 1993) (holding trades are not contemporaneous for Section 20A unless they take place within one day of insider’s trades); Gerstein v. Micron Tech., No. CIV. 89-1262, 1993 WL 735031, at *8 (D. Idaho Jan. 9, 1993) (holding trade must take place no more than four days after); In re Cypress Semiconductor Sec. Litig., 836 F. Supp. 711, 714 (N.D. Cal. 1993) (five-day limit). Accordingly, it is doubtful that a broad class of investors could assert a broad duty to disclose based upon executives’ insider trading. Only a small subset of such investors can meet the “contemporaneous trading requirement,” with most investors lacking standing to assert a claim based upon such a duty of disclosure. g. Attorneys’ And Accountants’ Duty To Disclose Misconduct Under certain circumstances, attorneys and accountants are required to raise issues of their client’s misconduct with the client’s management and the SEC.

1) Section 10A Of The Exchange Act Section 10A requires auditors to implement procedures for detecting illegal acts that would have a direct and material effect on the determination of financial statement amounts, identify material related party transactions, and evaluate whether there is substantial doubt about the issuer’s ability to continue as a going concern. An auditor must inform his or her client’s management, audit committee, or board of directors of any such illegal act detected. If the auditor is not satisfied that the management or board have taken appropriate steps to address the findings, the auditor must report his or her conclusions directly to the board, which, in turn, must make a report to the SEC within one business day. If the board does not inform the SEC, the auditor must do so or resign from the engagement. Auditors are protected from liability for reports they make under this provision. Auditors are subject to civil penalties for failing to conform to the Section 10A reporting requirements. However, Section 10A does not provide a private right of action making accountants liable to third parties for failing to make reports under the section.

2) Section 307 Of The Sarbanes-Oxley Act Sarbanes-Oxley Act Section 307 imposes disclosure requirements on both accountants and attorneys. On

January 24, 2003, the SEC adopted a final rule to implement Section 307. The rules adopted: (a) “require an attorney to report evidence of a material violation, determined according to an objective standard, ‘up-the-ladder’ within the issuer to the chief legal counsel or the chief executive officer or the equivalent;” (b) “require an attorney if the chief legal counsel or [CEO] … do not respond appropriately to the evidence, to report the evidence to the audit committee, another committee of independent directors, or the full board of directors;” (c) “clarify that the rules cover attorneys providing legal services to an issuer who have an attorney-client relationship with an issuer, and who have notice that the documents that they are preparing will be filed with or submitted to the Commission;” (d) “provide that foreign attorneys who are not admitted in the United States, and who do not advise clients regarding U.S. law, would not be covered by the rule, while foreign attorneys who provide legal advice regarding U.S. law would be covered to the extent they are appearing and practicing before the Commission, unless they provide such advice in consultation with U.S. counsel;” (e) “allow an issuer to establish a ‘qualified legal compliance committee’ (QLCC) as an alternative procedure for reporting evidence of a material violation;” (f) “allow an attorney, without consent of an issuer client, to reveal confidential information related to his or her representation to the extent the attorney reasonably believes necessary (1) to prevent the issuer from committing a material violation likely to cause substantial financial injury to the financial interests or property of the issuer or investors; (2) to prevent the issuer from committing an illegal act; or (3) to rectify the consequences of a material violation or illegal act in which the attorney’s services have been used;” (g) “state that its provisions govern in the event the rule conflicts with state law, but will not preempt the ability of a state to impose more rigorous obligations;” and (h) “affirmatively state that it does not create a private cause of action and that authority to enforce compliance with the rule is vested exclusively with the Commission.” SEC Adopts Attorney Conduct Rule Under Sarbanes-Oxley Act, SEC NEWS DIGEST 2003-16, Commission Announcements, January 24, 2003. The final rules also provide that by the phrase “evidence of a material violation,” the Commission intends “an objective, rather than a subjective, triggering standard, involving credible evidence, based upon which it would be unreasonable, under the circumstances, for a prudent and competent attorney not to conclude that it is reasonably likely that a material violation has occurred, is ongoing, or is about to occur.” Id. However, the Commission declined to impose the obligation of “noisy withdrawals,” which “would permit an attorney, if an issuer failed to comply with the disclosure requirement, to inform the Commission that the attorney has withdrawn from representing the issuer or provided the issuer with notice that the attorney has not received an appropriate response to a report of a material violation.” Id.

3) Auditors’ Duty To Correct Prior Audit Opinions The Second Circuit has held that an accountant has a duty to correct its past audit opinions, and may in some circumstances incur primary liability under § 10(b) and Rule 10b-5 if it fails to do so. In Overton v. Todman & Co., 478 F.3d 479 (2d Cir. 2007), plaintiffs alleged that, over several years, Todman & Co. issued opinions certifying that a broker-dealer’s financial statements were accurate. Plaintiffs further alleged that Todman & Co. then failed to correct those prior opinions despite “red flags” indicating that the broker-dealer’s financial

statements understated a material liability. The Second Circuit ruled that plaintiffs could proceed with their claim and held that an accountant may violate the so-called “duty to correct” and become primarily liable under § 10(b) and Rule 10b-5 if it: (1) makes a statement in its audit opinion that is false or misleading when made; (2) subsequently learns or was reckless in not learning that the earlier statement was false or misleading; (3) knows or should know that potential investors are relying on the opinion and financial statements; (4) fails to take reasonable steps to correct or withdraw its opinion and/or the financial statements; and (5) all the other requirements for § 10(b) and Rule 10b-5 liability are satisfied. However, in Lattanzio v. Deloitte & Touche LLP, 476 F.3d 147, 155-56 (2d Cir. 2007), the Second Circuit held that an auditor owed no duty to correct financial misstatements in unaudited quarterly reports despite the fact that it was required by regulation to review them. The Court held that section 10(b) liability is limited to those who make misstatements or who violate a duty to disclose. The purpose of regulations requiring auditor review of quarterly reports is to minimize large year-end adjustments to quarterly statements that historically have been uncovered in the annual audit process, not to detect fraud. h. Duty To Disclose Under Item 303 Item 303 of Regulation S-K governs certain filings required by the Securities Act and the Exchange Act. Regulation S-K requires that issuers of securities disclose trends, demands, commitments, events, or uncertainties known to the issuer that are likely to affect the corporation’s liquidity, net sales, or revenues. 17 C.F.R. § 229.303(a)(1)-(3). Instruction 7 to Item 303 provides that corporations “are encouraged, but not required, to supply forward-looking information” and that any forward-looking information disclosed is protected by the Rule 175 “safe harbor.” 17 C.F.R. § 229.303, Instruction 7. S.E.C. Rule 175, 17 C.F.R. § 230.175(c)(1), provides a “safe harbor” from liability under both the 1933 and 1934 Acts for good faith, voluntary disclosures “containing a projection of revenues, income (loss), earnings (loss) per share, capital expenditures, dividends, capital structure or other financial items” if they were made with a reasonable basis, even if they ultimately prove to be wrong. A majority of courts have found that a mere “failure to comply with the disclosure duties under Item 303” may not be the basis of a Section 10(b) action. Oran v. Stafford, 226 F.3d 275, 288 (3d Cir. 2000) (holding violation of Item 303 “does not lead inevitably to the conclusion that such disclosure would be required under Rule 10b-5” because materiality standards for Rule 10b-5 and SK-303 “differ significantly”); In re Marsh & McLennan Cos., Inc. Sec. Litig., 501 F. Supp. 2d 452 (S.D.N.Y. 2006) (holding no duty to disclose under SK303 or SEC Staff Accounting Bulletins Nos. 99 or 101); Iron Workers Loc. 16 Pens. v. Hilb Rogal & Hobbs, 432 F. Supp. 2d 571 (E.D. Va. 2006) (holding no duty to disclose under Reg. S-K because no private right of action; materiality standard different from 10b-5; violation of S-K does not amount to material omission under 10b-5); Menkes v. Stolt-Nielsen S.A., No. 3:03 CV 409 (DJS), 2005 WL 3050970, at *6 (D. Conn. Nov. 10, 2005) (holding that, although management may be compelled to disclose uncharged illegal conduct when there is insider trading, when a statute or regulation requires disclosure, or when disclosure is necessary to prevent another statement from misleading the public, neither Reg. S-K nor the SEC instructions for completing Form 10-F required such disclosure in these circumstances); In re Quintel Entm’t, Inc. Sec. Litig., 72 F. Supp. 2d 283, 293 (S.D.N.Y. 1999) (citing In re Sofamor Danek Group, Inc., 123 F.3d 394, 402 (6th Cir. 1997), for the proposition that “violations of Item 303 do not necessarily create a private right of action” but finding that such violations “may be relevant to determining when a false or misleading omission has been made”); In re Sun Microsystems, Inc. Sec. Litig., No. C-89-20351-RPA, 1990 WL 169140 (N.D. Cal. Aug. 20, 1990) (holding no duty under Item 303(a)(3) to discuss competitive position except in annual report). Plaintiff bears the burden of persuasion on both the good faith and reasonable basis issues. Roots P’ship v. Lands’ End, Inc., 965 F.2d 1411, 1418 (7th Cir. 1992) (discussing the Rule 175 Safe Harbor and stating “simple differences between the company’s stated earnings goal and its internal earnings estimates do not alone suggest that the defendants’ statements lacked a reasonable basis”). Courts often find that this burden is not satisfied. See, e.g., In re Lyondell Petrochem. Co. Sec. Litig., 984 F.2d 1050, 1052-53 (9th Cir. 1993) (holding corporation need not disclose internal financial projections where it had disclosed forecasts to potential lender

banks but not to public generally); Roots, 965 F.2d at 1417-18; accord Glassman v. Computervision Corp., 90 F.3d 617, 631 (1st Cir. 1996); In re Convergent Techs. Sec. Litig., 948 F.2d 507, 516 (9th Cir. 1991); Wright v. Int’l Bus. Mach. Corp., 796 F. Supp. 1120, 1126 (N.D. Ill. 1992) (citing, inter alia, Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 516 (7th Cir. 1989)) (“Firms need not disclose tentative internal estimates even though they conflict with published estimates, unless the internal estimates are so certain that they reveal the published figures as materially misleading.”). Partial disclosures of financial projections, however, if misleading, may be actionable. See Steiner v. Tektronix, Inc., 817 F. Supp. 867, 883 (D. Or. 1992) (citing Vaughn v. Teledyne, Inc., 628 F.2d 1214, 1221 (9th Cir. 1980)). i. Duty To Disclose Under Item 103 Item 103 of Regulation S-K governs what companies must disclose to investors regarding pending litigation. 17 C.F.R. § 229.103. Under Item 103, if an issuer or its subsidiary is a party to material pending litigation, the issuer must disclose the tribunal, principal parties, date instituted, underlying facts, and relief sought. Id. However, Item 103 does not require an issuer to disclose its own internal assessment of the outcome of the pending litigation. See In re Boston Scientific Corp. Sec. Litig., 490 F. Supp. 2d 142, 154 (D. Mass. 2007) (refusing to impose liability where issuer disclosed the pending litigation and potential risks), rev’d on other grounds sub nom. Miss. Public Employees’ Retirement Sys. v. Boston Scientific Corp., 523 F.3d 75 (1st Cir. 2008). j. No Duty To Disclose Business, Products And Plans Of Competitors Federal securities laws “do not ordain that the issuer of a security compare itself in myriad ways to its competitors, whether favorably or unfavorably.” In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1419 (9th Cir. 1994) (quoting In re Donald J. Trump Casinos Sec. Litig., 7 F.3d 357, 375 (3d Cir. 1993)); see also In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1406-07 (9th Cir. 1996) (holding no duty to disclose the products or plans of competitors); Castillo v. Dean Witter Discover & Co., No. 97 CIV. 1272 (RPP), 1998 WL 342050, at *8 (S.D.N.Y. June 25, 1998) (citing In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357, 375-76 (3d Cir. 1993)); In re DSP Group, Inc. Sec. Litig., No. C 95-4025-CAL, 1997 WL 678151 (N.D. Cal. Mar. 5, 1997) (holding no duty to disclose competitor’s market advantage); In re Silicon Graphics Inc., Sec. Litig., No. C 96-0393, 1996 WL 664639 (N.D. Cal. Sept. 25, 1996) (holding that plaintiff’s allegation that defendants withheld information that their products were not competitive with those of Sun Microsystems not actionable). k. Duty To Disclose Technical Or Development Problems A duty to disclose technical or developmental problems with a product may arise where a company makes strongly optimistic or concrete statements about that product that are in stark contrast to its internal reports. See Hanon v. Dataproducts Corp., 976 F.2d 497, 504 (9th Cir. 1992) (finding company obligated to disclose severe and persisting technical problems with its printer when making enthusiastic promotional statements about the printer’s performance); In re Apple Computer Sec. Litig., 886 F.2d 1109, 1118-19 (9th Cir. 1989) (noting company executives stated that new computer product would be “phenomenally successful the first year out of the chute” and would make company’s “growth before this look small”); cf. Glassman v. Computervision Corp., 90 F.3d 617, 634-35 (1st Cir. 1996) (holding cautiously optimistic statements expressing at most the hope that product will eventually gain acceptance in the market do not trigger a duty to disclose initial developmental problems the product was facing); In re Carter-Wallace, Inc. Sec. Litig, 150 F.3d 153, 157 (2nd Cir. 1998) (holding that drug manufacturers have no duty to disclose isolated reports of illnesses suffered by users of their drugs until those reports provide statistically significant evidence that the ill effects may be caused by use of the drugs and thus giving reason to believe that the commercial viability of the drug is threatened). 8. Market Manipulation

In proscribing the use of a “manipulative or deceptive device or contrivance,” Section 10(b) prohibits not only material misrepresentations and omissions, but also manipulative acts. 15 U.S.C. § 78j(b); Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 177 (1994). Manipulation “connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities.” Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199 (1976). The Second Circuit requires a plaintiff to prove manipulation by showing that “an alleged manipulator engaged in market activity aimed at deceiving investors as to how other market participants have valued a security.” ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 100 (2d Cir. 2007); see also Mobil Corp. v. Marathon Oil Co., 669 F.2d 366, 374 (6th Cir. 1981) (stating that the Supreme Court has indicated that manipulation under Section 10(b) refers to “means unrelated to the natural forces of supply and demand”). However, a market manipulation claim cannot be based solely upon misrepresentations or omissions. ATSI Commc’ns, Inc., 493 F.3d at 101. There must be some market activity, such as “wash sales, matched orders, or rigged prices.” See Santa Fe Indus. v. Green, 430 U.S. 462, 476 (1977). Because a claim of market manipulation is a claim for fraud, the plaintiff must satisfy the requirements of Rule 9(b) and plead the following with particularity: the nature, purpose, and effect of the fraudulent conduct as well as the roles of the defendants. ATSI Commc’ns, Inc., 493 F.3d at 101-02. However, because a claim of manipulation can include facts that are solely within the defendant’s knowledge, the plaintiff need not plead manipulation with the same degree of specificity as a claim of misrepresentation. Id. at 102. Nevertheless, the plaintiff must satisfy the PSLRA’s heightened standard for scienter by pleading with particularity facts that create “a strong inference that the defendant intended to deceive investors by artificially affecting the market price of securities.” Id. at 102-03 (finding claim that manipulation may be inferred from a stock price drop in reaction to positive news is insufficient to show a particular connection between the price and defendants’ actions). 9. The “In Connection With” Element To give rise to liability, the misrepresentation or omission must be made “in connection with” the purchase or sale of a security. Although, as previously noted, the Supreme Court relied on the “in connection with” language to limit the class of possible plaintiffs, in general, attempts to use this language as a broad limiting mechanism have failed. “[I]n its role enforcing the Act, the SEC has consistently adopted a broad reading of the phrase … [and] has maintained that a broker who accepts payment for securities that he never intends to deliver, or who sells customer securities with intent to misappropriate the proceeds violates 10(b) and Rule 10b-5.” S.E.C. v. Zandford, 535 U.S. 813, 819 (2002) (citing In re Bauer, 26 S.E.C. 770 (1947)); In re Se. Sec. Corp., 29 S.E.C. 609 (1949). In Zandford, the Supreme Court explained that, “while the statute must not be construed so broadly as to convert every common-law fraud that happens to involve a violation of § 10(b),” a broad construction of the phrase is reasonable. 535 U.S. at 820. The Court has been clear that the statute should be “‘construed not technically and restrictively, but flexibly to effectuate its remedial purposes.’” Id. (quoting Affiliated Ute Citizens of Utah v. U.S., 406 U.S. 128, 151 (1972)). Zanford has also been interpreted to conclude that an investor plaintiff need not identify a specific security in order to meet the “in connection with” requirement of federal and state securities laws. Grippo v. Perazzo, 357 F.3d 1218, 1223-24 (11th Cir. 2004); see S.E.C. v. Trabulse, 526 F. Supp. 2d 1001, 1006 (N.D. Cal. 2007) (noting that this requirement is met if “the fraud alleged somehow touched upon or has some nexus with any securities transaction,” and that the Ninth Circuit explicitly stated in S.E.C. v. Rana Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1993) that the “in connection with” requirement in SEC actions “remains as broad and flexible as is necessary to accomplish the statute’s purpose of protecting investors” (internal quotation marks omitted)). Other Supreme Court decisions have held in favor of a broad interpretation of the “in connection with” clause. In Wharf (Holdings) Ltd. v. United International Holdings, Inc., 532 U.S. 588 (2001), the Court’s decision that a seller had violated Section 10(b) focused on the “secret intent of the seller when the sale occurred.” The plaintiff had asserted its claim as an ownership dispute and therefore no one argued that the complaint lacked the requisite connection with a sale of securities. The Court nevertheless held that the appropriate claim was that the defendant sold a security while never intending to honor its agreement. In both Wharf and Zandford,

the Court held that, where fraudulent intent deprived the purchaser (Wharf) or the seller (Zandford) of the benefit of the sale, the “in connection with” clause was satisfied because the complaint “describe[d] a fraudulent scheme in which securities transactions and breaches of fiduciary duty coincided.” Zandford, 535 U.S. at 814. Most circuit courts have also adopted broad interpretations of the “in connection with” clause. For example, in S.E.C. v. Texas Gulf Sulphur Co., the Second Circuit held that false and misleading assertions are made “in connection with” securities trading “whenever [such] assertions are made … in a manner reasonably calculated to influence the investing public[.]” 401 F.2d 833, 858-62 (2d Cir. 1968) (en banc). In adopting an expansive interpretation of “in connection with,” the court declined to interpret the phrase as requiring that the maker of the misleading statement “participated in pertinent securities transactions,” or that the maker “was motivated by a plan to benefit the corporation or themselves” at the public’s expense. Id. at 860; see also Dujardin v. Liberty Media Corp., 359 F. Supp. 2d 337, 353 (S.D.N.Y. 2005) (holding fraudulent promise to make plaintiff head of a division after the merger was complete, which induced plaintiff into selling his company, satisfied the “in connection with” requirement). Several other circuits also have adopted Texas Gulf’s interpretation of the “in connection with” language of Section 10(b). See S.E.C. v. Savoy Indus., Inc., 587 F.2d 1149, 1171 (D.C. Cir. 1978); Gottlieb v. Sandia Am. Corp., 452 F.2d 510, 516 (3d Cir. 1971); Akin v. Q-L Invs., Inc., 959 F.2d 521, 528 (5th Cir. 1992); Wessel v. Buhler, 437 F.2d 279, 282 (9th Cir. 1971); Mitchell v. Tex. Gulf Sulphur Co., 446 F.2d 90, 100-01 (10th Cir. 1971). The Supreme Court has never squarely addressed the validity of the Texas Gulf test. However, in discussing the materiality of merger discussions for the purposes of Section 10(b), the Court favorably quoted Texas Gulf’s interpretation of the “in connection with” language. Basic Inc. v. Levinson, 485 U.S. 224, 235 n.13 (1988). Additionally, the Ninth Circuit held that the Supreme Court’s decision in Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994), precluding aider and abettor liability for securities fraud, did not undermine Texas Gulf’s holding that there could be direct liability under Section 10(b) for actions “in connection with” the purchase or sale of securities, even though the actor did not trade in securities. McGann v. Ernst & Young, 102 F.3d 390, 393 (9th Cir. 1996) (holding the “in connection with” requirement satisfied by allegation that Ernst & Young produced a fraudulent audit report for corporation knowing the latter would include it in its Form 10K, and observing that “reports of Texas Gulf’s demise are greatly exaggerated”). But see In re Enron Corp. Sec. Derivative & ERISA Litig., No. MDL 1446, 2003 WL 230688, at *16 (S.D. Tex. Jan. 28, 2003) (stating that accountant’s alleged document destruction did not constitute a primary violation of Section 10(b) made in connection with the purchase or sale of securities). The Supreme Court and other circuits also have adopted a broad interpretation of the “in connection” language, but the plaintiffs must have “suffered an injury as a result of deceptive practices touching [the purchase or] sale of securities.” Superintendent of Ins. of State of N.Y. v. Bankers Life and Cas. Co., 404 U.S. 6, 12-13 (1971); see also Gavin v. AT&T Corp., 464 F.3d 634, 639 (7th Cir. 2006) (“[W]hat happens to shares after they are sold is not ‘in connection with’ the sale.”); Lawrence v. Cohn, 325 F.3d 141 (2d Cir. 2003) (holding that where alleged misrepresentations resulted in plaintiffs foregoing the purchase of securities, the misrepresentations did not “touch” the actual purchase made by plaintiffs and were therefore not “in connection with” the purchase or sale of securities). Some courts, including the Second Circuit, have recognized that the “in connection with” language requires that “misrepresentations or omissions involved in securities transactions but not pertaining to the securities themselves cannot form the basis of a Section 10(b) or Rule 10b-5 claim.” Bernstein v. Misk, 948 F. Supp. 228, 242 (E.D.N.Y. 1997) (citing Chemical Bank v. Arthur Andersen & Co., 726 F.2d 930, 943 (2d Cir. 1984)). In Bernstein, plaintiffs merely alleged that defendants made misrepresentations about their own financial positions and omitted certain facts concerning their backgrounds and intentions. The Court held these allegations did not in any way implicate the characteristics or attributes of the company’s shares and hence were not made “in connection with” the purchase and sale of securities. Id. Thus, “a ‘de minimus’ relationship between the fraudulent scheme and the purchase or sale of securities is insufficient.” Id.

Not only must there be a causal connection between the alleged fraudulent conduct and the specific securities transaction at issue, the misrepresentations or omissions involved in the transaction must also pertain to the securities themselves. This generally means that the misrepresentations go to “the value of the stock at issue or the value of the consideration in return for it.” Gurwara v. LyphoMed, Inc., 937 F.2d 380, 383 (7th Cir. 1991); see also U.S. v. Russo, 74 F.3d 1383 (2d Cir. 1996) (short sales of high value stock were “in connection with” the purchase or sale of securities within the meaning of Rule 10b-5 because the short sales enabled defendant to create a false impression of demand for the stock and to shield prices from the realities of the market); Melder v. Morris, 27 F.3d 1097 (5th Cir. 1994); Hunt v. Robinson, 852 F.2d 786 (4th Cir. 1988); Chem. Bank v. Arthur Andersen & Co., 726 F.2d 930, 943 (2d Cir. 1984); Adam v. Silicon Valley Bancshares, 884 F. Supp. 1398 (N.D. Cal. 1995) (holding “in connection with” requirement does not preclude claims against accountants for alleged misstatements in prospectus’s financials); Abrash v. Fox, 805 F. Supp. 206 (S.D.N.Y. 1992); S.E.C. v. Roanoke Tech. Corp., No. 6:05-cv-1880-Orl-31KRS, 2006 WL 3813755, at *4-5 (M.D. Fla. Dec. 6, 2006) (holding that receiving payments in the form of stock in an alleged illicit scheme does not satisfy the “in connection with” element). Some courts have found, in particular circumstances, that misrepresentations made by a company other than the issuer are sufficient to meet the “in connection with” requirement. For example, the court in In re Imperial Credit Indus., Inc., No. CV 98-8842, 2000 WL 1049320, at *3-4 (C.D. Cal. Feb. 23, 2000) found that misrepresentations by a subsidiary were “in connection with” the sale of the parent’s securities. Further, in Zelman v. JDS Uniphase Corp., the “in connection requirement” was met when the purchaser of an equitylinked debt security sued the issuer of the equity securities to which the debt was linked. 376 F. Supp. 2d 956 (N.D. Cal. 2005). Some courts have held that the “in connection with” statutory language requires a “nexus” between the allegedly misleading statement and the plaintiff investors. In Hudson v. Capital Mgmt. Int’l, Inc., 565 F. Supp. 615, 621 (N.D. Cal. 1983), the court held that plaintiffs in a tax shelter class action “must plead what allegedly deceptive information they had access to in order to demonstrate the requisite transactional nexus with the alleged fraud” to meet the statutory “in connection with” requirement. See also Landy v. F.D.I.C., 486 F.2d 139, 168 (3d Cir. 1973) (holding misleading accountants’ report which was not disseminated to public or to plaintiff investors was not made in connection with purchase or sale of security); Wessel v. Buhler, 437 F.2d 279, 282 (9th Cir. 1971) (holding misleading financial statement was not made “in connection with” sale of security if plaintiff investor did not see statement until after litigation began); In re Ramada Inns Sec. Litig., 550 F. Supp. 1127, 1130 (D. Del. 1982) (finding nexus established by showing “plaintiff’s personal exposure to the offending statements”). 10. Causation The element of causation helps ensure that Rule 10b-5 does not become “an insurance plan for the cost of every security purchased in reliance upon a material misstatement or omission.” Huddleston v. Herman & MacLean, 640 F.2d 534, 549 (5th Cir. 1981), rev’d in part on other grounds, 459 U.S. 375 (1983). The Supreme Court’s decision in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), that only a purchaser or seller has standing to sue under Section 10(b), highlights the causation requirement. Both “loss causation” (also referred to as “proximate causation” and “legal causation”) and “transaction causation” (also referred to as “cause in fact” and “but for” causation) are necessary for a 10b-5 claim. Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87, 95-96 (2d Cir. 2001); Binder v. Gillespie, 184 F.3d 1059, 1065 (9th Cir. 1999) (“[Plaintiffs] must show that the fraud caused, or at least had something to do with the decline in the value of the investment after the securities transaction took place.”); Bastian v. Petren Res. Corp., 892 F.2d 680, 685-86 (7th Cir. 1990) (finding no loss causation where decline in value of stock due to national economic forces). In McGonigle v. Combs, 968 F.2d 810, 820 (9th Cir. 1992), the Ninth Circuit explained that loss causation requires the plaintiffs to show that the alleged misrepresentation reduced the value of their investment, while transaction causation requires proof that defendants’ misrepresentations about the quality of the investment induced plaintiffs to buy the shares, which later declined in value. This means that the alleged misrepresentation or omission must be both the cause in fact and the legal cause of plaintiff’s alleged loss.

a. Transaction Causation Transaction causation has been characterized as a type of “causation in fact” or “but for” causation. Transaction causation requires that plaintiff show that the violations in question caused plaintiff to engage in the transaction. See, e.g., Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 259 F.3d 154, 172 (3d Cir. 2001); Suez Equity Investors, L.P. v. Toronto Dominion Bank, 250 F.3d 87, 95-96 (2d Cir. 2001); Weiner v. Quaker Oats Co., 129 F.3d 310, 315 (3d Cir. 1997); Robbins v. Koger Props., Inc., 116 F.3d 1441, 1447 (11th Cir. 1997). Transaction causation conceptually overlaps with the element of reliance, since a showing of transaction causation hinges on a determination that plaintiff relied on the violation. See Basic Inc. v. Levinson, 485 U.S. 224, 243 (1988) (“Reliance provides the requisite causal connection between a defendant’s misrepresentation and a plaintiff’s injury.”); Newton, 259 F.3d at 172 (“[T]ransaction causation is generally understood as reliance.”); AUSA Life Ins. Co. v. Ernst & Young, 206 F.3d 202, 209 (2d Cir. 2000) (analogizing transaction causation to reliance); In re Salomon Smith Barney Mutual Fund Litig., 441 F. Supp. 2d 579 (S.D.N.Y. 2006) (finding that plaintiffs’ assertion that they would not have purchased the shares had they known of the complained-of practices was sufficient to show transaction causation, but not loss causation). Cromer Fin. Ltd. v. Berger, 205 F.R.D. 113, 128 (S.D.N.Y. 2001) (“In [the Second] Circuit, the element of reliance is encapsulated in the concept of causation.”). b. Loss Causation Loss causation is often referred to as “proximate causation” or “legal causation.” It involves a determination that the misstatement caused the harm suffered by the investor. See, e.g., Ambassador Hotel Co., Ltd., v. WeiChuan Inv., 189 F.3d 1017, 1027 (9th Cir. 1999) (“‘Loss causation’ is an exotic name – perhaps an unhappy one – for the standard rule of tort law that the plaintiff must allege and prove that, but for the defendant’s wrongdoing, the plaintiff would not have incurred the harm of which he complains.”); see also In re Gilead Sciences Sec. Litig., 536 F.3d 1049, 1050-53, 1056-58 (9th Cir. 2008) (investors’ allegations of loss causation linking a pharmaceutical company’s misrepresentations about a drug marketed for non-FDA approved uses and the reduction in value of the company’s stock price months after the marketing practices were revealed was sufficient to survive a 12(b)(6) motion); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261, 269-70 (5th Cir. 2007) (requiring plaintiffs to establish loss causation before triggering the presumption of reliance, because the assumption that every material misrepresentation will move a stock in an efficient market is unfounded); Nathenson v. Zonagen Inc., 267 F.3d 400, 413 (5th Cir. 2001) (“‘[L]oss causation’ refers to a direct causal link between the misstatement and the claimant’s economic loss”) (citations omitted); Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 186 (2d Cir. 2001) (holding plaintiff must allege that “the subject of the fraudulent statement or omission was the cause of the actual loss suffered”); Semerenko v. Cendant Corp., 223 F.3d 165, 184 (3d Cir. 2000) (explaining there must be a “sufficient causal nexus between the loss and the alleged misrepresentation”); Bastian v. Petren Res. Corp., 892 F.2d 680, 685 (7th Cir. 1990); In re Omnicom Group, Inc. Sec. Litig., 541 F. Supp. 2d 546 (S.D.N.Y. 2008) (holding negative press characterizations are not corrective disclosures and cannot establish loss causation where the underlying facts were already known to the market and did not themselves affect stock price), aff’d, 597 F.3d 501 (2d Cir. 2010); Shanahan v. Vallat, No. 03 Civ. 3496(PAC), 2008 WL 4525452, at *5 (S.D.N.Y. Oct. 3, 2008) (no loss causation because “industrywide phenomena” caused plaintiffs’ losses; “‘[w]hen the plaintiff’s loss coincides with a marketwide phenomenon causing comparable losses to other investors, the prospects that the plaintiff’s loss was caused by the fraud decreases’” (quoting First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 722 (2d. Cir. 1994))); In re Polaroid Corp. Sec. Litig., 134 F. Supp. 2d 176, 189 (D. Mass. 2001) (dismissing complaint where plaintiffs failed to allege that violation of GAAP “was a substantial factor in the decline of the stock price”). c. Dura Pharmaceuticals In 2005, the Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), resolved a split in

the circuits by unanimously rejecting a “price inflation” approach to loss causation employed in the Eighth and Ninth Circuit as insufficient. Under the price inflation approach, plaintiffs could establish loss causation by relying on the fraud-on-the-market theory to plead and prove that the price of the security on the date of the purchase was inflated because of the misrepresentation. See, e.g., Broudo v. Dura Pharms., Inc., 339 F.3d 933, 937-38 (9th Cir. 2003); Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824, 832 (8th Cir. 2003). The Supreme Court, in rejecting that approach, stated that “as a matter of pure logic, at the moment the transaction takes place, the plaintiff has suffered no loss; the inflated purchase payment is offset by ownership of a share that at that instant possesses equivalent value.” Dura, 544 U.S. at 342. Accordingly, if the purchaser sells the shares “before the relevant truth begins to leak out, the misrepresentation will not have led to any loss.” Id. Instead, the Court adopted the “price correction” approach employed in the Second, Third, Seventh and Eleventh Circuits. The Court explained that a person who misrepresents the financial condition of a corporation in order to sell its stock becomes liable to a relying purchaser for the loss the purchaser sustains when the true facts become generally known and, as a result, share value depreciates. Id. at 1633; see also Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 170-71 (2d Cir. 2005); Emergent Capital Inv. Mgmt., LLC v. Stonepath Group, Inc., 343 F.3d 189 (2d Cir. 2003) (rejecting the argument that pleading artificial inflation of the market will, by itself, satisfy loss causation); Semerenko v. Cendant Corp., 223 F.3d 165, 185 (3d Cir. 2000) (“Where the value of the security does not actually decline as a result of an alleged misrepresentation, it cannot be said that there is in fact an economic loss attributable to that misrepresentation.”); Robbins v. Koger Props., Inc., 116 F.3d 1441 (11th Cir. 1997) (holding that a showing of price inflation does not satisfy the loss causation requirement, and that a connection between the misrepresentation and the investment’s subsequent decline must be shown); Bastian v. Petren Res. Corp., 892 F.2d 680 (7th Cir. 1990). In explaining the required causal connection between a misrepresentation and a loss, the Dura Court observed that the mere fact that a purchaser later sells his or her shares at a lower price does not automatically equate to a finding of loss causation. Dura, 544 U.S. at 336. Justice Breyer, writing for the Court, elaborated that “[w]hen the purchaser subsequently resells such shares, even at a lower price, that lower price may reflect not the earlier misrepresentation, but changed circumstances, changed investor expectations, new industry-specific or firmspecific facts, conditions, or other related events which, taken separately or together, account for all of that lower price.” Id. at 342-43. Thus, Dura complements the widely publicized decision by Judge Pollack in the Southern District of New York rejecting the theory that loss causation may be based upon a fraud-on-themarket theory and finding that the reduction in value of plaintiffs’ shares was caused by an intervening force: the bursting of the Internet bubble. In re Merrill Lynch & Co., Inc., 273 F. Supp. 2d 351 (S.D.N.Y. 2003), aff’d sub nom. Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161 (2d Cir. 2005). In Merrill Lynch, the plaintiff had invested in Internet stocks and argued that material misstatements in Merrill Lynch’s optimistic analyst reports concerning these stocks caused plaintiffs’ losses after a drop in value of these stocks. Plaintiffs employed a fraud on the market theory, claiming that they effectively relied on these reports even though they had not actually seen or read them. Defendants contended that any reduction in the price of shares held by plaintiffs was caused by the collapse of the Internet market and the resultant market-wide price drop, not the content of analyst reports. The court found that plaintiffs failed to make a showing that “each of the challenged [analyst report] ratings was the substantial cause of artificial inflation [of the stock price].” Id. at 368 n.29. The Second Circuit affirmed the dismissal, finding that there was no allegation “that the subject of the false [investment] recommendations … or any corrective disclosure regarding the falsity of those recommendations … is the cause of the decline in stock value.” Lentell, 396 F.3d at 175 (emphasis in original). But see DeMarco v. Robertson Stephens, Inc., 318 F. Supp. 2d 110 (S.D.N.Y. 2004) (denying motion to dismiss based on holding that the Internet market collapse was not an intervening cause of plaintiffs’ loss). d. Dura’s Effect In The Eighth And Ninth Circuits Dura’s effect is most acutely felt in the Eighth and Ninth Circuits. Under the price inflation approach employed in those circuits, plaintiffs were required to plead and prove only that the defendants committed a fraud that caused the security price, at the time of purchase, to be artificially inflated. Plaintiffs did not need to

plead or prove that the artificial inflation was removed from the stock price during the class period. Thus, under pre-Dura standards, loss causation was established even if the market never learned the truth about the fraud and the stock price never dropped upon disclosure of the truth. After Dura, however, plaintiffs must show that the “misrepresentation touches upon the reasons for the investment’s decline in value” by pleading and proving a corrective disclosure of the false information and the manner in which the stock price inflation was removed from the stock price during the class period, usually in the form of a stock price drop. Dura’s impact is apparent in the Ninth Circuit’s decisions in In re Daou Systems, Inc., 411 F.3d 1006 (9th Cir. 2005), subsequently amended at 411 F.3d 1006 (9th Cir. 2005). In Daou, the plaintiffs alleged that the defendants fraudulently overstated earnings by, among other things, misapplying the percentage of completion method of recognizing revenue. As a result, the company’s share price allegedly was inflated to as high as $34; from there, the share price declined to $18.50. Upon the defendants’ announcement of deteriorating earnings and other negative financial metrics from recognizing revenue prematurely, the share price quickly fell from $18.50 to $3.25. On these allegations, the Ninth Circuit cited Dura to hold that shareholder losses arising from the price drop from $34 to $18.50 were not recoverable under Rule 10b-5 because the drop to $18.50 occurred before the company revealed the truth about its earnings situation. However, the court held that loss causation was adequately pled as to the post-disclosure price decline from $18.50 to $3.25. In another Ninth Circuit case applying Dura, Metzler Investment GMBH v. Corinthian Colleges, Inc., 540 F.3d 1049, 1054-55 (9th Cir. 2008), plaintiff brought a fraud claim against defendant based on questionable practices at one of defendant’s privately owned universities. Plaintiff based its loss causation theory on a newspaper article and a financial disclosure made by defendant. Id. at 1059. However, plaintiff did not meet the standard for pleading loss causation because plaintiff was not permitted to “plead loss causation through ‘euphemism’ and thereby avoid alleging the necessary connection between defendant’s fraud and the actual loss. So long as there is a drop in a stock’s price, a plaintiff will always be able to contend that the market ‘understood’ a defendant’s statement precipitating a loss as a coded message revealing the fraud. Enabling a plaintiff to proceed on such a theory would effectively resurrect what Dura discredited—that loss causation is established through an allegation that a stock was purchased at an inflated price.” Id. at 1063-63. Nevertheless, the Ninth Circuit has also circumscribed Dura’s impact. In Daou, the Court noted that, despite Dura, a plaintiff is not required to show that the misrepresentations are the “sole reason” for the decline in share price in order to plead loss causation. Rather, all that is required is that the misrepresentation is “one substantial cause” of the decline. Daou, 411 F.3d at 1025. The Ninth Circuit has also held that in the case of a private sale of a privately traded company, “Dura is not controlling.” Livid Holdings, Ltd v. Salomon Smith Barney, Inc., 416 F.3d 940, 949 n.2 (9th Cir. 2005). The Eighth Circuit cited extensively to and applied Dura in Schaaf v. Residential Funding Corp., 517 F.3d 544 (8th Cir. 2008). The Eighth Circuit followed the Second Circuit’s “materialization of the risk” approach (discussed below), stating that to recover for securities fraud “a plaintiff must show ‘that the loss [was] foreseeable and that the loss [was] caused by the materialization of the concealed risk.’” Id. at 550 (quoting Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 173 (2nd Cir. 2005)). e. Dura’s Effect In Other Circuits Dura has had a lesser impact on the circuits that followed the “price correction” approach because those circuits already required plaintiffs to plead and prove more than just an artificially inflated share price. “While the Supreme Court rejected the Ninth Circuit’s lenient test for economic loss and loss causation as inadequate pleading in fraud on the market cases, it did not address, and thus left intact, more stringent requirements that had been established by other Circuit Courts of Appeals, including the Second, Third, Seventh, and Eleventh.” In re Enron Corp. Sec., Derivative & ERISA Litig., No. MDL-1446, Civ.A. H013624, Civ.A. H040087, 2005 WL 3504860, at *14 (S.D. Tex. Dec. 22, 2005). Post-Dura decisions from these jurisdictions have emphasized the need for a corrective disclosure to establish loss causation. See, e.g., Tricontinental Indus. v. PricewaterhouseCoopers, LLP, 475 F.3d 824, 843 (7th Cir. 2007) (holding that in the wake of Dura, plaintiffs

cannot overcome the lack of a corrective disclosure specific to the alleged fraud with allegations of a broader fraudulent scheme); Teachers’ Ret. Sys. v. Hunter, 477 F.3d 162, 185 (4th Cir. 2007) (holding that causation cannot be shown where facts in the alleged corrective disclosure have already been disclosed in public filings); In re Williams Sec. Litig. – WCG Subclass, 558 F.3d 1130, 1138 (10th Cir. 2009) (“The inability to point to a single corrective disclosure does not relieve the plaintiff of showing how the truth was revealed; he cannot say, ‘Well, the market must have known.’” (emphasis in original)); Schleicher v. Wendt, No. 1:02CV1332DFHTAB, 2005 WL 1656871 (S.D. Ind., July 14, 2005); Joffee v. Lehman Bros., Inc., No. 04 CIV. 3507 RWS, 2005 WL 1492101 (S.D.N.Y., June 23, 2005); In re Initial Pub. Offering Sec. Litig., 399 F. Supp. 2d 261 (S.D.N.Y. 2005). One issue that has arisen in the Third Circuit is the question whether plaintiffs must have sold shares to establish loss causation, a question that was not reached in Dura. One district court held that they do not, reasoning that imposition of a requirement of sales would conflict with the policy of the Exchange Act and lead to a market imbalance by causing “additional precipitous drops in the stock’s market price.” In re Royal Dutch/Shell Transport Sec. Litig., 404 F. Supp. 2d 605 (D.N.J. 2005). Another question that Dura left unresolved is the issue of how to treat in-and-out stock traders (investors who bought and sold their shares before the corrective disclosure). In a post-Dura class certification decision, In re BearingPoint, Inc. Securities Litigation, 232 F.R.D. 534, 544 (E.D. Va. 2006), the district court for the Eastern District of Virginia determined that in-and-out traders are appropriately counted as members of the proposed class because they could conceivably prove loss causation. One example noted by the court would be where there are multiple disclosures. Id. Another instance would be where the inflationary effect of a misrepresentation diminished over time, even without a corrective disclosure. Id.; see also In re CIGNA Corp. Sec. Litig., 459 F. Supp. 2d 338 (E.D. Pa. Aug. 18, 2006) (denying motion for summary judgment dismissal of claim on allegation that plaintiff made a net profit, losing on some trades but also gaining on other trades, including short sales, during the class period and holding that Dura did not speak to the situation). But see In re Organogenesis Sec. Litig., 241 F.R.D. 397 (D. Mass. 2007) (rejecting in-and-out trader as proposed class representative because, under Dura and the specific facts of the case, such an investor could show no losses); In re Comverse Tech., Inc. Sec. Litig., No. 06-CV-1825 NGG, 2007 WL 680779, at *4 (E.D.N.Y. Mar. 2, 2007) (holding that in-and-out losses must not be considered in the recoverable losses calculation in which courts engage when selecting lead plaintiff). f. “Corrective Disclosure” Approach To Pleading Loss Causation Since Dura Courts have also clarified and curtailed the scope of “corrective disclosure” allegations. The mere existence of a disclosure that has a negative effect on the share price, without more, is insufficient to plead loss causation. Rather, the share price decline must result from the disclosure to the market of the true state of affairs that also reveals the falsity of prior disclosures. See, e.g., In re Initial Pub. Offering Sec. Litig., 399 F. Supp. 2d 261 (S.D.N.Y 2005) (“If downturns in stock prices based on such mundane events as failures to meet forecasts and downward revisions of forecasts were legally sufficient to constitute disclosures of securities fraud, then any investor who loses money in the stock market could sue to recover for those losses without alleging that a fraudulent scheme was ever disclosed and that the disclosure caused their losses.”); Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 175 n.4 (2d Cir. 2005) (holding that stock price drop following downgrade of stock did not amount to a corrective disclosure because the downgrades did not reveal to the market the falsity of the prior recommendations). Most courts have found that the corrective disclosure does not have to mirror the alleged fraudulent scheme to adequately plead loss causation, so long as when taken as a whole, the disclosure in question was congruent to the alleged fraud. See In re Williams Sec. Litig. – WCG Subclass, 558 F.3d 1130, 1140 (10th Cir. 2009) (“To be corrective, the disclosure need not precisely mirror the earlier misrepresentation, but it must at least relate back to the misrepresentation and not to some other negative information about the company.”); Alaska Elec. Pension Fund v. Flowserve Corp., 572 F.3d 221, 230 (5th Cir. 2009) (stating that a corrective disclosure need not mirror the alleged misrepresentations but must disclose information that “reflect[s] part of the ‘relevant

truth’ – the truth obscured by the fraudulent statements.”); see also In re Take-Two Interactive Sec. Litig., 551 F. Supp. 2d 247, 285-86 (S.D.N.Y. 2008) (“if a plaintiff relies upon a particular disclosure as the basis for his loss causation allegations, that disclosure must somehow reveal to the market some part of the truth regarding the alleged fraud,” even though it does not have to “precisely mirror” the alleged fraud). Thus, the disclosure does not have to state that the company was committing fraud, but rather can state facts that would give rise to a causal connection. See Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261, 271 (5th Cir. 2007) (holding that when multiple negative items are announced contemporaneously, plaintiffs must “offer some empirically-based showing” that some percentage of the stock drop was attributable to corrective disclosure); Lapin v. Goldman Sachs Group, Inc., 506 F. Supp. 2d 221 (S.D.N.Y. 2006) (holding that the announcement of investigations against the defendant by the New York Attorney General, the Justice Department and the SEC was the corrective disclosure, which need not come from the defendant company); In re Hienergy Tech., Inc., No. SACV04-1226 DOC (JTLX), 2005 WL 3071250, at *4 (C.D. Cal. Oct. 25, 2005) (holding that a disclosure indicating that the SEC was going to file charges against the company was sufficient to plead a causal connection). But see In re Maxim Integrated Prods., Inc. Sec. Litig., 639 F. Supp. 2d 1038, 1046 (N.D. Cal. 2009) (holding that disclosures regarding compliance with an SEC investigation, subpoenas from the U.S. Attorney’s office, and the formation of special committee to investigate options backdating practices were not corrective disclosures because they did not indicate anything more than a risk or potential that defendants engaged in widespread fraudulent conduct). A disclosure need not come from the defendants to be corrective; a plaintiff “may plead loss causation based on truth about the alleged fraud disclosed to the market by persons other than the defendants.” Lormand v. U.S. Unwired, Inc., 565 F.3d 228, 264 (5th Cir. 2009); In re StockerYale, 453 F. Supp. 2d 345 (D.N.H. 2006) (holding that the Dura standard for loss causation does not mandate that the source of the misrepresentation also be the source of the corrective disclosure). And a corrective disclosure need not take the form of a single announcement, but rather can occur through a series of disclosing events. See Lormand, 565 F.3d at 261; Metzler Inv. GMBH v. Corinthian Colls., Inc., 540 F.3d 1049, 1063 n.6 (9th Cir. 2008). Finally, at the pleading stage, the fact that a disclosure is not followed immediately by a stock price decrease is insufficient to warrant dismissal where the complaint properly alleges a specific causal link between the defendant’s fraud and the plaintiff’s economic loss. Lormand, 565 F.3d at 267 n.33 (“The market could plausibly have had a delayed reaction; a delayed reaction can still satisfy the pleading requirements for ‘loss causation’”); In re Gilead Sci. Sec. Litig., 536 F.3d 1049, 1058 (9th Cir. 2008) (“A limited temporal gap between the time the misrepresentation is publicly revealed and the subsequent decline in stock value does not render a plaintiff’s theory of loss causation per se implausible.”). g. The “Materialization Of Risk” Approach To Pleading Loss Causation The Second Circuit has also developed an alternate framework for pleading and proving loss causation, known as the “materialization of risk” approach. Under that framework, “a misstatement or omission is the ‘proximate cause’ of an investment loss if the risk that caused the loss was within the zone of risk concealed by the misrepresentations and omissions alleged by the disappointed investor.” Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 173 (2d Cir. 2005). Thus, a plaintiff can plead and prove loss causation if the loss is foreseeable and caused by the materialization of the concealed risk. See Catton v. Defense Tech. Sys., Inc., No. 05 CIV. 6954 (SAS), 2006 WL 27470 (S.D.N.Y. Jan 3, 2006). This approach recognizes that a plaintiff’s injury from a drop in the value of a security may be caused by the misstatement or omissions made about it, or by the emergence of the underlying circumstance that was concealed or misstated. Plaintiffs may cite to the “materialization of risk” approach to pleading loss causation in some cases – particularly where a company’s stock price declined, not in response to a disclosure, but in response to a corporate crisis or event. This approach is well illustrated in Suez Equity Investors, L.P. v. Toronto-Dominion Bank, 250 F.3d 87 (2d Cir. 2001). Defendants, in soliciting plaintiffs’ investment in a company, provided plaintiffs with an edited version of a report on one of the company’s principal executives. The edited version omitted important negative events in the executive’s financial and business history, such as multiple tax liens, delinquent credit accounts, an involuntary bankruptcy proceeding, and pending civil lawsuits. Plaintiffs claimed

that the concealed events reflected the executive’s inability to manage debt and maintain adequate liquidity. Plaintiffs also alleged that their investment ultimately became worthless because of the company’s eventual liquidity crisis and expressly attributed that crisis to the executive’s inability to manage the company’s finances. Thus, plaintiffs specifically alleged a causal connection between the concealed information – the executive’s profile – and the materialization of the foreseeable risk of the true facts, i.e., the ultimate failure of the enterprise due to the inability to manage debt and liquidity. Similarly, in In re Vivendi Universal, S.A. Sec. Litig., 605 F. Supp. 2d 586 (S.D.N.Y. 2009), under a very broad “materialization of the risk” theory, plaintiffs argued that defendants’ false and misleading statements concealed the company’s risk of a liquidity crisis, and that subsequent events, such as credit ratings downgrades and quick asset sales, gradually revealed the company’s deteriorating liquidity condition. Because the subject of defendants’ statements concerned matters relating to liquidity, including the company’s debt load, its income stream, and ability to convert assets into cash, the district court found that the “revealing” events identified by the plaintiffs had a reasonable relationship to liquidity risks and to a trier of fact therefore could be seen as materializations of such risks. Id. at 601-02. Further, the loss causation requirement also imposes a burden on plaintiffs to rebut any showing that the loss was the result of an intervening event, like, for example, the bursting of the internet bubble, rather than a materialization of the undisclosed risk. In re Merrill Lynch & Co. Inc., 273 F. Supp. 2d 351 (S.D.N.Y. 2003), aff’d sub nom. Lentell, 396 F.3d 161; In re Acterna Corp. Sec. Litig., 378 F. Supp. 2d 561, 588 (D. Md. 2005) (“This decline, however, was not unique to Acterna, as evidenced by the near 50% drop in the Dow Jones U.S. Telecommunications Index during the Class Period.”); Lentell, 396 F.3d at 174 (“[W]hen the plaintiff’s loss coincides with a marketwide phenomenon causing comparable losses to other investors, the prospect that the plaintiff’s loss was caused by the fraud decreases, and a plaintiff’s claim fails when it has not adequately pled facts which, if proven, would show that its loss was caused by the alleged misstatements as opposed to intervening events.”); In re Moody’s Corp. Sec. Litig., 612 F. Supp. 2d 397, 399 (S.D.N.Y. 2009) (a plaintiff “must make a more detailed showing of loss causation when there is evidence of an industry-wide downturn, or when the record indicates that the company’s stock lost almost all its value before the first alleged corrective disclosure” (internal citations omitted)). h. Pleading Standard For Loss Causation After Dura Apart from what facts a plaintiff must plead, Dura raises the question of how specifically the plaintiff must plead them. In Dura, the Supreme Court declined to answer this question. Instead, the Court stated that it would assume for the sake of argument that the notice pleading standard of Rule 8 of the Federal Rules of Civil Procedure governs pleading loss causation because the allegations in Dura failed even to meet that minimum bar. In the wake of Dura, lower courts have generally applied Rule 8 to loss causation pleading. See In re Elec. Arts Inc. Sec. Litig., No. C-05-1219-MMS, 2006 WL 27201, at *1 (N.D. Cal. Jan 5, 2006); In re Immucor Inc. Sec. Litig., No. 1:05-CV-2276-WSD, 2006 WL 3000133 (N.D.Ga. Oct. 4, 2006) (holding allegations of loss causation are evaluated under notice pleading standard); Ong ex rel. Ong v. Sears, Roebuck & Co., 459 F. Supp. 2d 729 (N.D. Ill. 2006) (same); In re Unumprovident Corp. Sec. Litig., 396 F. Supp. 2d 858, 899 (E.D. Tenn. 2005). But see In re First Union Corp. Sec. Litig., No. CIV. 3:99 CIV. 237-H, 2006 WL 163616, at *5 (W.D.N.C. Jan. 20 2006) (applying particularity requirements to loss causation). In Bell Atl. Corp. v. Twombly, 550 U.S. 544, 556 (2007), an antitrust case, the Supreme Court, partially relying on Dura, decided that Rule 8 implies a “plausibility” standard that any complaint must meet in order to state a claim for relief. That is, the complaint must contain sufficient factual matter, accepted as true, to “state a claim to relief that is plausible on its face.” Id. at 570. In Ashcroft v. Iqbal, 129 S. Ct. 1937, 1953 (2009), the Court clarified that the “facial plausibility” requirement applies in all civil actions, not just in the antitrust context. Since Twombly, the Fifth, Eighth, and Ninth Circuits have applied the “facial plausibility” standard to loss causation pleading. See Lormand, 565 F.3d at 258 (“[F]rom Dura’s holding … as well as Twombly’s

explanation of the plausibility standard, we conclude that Rule 8(a)(2) requires the plaintiff to allege, in respect to loss causation, a facially ‘plausible’ causal relationship between the fraudulent statements or omissions and plaintiff’s economic loss, including allegations of a material misrepresentation or omission, followed by the leaking out of relevant or related truth about the fraud that caused … plaintiff’s economic loss.”); McAdams v. McCord, 584 F.3d 1111, 1115 (8th Cir. 2009) (dismissing claimants’ loss causation allegations because they lacked “plausibility”); In re Gilead Sci. Sec. Litig., 536 F.3d 1049, 1057 (9th Cir. 2008) (citing Twombly and noting that “so long as the complaint alleges facts that, if taken as true, plausibly establish loss causation, a Rule 12(b)(6) dismissal is inappropriate.”). The Fourth Circuit, on the other hand, suggests that loss causation must be pled under Rule 9(b). In Teachers’ Retirement System of Louisiana v. Hunter, 477 F.3d 162 (4th Cir. 2007), the Fourth Circuit noted that “[n]either the PSLRA nor the Supreme Court has established whether loss causation is a significant part of an ‘averment of fraud’ to fall within the requirements of [Rule 9(b)]. A strong case can be made that [it does].” Id. at 18586. The Fourth Circuit reiterated this view in In re Mutual Funds Investment Litigation, 566 F.3d 111 (4th Cir. 2009), stating that while the pleading requirements of the PSLRA do not apply to loss causation, loss causation allegations must be pled with specificity. Id. at 119. i. Limitations On The Scope Of Dura In the wake of Dura, courts have mostly limited Dura’s application to fraud on the market type cases. See, e.g., McCabe v. Ernst & Young, LLP, No. CIV. 01-5747 (WHW), 2006 WL 42371, at *7 (D.N.J. Jan. 6, 2006), aff’d, 484 F.3d 418 (3d Cir. 2007); Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 416 F.3d 940, 949 n.2 (9th Cir. 2005). Further, courts have held Dura inapplicable in market manipulation cases because the “value” of the share purchased by the plaintiff is not the market price, but rather the price that would have existed had the market not been manipulated. See In re NYSE Specialists Sec. Litig., 405 F. Supp. 2d 281 (S.D.N.Y. 2005), vacated in part on other grounds, 503 F.3d 89 (2d Cir. 2007). Thus, in market manipulation cases, a plaintiff may plead and prove an artificially inflated share purchase price to demonstrate loss causation, with the loss being the difference between the manipulated price and the actual value of the stock. Id. Other cases have also found substantial limitations on Dura’s application. Notably, a New Jersey district court held that Dura does not impose a “sell-to-sue” requirement, i.e., a plaintiff does not actually have to sell securities in order to have standing to plead loss causation. In re Royal Dutch/ShellTransport Sec. Litig., 404 F. Supp. 2d 605 (D.N.J. 2005). The court narrowly construed Dura based on the plain language of Section 21D(e) of the Reform Act and in reliance on the Supreme Court’s express statement that it did not “consider other proximate cause or loss related questions,” other than whether pleading an artificially inflated purchase price alone, was sufficient for loss causation. Id. (citing Dura, 544 U.S. at 346-47). But see In re Citigroup Auction Rate Sec. Litig., No. 08 Civ. 3095 (LTS)(FM), 2009 WL 2914370, at *8 (S.D.N.Y. Sept. 11, 2009) (finding plaintiff’s loss causation allegations insufficient because plaintiff did not specifically allege that he tried to sell his securities). Subsequent courts have also focused on this limiting language to justify limiting Dura. See, e.g., Freeland v. Iridium World Commc’ns, Ltd., 233 F.R.D. 40, 46 (D.D.C. 2006) (finding that Dura does not defeat a lead plaintiff’s typicality requirement in a class action, even if the lead plaintiff is particularly susceptible to a loss causation defense); In re CMS Energy Sec. Litig., 403 F. Supp. 2d 625, 629 (E.D. Mich. 2005) (holding that Dura only applies to loss causation, and not transaction causation); In re WRT Energy Sec. Litig., No. 96 CIV. 3610, 2005 WL 3288142, at *1 (S.D.N.Y. Dec. 1, 2005) (stating that Dura is not applicable to § 11 claims, as there is no requirement to plead loss causation in such claims). But see Collier v. Aksys Ltd., 2005 WL 1949868, at *11 (D.Conn. Aug. 15, 2005) (finding that Dura applies not only to the typical situation where the share prices declines, but also to situations where the share price increases as a result of the truth emerging, e.g., where the plaintiff is a short-seller), aff’d, 179 F. App’x 770 (2d Cir. 2006). 11. Reliance A plaintiff must rely on the alleged material misstatement in making the investment decision; reliance is a

“critical element for recovery under 10b-5.” Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 180 (1994); see also Nathenson v. Zonagen Inc., 267 F.3d 400, 413 (5th Cir. 2001) (holding reliance generally requires that the plaintiff knew of the misrepresentation at issue, believed it to be true, and because of that knowledge and belief, purchased or sold the security in question). Reliance is a multi-faceted element in Rule 10b-5 cases, particularly because courts have afforded plaintiffs a presumption of reliance under certain circumstances. See, e.g., Semerenko v. Cendant Corp., 223 F.3d 165, 178 (3d Cir. 2000) (“Recognizing that the requirement of showing direct reliance presents an unreasonable evidentiary burden in a securities market where face-to-face transactions are rare and where lawsuits are brought by classes of investors … this court has adopted a rule that creates a presumption of reliance in certain cases.”). Courts are mindful, however, that “reliance is and long has been an element of common law fraud,” (Basic Inc. v. Levinson, 485 U.S. 224, 243 (1988)) and that Rule 10b-5 is not meant to create “insurers against national economic calamities.” Bastian v. Petren Res. Corp., 892 F.2d 680, 685 (7th Cir. 1990). Courts carefully consider what facts trigger a presumption of reliance, see e.g., Cammer v. Bloom, 711 F. Supp. 1264, 1286-87 (D.N.J. 1989), and how the presumption may be rebutted by defendants. See e.g., Basic, 485 U.S. at 248; see also Chase Manhattan Mortg. Corp v. Advanta Corp., No. CIV. A. 01-507, 2004 WL 422681 (D. Del. Mar. 4, 2004) (holding that a non-reliance clause does not establish per se that reliance was unreasonable). a. Fraud On The Market Presumption Of Reliance In class actions alleging misrepresentations concerning publicly traded securities, reliance by the class generally will be presumed based on the “fraud on the market” doctrine. Under that doctrine, investors do not have to prove individual reliance on a company’s false or misleading statements. Instead, the doctrine creates a rebuttable presumption that plaintiffs relied on the integrity of the market and were defrauded even if they did not rely specifically on the false or misleading statements at issue in the complaint. A plurality of the Supreme Court approved the “fraud on the market” theory in Basic Inc. v. Levinson, 485 U.S. 224 (1988). According to the Court, the key to the “fraud on the market” theory is that “in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business .… Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.” Id. at 241-42 (citation omitted). The theory is thus founded upon an efficient capital market hypothesis. Id. at 253 (White, J., concurring) (criticizing the plurality’s view, which was adopted “with no staff economists, no experts schooled in the ‘efficient-capitalmarket hypothesis,’ [and] no ability to test the validity of empirical market studies”). The Basic plurality explained that the doctrine did not eliminate the reliance requirement. Rather, since modern securities markets, involving millions of transactions daily, differ from the face-to-face transactions contemplated by early fraud cases, an understanding of the reliance requirement of Rule 10b-5 must encompass those differences. “With the presence of a market, the market is interposed between seller and buyer and, ideally, transmits information to the investor in the processed form of a market price.… The market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price.” Id. at 244 (citation omitted). The Court concluded that “[a]n investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action.” Id. at 247; accord In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1419 n.8 (3d Cir. 1997) (recognizing that the fraud-on-themarket theory, on which that suit was grounded, “accords … a rebuttable presumption of reliance if plaintiffs bought or sold their securities in an efficient market,” “the presumption of reliance [being] based on the theory

that in an efficient market the misinformation directly affects the stock prices at which the investor trades and thus, through the inflated or deflated price, causes injury even in the absence of direct reliance”); In re Clearly Canadian Sec. Litig., 875 F. Supp. 1410, 1414-16, 1418-19 (N.D. Cal. 1995); see also, In re Salomon Analyst Metromedia Litig., 544 F.3d 474, 481-82 (2d Cir. 2008) (extending the “fraud on the market presumption” to misinformation and omissions transmitted to the market by a secondary actor, noting that nothing in the language of Basic limits its holding to issuer statements). The fraud on the market presumption is also available to purchasers of other types of securities, such as options. For instance, in Moskowitz v. Lopp, 128 F.R.D. 624, 630-31 (E.D. Pa. 1989), defendants attacked class certification on the ground of typicality, claiming that plaintiff could not avail himself of the fraud on the market presumption because he had engaged in takeover speculation. Defendants asserted that plaintiff did not rely on market price as an indication of the value of the securities but, instead, sought to profit from short-term movements in price arising from takeover speculation. The Court rejected defendants’ theory, holding that first, the possible availability of a unique defense does not foreclose class certification, and second, “[t]raders in puts and calls rely on the integrity of information disseminated in the market just as do purchasers and sellers of the underlying security.” Id. (quoting Tolan v. Computervision Corp., 696 F. Supp. 771, 779 (D. Mass. 1988)). Furthermore, the fraud on the market presumption has been held to apply to convertible bonds. Argent Classic Convertible Arbitrage Fund v. Rite Aid Corp., 315 F. Supp. 2d 666, 675-77 (E.D. Pa. 2004) (holding that the investor’s strategy of selling company’s stock short as a hedge against possible declines in convertible bond prices did not defeat the fraud on the market allegation of reliance); see also Levie v. Sears, Roebuck & Co., 496 F. Supp. 2d 944, 949 (N.D. Ill. 2007) (holding that short sellers, options traders and day traders may rely on the fraud-on-the-market presumption of reliance). The fraud on the market doctrine does not apply to claims brought by investors in mutual funds. In Siemers v. Wells Fargo & Co., 243 F.R.D. 369, 373-74 (N.D. Cal. 2007), the court noted that the presumption that the price of a stock reflects all public information does not apply to mutual funds because the daily share value of a mutual fund does not fluctuate with the public opinion of the fund. Id. The daily share value of the fund is based on the fund’s underlying portfolio and the number of shares the fund holds. Id. Therefore, bad news about the fund’s management will not affect the daily share value of the fund. Id. at 374. Thus, the presumption that misleading statements concerning a company will inflate a stock price does not apply to mutual funds.

1) Existence Of An Efficient Market The fraud on the market doctrine is grounded on the assumption that the market price “incorporates into a stock’s price all publicly available information.” Heliotrope Gen. Inc. v. Ford Motor Co., 189 F.3d 971, 977 (9th Cir. 1999) (explaining efficient market is presumed to incorporate into stock price all publicly available information, including, for example, all provisions of the Federal Tax Code, no matter how arcane); In re PolyMedica Sec. Litig., 432 F.3d 1 (1st Cir. 2005) (noting efficient market requires only informational efficiency, not value efficiency); Nathenson v. Zonagen, Inc., 267 F.3d 400 (5th Cir. 2001); Newton v. Merrill Lynch, Pierce, Fenner & Smith, 259 F.3d 154 (3d Cir. 2001); Binder v. Gillespie, 184 F.3d 1059, 1064 (9th Cir. 1999) (holding presumption of reliance under fraud on the market theory available only when plaintiff alleges that defendant made material misrepresentations or omissions concerning a security that is traded in an efficient market); Longman v. Food Lion, Inc., 197 F.3d 675, 682 n.1 (4th Cir. 1999); Robbins v. Koger Props., Inc., 116 F.3d 1441 (11th Cir. 1997). Accordingly, the doctrine rests on the efficient market hypothesis, i.e., the assumption that the underlying security is being traded on an efficient market in which all public information, truthful or otherwise, is reflected in the market price. See Barbara Black, Fraud on the Market: A Criticism of Dispensing with Reliance Requirements in Certain Open Market Transactions, 62 N.C. L. REV. 435, 437 (1984); Peter J. Dennin, Note, Which Came First, The Fraud Or The Market: Is The Fraud-Created-TheMarket Theory Valid Under Rule 10b-5?, 69 FORDHAM L. REV. 2611 (2001). When analyzing the applicability of the fraud on the market doctrine, courts have traditionally considered at

least five factors to determine whether a company’s stock is sold in an “efficient market:” (1) whether the stock trades at a high weekly volume; (2) whether securities analysts follow and report on the stock; (3) whether the stock has market makers and arbitrageurs; (4) whether the company is eligible to file SEC registration form S-3, rather than forms S-1 or S-2; and (5) whether there are “empirical facts showing a cause and effect relationship between unexpected corporate events or financial releases and an immediate response in the stock price.” Cammer v. Bloom, 711 F. Supp. 1264, 1285-87 (D.N.J. 1989). Numerous courts have adopted these so-called “Cammer factors” in analyzing whether a given market is “efficient” for these purposes. See, e.g., Binder v. Gillespie, 184 F.3d 1059, 1064 (9th Cir. 1999) (using Cammer five-factor analysis to determine whether market is efficient; concluding that the mere existence of market makers and arbitrageurs is insufficient under this test); Hayes v. Gross, 982 F.2d 104, 107 n.1 (3d Cir. 1992) (adopting Cammer’s “thorough analysis”); Freeman v. Laventhol & Horwath, 915 F.2d 193, 199 (6th Cir. 1990) (same); In re USA Talks.com Sec. Litig., No. 99-CV0162-L (JA), 2000 WL 1887516 (S.D. Cal. Sept. 14, 2000); In re Healthsouth Corp. Sec. Litig., 261 F.R.D. 616, 632-38 (N.D. Ala. 2009) (applying Cammer to the market for defendant corporation’s bonds and finding ample indicia of an efficient market).

2) Misrepresentation Must Be A Public Presentation The alleged misrepresentation also must be publicly made so that it could theoretically have some impact on market price. In re LTV Sec. Litig., 88 F.R.D. 134, 144 (N.D. Tex. 1980) (“[T]he price of the stock appears to reflect all publicly available information, but not all privately held information.”); accord Grossman v. Waste Mgmt., Inc., 589 F. Supp. 395, 403 (N.D. Ill. 1984) (explaining theory assumes that market price of stock reflects “all publicly available information”). Available public information includes, for example, research analysts’ reports. DeMarco, Inc. v. Lehman Bros., Inc., 309 F. Supp. 2d 631, 635-36 (S.D.N.Y. 2004) (holding that such reports were not exempt from the reach of the fraud on the market presumption); DeMarco v. Robertson Stephens Inc., 318 F. Supp. 2d 110, 120 (S.D.N.Y. 2004) (rejecting defendant’s argument that the fraud on the market theory applies only to misrepresentations by corporate insiders and not opinions published in analyst reports). Personal involvement in the dissemination by the defendant is not required. Simpson v. AOL Time Warner, 452 F.3d 1040 (9th Cir. 2006), vacated by Simpson v. Homestore.com, Inc., 519 F.3d 1041 (9th Cir. 2008). But see In re Credit Suisse First Boston Corp. (Lantronix, Inc.) Analyst Sec. Litig., 250 F.R.D. 137 (S.D.N.Y. 2008) (when the misleading statements are made by an analyst and the statements do not impact stock price, no presumption of reliance arises). Closed public lawsuits are not considered public information. JHW Greentree Capital, L.P., v. Whittier Trust Co., No. 05 CIV. 2985, 2005 WL 3008452, at *4 (S.D.N.Y. Nov. 10, 2005) ([“I]t is unrealistic to expect a party to a transaction, even a sophisticated private equity firm, to scour the dockets of every court in the nation for closed actions involving an acquisition target.”). Thus, defense counsel should consider whether the fraud on the market doctrine should apply to Rule 10b-5 allegations concerning nonpublic misrepresentations, i.e., private opinion letters of counsel, feasibility studies and other materials not disseminated to the public and thus unavailable to the market “transmission belt.”

3) Application Of Fraud On The Market Theory To Short Sellers In Zlotnick v. TIE Communication, 836 F.2d 818, 823 (3d Cir. 1988), the court held that short sellers are not entitled to the presumption of reliance because, unlike typical investors who rely on the market to be efficient and therefore reflect the true value of stock, short sellers rely on an inefficient market. Nonetheless, a short seller can still show “actual indirect reliance” by “demonstrating a change in investment strategy and actual reliance on the ‘integrity’ of the inflated market price at the time of cover.” Rocker Mgmt. L.L.C. v. Lernout & Hauspie Speech Prods. N.V., No. CIV. A. 00-5965, 2005 WL 1365772, at *5 (D.N.J. June 8, 2005). In Rocker, the court found such actual indirect reliance where the plaintiffs alleged that a rise in stock price “increased the risk of loss beyond acceptable levels, [and] caused one to enter into a cover transaction.” Id. At least two other courts have allowed short sellers to utilize the fraud-on-the-market presumption. See Argent Classic Convertible Arbitrage Fund v. Rite Aid Corp., 315 F. Supp. 2d 666, 675-77 (E.D. Pa. 2004); Levie v. Sears,

Roebuck & Co., 496 F. Supp. 2d 944, 949 (N.D. Ill. 2007).

4) Application Of Fraud On The Market Theory To State Securities Law And State Common Law Fraud Claims The fraud on the market theory may be available to establish reliance under state securities statutes. At least two federal courts have extended the fraud on the market theory to establish reliance with respect to pendent state common law fraud claims. In Hurley v. FDIC, 719 F. Supp. 27, 34 (D. Mass. 1989), the Court held that the fraud on the market presumption was applicable to plaintiff’s fraud claims arising under Massachusetts common law, even though no Massachusetts state court had adopted the theory. Similarly, in Minpeco S.A. v. Hunt, 718 F. Supp. 168, 176 (S.D.N.Y. 1989), the court applied the fraud on the market presumption to a common law fraud claim arising under New York law without any New York court having decided the issue. See also In re Sumitomo Copper Litig., 995 F. Supp. 451, 458 (S.D.N.Y. 1998) (citing Minpeco and In re Blech Sec. Litig., 961 F. Supp. 569, 587 (S.D.N.Y. 1997)). However, several district courts and state supreme courts have held that the fraud on the market theory is not applicable to state common law claims. See, e.g., Kaufman v. i-Stat Corp., 754 A.2d 1188, 1189 (N.J. 2000); Malone v. Brincat, 722 A.2d 5 (Del. 1998); Zuckerman v. Foxmeyer Health Corp., 4 F. Supp. 2d 618 (N.D. Tex. 1998); In re Information Res., Inc. Sec. Litig., No. 89 C 3772, 1994 WL 124890, at *4 (N.D. Ill. Apr. 11, 1994); Mirkin v. Wasserman, 5 Cal. 4th 1082, 1089-91 (1993). b. Rebutting The Presumption Of Reliance Although it preceded Basic, Blackie v. Barrack, 524 F.2d 891, 906 (9th Cir. 1975), delineated four basic ways that a defendant can rebut the presumption of reliance: (1) disproving materiality; (2) despite materiality, showing that an insufficient number of traders relied to inflate the price (i.e., the market was not efficient); (3) showing that an individual plaintiff purchased despite knowledge of the falsity of a representation; or (4) showing that an individual plaintiff would have purchased anyway had he known of the falsity of the representation. Id.; Kalnit v. Eichler, 85 F. Supp. 2d 232, 241 (S.D.N.Y. 1999) (holding fraud on the market theory creates rebuttable, not absolute, presumption of reliance); see also DeMarco v. Lehman Brothers Inc., 222 F.R.D. 243, 245-46 (S.D.N.Y. 2004) (the fraud on the market doctrine applies only where there is a showing that the statements materially impacted the market price in a reasonably quantifiable respect); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261, 265 (5th Cir. 2007) (“We now require more than proof of a material misstatement; we require proof that the misstatement actually moved the market.”) (emphasis in original). Where the plaintiffs consist of a class of persons as opposed to an individual, defendants can rebut the presumption of reliance by showing that “many” of the class members did not rely on the representation. Jaffe Pension Plan v. Household Int’l, Inc., No. 02 C 5893, 2005 U.S. Dist. LEXIS 8610, at *12 (E.D. Ill. April 18, 2005). However, showing that only one individual or a “handful” of persons did not rely on the integrity of the market when purchasing or selling their stock is insufficient to rebut the presumption. Id. (citing In re Lucent Techs. Inc. Sec. Litig., No. 00-621 (JAP), 2002 U.S. Dist. LEXIS 8799, at *4 (D.N.J. May 7, 2002) (“[T]he investment behavior of a handful of plaintiffs … cannot be extrapolated to represent the experience of a class of hundreds of thousands of individuals of which the putative class is comprised.”)). Defendants may also be able to rebut the presumption of reliance in a fraud on the market action by showing that sophisticated buyers, or “marketmakers,” were not taken in by the misrepresentations at issue. Cione v. Gorr, 843 F. Supp. 1199, 1202 (N.D. Ohio 1994); see also Phillips v. LCI Int’l, Inc., 190 F.3d 609, 617 (4th Cir. 1999) (“‘[E]ven lies are not actionable’ when an investor ‘possesses information sufficient to call the [mis]representation into question.’”) (second alteration in original)); Marksman Partners, L.P. v. Chantal Pharms. Corp., 927 F. Supp. 1297, 1307 n.6 (C.D. Cal. 1996). But see Hanon v. Dataproducts Corp., 976 F.2d 497, 506 (9th Cir. 1992) (“Sophisticated investors are as entitled to rely on the fraud-on-the-market theory as

anyone else.”).

1) Underdeveloped Or Inefficient Markets As noted above, defendants can rebut the presumption of reliance by, inter alia, showing that a plaintiff’s decision to purchase or sell shares was not influenced by the misstatements or that the misrepresentation did not in fact distort the price of the stock. In developing the fraud on the market theory, the Supreme Court in Basic emphasized “well-developed markets” which “reflect all publicly traded information and, hence, any material misrepresentations.” Basic Inc. v. Levinson, 485 U.S. 224, 246 (1988); see also In re Polymedica Corp. Sec. Litig., 224 F.R.D. 27, 43 (D. Mass. 2004) (deriving from Basic the definition of “efficient market” as that in which market professionals generally consider most publicly announced material statements about companies, not one in which stock price rapidly reflects all publicly available information). The critical factor in determining whether a market is open, developed, and efficient for purposes of the fraud on the market presumption is the trading characteristics of the individual stock itself. The location of where the stock trades may be relevant, but location is not dispositive of whether the current market price reflects all available information. Cammer v. Bloom, 711 F. Supp. 1264, 1281 (D.N.J. 1989) (applying fraud on the market presumption to claims of investors who purchased stock in the over-the-counter market and noting that ineligibility of issuer to file S-3 registration statement was not fatal to applicability of presumption); Hurley v. FDIC, 719 F. Supp. 27 (D. Mass. 1989) (holding the fraud on the market presumption applies to an over-thecounter traded security so long as the market for that security is an efficient and developed one, i.e., one that accurately reflects all public material information about a company in the price of the security). An initial public offering presents an interesting question as to whether the security is trading in an efficient market. See Comment, Robert G. Newkirk, Sufficient Efficiency: Fraud on the Market in the Initial Public Offering Context, 58 U. CHI. L. REV. 1393, 1422 (1991). Some courts have held that the market for an initial public offering is not efficient. In In re Initial Public Offering Securities Litigation, 471 F.3d 24 (2d Cir. 2006), the Second Circuit concluded that the “fraud on the market” presumption could not be applied because the market for IPO shares cannot be efficient under any circumstances. As “just one example” of why an efficient market could not be established with an IPO, the court pointed to the 25-day “quiet period” during which analysts cannot report concerning securities. Id. at 43. This “quiet period” necessarily precluded the contemporaneous “significant number of reports by securities analysts” that are characteristic of an efficient market. Id. (citing Freeman v. Laventhol & Horwath, 915 F.2d 193,199 (6th Cir. 1990)); see also Chavin v. McKelvey, 25 F. Supp. 2d 231, 238-39 (S.D.N.Y. 1998), aff’d, 182 F.3d 898 (2d Cir. 1999) (pre-IPO relinquishment of conversion rights not part of an efficient market); Gruber v. Price Waterhouse, 776 F. Supp. 1044 (E.D. Pa. 1991) (“Given this theoretical underpinning, the ‘fraud on the market’ theory cannot apply to initial public offerings.”); see generally In re Res. Am. Sec. Litig., 202 F.R.D. 177 (E.D. Pa. 2001) (providing extended analysis of Cammer factors and theory of efficient markets). But see In re Initial Public Offering Sec. Litig., 544 F. Supp. 2d 277, 295-96 (S.D.N.Y. 2008) (holding that while the primary market for IPO shares is not efficient, the secondary market that had developed in the days and weeks after the IPO, in which plaintiffs bought their shares, was efficient). Other cases have considered efficient markets in different securities contexts. See Chavin v. McKelvey, 25 F. Supp. 2d 231 (S.D.N.Y. 1998), aff’d, 182 F.3d 898 (2d Cir. 1999) (declining to apply fraud on the market theory when the stock was not publicly traded); Freeman v. Laventhol & Horwath, 915 F.2d 193, 198-99 (6th Cir. 1990) (finding primary market for newly issued municipal bonds not an efficient market); Lipton v. Documation, Inc., 734 F.2d 740, 746 (11th Cir. 1984) (“[I]t is not necessarily reasonable to presume that misinformation will affect the market price, as information on an undeveloped market does not readily affect market prices and, in the case of new securities, the price will be set by the offeror and underwriters, not the market.”); Epstein v. Am. Reserve Corp., No. 79 C 4767, 1988 WL 40500, at *5 (N.D. Ill. Apr. 21, 1988) (“We believe that the over-the-counter market is incapable of meeting the Supreme Court’s test in Basic Inc. v. Levinson for an efficient market.”). But see In re Am. Cont’l Corp./Lincoln Sav. & Loan Sec. Litig., 140 F.R.D. 425, 431-34 (D. Ariz. 1992) (applying fraud on the market theory to an offering of newly issued bonds, emphasizing the financial strength of the promoters and presumption of reliance on the “regulatory process”); In re Healthsouth Corp. Sec. Litig., 261 F.R.D. at 630-31 (finding market for defendant corporation’s bonds

was efficient). While the fraud on the market theory generally has not been applied to initial public offerings, some courts have recognized the related “fraud created the market” theory in limited circumstances, as discussed infra.

2) Truth On The Market Defense Courts also have adopted a “truth on the market” defense to rebut the “fraud on the market” presumption. If the information that is alleged to have been withheld from or misrepresented to the market has entered the market through other channels, the market will not have been misled and plaintiff’s claims will fail. See, e.g., Ganino v. Citizens Utilities Co., 228 F.3d 154, 167 (2d Cir. 2000) (“[A] misrepresentation is immaterial if the information is already known to the market because the misrepresentation cannot then defraud the market.”); Provenz v. Miller, 102 F.3d 1478, 1492 (9th Cir. 1996); Associated Randall Bank v. Griffin, Kubik, Stephens & Thompson, Inc., 3 F.3d 208, 213-14 (7th Cir. 1993); In re Apple Computer Sec. Litig., 886 F.2d 1109, 1111 (9th Cir. 1989) (“[T]he defendants’ failure to disclose material information may be excused where the information has been made credibly available to the market by other sources.”); Ley v. Visteon Corp., No. 05-CV-70737DT, 2006 WL 2559795 (E.D. Mich. Aug. 31, 2006) (dismissing claims based on defendants’ operations issues because the issues were discussed in analyst reports and newspaper articles during the class period), aff’d, 543 F.3d 801 (6th Cir. 2008); Iron Workers Local 16 Pension v. Hilb Rogal & Hobbs, 432 F. Supp. 2d 571, 582 (E.D. Va. 2006) (holding that the fraud on the market theory can cut both ways for a plaintiff because it not only includes information supporting a plaintiff’s theory of nondisclosure, but also information from other publicly available sources that may discredit that theory). Some courts have held that this defense is not available at the pleading stage, as it is fact-specific and best resolved on summary judgment motion or at trial. Asher v. Baxter Int’l Inc., 377 F.3d 727 (7th Cir. 2004) (reversing dismissal when there was a sharp drop in the stock price, despite defendant’s contention that the full truth had reached the market); Freeland v. Iridium World Commc’ns, Ltd., 545 F. Supp. 2d 59, 79 (D.D.C. 2008) (“Whether the purported corrective information was conveyed to the public with a degree of intensity and credibility sufficient to effectively counterbalance any misleading information created by the alleged misstatements is a fact-intensive inquiry.”); In re Globalstar Sec. Litig., No. 01 CIV. 1748, 2003 WL 22953163 (S.D.N.Y. Dec. 15, 2003); see also Kaplan v. Rose, 49 F.3d 1363, 1376-78 (9th Cir. 1994) (following Apple standard but finding that genuine issue of fact remained as to whether market was misled by misrepresentations and omissions). The information need only be retrievable by a “reasonable investor.” In re Discovery Labs. Sec. Litig., No. 06-1820, 2006 WL 3227767 (E.D. Pa. Nov. 1, 2006) (holding alleged misstatements were not actionable because of the widely known fact that the company would have to comply with FDA regulations and public reports of facility problems). In In re Stac Electronics Sec. Litig., 89 F.3d 1399, 1409 (9th Cir. 1996), the Ninth Circuit found that if customers knew that upgraded operating systems were likely to include data compression, the market was aware that Stac’s product could become obsolete. The court also noted that even without such disclosures, investors could easily have predicted that if Stac’s key product were to lose its market share, the company would be in serious trouble. Accordingly, the court held the foregoing “market awareness” precluded plaintiffs’ Section 10(b) claim for fraud on the market. Id. But see Kaplan v. Rose, 49 F.3d 1363, 1376-78 (9th Cir. 1994); In re Newbridge Networks Sec. Litig., 962 F. Supp. 166, 178 (D.D.C. 1997) (holding defendants had not effectively demonstrated that corrective information had credibly entered the market by pointing to a change in one analyst’s growth estimates); Marksman Partners, L.P. v. Chantal Pharms. Corp., 927 F. Supp. 1297, 130608 (C.D. Cal. 1996) (holding misleading statements were not counterbalanced by the marketing agreement attached to the 10-K where nothing in the body of the 10-K discussed the marketing agreement, explained the significance of its terms, or disclosed that revenues were being recognized while the buyer had a right of return or before the buyer was actually obligated to make payment). c. Variations On The Fraud On The Market Presumption

1) “Fraud Created The Market” Under the “fraud created the market” theory, investors are presumed to rely not on the integrity of the market price, but on the existence of a market for the security. Ross v. Bank South N.A., 885 F.2d 723, 729 (11th Cir. 1989). The “fraud created the market” theory is distinct from its more often discussed cousin, “fraud on the market,” and not as widely accepted. To invoke the “fraud created the market” presumption, plaintiffs must allege facts establishing that “but for” the fraud, the securities would never have been marketed at all. Id. at 729-30; Joseph v. Wiles, 223 F.3d 1155, 1164 (10th Cir. 2000) (“[I]n order to invoke the presumption of reliance” on the doctrine, the securities must have either “economic unmarketability” or “legal unmarketability.”); Kirkpatrick v. J.C. Bradford & Co., 827 F.2d 718, 723 (11th Cir. 1987). The theory has been attacked on several grounds and remains controversial. See, e.g., Ross v. Bank South, N.A., 885 F.2d 723, 732-45 (11th Cir. 1989) (Tjoflat, J., concurring).

(a) Evolution Of The “Fraud Created The Market” Theory In Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981) (en banc), a sharply divided Fifth Circuit (12-10) extended the fraud on the market doctrine under special circumstances to create a presumption of reliance in a case arising from an initial offering of unregistered tax-exempt bonds. Plaintiff had not reviewed an allegedly misleading offering circular. The Fifth Circuit, focusing on subsections (1) and (3) of Rule 10b-5 (schemes to defraud or course of business operating as a fraud) held that plaintiff could state a 10b-5 cause of action despite his lack of actual reliance if he could prove three conjunctive elements: (1) the defendants knowingly conspired to bring securities onto the market which were not entitled to be marketed, intending to defraud purchasers; (2) plaintiff reasonably relied on the bonds’ availability on the market as an indication of their apparent genuineness; and (3) plaintiff suffered a loss as a result of the scheme to defraud. Id. at 469-70. The Shores court observed that plaintiff would not recover if he proved only that the bonds would have been offered at a lower price or higher rate. Rather, plaintiff had to show that they would never have been issued at all. Id. at 470. The complaint in Shores met this requirement by alleging that defendants engaged in an elaborate scheme to create a bond issue that appeared genuine but was so lacking in basic requirements that the issue would never have been approved by the Board or presented by the underwriters except that the participants in the scheme acted with intent to defraud or reckless disregard for whether the other defendants were perpetrating a fraud. Id. at 468.

(b) Courts Utilizing The “Fraud Created The Market” Theory In T.J. Raney & Sons, Inc. v. Fort Cobb, Oklahoma Irrigation Fuel Authority, 717 F.2d 1330 (10th Cir. 1983), the Tenth Circuit found Shores persuasive and held that “plaintiff has stated grounds for relief by alleging that the defendants knowingly conspired to bring unlawfully issued Series C bonds to market with the intent to defraud, that it reasonably relied on the availability of the bonds as indicating their lawful issuance, and that it suffered injury resulting from the purchase of the bonds.” Id. at 1333; see also Arena Land & Inv. Co. v. Petty, 906 F. Supp. 1470, 1481 (D. Utah 1994), aff’d, 69 F.3d 547 (10th Cir. 1995) (finding that the theory is limited to situations where plaintiffs allege some illegality in the process of issuing the securities); Gruber v. Price Waterhouse, 776 F. Supp. 1044, 1052 (E.D. Pa. 1991) (holding doctrine applies only if business is an “absolute sham, worthless from the beginning”). The Tenth Circuit affirmed the “fraud created the market” theory’s validity but adopted the Sixth Circuit’s approach to narrowly constrain its scope. Joseph v. Wiles, 223 F.3d 1155, 1164 (10th Cir. 2000) (citing

Ockerman v. May Zima & Co., 27 F.3d 1151, 1160 (6th Cir. 1994)). This approach dictates that in order to qualify for a presumption of reliance, a security must be “unmarketable” in either an “economic” or “legal” respect. Joseph, 223 F.3d at 1164. The Joseph court cautioned, however, that “cases discussing the [fraud created the market] issue define ‘unmarketable’ strictly.” Id. To be economically unmarketable, a security must be “patently worthless;” to be legally unmarketable, issuance of a security must be legally prohibited by a regulatory or municipal agency. Id. Thus, where plaintiff suffered a “substantial loss,” but his debentures did not lack all economic value and were issued with legal authority, plaintiff is not entitled to a presumption of reliance. Id. at 1164-65. Additionally, in Rosenthal v. Dean Witter Reynolds, Inc., 945 F. Supp. 1412, 1418, 1420 (D. Colo. 1996), the court applied the “fraud-created-the-market” doctrine to securities-related allegations concerning the public offering of bonds. However, the court held that the doctrine “is reserved for those cases in which fraud ‘truly’ created the market.” Id. at 1419. The court ultimately rejected plaintiffs’ claims, finding that merely alleging that the bonds were “unworthy” of trading (instead of alleging that the bonds were unlawfully issued) could not establish that the fraud created the market. Id.; see also Dalton v. Alston & Bird, 741 F. Supp. 1322 (S.D. Ill. 1990) (rejecting a “no chance of success test” for fraud on the market in the new issue context, stating that almost any venture has some potential for success; the court held that, under Shores, a new issue is marketable at some price “if it is what it claims to be: a validly issued security, the terms of which are the same as the terms at which it is offered, the proceeds of which are intended to be used to finance some project; beyond this, investors in a new venture issue cannot rely on the integrity of an underdeveloped market to protect them from risk”). But see In re Healthsouth Corp. Sec. Litig., 261 F.R.D. at 642-44 (applying fraud-created-the-market theory where but for defendant’s fraud, its bonds could not have been issued at any price).

(c) Cases Rejecting Or Uncertain About The Fraud Created The Market Theory In Ross v. Bank South, N.A., 885 F.2d 723 (11th Cir. 1989), the Eleventh Circuit, sitting en banc, refused to overrule Shores and the fraud created the market theory. Id. at 730 n.11. Four of the judges who concurred in the result argued, however, that Shores should be overruled. One of the concurring judges argued that the Shores “reliance on marketability” holding should be overruled because (1) reliance on a primary market to exclude “unmarketable” bonds is unreasonable, (2) juries will find the distinctions drawn by Shores to be arbitrary and meaningless, and (3) the calculation of damages under Shores is problematic. Id. at 732-45 (Tjoflat, J., concurring). Nonetheless, the Court affirmed summary judgment in favor of defendants, holding that plaintiffs had failed to generate a genuine issue of fact as to marketability, finding that most of the facts about which plaintiffs were complaining were actually disclosed in the offering documents without any adverse effect on marketability. Id. at 730. In Desai v. Deutsche Bank Secs. Ltd., 573 F.3d 931 (9th Cir. 2009), the court called into question the continued viability of the “fraud created the market” theory. In George v. Cal. Infrastructure etc. Bank, 2010 U.S. Dist. LEXIS 57401 (E.D. Cal. June 10, 2010), the court relied on Desai in rejecting the doctrine. And in Malack v. BDO Seidman, LLP, 617 F.3d 743 (3d Cir. 2010), the court affirmed the district court’s refusal to certify a class based on rejection of the “fraud created the market” theory. Defendants can and should make several additional arguments that the Shores extension of the fraud on the market doctrine should not be adopted. First, defendants should argue that the theory ignores that a market for newly issued securities is not efficient and developed in the same manner as rational secondary markets because the price of newly issued securities is set primarily by the underwriter and the offeror, not the market. See Freeman v. Laventhol & Horwath, 915 F.2d 193 (6th Cir. 1990). Second, defendants should argue that the theory should be rejected because, by requiring a knowing conspiracy to market otherwise unmarketable securities, a Shores fraud on the market claim really is a species of traditional tort-conspiracy law and not a legitimate claim under the federal securities laws. Ross v. Bank South, N.A., 885

F.2d 723, 732-45 (11th Cir. 1989) (Tjoflat, J., concurring). Third, defendants may follow the lead of the Seventh Circuit. In Eckstein v. Balcor Film Investors, 8 F.3d 1121 (1993), aff’d, 58 F.3d 1161 (7th Cir. 1995), the Seventh Circuit rejected the fraud-created-the-market theory. The court held that the Shores doctrine (but for the fraud, the securities would be “unmarketable”) wrongly presupposes that requiring full disclosure of bad information keeps securities off the market. The court noted that shares of bankrupt companies and penny stocks trade freely. Finally, as an alternative, defendants should argue that, if adopted, the theory’s use should be highly limited and narrowly construed, i.e., applying only if plaintiffs establish that an illegality existed in the process of issuing the securities. See, e.g., Rosenthal v. Dean Witter Reynolds, Inc., 945 F. Supp. 1412 (D. Colo. 1996); Arena Land & Inv. Co., 906 F. Supp. 1470, 1481 (D. Utah 1994), aff’d, 69 F.3d 547 (10th Cir. 1995); In re T.J. Raney & Sons, Inc. v. Fort Cobb, Okla. Irrigation Fuel Auth., 717 F.2d 1330, 1333 (10th Cir. 1983).

2) Reliance On Integrity Of Regulatory Process Another variation of the “fraud on the market” theory is “fraud on the regulatory process.” This theory has been heavily criticized, however, and only a few cases (all within the Ninth Circuit) recognize its validity. See Joseph v. Wiles, 223 F.3d 1155, 1165 (10th Cir. 2000). The theory itself is grounded on the view that an investor’s decision relies “at least indirectly, on the integrity of the regulatory process and the truth of any representations made to the appropriate agencies and investors.” Sec. Investor Prot. Corp. v. BDO Seidman, LLP, 222 F.3d 63, 72 (2d Cir. 2000) (citation omitted) (rejecting theory in context of New York state common law claim). The primary criticism of the theory is that it expands the SEC’s role beyond its scope, and “appears to create a form of investor’s insurance.” Joseph, 223 F.3d at 1165. The “fraud on the regulatory process” theory was established in Arthur Young & Co. v. District Court, 549 F.2d 686 (9th Cir. 1977). In Arthur Young, the Ninth Circuit extended the fraud on the market doctrine to initial offerings of securities registered with the SEC. “The standardized statements appearing in the prospectuses were sent or shown to every investor in the partnerships. Just as the open market purchaser relies on the integrity of the market and the price of the security traded on the open market to reflect the true value of the securities in which he invests, so the purchaser of an original issue security relies, at least indirectly, on the integrity of the regulatory process and the truth of any representations made to the appropriate agencies and the investors at the time of the original issue.” Id. at 695; see also In re Am. Cont’l Corp./Lincoln Sav. & Loan Sec. Litig., 140 F.R.D. 425, 433-34 (D. Ariz. 1992). Arthur Young has been the object of attack, and, in his separate opinion in Basic, Justice White specifically cited the case as an example of the discredited version of the fraud on the market theory. Basic Inc. v. Levinson, 485 U.S. 224, 251 n.2 (1988) (White, J., concurring and dissenting); see also Joseph v. Wiles, 223 F.3d 1155, 1165 (10th Cir. 2000); In re Keegan Mgmt. Co. Sec. Litig., No. CIV. 91-20084 SW, 1991 WL 253003 (N.D. Cal. Sept. 10, 1991) (courts have been “hesitant to affirm [theory’s] continued validity after Basic”). Additionally, Arthur Young can be construed as improperly equating loss causation with transaction causation, both of which are separately necessary for a Rule 10b-5 claim. See, e.g., Bastian v. Petren Res. Corp., 892 F.2d 680, 683-84 (7th Cir. 1990). Finally, because regulators do not pass on the appropriateness of an IPO offering price, or on the truth of disclosures in a prospectus, the analytical underpinning for the Arthur Young presumption is absent. d. Reliance On Omissions And The Affiliated Ute Presumption In Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972), the Supreme Court held that where a fiduciary in a face-to-face transaction elected to “stand mute” and failed to disclose material facts, “positive

proof of reliance is not necessary to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of this [investment] decision.” Id. at 153-54. The Supreme Court held that the plaintiffs were entitled to a presumption of reliance, holding that in cases “involving primarily a failure to disclose [material facts], positive proof of reliance is not a prerequisite to recovery.” Id.; see also Joseph v. Wiles, 223 F.3d 1155, 1162 (10th Cir. 2000) (“[The] Affiliated Ute presumption of reliance exists in the first place to aid plaintiffs when reliance on a negative would be practically impossible.”). Despite the unique circumstances of Affiliated Ute (i.e., a fiduciary relationship between defendant and plaintiff, a face-to-face transaction, and defendant’s election to stand mute rather than partially disclose material information), many courts have interpreted Affiliated Ute to hold that a defendant’s alleged failure to disclose material information while under a duty to speak creates a rebuttable presumption of reliance See, e.g., Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 259 F.3d 154, 174 (3d Cir. 2001) (featuring extended discussion of cases applying Affiliated Ute); Rifkin v. Crow, 574 F.2d 256, 262 (5th Cir. 1978); Blackie v. Barrack, 524 F.2d 891, 905-06 (9th Cir. 1975). A duty to disclose under Section 10(b) does not arise from the mere possession of nonpublic market information. See Chiarella v. United States, 445 U.S. 222, 234 (1980). A duty arises only where one party has information that the other party is entitled to know because of a fiduciary or other relation of trust and confidence between them. Id. at 228. This rule applies to corporate insiders who have obtained confidential information by reason of their position in the corporation, and guarantees that those insiders, who have an obligation to place the shareholders’ welfare above their own, will not benefit personally through fraudulent use of material, nonpublic information. Id. at 230. Thus, a duty to speak arises only where a defendant has some relationship with the purchasers or sellers of the company’s securities. See id. at 232-33. Even absent a duty to speak, however, a party who discloses material facts in connection with securities transactions assumes a duty to speak fully and truthfully on those subjects. See In re Ford Motor Co. Sec. Litig., 381 F.3d 563, 569 (6th Cir. 2004). Not all courts have agreed with a liberal reading of the Affiliated Ute presumption of reliance. See, e.g., Desai v. Deutsche Bank Sec. Ltd., 573 F.3d 931, 941 (9th Cir. 2009) (“We cannot allow concealment to transform the alleged malfeasance into an omission rather than an affirmative act. To do otherwise would permit the Affiliated Ute presumption to swallow the reliance requirement almost completely.” (quoting Joseph v. Wiles, 223 F.3d 1155, 1163 (10th Cir. 2000))); Heliotrope Gen. Inc. v. Ford Motor Co., 189 F.3d 971, 975 (9th Cir. 1999) (“In a fraud-on-the-market case, an omission is actionable under Section 10(b) and Rule 10(b)(5) ‘only if the [allegedly undisclosed] information has not already entered the market;” moreover, Affiliated Ute does not apply to “mixed claims” that allege both misstatements and material omissions (quoting In re Convergent Techs. Sec. Litig., 948 F.2d 507, 513 (9th Cir. 1991))); Cavalier Carpets, Inc. v. Caylor, 746 F.2d 749, 756 (11th Cir. 1984) (“In order to be entitled to an Affiliated Ute presumption of reliance upon an omission obviating the requirement that plaintiffs must prove specific reliance upon a particular nondisclosure, plaintiffs must demonstrate that they generally relied upon the defendant in order to recover in a Rule 10b-5 case.”); but see Levitt v. J.P. Morgan Secs., Inc., 2010 U.S. Dist. LEXIS 68257 (E.D.N.Y. June 24, 2010) (disagreeing with Desai and applying Affiliated Ute to grant class certification). Most circuits now agree that “the Affiliated Ute presumption should not be applied to [mixed] cases that allege both misstatements and omissions unless the case can be characterized as one that primarily alleges omissions.” Binder v. Gillespie, 184 F.3d 1059, 1064 (9th Cir. 1999). Significantly, where there are “mixed claims” of both misstatements and omissions, the burden is on the plaintiff to show “that the gravamen of their case is [defendant’s] failure to disclose material facts, as contrasted with misrepresentation.” Krogman v. Sterritt, 202 F.R.D. 467, 478 (N.D. Tex. 2001). Thus, courts considering the Affiliated Ute presumption must engage in a close analysis of plaintiff’s allegations to determine whether a 10b-5 claim is predicated on affirmative misrepresentations requiring proof of reliance, or on omissions resulting in a rebuttable presumption of reliance. Not surprisingly, then, plaintiffs will often characterize a case which appears to be a misrepresentations case

(and thus not entitled to the Affiliated Ute presumption) as an omissions case. See, e.g., Griffin v. GK Intelligent Sys., Inc., 196 F.R.D. 298, 307 (S.D. Tex. 2000) (“Notwithstanding Plaintiffs’ belated attempt to recharacterize their complaint as one involving primarily a failure to disclose,” complaint predominantly was one involving misrepresentation). Plaintiff may go so far as to argue that the “omission” is the failure to reveal that the statement was false. Cavalier Carpets, 746 F.2d at 757; Vervaecke v. Chiles, Heider & Co., Inc., 578 F.2d 713, 717-18 (8th Cir. 1978). But see Little v. First Cal. Co., 532 F.2d 1302, 1304 n.4 (9th Cir. 1976) (“The categories of ‘omission’ and ‘misrepresentation’ are not mutually exclusive.”). e. Additional Issues Relating To Reliance 1) Effect Of Central Bank The Supreme Court eliminated private aiding and abetting causes of action under Section 10(b) in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994). In so ruling, the Court emphasized the importance of reliance. Id. at 180 (calling reliance an “element critical for recovery under 10b-5”). Thus, claims against secondary actors (such as attorneys and accountants) must allege that the secondary actor is actually a primary violator of the securities laws who made material misrepresentations (or omitted to disclose material information while under a duty to speak on which investors relied. See, e.g., In re Enron Sec., Derivative & ERISA Litig., Nos. H-01-3624, H-03-1087, H-03-3320, H-03-5332, H-03-5333, H-035334, H-03-5335, H-04-3330, 04-3331, 04-4455, H-01-3914, 2006 WL 3716669 (S.D. Tex. Dec. 12, 2006) (holding no primary liability for providing loans to entities that were part of Enron’s fraudulent scheme because actual fraud occurred only in the subsequent accounting violations), aff’d, 535 F.3d 325 (5th Cir. 2008); see also Simpson v. AOL Time Warner, 452 F.3d 1040 (9th Cir. 2006) vacated by Simpson v. Homestore.com, Inc., 519 F.3d 1041 (9th Cir. Mar. 26, 2008); Cromer Fin. Ltd. v. Berger, 205 F.R.D. 113, 131-32 (S.D.N.Y. 2001). In 2008, the Supreme Court again focused on reliance in rejecting a theory of “scheme liability,” which involved the concept that secondary actors, such as bankers, creditors, and attorneys, who do not themselves make misleading statements, are liable for assisting the company that does make misleading statements. See Stoneridge Inv. Partners, LLC v. Scientific-Atlantics, 552 U.S. 148 (2008). Because the secondary actors in Stoneridge had no duty to speak, and no member of the public had actual or presumed knowledge of the allegedly false statements made by the secondary actors, the plaintiffs could not show reliance on any of the secondary actors’ actions except in a manner that was too remote to find liability. Since the secondary actors in fact had made false statements, Stoneridge can be interpreted as an expansion of Central Bank. See also Desai v. Deutsche Bank Sec. Ltd., 573 F.3d 931, 942 (9th Cir. 2009) (affirming denial of class certification because the court determined that based on Stoneridge, a district court is not obligated to recognize theories of presumptive reliance beyond the two recognized in Stoneridge).

2) Plaintiff’s Diligence To Discover The True Facts Laser Mortg. Mgmt., Inc. v. Asset Securitization Corp., No. 00 CIV 8100 (NRB), 2001 WL 1029407, at *9 (S.D.N.Y. Sept. 6, 2001) (“An investor may not justifiably rely on a misrepresentation if, through minimal diligence, he should have discovered the truth.”); see also Brown v. E.F. Hutton Group, Inc., 991 F.2d 1020, 1032 (2d Cir. 1993) (citing Royal Am. Managers, Inc. v. IRC Holding Corp., 885 F.2d 1011, 1015-16 (2d Cir. 1989)). In determining whether an investor acted recklessly, and thus without justifiable reliance, courts consider the following factors: (1) the sophistication and expertise of the plaintiff in financial and securities matters; (2) the existence of longstanding business or personal relationships; (3) access to the relevant information; (4) the existence of a fiduciary relationship; (5) concealment of the fraud; (6) the opportunity to detect the fraud; (7) whether the plaintiff initiated the stock transaction or sought to expedite the transaction; and (8) the generality or specificity of the misrepresentations. Brown, 991 F.2d at 1032 (citations omitted). In

considering these factors, “no single factor is dispositive and all relevant factors must be considered and balanced.” Id. Other factors that shed light on the reasonableness of a plaintiff’s reliance, such as the context, complexity and magnitude of the transaction, may also counter the presumption of reliance. Emergent Capital Inv. Mgmt., LLC v. Stonepath Group Inc., 343 F.3d 189, 195 (2d Cir. 2003) (stating that the entire context of the transaction, including factors such as its complexity and magnitude, sophistication of the parties, and context of any agreement should be considered when determining reasonableness of plaintiff’s reliance); see also AES Corp. v. Dow Chem. Co., 325 F.3d 174, 179 (3d Cir. 2003) (holding that the terms of any agreement between parties may be among circumstances relevant to reliance in the context of establishing the effect of a non-reliance clause).

3) Forced Sale Doctrine Although reliance provides the necessary causal connection in a fraud case, reliance is not always synonymous with causation. Courts in “forced sale” cases recognize that even if a plaintiff knows a defendant has misrepresented or omitted material facts before he sells, such misrepresentation can be the cause in fact of plaintiff’s injury because misrepresentation is what places him in the position of having to sell. See Vine v. Beneficial Fin. Co., 374 F.2d 627 (2d Cir. 1967) (first articulating doctrine); Stitt v. Williams, 919 F.2d 516, 525 (9th Cir. 1990) (holding refinancing which damaged underlying equity of limited partnership but not the ownership interest not a forced sale). But see Grace v. Rosenstock, 228 F.3d 40, 49 (2d Cir. 2000) (holding plaintiffs do not meet forced sale test because “[n]o vote, sale of shares, or other action was required of minority shareholders in order to accomplish the merger”). The “forced sale” doctrine has been limited, significantly, to cases in which the transaction at issue effected a “fundamental change” in the plaintiff’s holdings. Rathborne v. Rathborne, 683 F.2d 914 (5th Cir. 1982); see also Isquith by Isquith v. Caremark Int’l, Inc., 136 F.3d 531, 535 (7th Cir. 1998) (“[T]he ‘forced seller’ doctrine is seen to be limited to situations in which the nature of the investor’s holding is so far altered as to allow the alteration to be characterized as a sale, as in the exchange of stock for cash.”); 7547 Corp. v. Parker & Parsley Dev. Partners, L.P., 38 F.3d 211, 229 (5th Cir. 1994) (“There is no question but that the plaintiffs’ allegations describe a complete alteration of their limited partnership investment.”). 12. Scienter a. Scienter Defined In a Rule 10b-5 fraud action, a plaintiff must allege that a defendant acted with “scienter,” i.e., an intent to defraud. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976). The Supreme Court in Ernst defined scienter as “a mental state embracing intent to deceive, manipulate, or defraud” but did not decide whether recklessness satisfied the scienter requirement under Section 10(b) and Rule 10b-5. Id. at 194 n.12. Nevertheless, courts in every federal circuit have found that a sufficient showing of recklessness satisfies the scienter requirement. The circuits differ, however, on how they define “recklessness” and on the type of conduct sufficient to qualify as evidence of scienter. See, e.g., Lipton v. Pathogenesis Corp., 284 F.3d 1027, 1034-39 (9th Cir. 2002); Aldridge v. A.T. Cross Corp., 284 F.3d 72, 78-84 (1st Cir. 2002); Abrams v. Baker Hughes Inc., 292 F.3d 424, 430-32 (5th Cir. 2002); Helwig v. Vencor, Inc., 251 F.3d 540, 550-52 (6th Cir. 2001); City of Philadelphia v. Fleming Cos., 264 F.3d 1245, 1259-63 (10th Cir. 2001); Novak v. Kasaks, 216 F.3d 300, 310-13 (2d Cir. 2000); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999); Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1283-84 (11th Cir. 1999), rev’d sub nom. Bryant v. Dupree, 252 F.3d 1161 (11th Cir. 2001). Most courts have adopted the Seventh Circuit’s recklessness standard, set forth in Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977). That standard defined reckless conduct as, “a highly unreasonable omission, involving not merely simple, or even inexcusable, negligence, but an extreme departure

from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious the actor must have been aware of it.” Id. The Ninth Circuit, while agreeing that recklessness may satisfy the scienter requirement under Section 10(b), requires in the wake of the Reform Act a showing of “deliberate recklessness,” or particularly egregious conduct that reflects some degree of conscious or intentional misconduct. See In re Silicon Graphics Inc., Sec. Litig., 183 F.3d 970 (9th Cir. 1999). In the Second Circuit, sufficiently reckless behavior is merely one basis from which intent may be inferred, but “[t]his showing of recklessness must be such that it gives rise to a strong inference of fraudulent intent.” Chill v. General Elec. Co., 101 F.3d 263, 267 (2d Cir. 1996). b. Pleading Scienter Prior To The Reform Act Before the Reform Act, courts differed as to the degree of specificity required for pleading scienter. The Ninth Circuit held that scienter may be averred generally, “that is, simply by saying that scienter exists.” In re GlenFed, Inc. Sec. Litig, 42 F.3d 1541, 1547 (9th Cir. 1994). The First Circuit required plaintiffs to plead facts giving rise to an “inference” of fraudulent intent. The Second Circuit went further, demanding a “strong inference” of intent. O’Brien v. Nat’l Prop. Analyst Partners, 936 F.2d 674, 676 (2d Cir. 1991). The Second Circuit recognized two distinct ways in which a plaintiff may plead scienter. Plaintiffs could either (1) “allege facts establishing a motive to commit fraud and an opportunity to do so,” or (2) “allege facts constituting circumstantial evidence of either reckless or conscious behavior.” In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 269 (2d Cir. 1993); Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994); Chill v. Gen. Elec. Co., 101 F.3d 263, 267 (2d Cir. 1996). c. The Reform Act Pleading Standard For Scienter In 1995, Congress passed the Private Securities Litigation Reform Act of 1995. The Reform Act requires that complaints in all securities fraud actions, not just class actions, allege with particularity facts giving rise to a “strong inference” that defendants acted with scienter. 15 U.S.C. § 78u-4(b)(2); see also Klein v. Autek Corp., 147 F. App’x 270, 273 (3d Cir. 2005) (“We note that 15 U.S.C. § 78u-4(b), which contains the heightened pleading requirements applicable to this matter, is titled ‘Requirements for securities fraud actions’ and plainly states that it applies to ‘any private action under this chapter,’ without reference to whether the action is brought as a class action or not.”). The Reform Act changed the pleading standard in several key ways: 1) The Reform Act clarified and amplified Rule 9(b) by requiring a complaint to “specify each statement alleged to have been misleading, [and] the reason or reasons why the statement is misleading.” 15 U.S.C § 78u-4(b)(1). Where a plaintiff alleges on “information and belief,” the Reform Act requires that the complaint “state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1). 2) The Reform Act imposed additional requirements for pleading scienter, requiring that a plaintiff “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C § 78u-4(b)(2). 3) The Reform Act ensures strict compliance with its standards by mandating that a complaint that does not meet them shall be dismissed. 15 U.S.C. § 78u-4(b)(3)(A). While the Reform Act resolved the debate over the strength of the “inference” of scienter, the Act left open the related issues of (1) what degree of “recklessness,” if any, satisfies the unspecified “state of mind” requirement, and (2) whether “motive and opportunity” allegations can provide, or even contribute to, the requisite “strong inference” of scienter. Since the Reform Act was enacted, courts have taken divergent views of the post-

Reform Act standards for pleading scienter and the extent to which Congress meant to codify fully the Second Circuit’s case law has been vigorously debated. See Section II.C.7 above for related discussion. d. The Post-Reform Act Debate The “strong inference” language was taken from Second Circuit case law interpreting the requirements of Federal Rules of Civil Procedure 8 and 9(b) in the context of securities fraud cases. See In re Time Warner, Inc. Sec. Litig., 9 F.3d 259, 269 (2d Cir. 1993). President Clinton cited this provision in his veto of the Reform Act because, in his view, the language in the Act’s legislative history indicated that Congress was adopting a standard that was more stringent than the Second Circuit’s standard at the time. After President Clinton’s veto and its subsequent Congressional override, commentators and courts for years debated whether the Reform Act codified the Second Circuit’s test for pleading scienter or set a higher standard.

1) The Supreme Court’s Decision In Tellabs As discussed in further detail below, plaintiffs, defendants and the appellate courts alike relied on statutory language and legislative history of the Reform Act to support their interpretations of the Reform Act, creating a split in the Circuits over the requirements for pleading a “strong inference” of scienter. In 2007, the United States Supreme Court addressed and resolved the split of authority in Tellabs, Inc. v. Makor Issues & Rights, 551 U.S. 308 (2007). The question presented in Tellabs was “whether, and to what extent, a court must consider competing inferences in determining whether a securities fraud complaint gives rise to a ‘strong inference’ of scienter.” Id. at 317-18. In reaching its conclusion, the Supreme Court found that the Seventh Circuit had failed to give sufficient weight to possible innocent explanations for the alleged fraud, and held that the “strong inference” standard requires consideration of both fraudulent inferences as well as innocent inferences. Id. at 324 (“[A] court must consider plausible nonculpable explanations for the defendant’s conduct as well as inferences favoring the plaintiff.”). To qualify as “strong,” an inference of scienter must be “cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Id. at 314. The Court noted that “omissions and ambiguities count against inferring scienter,” but a court must assess all the allegations “holistically” rather than in isolation. Id. at 326. The Court rejected Justice Scalia’s view that the inference of scienter should be more plausible than the inference of innocence. Id. at 324 n.5; see id. at 329 (Scalia, J., concurring). But see id. at 334 (Alito, J., concurring) (“[F]acts not stated with the requisite particularity cannot be considered in determining whether the strong-inference test is met.”). The lower courts generally read Tellabs to provide a three-step process for evaluating motions to dismiss Section 10(b) claims for failure to plead scienter sufficiently. First, the court must accept all allegations as true. Second, the court must consider whether all of the facts alleged, taken together, give rise to a strong inference of scienter. Third, the court must take into account plausible opposing inferences of nonfraudulent intent. This last requirement has had the most significant impact on district and circuit courts’ consideration of complaints asserting claims of securities fraud. Once the three steps are taken, the court determines whether the inference of scienter is cogent and at least as compelling as any plausible opposing inference. In most circuits, Tellabs appears to have made it harder for plaintiffs to plead scienter.

2) The Pre-Tellabs Circuit Split Before Tellabs was decided, the Second and Third Circuits had found that Congress meant to codify existing methods of pleading scienter, thus allowing plaintiffs to show scienter by alleging either motive and opportunity or evidence of reckless or conscious behavior sufficient to raise a strong inference of scienter. See Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000); In re Advanta Corp. Sec. Litig., 180 F.3d 525, 531 (3d Cir. 1999). Other courts had concluded that, in passing the Reform Act, Congress specifically sought to prohibit

plaintiffs from alleging mere motive and opportunity to commit fraud. See, e.g., In re Silicon Graphics Inc., Sec. Litig., 183 F.3d 970 (9th Cir. 1999); Bryant v. Avado Brands, Inc., 187 F.3d 1271 (1999), rev’d sub nom. Bryant v. Dupree, 252 F.3d 1161 (11th Cir. 2001). Still other circuits had taken a middle position and declined to “categorize” fact patterns; those courts called for more individualized, case-based fact analyses to determine whether the facts alleged in any particular complaint satisfied the requirement of pleading a strong inference of scienter under the Reform Act. See Greebel v. FTP Software, Inc., 194 F.3d 185 (1st Cir. 1999); Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir. 2001). Since Tellabs was decided in July 2007, several courts have had the opportunity to address the impact of the Supreme Court’s decision on their own interpretation of the “strong inference” requirement. Others have yet to undertake that analysis. Therefore, a summary of the standard in each circuit before Tellabs and, where possible, post-Tellabs is appropriate. e. First Circuit Prior to the Reform Act, the First Circuit, like most circuits, adopted the Seventh Circuit’s recklessness standard in Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1045 (7th Cir. 1977). After the Reform Act was enacted, the First Circuit held that the statute had not altered the state of mind requirement, and continued to utilize the Sundstrand recklessness test. GreebeL, 194 F.3d at 199-200. The court did find, however, that the Reform Act had heightened the standard for joint and several liability to actual knowledge, but stressed that the existing definition still sufficed for individual liability. Id. at 200-01. The Greebel court emphasized the importance of the Reform Act’s requirement that pleaded facts represent a “strong inference” rather than a mere “reasonable inference” of scienter, but indicated that fact pattern analysis would continue on a case-by-case basis to determine whether allegations supported scienter. Greebel, 194 F.3d at 196; see also Ezra Charitable Trust v. Tyco Int’l, Ltd., 466 F.3d 1 (1st Cir. 2006) (finding the fact that officers had recently assumed their positions undermined the inference of scienter). The court continued to disagree with other courts that concluded that the Reform Act specifically permits or forbids certain formalistic categories of scienter pleading, such as “motive and opportunity.” Id. at 197. The First Circuit allied itself with the Sixth Circuit’s holding in In re Comshare, Inc. Securities Litigation, 183 F.3d 542, 550 (6th Cir. 1999) (see below). Both courts held that evidence of motive and opportunity are relevant to pleading facts establishing scienter and “on occasion, could ‘rise to the level of creating a strong inference of reckless or knowing conduct.’” Greebel, 194 F.3d at 197 (citing In re Comshare, 183 F.3d at 551); accord Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1282-83 (1999), rev’d sub nom. Bryant v. Dupree, 252 F.3d 1161 (11th Cir. 2001). The First Circuit rejected the notion that a showing of motive and opportunity can never be enough to permit the drawing of a strong inference of scienter. Nevertheless, the court cautioned that “merely pleading motive and opportunity, regardless of the strength of the inferences to be drawn of scienter, is not enough.” Greebel, 194 F.3d at 197. The same day as the Supreme Court announced its Tellabs decision, the First Circuit issued an opinion in Rodriguez-Ortiz v. Margo Caribe, Inc., 490 F.3d 92 (1st Cir. 2007), holding that an inference of scienter is not strong when “there are legitimate explanations for the behavior that are equally convincing.” Id. at 96. The First Circuit’s conclusion is consistent with the Supreme Court’s analysis of “strong inference.” Nevertheless, the decision reaffirmed that the First Circuit avoids the use of any “rigid pleading formula” for determining the sufficiency of allegations of scienter, “instead ‘preferring to rely on a “fact-specific approach” that proceeds case by case. Id. On January 8, 2008, the First Circuit had its “first occasion to apply the Supreme Court’s recent guidance regarding the standards for pleadings under the PSLRA” in ACA Financial Guaranty Corp. v. Advest, Inc., 512 F.3d 46, 52 (1st Cir. 2008). The First Circuit concluded that Tellabs had “altered this circuit’s prior standard … for determining the sufficiency of pleadings of scienter in securities fraud cases.” Id. The First Circuit concluded that under Tellabs, and unlike prior circuit law, “where there are equally strong inferences for and against scienter, Tellabs now awards the draw to the plaintiff.” Id. at 59. In the past, the defendant enjoyed the benefit of equally strong inferences, and the complaint would be dismissed. Id. Nevertheless, the court noted

that Tellabs “affirms our case law that plaintiffs’ inferences of scienter should be weighed against competing inferences of non-culpable behavior” and “our rule that the complaint is considered as a whole rather than piecemeal.” Id. at 52. See also Miss. Public Employee’s Retirement Sys. v. Boston Scientific Corp., 523 F.3d 75 (1st Cir. 2008) (reversing district court’s dismissal for failure to adequately plead scienter and holding under Tellabs, the inference of scienter was at least as likely as the opposing nonculpable inference, and rejecting an inference negating scienter based on 10b5-1 trading plans due to insufficient facts regarding the plans). f. Second Circuit Before Tellabs, the Second Circuit interpreted the Reform Act pleading standard for scienter in Press v. Chemical Investment Services., Corp., 166 F.3d 529, 538 (2d Cir. 1999), stating that the PSLRA heightened the requirement for pleading scienter to the level already used by the Second Circuit. See also Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000); In re Philip Servs. Corp. Sec. Litig., 383 F. Supp. 2d 463 (S.D.N.Y. 2004). In Novak, the Second Circuit concluded that “the PSLRA effectively raised the nationwide pleading standard to that previously existing in this circuit and no higher (with the exception of the ‘with particularity’ requirement).” Novak, 216 F.3d at 310. The court cited Congress’s specific incorporation of the Second Circuit’s “strong inference” language and agreed with the Third Circuit’s holding in Advanta, discussed infra, that use of that language in the Act “establishes a pleading standard approximately equal in stringency to that of the Second Circuit.” Id. (citing In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999)). Noting prior case law, the court stated that a “strong inference” of scienter may be established either (a) by alleging facts showing that defendants had motive and opportunity to commit fraud; or (b) by alleging facts constituting strong circumstantial evidence of conscious misbehavior or recklessness. Novak, 216 F.3d at 307. The inference may arise where the complaint sufficiently alleges that the defendants: (1) benefited in a concrete and personal way from the purported fraud, (2) engaged in deliberately illegal behavior, (3) knew facts or had access to information suggesting that their public statements were not accurate, or (4) failed to check information they had a duty to monitor. Novak, 216 F.3d at 311; see also In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 392 (S.D.N.Y. 2003). The Second Circuit explained that a plaintiff cannot base allegations of motive on generic incentives possessed by almost all corporate executives, such as “the desire to maintain a high corporate credit rating or otherwise sustain the appearance of corporate profitability or of the success of an investment … [or] the desire to maintain a high stock price in order to increase executive compensation or prolong the benefits of holding corporate office.” Novak, 216 F.3d at 307 (citations and internal quotation marks omitted); see also In re PXRE Group, Ltd., Sec. Litig., 600 F. Supp. 2d 510, 531-32 (S.D.N.Y. 2009) (finding that the desire to maintain a high credit rating to raise money that is “desperately needed” or necessary “protect the very survival” of a company is far too generalized to allege the proper “concrete and personal” benefit required by the Second Circuit), aff’d sub nom. Condra v. PXRE Group Ltd., 2009 WL 4893719 (2d Cir. Dec. 21, 2009); In re Dynex Capital, Inc. Sec. Litig., No. 05 Civ. 1897(HB), 2006 WL 314524, at *5 (S.D.N.Y. Feb. 10, 2006) (holding allegations against particular individual must demonstrate culpability based on more than person’s position in corporate hierarchy); Goplen v. 51job, Inc., 453 F. Supp. 2d 759 (S.D.N.Y 2006) (finding generalized allegations of management access to inside information insufficiently particular to state claim); In re eSpeed, Inc. Sec. Litig., 457 F. Supp. 2d 266 (S.D.N.Y. 2006) (holding plaintiffs were required to allege that officers lacked reasonable basis for their cautious optimism, even though the electronic bond trading product ultimately failed); In re DRDGOLD Ltd. Sec. Litig., 472 F. Supp. 2d 562, 570 (S.D.N.Y. 2007) (holding a significant stock sale by just one corporate insider is insufficient to support the inference of fraudulent intent). The Second Circuit had its first opportunity to consider the impact of Tellabs in ATSI Communications, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007). The Second Circuit affirmed the dismissal of market manipulation claims for failure to plead scienter adequately. The court confirmed the Second Circuit’s jurisprudence requiring a showing either (1) that the defendants had both motive and opportunity to commit the fraud, or (2) facts constituting strong circumstantial evidence of conscious misbehavior or recklessness. Id. at

99. In light of Tellabs, however, the court acknowledged its obligation to consider and weigh competing inferences, and that the inference of scienter would be strong only if it was at least as compelling as any opposing inference one could draw from the facts. Id. Ultimately, the court found the allegations in the case too vague and speculative to meet even the motive and intent requirements, and concluded that there was a plausible, non-culpable reason for the defendants conduct, and so affirmed the district court’s dismissal of the complaint. See also South Cherry Street, LLC v. Hennessee Group LLC, 573 F.3d 98, 108-134 (2nd Cir. 2009). The sufficiency of alleging motive as a basis for scienter after Tellabs was addressed in In re Take-Two Interactive Sec. Litig., 551 F. Supp. 2d 247, 269-70 (S.D.N.Y. 2008). In Take-Two, the plaintiffs alleged that the defendants made misstatements concerning compliance with videogame rating requirements in order to improve profitability and avoid excessive costs. Id. In granting defendants’ motion to dismiss the claims, the court noted that “the desire to improve a company’s year-end financial numbers is essentially identical to the motive to maintain the appearance of corporate profitability, which does not give rise to an inference of scienter.” Id. at 270 (internal quotations omitted). Similarly, in ECA & Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187, 201-02 (2nd Cir. 2009), the Second Circuit held that the plaintiffs’ motive allegations that JP Morgan sought to inflate its stock price to reduce the cost of its acquisition of another financial institution did not establish a motive to defraud, rather it established a motive to increase profits. The court further stated that “[e]ven if [JP Morgan] was actively engaged in duping other institutions for the purpose of gaining at the expense of those institutions, it would not constitute a motive for [JP Morgan] to defraud its own investors.” Id. at 203. On the other hand, motive was sufficiently pled where a plaintiff alleged that defendants misrepresented corporate performance to inflate stock prices while they sold their own shares. See In re LaBranche Sec. Litig., 405 F. Supp. 2d 333, 356-357 (S.D.N.Y. 2005) (finding motive and opportunity supported by significance of stock price to defendant’s stock-based strategy of acquiring competitors, given the scope, impact and industrywide trend of acquisitions); Lapin v. Goldman Sachs Group Inc., 506 F. Supp. 2d. 221 (S.D.N.Y. 2006) (finding a strong inference of scienter where defendants had access to information about the conflict of interest in its analyst recommendations). Insider trading complaints must allege more than mere benefit; trades must be “unusual” in amount of profit earned, amount of stock traded, portions of stock sold, or number of insiders before they will be deemed sufficient to give rise to a strong inference of scienter. See Rothman v. Gregor, 220 F.3d 81, 94 (2d Cir. 2000). District courts within the Second Circuit have had more opportunities to consider the impact of Tellabs. The Southern District of New York recognized that the comparative analysis of the strength of the inference is an “addition to the PSLRA jurisprudence.” In re Top Tankers, Inc. Sec. Litig., 528 F. Supp. 2d. 408, 413 (S.D.N.Y. 2007) (describing Tellabs as “the only truly relevant case for assessing the viability of the scienter allegations” in the complaint, and dismissing complaint). The district court recognized that equally strong inferences weighed against dismissal. In addition, the court continued to apply the Second Circuit’s “motive and opportunity” and “strong circumstantial evidence of recklessness standards.” See also In re Comverse Tech., Inc. Sec. Litig., 543. F. Supp. 2d 134, 141-42 (E.D.N.Y. 2008) (considering motive and intent as part of Tellabs analysis of scienter allegations); In re Scottish RE Group Sec. Litig., 524 F. Supp. 2d 370 (S.D.N.Y. 2007) (finding scienter allegations adequate under Tellabs’ competing inference analysis); In re Openwave Sys. Sec. Litig., 528 F. Supp. 2d. 236 (S.D.N.Y. 2007) (denying motion to dismiss where defendants pointed to no competing inferences that could be rationally drawn from the facts alleged in options backdating scheme); In re Dynex Capital, Inc. Sec. Litig., No. 05-1897, 2009 WL 3380621, at *12 (S.D.N.Y. Oct. 19, 2009) (finding strong inference of scienter when a restatement is paired with allegations of direct information and supported by the fact that the misrepresentations involve the company’s “core operations”). g. Third Circuit The Third Circuit in In re Advanta Corp. Securities Litigation (which the First Circuit followed in Greebel), in considering the “strong inference” standard after the Reform Act was enacted, dismissed legislative history and

the presidential veto, finding it “ambiguous and even contradictory.” 180 F.3d 525, 531 (3d Cir. 1999). The court instead focused on the “plain language” of the statute, and concluded that Congress’ use of the Second Circuit language in the Reform Act established a standard “approximately equal in stringency to that of the Second Circuit.” Id. at 534. The Third Circuit held in Advanta that the Seventh Circuit’s Sundstrand recklessness standard, “remains a sufficient basis for liability.” 180 F.3d at 535. See also GSC Partners CDO Fund v. Washington, 368 F.3d 228, 239 (3d Cir. 2004) (quoting In re Advanta, 180 F.3d at 535); In re Alpharma Sec. Litig., 372 F.3d 137, 148-49 (3d Cir. 2004). The Advanta court stated that “[r]etaining recklessness not only is consistent with the [PSLRA’s] expressly procedural language, but also promotes the policy objectives of discouraging deliberate ignorance and preventing defendants from escaping liability solely because of the difficulty of proving conscious intent to commit fraud.” Id. The Advanta court stressed that adherence to the Second Circuit’s standard – which had been the most stringent standard nationwide before the Reform Act – would generally increase the difficulty of pleading scienter, as was clearly Congress’ intent. However, by adding the “particularity” requirement to the strong inference standard, the Reform Act raised the standard higher than that imposed in the Second Circuit. Thus, the court found that plaintiffs could indeed plead scienter by alleging facts establishing motive and opportunity, but those allegations must be supported by particular facts giving rise to a “strong inference” of scienter. Id. at 532. “Blanket” assertions will not suffice. Id. at 539; In re Bio-Tech. Gen. Corp., No. CIV.A. 02-6048(HAA), 2006 WL 3068553 (D.N.J. Oct. 26, 2006) (scienter allegation that accounting principle at issue was “simple” did not alone establish its violation as reckless), aff’d sub nom. In re Savient Pharms., Inc. Sec. Litig., 283 F. App’x 887 (3d Cir. 2008). Cf. In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256 (3d Cir. 2006) (holding complaint sufficiently alleged scienter as to two officers who sold a substantial amount of stock just before resigning and who boasted of close relationships with customers who had already pled guilty to fraud in connection with round-tripping scheme; also sufficiently alleged scienter as to auditors because evidence of the company’s “financial foul play was hiding in plain sight”); Baker v. MBNA Corp., No. 05-272, 2007 WL 2009673, at *7 (D. Del. July 6, 2007) (“[An officer’s] sale of nearly two-thirds of his stock holdings during the Class Period is sufficient to create the requisite inference of scienter.”); Aviva Partners LLC v. Exide Techs., No. 05-3098 (MLC), 2007 WL 789083, at *16-17 (D.N.J. Mar. 13, 2007) (applying Advanta and finding that plaintiffs adequately alleged “conscious misbehavior” by detailing specific facts that were known to the individual defendants at the time the alleged misstatements were made thereby constituting circumstantial evidence of reckless or conscious behavior without alleging that defendants “must have known” that their statements were false by virtue of their positions in the company). In insider trading cases, the Third Circuit also requires that the trades be “unusual.” See id. at 540-41; Oran v. Stafford, 226 F.3d 275, 290 (3d Cir. 2000). The Third Circuit addressed the “strong inference” standard again after Tellabs in Winer Family Trust v. Queen, 503 F.3d 319 (3d Cir. 2007). The court modified its existing jurisprudence to allow for competing inferences, as required by Tellabs. Specifically, the court held that an inference of scienter requires careful examination of all other likely inferences that could explain a defendant’s actions. Id. at 327. The Third Circuit therefore affirmed the district court’s decision to grant a motion to dismiss because “[a] reasonable person would not deem the inference of scienter cogent and at least as compelling as any nonculpable inference.” Id. at 329; see also Key Equity Investors, Inc. v. Sel-Lab Marketing, Inc., 246 F. App’x 780 (3d Cir. Sept. 6, 2007). In Institutional Investors Group v. Avaya, Inc., 564 F.3d 242 (3rd Cir. 2009), the Third Circuit noted that the Supreme Court in Tellabs made clear that allegations of scienter need not be irrefutable and that the relevant inquiry is whether all the facts alleged, taken collectively, give rise to a strong inference of scienter. Id. at 269. Accordingly, the court applied a “totality-of-the-circumstances” approach to determining the sufficiency of plaintiffs’ scienter allegations, rather than looking for the presence or absence of certain types of allegations. Id. Moreover, the court reevaluated Advanta, and held that attempts to establish scienter through proof of motive and opportunity alone is no longer tenable in light of Tellabs. Id. at 276. Thus, in light of Tellabs, allegations of motive and opportunity “are to be considered along with all other allegations in the complaint” rather than be “entitled to a special, independent status.” Id. at 277.

h. Fourth Circuit In examining the pleading standard for scienter pre-Tellabs, the Fourth Circuit noted the absence of any statutory language addressing particular methods of pleading and the inconclusive legislative history regarding the adoption of Second Circuit pleading standards. Ottmann v. Hanger Orthopedic Group, Inc., 353 F.3d 338, 345 (4th Cir. 2003). The Fourth Circuit opted for a flexible case-specific approach. See, e.g., Phillips v. LCI Int’l, 190 F.3d 609, 620-21 (4th Cir. 1999); Ottmann, 353 F.3d at 345 (citing Phillips, 190 F.3d at 620-21). The Fourth Circuit held that while the Reform Act did not alter the substantive standard for proving scienter in securities fraud actions, the Reform Act did, however, heighten the standard for pleading scienter by requiring allegations of particular facts raising a “strong inference” of the requisite state of mind. Phillips, 190 F.3d at 620. The Fourth Circuit also articulated the same definition of recklessness as the Third Circuit. Id.; see also Pub. Employees’ Ret. Ass’n of Colo. v. Deloitte & Touche LLP, 551 F.3d 305, 313-14 (4th Cir. 2009). Further, while facts demonstrating motive and opportunity to commit fraud may be relevant, the Fourth Circuit concluded that courts should not restrict their scienter inquiry by focusing on these specific categories of facts, but should instead examine all the allegations. Philips at 345-46. The Fourth Circuit considered the post-Tellabs standard in Cozzarelli v. Inspire Pharmaceuticals, 549 F.3d 618 (4th Cir. 2008), in which it affirmed the district court’s dismissal of the complaint for failure to establish a strong inference of scienter. Noting that the Tellabs decision required it to “determine whether plaintiffs’ inference of scienter is ‘cogent and at least as compelling’ as defendants’ inference of a legitimate business judgment,” the court ultimately found that the “most persuasive inference” to be drawn from the “record as a whole” was that defendants “acted with a lawful intent to protect their competitive interests” when they withheld information from the market. Id. at 628 (internal quotation marks omitted); see also In re BearingPoint, 525 F. Supp. 2d 759, 778 (E.D. Va. 2007) (granting motion to dismiss for failure to plead scienter adequately); In re aaiPharma Inc. Sec. Litig., 521 F. Supp. 2d 507 (E.D.N.C. 2007) (same). i. Fifth Circuit The Fifth Circuit addressed the pre-Tellabs pleading standard in Nathenson v. Zonagen, Inc., 267 F.3d 400 (5th Cir. 2001). Before the Reform Act, the Fifth Circuit had adopted the Seventh Circuit’s definition of recklessness. Nathenson, 267 F.3d at 408 (citing Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033 (7th Cir. 1977)). The Fifth Circuit in Nathenson took the majority view that the Reform Act had not altered the substantive scienter requirement, and found that “severe recklessness remains a basis for such liability.” Id. The court in Nathenson observed that the controversial “motive and opportunity” pleading “is proper only as an analytical device for assessing the logical strength of the inferences arising from particularized facts pled by a plaintiff to establish the necessary mental state.” Id. at 411. The Reform Act, according to the court, “neither mandated nor prohibited any particular method of establishing a strong inference of scienter.” Id. Like many circuits, the Fifth Circuit refused to find that the Reform Act prohibited motive and opportunity pleading altogether. However, voicing its distaste, the court stated that while “allegations of motive and opportunity may meaningfully enhance the strength of scienter … it would seem to be a rare set of circumstances indeed where those allegations alone are both sufficiently persuasive to give rise to a scienter inference of the necessary strength and yet at the same time there is no basis for further allegations also supportive of that inference” Id. at 412. Thus, while not rejecting motive and opportunity pleading outright, the Fifth Circuit generally rejects pleadings that merely allege motive and opportunity without further allegations to support a strong inference of scienter. See also Abrams v. Baker Hughes, Inc., 292 F.3d 424, 431 (5th Cir. 2002) (stating that the appropriate analysis, under Nathenson, is to consider whether all facts and circumstances “taken together” are sufficient to support the necessary strong inference of scienter); Goldstein v. MCI WorldCom, 340 F.3d 238, 250-51 (5th Cir. 2003) (holding that while allegations of motive and opportunity may meaningfully enhance the strength of inference of scienter, such allegations without more do not fulfill the Reform Act’s pleading requirements);

Cent. Laborers’ Pension Fund v. Integrated Elec. Servs. Inc., 497 F.3d 546, 555 (5th Cir. 2007) (holding the mere fact that officers signed a Sarbanes-Oxley Act Section 302 certification did not establish a strong inference of scienter because “otherwise scienter would be established in every case where there was an accounting error or an auditing mistake made by a publicly traded company, which would eviscerate the pleading requirements for scienter set forth in the PSLRA”). In Central Laborers’ Pension Fund, 497 F.3d at 551, the Fifth Circuit acknowledged its post-Tellabs obligation to consider competing inferences at the pleading stage in deciding whether a complaint pleads a strong inference of scienter. In weighing inferences, the Fifth Circuit concluded that neither mere GAAP violations nor incorrect Sarbanes-Oxley certifications, without more, raised a strong inference of scienter, that the use of confidential witnesses to plead scienter required specific details about the witnesses, and that the circumstances of alleged insider trading must be examined for plausible, nonculpable explanations. See id. at 553-56. In Flaherty & Crumrine Preferred Income Fund, Inc. v. TXU Corp., 565 F.3d 200, 208 (5th Cir. 2009), the Fifth Circuit reiterated that while “allegations of motive and opportunity standing alone will not suffice to meet the scienter requirement, motive and opportunity allegations may meaningfully enhance the strength of the inference of scienter.” Thus, the suspect fact that management recommended a dividend increase only days after the end of the corporation’s self-tender offer, was insufficient, without more, to establish a strong inference of scienter. Id. at 210; see also In re Cyberonics Inc. Sec. Litig., 523 F. Supp. 2d 547, 554 (S.D. Tex. 2007) (“[I]nsider trading can only be a strong enhancement of an inference of scienter, not an inference by itself, if the trading occurs at suspicious times or in suspicious amounts.”), aff’d sub nom. Catogas v. Cyberonics, Inc., 292 F. App’x 311 (5th Cir. 2008). j. Sixth Circuit Post-Reform Act cases in the Sixth Circuit interpreting the requirements of pleading scienter include In re Comshare Securities Litigation, 183 F.3d 542, 550 (6th Cir. 1999), Helwig v. Vencor, Inc., 251 F.3d 540 (6th Cir. 2001) (en banc), as well as PR Diamonds, Inc. v. Chandler, 364 F.3d 671, 681 (6th Cir. 2004) (citing Helwig, 251 F.3d at 550-51). Comshare adopted the First Circuit’s fact-specific approach. Similarly, the Helwig court held that the Reform Act’s requirement of a “strong inference that the defendant acted with the required state of mind” did not alter the substantive scienter requirement already adhered to by the Sixth Circuit. Helwig, 251 F.3d at 551. Thus, in the Sixth Circuit, the required state of mind remains recklessness, defined as “highly unreasonable conduct which is an extreme departure from the standards or ordinary care.” Id. at 550. “[T]he meaning of recklessness … is especially stringent when brought against an outside auditor.” PR Diamonds, 364 F.3d at 693. Specifically, “recklessness on the part of an independent auditor entails a mental state so culpable that it approximates an actual intent to aid in the fraud being perpetrated by the audited company.” Id. (internal quotation marks omitted); see also Fidel v. Farley, 392 F.3d 220, 226 (6th Cir. 2004). The Sixth Circuit requires that the totality of allegations pleaded must give rise to a strong inference of at least recklessness. PR Diamonds, 364 F.3d at 683. That requirement is consistent with Tellabs. Moreover, the Sixth Circuit had held that plaintiffs were entitled only to the most plausible of competing inferences. See Fidel, 392 F.3d at 227. The Sixth Circuit thus has acknowledged that “[f]acts regarding motive and opportunity may be relevant to pleading circumstances from which a strong inference of fraudulent scienter may be inferred, and may, on occasion, rise to the level of creating a strong inference of reckless or knowing conduct.” Comshare, 183 F.3d at 551 (internal quotation marks and citation omitted). As in the First Circuit, factual predicates in the Sixth Circuit are judged on a case-by-case basis under the strong inference standard and post-Reform Act heightened particularity requirements. The Sixth Circuit considered the impact of Tellabs in Frank v. Dana Corp., 547 F.3d 564, 570 (6th Cir. 2008), holding that the governing standard regarding an allegation of scienter is “whether Plaintiffs have made allegations that support an inference of scienter at least as compelling as competing nonculpable inferences.” District courts from within the circuit that have considered the question focused on the comparative inference analysis prescribed by the Supreme Court. In Ross v. Abercrombie & Fitch Co., 501 F. Supp. 2d 1102, 1106-7 (S.D. Ohio 2007), the district court cited both Tellabs and the Sixth Circuit’s decision in Fidel for the

proposition that the scienter inquiry “is inherently comparative” and that the inference need not be irrefutable, or even the most plausible of competing inferences. See id. at 1117 (refusing to dismiss complaint even though defendants raised plausible explanations for the events in the case); see also In re Diebold Sec. Litig., No. 5:05CV2873, 2008 WL 3927467 (N.D. Ohio Aug. 22, 2008) (conclusory, generalized allegations of accounting irregularities coupled with defendants’ access to internal financial documents alone are insufficient to raise a strong inference of scienter), aff’d sub nom. Konkol v. Diebold, Inc., 590 F.3d 390 (6th Cir. 2009); In re Proquest Sec. Litig., 527 F. Supp. 2d 728 (E.D. Mich. 2007); Nicholson v. N-Viro Int’l Corp., No. 3:06CV01669, 2007 WL 2994452, at *4 (N.D. Ohio Oct. 12, 2007). k. Seventh Circuit The Seventh Circuit ruled in 2006 on the post-Reform Act pleading standard in Makor Issues & Rights Ltd. v. Tellabs, Inc., 437 F.3d 588 (7th Cir. 2006), which ultimately led to the Supreme Court’s decision in Tellabs. The Seventh Circuit concluded in Tellabs that Congress did not intend to change the substantive scienter standard in passing the PSLRA, and applied the Seventh Circuit’s pre-Reform Act standard requiring “an extreme departure from the standards of ordinary care . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.” Id. (citing Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)). The court also held that in order to determine whether plaintiff has raised a “strong inference” of scienter under the PSLRA, courts must “examine all of the allegations in the complaint and then [] decide whether collectively they establish such an inference. Notably, the Seventh Circuit appeared to endorse a standard that would allow a complaint to survive even upon raising only a “reasonable” inference of scienter, as opposed to a “strong” one. Id. at 2505. On remand, from the Supreme Court, and in light of the standard articulated by the Court, the Seventh Circuit still found that the complaint in Tellabs sufficiently alleged scienter, even under the Supreme Court’s articulated standard, and again reversed the district court’s dismissal of the case. Makor Issues & Rights Ltd. v. Tellabs, Inc., 513 F.3d 702 (7th Cir. 2008). On remand, the district court ultimately granted summary judgment dismissing most of plaintiff’s claims. Makor Issues & Rights, Ltd. v. Tellabs, Inc., 2010 U.S. Dist. LEXIS 82444 (N.D. Ill. Aug. 13, 2010) (granting summary judgment to defendants on claims regarding quarterly and annual reports for one year, guidance for the following year, and a statement that end-user demand continued to grow, but denying summary judgment as to whether one particular statement was misleading and gave rise to control person liability). In the wake of the Supreme Court’s Tellabs decision, the Seventh Circuit considered what weight confidential witnesses testimony should receive at the pleading stage in Higginbotham v. Baxter International, Inc., 495 F.3d 753 (7th Cir. 2007). The court held that anonymity frustrates courts’ abilities to weigh plaintiffs’ favorable inferences from competing inferences. Id. at 757. Plaintiffs must eventually provide defendants with the identity of persons with relevant information (see Fed. R. Civ. P. 26(a)(1)(A)), so concealing names at the complaint stage “does nothing but obstruct the judiciary’s ability to implement the PSLRA.” Higginbotham, 495 F.3d at 757. Because Tellabs requires a court to evaluate what a complaint reveals and disregard what it conceals, allegations by “confidential witnesses” usually must be steeply discounted. Id. Thus, in the Seventh Circuit at least, the use of confidential witnesses is not a persuasive tool for pleading a strong inference of scienter. The Tellabs decision settles previous disagreement in the District Courts of the Seventh Circuit over the standard of scienter. Most courts had followed the Second Circuit’s approach. See, e.g., In re Motorola Sec. Litig., No. 03 C 287, 2004 WL 2032769, at *26 (N.D. Ill. Sep. 9, 2004); 766347 Ontario Ltd. v. Zurich Capital Markets Inc., 249 F. Supp. 2d 974 (N.D. Ill. 2003); Great Neck Capital Appreciation Inv. P’ship L.P. v. PricewaterhouseCoopers, LLP, 137 F. Supp. 2d 1114 (E.D. Wisc. 2001); In re Next Level Sys., Inc., No. 97 C 7362, 2000 WL 15091, at *4 (N.D.Ill. Jan. 6, 2000) (declining to adopt the Silicon Graphics standard, noting that “[t]he majority of courts agree with the Second Circuit, including those within this district”). A few courts reached the opposite conclusion, however, and rejected the Second Circuit approach as inconsistent with the Reform Act. See Great Neck Capital Appreciation Inv. P’ship L.P. v. PricewaterhouseCoopers, LLP, 137 F. Supp. 2d 1114, 1120 (E.D. Wisc. 2001); Danis v. USN Commc’ns, Inc., 73 F. Supp. 2d 923, 937-38 (N.D. Ill.

1999). l. Eighth Circuit The Eighth Circuit interpreted the post Reform Act scienter standard in Florida State Board of Administration v. Green Tree Financial Corp., 270 F.3d 645 (8th Cir. 2001) and in In re Navarre Corp. Securities Litigation, 299 F.3d 735 (8th Cir. 2002). The Eighth Circuit held that since the Reform Act had not changed the substantive scienter standard, plaintiffs could still plead under the Sunstrand recklessness standard. Green Tree Fin. Corp., 270 F.3d at 653-54. After surveying the “motive and opportunity” stances taken by the other circuits, and finding the legislative history ambiguous, the Eighth Circuit held that: (1) allegations of motive and opportunity are generally relevant to a fraud case, and a showing of unusual or heightened motive will often form an important part of a complaint that meets the Reform Act standard; (2) where circumstantial allegations that establish motive and opportunity also tend to show knowing or reckless misrepresentations, such allegations may meet the Reform Act standard, because they raise a strong inference of scienter, not merely because they establish motive and opportunity; and (3) without allegations of motive and opportunity, averments tending to show scienter would have to be particularly strong in order to meet the Reform Act standard. Id. at 660; see also In re Hutchinson Tech., Inc. Sec. Litig., 502 F. Supp. 2d 884, 898 (D. Minn. June 4, 2007) (“[M]otive-and-opportunity allegations must go beyond alleging a general desire to increase stock prices and officer compensation . . . . [they] must show that the particular defendant benefited in some concrete and personal way from the alleged fraud.”), aff’d, 536 F.3d 952 (8th Cir. 2008). The Eighth Circuit made the unique observation that motive and opportunity are not simply “allowed,” but may be substantively necessary to meet the Reform Act standard. While allegations of motive and opportunity may suffice, they will suffice only where they also tend to show knowing and reckless misrepresentations and, therefore, give rise to a strong inference of scienter. The Eighth Circuit addressed pleading standards under Tellabs in two cases in 2008. In In re Ceridian Corp. Sec. Litig., 542 F.3d 240, 244 (8th Cir. 2008), the Circuit Court noted that Tellabs added “an additional hurdle for Eighth Circuit plaintiffs to overcome to satisfy [their] pleading requirements” with its mandate that an inference of scienter must be at least as compelling as any opposing inference of fraud. Applying Tellabs’ holding, the Circuit Court affirmed the district court’s dismissal of plaintiffs’ claims. In Elam v. Niedorff, 544 F.3d 921 (8th Cir. 2008), the Eighth Circuit reached the same conclusion. In Horizon Asset Mgmt. Inc. v. H&R Block, Inc., 580 F.3d 755, 767 (8th Cir. 2009), the plaintiff argued that the defendant corporation’s scienter could be imputed from the allegations of the scienter of a corporate officer who was not a named defendant. The court noted that the appropriate standard for considering the pleading of corporate scienter under the PSLRA is an open question in the Eight Circuit. Id. But the court “assume[ed] for the sake of argument that [the non-defendant officer’s] state of mind can be imputed to the corporation,” and concluded that the scienter allegations were insufficient to raise a strong inference that the officer acted with scienter, and therefore held that the plaintiff failed to plead scienter adequately with respect to the corporation. Id. m. Ninth Circuit The Ninth Circuit interpreted the Reform Act scienter pleading standard in In re Silicon Graphics Inc. Sec. Litig., 183 F.3d 970 (9th Cir. 1999), where it took the most stringent approach of all the circuits to address the issue before the Supreme Court’s decision in Tellabs. See, e.g., Nursing Home Pension Fund v. Oracle Corp., 380 F.3d 1226, 1230 (9th Cir. 2004) (citing Silicon Graphics, 183 F.3d at 475); Ronconi v. Larkin, 253 F.3d 423 (9th Cir. 2001); In re Vantive Corp. Sec. Litig., 283 F.3d 1079 (9th Cir. 2002); Gompper v. VISX, Inc., 298 F.3d 893 (9th Cir. 2002). The Ninth Circuit expressly rejected the Second Circuit “motive and opportunity” standard, adopting instead a heightened standard requiring “deliberate or conscious recklessness.” Silicon Graphics, 183 F.3d at 974.

In Silicon Graphics, the Ninth Circuit held that plaintiffs must plead “in great detail, facts that constitute strong circumstantial evidence of deliberately reckless or conscious misconduct.” 183 F.3d at 974. “[M]indful that not all courts share [its] view,” the Ninth Circuit attempted in Silicon Graphics to reconcile Congress’ adoption of the Second Circuit’s “strong inference” language with Congressional refusal to codify Second Circuit case law interpreting the pleading standard. Id. at 974, 978-79. The Ninth Circuit is the only circuit to hold that the Reform Act raised the scienter standard to one of “deliberate recklessness.” See id. at 979. Prior to the Reform Act, the Ninth Circuit had also adopted the 7th Circuit’s standard of recklessness in Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033 (7th Cir. 1977). Afterwards, however, the Ninth Circuit “read the PSLRA language that the particular facts must give rise to a ‘strong inference … [of] the required state of mind’ to mean that the evidence must create a strong inference of, at a minimum, ‘deliberate recklessness.’” Silicon Graphics, 183 F.3d at 976. The Silicon Graphics court pointed to legislative history, determining that, because the Joint Committee had expressly declined to codify the Second Circuit’s “recklessness” standard, that it must have intended to strengthen that standard. Thus, plaintiffs “can no longer aver intent in general terms of mere ‘motive and opportunity’ or ‘recklessness,’ but rather, must state specific facts indicating no less than a degree of recklessness that strongly suggests actual intent.” Id. at 979. In explaining its holding, the court added, “We believe that this ‘deliberate recklessness’ standard best reconciles Congress’ adoption of the Second Circuit’s so-called ‘strong inference standard’ with its express refusal to codify that circuit’s two-prong … test.” Id. The court also pointed to the Congressional override of President Clinton’s veto of the Reform Act, which stemmed from his concern that the Act would elevate the standard above that already required in the Second Circuit. In overriding the veto, the court argued, Congress meant to show a deliberate intent to raise the pleading standard above that already in existence in the Second Circuit. Id. The Silicon Graphics court thus concluded that Congress adopted the Second Circuit’s “strong inference” language “only because it was facially more stringent than the ‘reasonable inference standard’ in other circuits.” Id. In so holding, the court also found that mere motive and opportunity pleading could not be sufficient to survive a motion to dismiss. Id. In fact, the court went even further, stating that plaintiffs “must state specific facts indicating no less than a degree of recklessness that strongly suggests actual intent.” Id. No other circuit has adopted this standard. The Ninth Circuit, under Silicon Graphics and its progeny, examines the totality of circumstances to determine whether plaintiffs have demonstrated the deliberate recklessness to raise a strong inference of scienter. Id. at 979 (examining plaintiff’s allegations regarding internal reports and stock sales); In re Vantive Corp. Sec. Litig., 283 F.3d 1079 (9th Cir. 2002) (examining plaintiffs’ allegations of misrepresentations, accounting manipulations, stock sales, and corporate transactions). Moreover, in considering all circumstances, “all reasonable inferences to be drawn from the allegations, including inferences unfavorable to the plaintiffs” must be considered. Gompper v. VISX, Inc., 298 F.3d 893, 896-97 (9th Cir. 2002) (considering only inferences favorable to plaintiffs’ position “would . . . eviscerate the PSLRA’s strong inference requirement by allowing plaintiffs to plead in a vacuum”). In No. 84 Employer-Teamsters Joint Council Pension Trust Fund v. America West Holding Corp., the Ninth Circuit found that allegations that were individually lacking were sufficient to meet the stringent pleading standards set forth in the PSLRA when considered collectively. 320 F.3d 920, 945 (9th Cir. 2003); see also Oracle, 380 F.3d at 1234. Further, a panel of the Ninth Circuit in dicta has expressed the view that the Silicon Graphics holding relates only to a pleading requirement, stating that the Reform Act “did not alter the substantive requirements for scienter under Section 10(b).” Howard v. Everex Sys., Inc., 228 F.3d 1057, 1064 (9th Cir. 2000). However, one court has extended the Silicon Graphics “deliberate recklessness” standard past the pleading stage, and to non-private actions. See S.E.C. v. Platforms Wireless Int’l Corp., 559 F. Supp. 2d 1091, 1097 n.3 (S.D. Cal. 2008) (applying “deliberate recklessness” standard to an SEC action at summary judgment stage).

When evaluating the totality of circumstances, the Ninth Circuit has often examined stock trades by insiders. In Silicon Graphics, the court stated that stock trades are only suspicious when “dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.” Silicon Graphics, 183 F.3d at 986; see also Langley Partners, LP v. Tripath Tech., Inc., No. C-05-4194, 2006 WL 563053, *5 (N.D. Cal. Mar. 7, 2006) (holding although the timing was suspicious plaintiff’s allegations of insider trading did not show scienter without a showing such trading was unusual for defendants); In re Nature’s Sunshine Prods. Sec. Litig., 486 F. Supp. 2d 1301, 1311 (D. Utah 2007) (finding plaintiff pled sufficient facts to show scienter where plaintiff pled that the defendant, having never sold stock previously, sold significant quantities of stock and received significant profits in great excess of his salary). In the past, great weight has been given to the percentage of stock sold. See, e.g., Am. W. Holding, 320 F.3d at 939. However, “when stock sales result in a truly astronomical figure, less weight [will be] given to the fact that they may represent a small portion of the defendant’s holdings.” Oracle, 380 F.3d at 1232 (involving sale of $900 million worth of stock representing only 2.1% of defendant’s holdings). On the other hand, if a defendant purchases stock during the class period, that fact will assist to tip the scienter balance in defendants’ favor, all other things being equal. In re Aspeon, Inc. Sec. Litig., 168 F. App’x 836, 838-40 (9th Cir. 2006) (finding complaint lacked particularity necessary to raise a strong inference of scienter because allegations did not detail how information was inaccurate or CEO obstructed audit; CEO’s stock purchase also indicated he knew or believed that issued statements were in fact accurate). In addition, the Northern District of California made several observations about the software industry that may inform the scienter analysis for high technology companies. In In re Siebel Systems, Inc. Securities Litigation, No. C 04-0983 CRB, 2005 WL 3555718 (N.D. Cal. Dec. 28, 2005), the district court held that the release of an improved version of software to address “kinks” and “bugs” did not mean that the company’s earlier positive statements about the previous version were false. “If that were the case, the federal securities laws would prevent software companies from making any positive statements about new software.” Id. at *4. The CFO’s statement that there was “little sign of improvement” one month before the end of a quarter of declining revenues also failed to support a scienter finding because “[i]t is common knowledge that high tech companies complete many deals in the last few days of a quarter in order to meet revenue projections.” Id. at *12. Post-Tellabs. In Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981 (9th Cir. 2009) the Ninth Circuit definitively established its post-Tellabs pleading standard for scienter under the Reform Act. In Zucco, the Court articulated the two-part test that is now required under Tellabs (a segmented, then a holistic analysis). However, the Court also reiterated the vitality of Silicon Graphics and its progeny by stating that “Tellabs did not materially alter the particularity requirements for scienter claims established in the court’s previous decisions, but instead only added an additional ‘holistic’ component to those requirements.” The ultimate holding of Zucco in affirming dismissal with prejudice and its analysis in rejecting plaintiffs’ arguments make it a particularly significant decision for defense counsel. Zucco is especially important in light of other recent Ninth Circuit decisions finding that plaintiffs had adequately pled scienter based on less specific factual allegations. See, e.g., Siracusano v. Matrixx Initiatives, Inc., 585 F.3d 1167, 1180-83 (9th Cir. 2009) (reversing dismissal for failure to plead scienter when plaintiffs had alleged that defendant made statements generally about the risks of product liability claims but gave no indication that a lawsuit had already been filed and thus the risk “may already have come to fruition”). In South Ferry LP #2 v. Killinger, 542 F.3d 776 (9th Cir. 2008), the Ninth Circuit held that “core operations” allegations, that is, allegations regarding management’s role in a company, may be relevant and help satisfy the PSLRA scienter requirement in three circumstances. Id. at 785. First, the allegations may be used along with other allegations, that when read together, create a strong inference of scienter. Id. Second, core operations allegations may independently satisfy the PSLRA where they are particular and suggest that defendants had actual exposure to the disputed information. Id. at 786. Finally, core operations allegations may “conceivably” meet the PSLRA where the nature of the relevant fact is of such prominence that it would be “absurd” to suggest that management was unaware of the matter. Id.; see also In re Countrywide Fin. Corp. Deriv. Litig., 554 F. Supp. 2d 1044 (C.D. Cal. 2008) (finding strong inference of scienter (i) as to outside directors based, in part, on oversight responsibilities of various board committees and (ii) as to officer defendants, because “they were involved in the day-to-day operation of the company”); McCasland v. FormFactor Inc., No. C 07-5545

SI, 2009 WL 2086168, at *5-6 (N.D. Cal. July 14, 2009) (holding that plaintiffs failed to meet South Ferry’s standard because the complaint did not identify any specific information that was either received or communicated by any defendant). The Ninth Circuit affirmed its Zucco ruling in Rubke v. Capitol Bancorp Ltd., 441 F.3d 1156, 1165 (9th Cir. 2009), noting that courts “can no longer summarily dismiss a complaint whose individual allegations are insufficient under the PSLRA” and that it “must perform a second holistic analysis to determine whether the complaint contains an inference of scienter that is greater than the sum of its parts.” The Rubke court applied the Tellabs/Zucco standard and determined that plaintiffs had failed to demonstrate with particularity that defendants made statements or omissions “intentionally or with deliberate recklessness.” Id. at 1166. Prior to Zucco, District Courts within the Ninth Circuit applied the Tellabs standards with varying results. In In re Countrywide Financial Corp. Derivative Litigation, 554 F. Supp. 2d 1044, 1050-51 (C.D. Cal. 2008) plaintiffs alleged that the individual defendants, directors and officers of Countrywide, misled the public as to the type of loans the company was willing to issue. In denying the motion to dismiss, the court found that scienter had been adequately pled due to the statements of confidential witnesses and the oversight responsibilities of the board committees. Id. at 1058-63. Specifically, the court found that members of the Audit & Ethics Committee were required to oversee Countrywide’s risk management practices, and therefore a strong inference of scienter was pled where the committee members ignored “red flags” related to delinquencies, negative amortizations, and other signs of non-performance. Id. at 1063. On the other hand, the court in In re Impac Mortgage Holdings, Inc. Securities Litigation, 554 F. Supp. 2d 1083 (C.D. Cal. 2008) dismissed the plaintiffs’ claims with prejudice after finding that the claims failed to plead scienter under the “deliberate recklessness” standard. The Impac court noted that even if the individual defendant knew that the company was taking on increasingly risky loans or that the company operated in a “do any deal” culture, such did not establish deceitfulness in stating publicly that he “anticipated solid loan acquisitions” by the company. Id. at 1100. In In re InfoSonics Securities Litigation, No. 06-cv-1231-BTM, 2007 WL 2301757, at *4-8 (S.D. Cal. Aug. 7, 2007), the court found that plaintiffs’ claims regarding improper accounting for warrants, which eventually resulted in a restatement, did not meet the heightened pleading standards enunciated in Tellabs. Plaintiffs failed to allege scienter adequately because statements of a confidential witness alleging that management knew the restatement would be necessary failed to state how the witness knew that management was aware the warrants were misclassified. By contrast, allegations regarding misstatements about certain product sales withstood the motion to dismiss because management was aware that a series of defective product shipments had derailed the business but continued to make affirmative representations to the public that the products were well received and that they were excited about growth opportunities in the U.S. market. See also In re Impax Labs., Inc. Sec. Litig., No. C 04-04802 JW, 2007 U.S. Dist. LEXIS 52356, at *31-32 (N.D. Cal. July 18, 2007) (finding that significant GAAP violations as well as likelihood that high-ranking officers were aware of wrongdoing established a “strong inference” of scienter); Commc’ns Workers of Am. Plan for Employees’ Pensions & Death Benefits v. CSK Auto Corp., 525 F. Supp. 2d 1116 (D. Ariz. 2007) (describing Tellabs’ equal-inference approach as “a tie goes to the plaintiff”). n. Tenth Circuit The Tenth Circuit interpreted the scienter pleading standard in Philadelphia v. Fleming Cos. Inc., 264 F.3d 1245 (10th Cir. 2001). Like the First, Second, Third, Sixth, and Eleventh Circuits before it, the Tenth Circuit found that “plaintiffs can adequately plead scienter by setting forth facts raising a ‘strong inference’ of intentional or reckless misconduct.” Fleming, 264 F.3d at 1259. The Tenth Circuit defines recklessness as “conduct that is an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.” Id. However, recognizing that courts in general “have been cautious about imposing liability for securities fraud based on reckless conduct,” the Tenth Circuit has limited its scope. Id. at 1260. The court reviewed the facts of the case under the Second Circuit’s recklessness standard in Novak. Id. (citing Novak v. Kasaks, 216 F.3d 300, 308 (2d Cir. 2000)).

As for motive and opportunity pleading, the court adopted what it called the “middle ground chosen by the First and Sixth Circuits, and arguably by the Eleventh Circuit.” Id. at 1261-62. In doing so, the Tenth Circuit held that the “totality of the pleadings” was determinative in whether allegations permitted a “strong inference” of fraudulent intent. Id.; see also Pirraglia v. Novell, Inc., 339 F.3d 1182, 1187 (10th Cir. 2003). Like those “middle” circuits, the Tenth Circuit found that “[a]llegations of motive and opportunity may be important to that totality, but typically are not sufficient in themselves to establish a ‘strong inference’ of scienter.” Fleming, 264 F.3d at 1261-62; see also Andropolis v. Red Robin Gourmet Burgers, Inc., 505 F. Supp. 2d 662 (D. Colo. 2007) (holding that the lack of allegations of insider trading, when combined with the allegations of motive and opportunity shared by all corporate managers to raise stock price, warrant dismissal based on lack of scienter). As such, the Tenth Circuit rejected “defined, formalistic categories such as ‘motive and opportunity’” to determine whether the plaintiffs’ allegations overall give rise to a strong inference of scienter. Fleming, 264 F.3d at 1262. To establish scienter for allegations concerning non-disclosure, plaintiff must demonstrate that the defendant knew of the potentially material fact, and knew that failure to reveal the potentially material fact would likely mislead investors. Id. The Tenth Circuit has yet to revisit the PSLRA pleading standard in the wake of Tellabs. However, at least one district court in the Tenth Circuit has applied Tellabs in a way that substantially – although not completely – mirrors the Circuit’s pre-Tellabs standards. In New Jersey v. Sprint Corp., 531 F. Supp. 2d 1273, 1281 (D. Kan. 2008), the court denied defendants’ motion for judgment on the pleadings – filed by defendants following the Tellabs decision – observing that the Tenth Circuit’s Pirraglia standard for pleading scienter is substantially similar to the standard adopted by the Court in Tellabs. The court, however, noted that Pirraglia left open the possibility that an inference of scienter could be deemed sufficiently “strong” to survive a motion to dismiss even if an innocent inference tips the scales ever so slightly. Id. This result would be impermissible under Tellabs. Id. When the securities fraud claim is brought against an outside auditor, several courts within the Tenth Circuit have defined recklessness “as requir[ing] more than a misapplication of accounting principles. [Plaintiffs] must prove that the accounting the accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts.” In re Imergent Sec. Litig., No. 2:05-CV-204, 2009 WL 3731965, at *7 (D. Utah Nov. 2, 2009) (citations omitted). o. Eleventh Circuit The Eleventh Circuit first interpreted the effect of the Reform Act on the scienter pleading standard in Bryant v. Avado Brands, Inc., 187 F.3d 1271, 1283-84 (11th Cir. 1999). Explicitly rejecting the Ninth Circuit’s holding in Silicon Graphics, the Eleventh Circuit held that severe recklessness still sufficed to plead scienter in a securities fraud case. Bryant, 187 F.3d at 1283; see also Phillips v. Scientific-Atlanta, Inc., 374 F.3d 1015, 1018-19 (11th Cir. 2004). Prior to the Reform Act, the Eleventh Circuit had adopted the “recklessness” standard articulated in Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033 (7th Cir. 1977). Bryant, 187 F.3d at 1282, n.18. In Bryant, the court found that the Reform Act had not substantively raised the necessary level of scienter, but merely incorporated the reckless behavior standard already in general use by the federal courts. Id. at 1284. The court rejected the Silicon Graphics view as inconsistent with the plain language of the statute. Id. The court further suggested that had Congress “desired to require some other state of mind, that is, other than the reckless state of mind then uniformly held sufficient by the federal courts … [it] would have done so in explicit terms.” Id. at 1284. However, the court also refuted the contention that the Reform Act had codified the Second Circuit test, noting that the Act made “no express mention of the motive and opportunity test.” Id. at 1285. The court interpreted

the Reform Act’s language to mean that the plaintiff must state with particularity facts leading to a strong inference of “severe recklessness.” Therefore, allegations of motive and opportunity (without more), while relevant, could not be sufficient to show a “strong inference” of scienter. Id. at 1285-86. The court was particularly persuaded by the fact that only two circuits, the Second and Ninth, had allowed motive and opportunity pleading at the time the Reform Act was enacted. Id. at 1286. Thus, the court found that it was “certainly not so well-established that it was codified sub silentio.” Id. The Eleventh Circuit aligned itself with the Sixth Circuit’s holding in In re Comshare Securities Litigation, 183 F.3d 542, 550 (6th Cir. 1999), but when the Sixth Circuit revisited the issue in Helwig, it contended that the Eleventh Circuit had interpreted its Comshare decision in an “unduly rigid” way. The Sixth Circuit had left open the possibility that, under some fact patterns, motive and opportunity could be sufficient to plead scienter. Helwig, 251 F.3d at 550. The Eleventh Circuit recently addressed the impact of Tellabs in Mizzaro v. Home Depot, Inc., 544 F.3d 1230, 1238 (11th Cir. 2008). The court highlighted that though the PSLRA “raised the pleading standard for scienter, it did not change the substantive intent requirements.” Id. (emphasis in original). Reiterating the “recklessness” standard outlined in Bryant, the court outlined a “stringent” scienter standard: to withstand a motion to dismiss, plaintiff “must (in addition to pleading all of the other elements of a § 10(b) claim) plead with particularity facts giving rise to a strong inference that the defendants either intended to defraud investors or were severely reckless when they made the allegedly materially false or incomplete statements.” Id. (internal quotation marks omitted). A court must take into account “all of the facts alleged,” which is an “inherently comparative” exercise. Id. (citing Tellabs). The court emphasized that the test under Tellabs is different from the summary judgment standard, as “it asks what a reasonable person would think, not what a reasonable person could think.” Id. at 1239 (emphasis in original). The court rejected plaintiffs’ “must have known” theory, among other reasons, because the fraud was not complex in nature, the amount of the fraud was speculative, and the type of fraud alleged would be difficult for senior management to detect. Id. at 1251. p. DC Circuit The D.C. Circuit first interpreted the post-Reform Act scienter pleading standard in Rockies Fund, Inc. v. S.E.C., 428 F.3d 1088 (D.C. Cir. 2005). This case provided no background regarding the court’s decision making process in adopting the pleading standard, but rather simply reiterated its pre-Reform Act standard found in S.E.C. v. Steadman, 967 F.2d 636, 641 (D.C. Cir. 1992). The court in Rockies Fund held that in order to plead a strong inference of scienter, a plaintiff is required to show that a defendant acted with “extreme recklessness.” 428 F.3d at 1093; see also Liberty Prop. Trust v. Republic Props. Corp., 577 F.3d 335, 342 (D.C. Cir. 2009) (“Either intentional wrongdoing or ‘extreme recklessness’ satisfies the standard.”). Extreme recklessness is defined by the D.C. Circuit as an “extreme departure from the standards of ordinary care … which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it. In other words, extreme recklessness requires a stronger showing than simple recklessness but does not rise to the level of specific intent.” Rockies Fund, Inc., 428 F.3d at 1093; see also Belizan v. Hershon, 495 F.3d 686 (D.C. Cir. 2007) (applying Tellabs to securities fraud allegations). At least one district court in the D.C. Circuit has rejected the “core operations” theory, holding that a generalized assertion that the defendants’ corporate positions exposed them to confidential information and thus they “should have known” of false statements, does not warrant an inference of scienter in the absence of details regarding what this information entailed, when the defendants received it, or how it related to the alleged fraud. Stevens v. InPhonic, Inc., 662 F. Supp. 2d 105, 121 (D.D.C. 2009). q. Corporate Scienter While establishing scienter against an individual is accomplished by pleading and proving the requisite mental state of the individual, establishing scienter for a corporation can be more complex. Courts agree that a

corporation acts with scienter if the authorized corporate agent making a false statement acted with scienter. See, e.g., Southland Sec. Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353, 366 (5th Cir. 2004) (explaining that corporate scienter is established by looking “to the state of mind of the individual corporate official or officials who make or issue the statement”); In re Cabletron Sys., Inc., 311 F.3d 11, 40 (1st Cir. 2002) (“The scienter alleged against the company’s agents is enough to plead scienter for the company.”). The more difficult question is whether a plaintiff, under a “collective scienter” theory, can plead and prove corporate scienter when the person responsible for the misstatement was not aware of the truth but some other corporate employee was, or when no single corporate employee knew the truth but the aggregate knowledge of several employees would have revealed it. Most courts have expressly or implicitly rejected the collective scienter approach, requiring proof that the person responsible for the misstatement had scienter. See Garfield v. NDC Health Corp., 466 F.3d 1255, 126367 (11th Cir. 2006) (holding that scienter was not pleaded where complaint did not allege specifically that officers who signed certifications to financial statements required by SOX were presented with reasons to doubt the financial statements, even though a “management level employee” allegedly notified outside auditors of revenue recognition problems); In re Tyson Foods, Inc. Sec. Litig., 155 F. App’x 53, 57 (3rd Cir. 2005) (“Having concluded that there is no primary liability on the part of any of the individual officers, the District Court properly held that Tyson Foods could not itself be primarily liable under the facts of this case.”); Nordstrom, Inc. v. Chubb & Son, Inc., 54 F.3d 1424, 1435 (9th Cir.1995) (“there is no case law supporting an independent ‘collective scienter’ theory,” i.e., the theory “that a corporation’s scienter could be different from that of an individual director or officer”); Teachers’ Retirement System v. Hunter, 477 F.3d 162, 184 (4th Cir. 2007) (“[I]f the defendant is a corporation, the plaintiff must allege facts that support a strong inference of scienter with respect to at least one authorized agent of the corporation, since corporate liability derives from the actions of its agents.”); Southland, 365 F.3d at 366 (stating that a court must look to the state of mind of the individuals “who make or issue the statement (or order or approve it or its making or issuance, or who furnish information or language for inclusion therein, or the like) rather than generally to the collective knowledge of all the corporation’s officers and employees acquired in the course of their employment.”); Phillips v. Scientific-Atlanta, Inc., 374 F.3d 1015, 1018 (11th Cir. 2004) (stating in dictum that “the most plausible reading [of the PSLRA] in light of congressional intent is that a plaintiff, to proceed beyond the pleading stage, must allege facts sufficiently demonstrating each defendant’s state of mind regarding his or her violations.”); see also In re Medtronic Inc., Sec. Litig., 618 F. Supp. 2d 1016, 1035 (D. Minn. 2009) (“While the Eighth Circuit has not directly addressed the issue of ‘collective scienter,’ … the Court will not apply [the doctrine], requiring instead that the Plaintiffs establish corporate scienter by adequately alleging the scienter of individual corporate officers.”); Zavolta v. Lord, Abbett & Co. LLC, 2010 U.S. Dist. LEXIS 16491 (D.N.J. 2010) (questioning whether Third Circuit would recognize concept of corporate scienter without identifying responsible individuals); City of Roseville Empl. Ret. Sys. v. Horizon Lines, Inc., 686 F. Supp. 2d 404 (D. Del. 2010) (scienter of low-level employees could not be attributed to high level employees or to corporation). Some circuit courts have indicated that, at least at the pleading stage, a plaintiff may allege scienter on the part of a corporate defendant without pleading scienter as to any particular employee. For example, in City of Monroe Employees Retirement Sys. v. Bridgestone Corp., 399 F.3d 651, 690 (6th Cir. 2005), the Sixth Circuit permitted a securities class action against a corporation to proceed even though the complaint failed to allege that the corporate agent whose scienter was imputed to the corporation “played any role in drafting, reviewing, or approving” the allegedly false representations or “that he was, as a matter of practice, or by job description, typically involved in the creation of such documents.” In affirming the dismissal of the claims against the corporate agent, the court acknowledged that “it might seem incongruous to reach this conclusion after relying in part on [his] knowledge … as a basis for [the corporation’s] scienter.” Id. at 690 n.34. In Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F.3d 702, 710 (7th Cir. 2008), the Seventh Circuit in dicta noted that “it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud.” The court gave the following as a hypothetical example of such a situation: “Suppose General Motors announced that it had sold one million SUVs in 2006, and the actual number was zero. There would a strong inference of corporate scienter, since so dramatic an announcement would have been approved by corporate officials sufficiently knowledgeable about the company

to know that the announcement was false.” Id. Thus, the Seventh Circuit has indicated that at the pleading stage, some fraudulent statements may be so flagrant as to support allegations of corporate scienter even when the knowledge of individual agents cannot be determined. The Second Circuit in Teamsters Local 445 Freight Div. Pension Fund v. Dynex Capital, Inc., 531 F.3d 190, 195 (2nd Cir. 2008), distinguished between “pleading rules and liability rules,” and explained that in pleading scienter “it is possible to raise the required inference with regard to a corporate defendant without doing so with regard to a specific individual defendant.” Thus, for pleading purposes, a plaintiff need only plead facts that “create a strong inference that someone whose intent could be imputed to the corporation acted with the requisite scienter,” without actually having to identify that someone. However, to succeed on the merits, a plaintiff must “prove that an agent of the corporation committed a culpable act with the requisite scienter, and that the act (and accompanying mental state) are attributable to the corporation.” Id.; cf. Defer LP v. Raymond James Fin., Inc., 654 F. Supp. 2d 204, 218-19 (S.D.N.Y. 2009) (refusing to aggregate the knowledge of two or more separate corporate entities to infer collective corporate scienter on the basis that they share the same parent and nothing more). But see In re Worldcom, Inc., Sec. Litig., 352 F. Supp. 2d 472, 497 (S.D.N.Y. 2005) (“[T]o carry their burden of showing that a corporate defendant acted with scienter, plaintiffs in securities fraud cases need not prove that any one individual employee of a corporate defendant also acted with scienter. Proof of a corporation’s collective knowledge and intent is sufficient.”); In re MBIA, Inc. Sec. Litig., 700 F. Supp. 2d 566 (E.D.N.Y. 2010 (corporate scienter adequately alleged via claims of confidential witnesses about unnamed officers). More recently, the Ninth Circuit in Glazer Capital Mgmt., LP v. Magistri, 549 F.3d 745 (9th Cir. 2008), revisited its decision in Nordstrom, which at least one district court had interpreted as rejecting collective scienter. See In re Apple Computers, Inc., 243 F. Supp. 2d 1012, 1023 (N.D. Cal. 2002) (“A corporation is deemed to have the requisite scienter for fraud only if the individual corporate officer making the statement has the requisite level of scienter at the time that he or she makes the statement. We have squarely rejected the concept of ‘collective scienter’ in attributing scienter to an officer and, through him, to the corporation.”). Citing the Seventh Circuit’s decision in Makor, the court explained that “Nordstrom does not foreclose the possibility that, in certain circumstances, some form of collective scienter pleading might be appropriate.” Glazer, 549 F.3d at 744. Ultimately, however, the court did not decide whether such circumstances were present “because the facts of this case are different than the hypothetical posed in Makor.” Id. at 745. Nonetheless, the Ninth Circuit left open the possibility that “there could be circumstances in which a company’s public statements were so important and so dramatically false that they would create a strong inference that at least some corporate officials knew of the falsity upon publication.” Id. 13. Damages Under Section 10(b) The private cause of action under Rule 10b-5 is implied. Therefore, until the Reform Act, courts had no statutory guidance to determine the appropriate measure of damages. Because the primary basis for implying this private cause of action is a tort theory, courts predominantly used tort concepts to shape the measure of recovery under Rule 10b-5. See Kardon v. Nat’l Gypsum Co., 69 F. Supp. 512, 513 (E.D. Pa. 1946) (relying on the tort principle that “[t]he disregard of the command of a statute is a wrongful act and a tort”). The result was uncertainty concerning the method to calculate damages because factors other than the information in dispute can impact stock price. There has been a “relative paucity of decisions dealing with damages in Rule 10b-5 cases.” Miller v. Asensio & Co., Inc. 364 F.3d 223, 228 (4th Cir. 2004); see also 3 Alan R. Bromberg & Lewis D. Lowenfels, Bromberg and Lowenfels on Securities Fraud & Commodities Fraud § 9.1 (2d ed. 1999) (“Few 10b-5 cases have reached the relief stage.”). In Asensio, for instance, the Fourth Circuit analyzed a question of first impression: whether a jury’s finding of liability under Rule 10b-5 in a private securities case required an award of damages. Asensio, 364 F.3d at 225. The Court concluded that a jury could properly determine that defendant’s fraud constituted substantial cause of plaintiff’s loss, and yet find that plaintiff failed to prove the amount of plaintiff’s loss solely caused by defendant’s fraud. Id. at 235. In Rocker Management, LLC v. Lernout & Hauspie Speech Products

N.V., No. 00-5965 (PGS), 2007 WL 2814653, at *14 (D.N.J. Sept. 24, 2007), the court held that to measure actual loss for damages purposes, the court must decide (1) whether “the gains and losses of [Plaintiff’s] short sales should be netted” or whether “a transactional approach” should be used, considering “each sale individually,” and allowing “plaintiff to recover on all losses without any offset for gains,” and (2) “the period of time in which [Plaintiff’s] short sales will be netted or considered on a transactional basis.” a. Pre-Reform Act Damage Theories Like a plaintiff in a common law case where a contract was allegedly induced by fraud, a plaintiff who proved a violation of Rule 10b-5 in a pre-Reform Act case had the choice of undoing the bargain or holding the defendant to the bargain and requiring the defendant to pay damages. Sackett v. Beaman, 399 F.2d 884, 891 (9th Cir. 1968); Estate Counseling Service, Inc. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 303 F.2d 527, 531 (10th Cir. 1962). Of the two alternative Pre-Reform Act measures of damages for Rule 10b-5 violations – the injury measure (also known as the “out-of-pocket” measure) and the restitution measure – the former is the predominant measure of damages post-Reform Act. Out-of-Pocket Measure of Damages. The out-of-pocket measure, which looks to the plaintiff’s loss, is the traditional measure of damages under Rule 10b-5. Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 154-55 (1972). The damages are “the difference between the fair value of all that the [plaintiff] received and the fair value of what he would have received had there been no fraudulent conduct.” Asensio, 364 F.3d at 225 (citing Affiliated Ute, 406 U.S. at 155). The guiding philosophy of the out-of-pocket measure is “not what the plaintiff might have gained if the false facts had been true, but rather what he has actually lost by being deceived into the purchase.” Barr v. Matria Healthcare, Inc., 324 F. Supp. 2d 1369, 1376 (N.D. Ga. 2004) (quoting Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1437 n.2 (9th Cir. 1987)). This rule is particularly appropriate where plaintiff’s basic claim is that, due to defendant’s fraud, he paid an inflated price for his stock. See, e.g., G & M, Inc. v. Newbern, 488 F.2d 742, 745 (9th Cir. 1973). The most crucial factor, and the one which causes the most difficulty in calculating out-of-pocket damages, is determining the “actual” or “fair” value of the stock. Actual Value. Under the out-of-pocket rule, the court measures the actual value of the stock on the day of the sales transaction and excludes that portion of the price decline that is the result of forces unrelated to the misrepresentation. See, e.g., In re Executive Telecard, Ltd. Sec. Litig., 979 F. Supp. 1021, 1025 (S.D.N.Y. 1997); Harmsen v. Smith, 693 F.2d 932, 946 (9th Cir. 1982). The out-of-pocket rule reflects what courts perceive to be the reality of the securities marketplace – that any investor must assume a risk of fluctuation in stock value. Huddleston v. Herman & MacLean, 640 F.2d 534, 549 (5th Cir. 1981), rev’d in part on other grounds, 459 U.S. 375 (1983). This approach prevents a plaintiff from shifting the usual risks involved in any securities transaction to the defendant. One factor considered by the court in determining actual value is the price of the stock on the date of purchase. Actual value equals the “real value,” Sackett v. Beaman, 399 F.2d 884, 891 (9th Cir. 1968), or the “prices at which [the buyer] would have purchased the stock in an unmanipulated market.” Sarlie v. E.L. Bruce Co., 265 F. Supp. 371, 375 (S.D.N.Y. 1967). The inflation in price caused by the misrepresentation may be measured by the change in price after the release of corrective information. Goldberg v. Household Bank, F.S.B., 890 F.2d 965, 967 (7th Cir. 1989); Wool, 818 F.2d at 1437; Blackie v. Barrack, 524 F.2d 891, 909 n.25 (9th Cir. 1975). The court may rely on other methods of determining actual value on the date of purchase, including expert testimony on actual value derived from capitalization of earnings techniques or testimony of book value. In re Home Theater Sec. Litig., No. SA CV 95 818 GLT EEX, 1997 WL 820968, at *3 (C.D. Cal. Sept. 2, 1997) (citing Blackie, 524 F.2d at 909 n.25). Face-To-Face Misrepresentation. The out-of-pocket rule is not appropriate for a plaintiff who claims that the

defendant’s misrepresentations about a publicly traded security were made to the plaintiff personally, rather than to the public. In this situation, because the plaintiff paid the market, or, in other words, “fair” price, the plaintiff would recover little or nothing under the out-of-pocket rule. Silverberg v. Paine, Webber, Jackson & Curtis, Inc., 710 F.2d 678, 687 (11th Cir. 1983). Under such circumstances, the applicable measure of damages will generally be a restitutionary measure. b. Post-Reform Act Damage Calculations The Reform Act modified the “traditional” out-of-pocket rule. One of the stated purposes of the Reform Act was to provide statutory guidance regarding the calculation of damages in securities fraud cases. See S. Rep. 104-98 at 19 (1995), reprinted in 1995 USCCAN 679, 698; In re Mego Fin. Corp. Sec. Litig., 213 F.3d 454, 461 n.3 (9th Cir. 2000). The Reform Act attempts to address the uncertainty of damage calculations by adopting the 90-day “look back” or “bounce back” period. This “bounce back” period seeks to limit damages to those losses caused by the defendant’s fraud and not by other market conditions. Therefore, damages under Section 10(b) are limited to the difference between the price paid or received by the plaintiff and the mean trading price during the earlier of (1) the 90 days after a disclosure is made correcting the false statement in question, or (2) the date on which the plaintiff sells or repurchases the security. 15 U.S.C. § 78u-4(e). One reason for the 90-day period was that Congress felt that “[c]alculating damages based on the date the corrective information is disclosed may substantially overestimate plaintiff’s actual damages.” S. Rep. 104-98, at 20 (1995), reprinted in 1995 USCCAN 679, 699; see also Mego, 213 F.3d at 461.

1) Basic Effect The Reform Act “essentially caps a plaintiff’s damages to those recoverable under the rescissory measure. Thus, if the mean trading price of a security during the 90-day period following the correction is greater than the price at which the plaintiff purchased his stock, the plaintiff would recover nothing under the PSLRA’s limitation on damages.” Mego, 213 F.3d at 461.

2) Effect On “Largest Financial Interest” Standard At least one court has found that damage calculations under the Reform Act has no effect in determining which plaintiff has the largest financial interest to qualify as the lead plaintiff. “[T]he determination of financial interest does not equate to damages … [and the] lead plaintiff provision in the PSLRA does not use the term ‘damages,’ but instead, ‘largest financial interest.’” In re Ribozyme Pharms., Inc. Sec. Litig., 192 F.R.D. 656, 661-62 (D. Colo. 2000). The court considers factors such as “(1) the number of shares the movant purchased during the class period; (2) the total net funds expended by the plaintiffs during the class period; and (3) the approximate losses suffered by the plaintiffs.” In re Peregrine Sys. Sec. Litig., No. 02cv870-J (RBB), 2002 WL 32769239, at *4 (S.D.Cal. Oct. 11, 2002) (citation omitted). These factors look to “relatively objective indicators … rather than to the ultimate question of damages.” Id. (citation omitted). c. Burden Of Proof A plaintiff in a Rule 10b-5 cause of action has the burden of proving damages. Harmsen v. Smith, 693 F.2d 932, 945 (9th Cir. 1982); Feldman v. Pioneer Petroleum, Inc., 813 F.2d 296, 302 (10th Cir. 1987); Pelletier v. Stuart-James Co., 863 F.2d 1550, 1558 (11th Cir. 1989). 14. Statute Of Limitations

Section 804 of the Sarbanes-Oxley Act of 2002, detailed below, amends the federal statute of limitations applicable to securities claims. Section 804 provides that the statute of limitations is the earlier of two years after discovery of the facts constituting a violation of the securities laws or five years after such a violation occurs. See Sarbanes-Oxley Act § 804(b). The Sarbanes-Oxley Act extends the statute of limitations established by the 1991 Supreme Court decision in Lampf. a. The Lampf Standard In Lampf, the Supreme Court adopted a uniform federal statute of limitations for litigation instituted pursuant to Section 10(b) and Rule 10b-5. Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 354 (1991). Under the Lampf standard, Section 10(b) and Rule 10b-5 actions were required to be commenced within one year after discovery of the facts constituting the violation and, in no event, more than three years after the occurrence of the violation. Id. Lampf resolved the split in the circuits as to whether a uniform federal statute or applicable state laws should govern the limitations period for Section 10(b) and Rule 10b-5 claims. See, e.g., In re Data Access Sys. Sec. Litig., 843 F.2d 1537 (3d Cir. 1988) (en banc). The Lampf Court held that state borrowing principles should not apply where the claim asserted is implied under a statute which contains an express cause of action with its own time limitation. Id. at 359. The Supreme Court in Lampf established a uniform federal limitations period in actions filed under section 10(b), and applied the rule in Lampf itself and in all cases then pending under section 10(b). Congress promptly responded to Lampf by passing section 27A of the Exchange Act, which became effective December 19, 1991. 15 U.S.C. § 78aa-1 (section 27A). Through section 27A, Congress repudiated the Supreme Court’s decision to apply Lampf retroactively. However, in Plaut v. Spendthrift Farm, Inc., 514 U.S. 211 (1995), the Supreme Court ruled that Section 27A(b), to the extent it requires federal courts to reopen final judgments entered before its enactment, violated the separation of powers doctrine. Accordingly, under Plaut, Section 27A could not be applied to reinstate a claim where the disposition qualifies as a final judgment. Plaut, 514 U.S. at 240. b. Period Extended By Sarbanes-Oxley Act Under the Sarbanes-Oxley Act, claims must be brought the earlier of two years after discovery of the facts constituting such a violation or five years after such violation. Sarbanes-Oxley Act § 804(b). Section 804 of the Sarbanes-Oxley Act applies to claims of “fraud, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws,” as defined in Section 3(a)(47) of the Securities Exchange Act of 1934. Id. But see In re Exxon Mobil Corp. Sec. Litig., 500 F.3d 189, 197 (3d Cir. 2007) (finding that Section 804 of the Sarbanes-Oxley Act does not extend the statute of limitations for claims brought under Section 14(a) as these claims do not require scienter and therefore do not involve “fraud, deceit, manipulation or contrivance”). Section 804 applies to all private rights of action brought on or after the date of enactment, irrespective of when the alleged conduct occurred. The statute does not alter the law regarding when inquiry notice is triggered. See, e.g., In re Enter. Mortg. Acceptance Co., LLC, Sec. Litig., 295 F. Supp. 2d 307, 311 (S.D.N.Y. 2003), aff’d, 391 F.3d 401 (2d Cir. 2004). Section 804 amends a general statute of limitations that applies to all federal civil suits. See 28 U.S.C. § 1658 (2002). This in effect replaces the prior statute of limitations announced in Lampf. c. Concerns Raised By The Extended Limitations Period Several problematic issues arose with the new statute of limitations period under Sarbanes-Oxley. First, although Sarbanes-Oxley clearly did not apply to pending claims, the answer as to whether the Act revived time-barred claims was less clear. The legislative history contains no evidence suggesting Congress intended to

revive time-barred claims. Almost all courts considering this issue decided that the extended limitations period did not apply retroactively. See Swack v. Credit Suisse First Boston, No. CIV. A. 02-11943-DPW, 2004 WL 2203482, at *5 (D. Mass. Sept. 21, 2004) (collecting cases); Foss v. Bear, Stearns & Co., Inc., 394 F.3d 540, 542 (7th Cir. 2005); In re Enterprise Mortgage Acceptance Co., LLC Sec. Litig., 391 F.3d 401 (2d Cir. 2004) (holding that Congress did not provide or intend for retroactive application of the Sarbanes-Oxley statute of limitations); In re ADC Telecomm., Inc. Sec. Litig., 409 F.3d 974 (8th Cir. 2005); Tello v. Dean Witter Reynolds, Inc., 410 F.3d 1275 (11th Cir. 2005); Livid Holdings Ltd. v. Salomon Smith Barney, Inc., 403 F.3d 1050 (9th Cir. 2005); Lieberman v. Cambridge Partners, LLC, 432 F.3d 482 (3d Cir. 2005); Margolies v. Deason, 464 F.3d 547 (5th Cir. 2006); In re Polaroid Corp. Sec. Litig., 465 F. Supp. 2d 232, 243 (S.D.N.Y. 2006) (holding that claims which expired before the passage of Sarbanes-Oxley cannot be revived); see also In re Apple Computer, Inc., No. C 06-4128 JF, 2007 WL 4170566 (N.D. Cal. Nov. 19, 2007) (holding that the five year statute of limitations under 28 U.S.C. §1658(b) begins to run on the date the option grant is made, therefore claims based on a combination of recent financial statements and time-barred options backdating, should be dismissed); In re Tyco Int’l, Ltd., No. 02-1335-B, 2007 WL 1703023, at *4 (D.N.H. June 11, 2007) (noting that the Sarbanes-Oxley Act does not revive expired claims). But see Roberts v. Dean Witter Reynolds, Inc., No. 8:02-CV-2115-T-26 (EAJ), 2003 WL 1936116, at *3-4 (M.D. Fla. Mar. 31, 2003) (relying on legislative history to find intent to make the statute retroactive). As the Third Circuit has noted, “analytically distinct” from the issue decided by the above courts is the question whether claims that had accrued but not yet expired were to be given the benefit of Section 804. Lieberman, 432 F.3d at 488. This remains undecided. Id. Second, “while Section 804(b) applies only to proceedings ‘commenced on or after’ July 30, 2002, the issue of what constitutes a new proceeding where plaintiff filed actions both before or after Sarbanes’ enactment” is still unclear (In re Adelphia Commc’ns Corp. Sec. & Derivative Litig., No. 03 MD 1529 (LMM), 2005 WL 1679540, *2 (S.D.N.Y. July 18, 2005)). In Adelphia, the court held that the extended Statute of Limitations did not apply where a first action was filed before the enactment of Sarbanes-Oxley and a second duplicative action was filed after the date of enactment. Id. at *3. Addressing the same question, the court in Quaak v. Dexia, 357 F. Supp. 2d 330, 334-36 (D. Mass. 2005), held that a consolidated complaint filed after the date of enactment against a new defendant constituted a new “proceeding” within the meaning of Section 804(b). Third, the Sarbanes-Oxley Act left open the question whether claims arising under Sections 11 and 12 of the Securities Exchange Act of 1934 which “sound in fraud” but do not actually require proof of fraud will also be subject to the longer statute of limitations period. See, e.g., In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 431, 440-44 (S.D.N.Y. 2003) (stating that because Sarbanes-Oxley only applies to claims involving fraud, deceit, manipulation or contrivance, the extended statute of limitations does not apply to Section 11 and 12(a) (2) claims which do not sound in fraud); Ato Ram, II, Ltd. V. SMC Multimedia Corp., No. 03 CIV. 5569 HB, 2004 WL 744792, at *5 (S.D.N.Y. Apr. 7, 2004) (holding that Sarbanes-Oxley did not extend the statute of limitations for Section 11 violations). But see Grippo v. Perazzo, 357 F.3d 1218, 1224 (11th Cir. 2004) (applying Lampf limitations period to both section 10(b) and section 12 claims); In re Enron Corp. Sec., Derivative & ERISA Litig., 310 F. Supp. 2d 819, 844 (S.D. Tex. 2004) (stating that the extended statute of limitations applies to Section 12(a)(2) claims). d. “Inquiry Notice” v. “Discovery” Prior to the Supreme Court’s 2010 decision in Merck v. Reynolds (see 4) below), most courts held that the oneyear limitations period announced in Lampf and, presumably, the two-year statute of limitations in the Sarbanes-Oxley Act, begins to run when the plaintiff has “inquiry notice” of the facts underlying the alleged claims. Whirlpool Fin. Corp. v. GN Holdings, Inc., 67 F.3d 605 (7th Cir. 1995) (ruling that action is timebarred because information alleged to be necessary to uncover the fraud was publicly available more than one year prior to suit); Berry v. Valence Tech., Inc., 175 F.3d 699, 703 (9th Cir. 1999) (“Every circuit to have addressed the issue since Lampf has held that inquiry notice is the appropriate standard.”) (citing Sterlin v. Biomune Sys., 154 F.3d 1191, 1201 (10th Cir. 1998)). The Ninth Circuit affirmed the “inquiry notice” standard for triggering the statute of limitations. Betz v. Trainer Wortham & Co., 504 F.3d 1017, 1024-1026 (9th Cir. 2007) (noting that (a) when there is “sufficient suspicion of fraud to cause a reasonable investor to investigate

the matter further,” inquiry notice exists; and (b) where inquiry notice is found to exist, the court must then ask whether the plaintiff “exercised reasonable diligence in investigating the facts underlying the alleged fraud.”); accord Alaska Elec. Fund v. Pharmacia Corp., 554 F.3d 342, 347 (3rd Cir. 2009). “A plaintiff in a federal securities case will be deemed to have discovered fraud for purposes of triggering the statute of limitations when a reasonable investor of ordinary intelligence would have discovered the existence of the fraud.” Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 (2d Cir. 1993); see also Rothman v. Gregor, 220 F.3d 81, 96 (2d Cir. 2000) (“Discovery of facts for the purpose of this statute of limitations includes constructive or inquiry notice, as well as actual notice.”) (internal quotation marks omitted). “Inquiry notice is triggered by evidence of the possibility of fraud, not full exposition of the scam itself.” Grippo v. Perazzo, 357 F.3d 1218, 1244 (11th Cir. 2004) (quoting Theoharous v. Fong, 256 F.3d 1219, 1228 (11th Cir. 2001)) (emphasis in original). “If the investor makes no inquiry once the duty arises, knowledge will be imputed as of the date the duty arose. However, if the investor makes some inquiry once the duty arises, [the court] will impute knowledge of what an investor in the exercise of reasonable diligence should have discovered.” In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 431, 444 (S.D.N.Y. 2003) (citation omitted). Where the relevant information is under the exclusive control of the defendants and would not have been available to a potential plaintiff without the aid of the legal process, the plaintiff cannot be found to have had inquiry notice of fraud. In re Motorola Sec. Litig., 505 F. Supp. 2d (N.D. Ill. 2007); see also In re Brocade Commc’ns Sys., Inc. Deriv. Litig., 616 F. Supp. 2d 1018, 1035-36 (N.D. Cal. 2009) (refusing to impute the knowledge of defendant officers and directors to the company for purposes of accrual because “it would create absurd results in that companies would be limited in their ability to seek relief from the fraudulent misdeeds of their officers and directors, even though others within the company or the shareholders were reasonably unaware of what was occurring.”). The circumstances giving rise to the duty to inquire are referred to as “storm warnings,” and must be triggered by information that “relates directly to the misrepresentations and omissions” the plaintiffs allege against the defendants. Levitt v. Bear Stearns & Co., 340 F.3d 94, 101 (2d Cir. 2003). Moreover, storm warnings must indicate that defendants acted with scienter. Alaska Elec. Fund, 554 F.3d at 348 (“[F]or investors to be on inquiry notice of §10(b) claims, there must be some indication that defendants did not, in fact, hold the views expressed.”). A plaintiff “is charged with knowledge of publicly available news articles and analysts’ reports, to the extent they constitute ‘storm warnings’ sufficient to trigger inquiry notice.” Adams v. Intralinks, Inc., No. 03 CIV. 5384 (SAS), 2004 WL 1627313, at *5 (S.D.N.Y. July 20, 2004) (citation omitted); Mathews v. Kidder, Peabody & Co., Inc., 260 F.3d 239, 252 (3rd Cir. 2001) (plaintiffs are “presumed to have read prospectuses, quarterly reports, and other information relating to their investments.”). However, the Eleventh Circuit has remarked that to qualify as putting plaintiffs on inquiry notice, national articles must be explicit; mere general skepticism expressed in a press article about corporate conduct is insufficient to trigger inquiry notice. There must be some reasonable nexus between the allegations made in the article and the nature of the actions subsequently brought. Tello v. Dean Witter Reynolds, Inc., 410 F.3d 1275, 1289-94 (11th Cir. 2005). The allegations need not be company-specific, however. “[W]hile company-specific information of the kind contemplated in Lentell contemplates a storm warning, information that is not so company-specific may also suffice for a court to find that the circumstances would suggest to an investor of ordinary intelligence that probability that she has been defrauded.” Staehr v. Hartford Fin. Servs. Group, Inc., 460 F. Supp. 2d 329 (D. Conn. 2006) (citing Lentell v. Merrill Lynch & Co., 396 F.3d 161, 169 (2d Cir. 2005)); see also DeBenedictis v. Merrill Lynch & Co., 492 F.3d 209 (3d Cir. 2007) (finding inquiry notice from publications that were not company-specific). These storm warnings do not necessarily dissipate in response to a defendant’s later reassuring statements. LC Capital Partners, LP v. Frontier Ins. Group, Inc., 318 F.3d 148 (2d Cir. 2003); see also In re Merck & Co., Inc. Sec., Derivative & “ERISA” Litig., 483 F. Supp. 2d 407, 421 (D.N.J. 2007) (after FDA warning letter and extensive media coverage put plaintiff on inquiry notice, company reassurances were unreliable). But see Ballard v. Tyco Int’l, Ltd., MDL No. 02-MD-1335-PB, Civil No. 04-CV-1336-PB, 2005 U.S. Dist. LEXIS 14523, at *30 (D.N.H. July 11, 2005); In re Alcatel Sec. Litig., 82 F. Supp. 2d 513 (S.D.N.Y. 2005). In both cases, the court held that defendant’s “persistent denial” or “words of comfort” mitigated storm warnings to the point where plaintiff’s claim was found not to be time barred. See also Lapin v. Goldman Sachs Group, Inc., 506 F. Supp. 2d 221 (S.D.N.Y. 2006) (finding plaintiff may not be considered to be on inquiry notice despite

existence of storm warnings when investors are “being fed reassuring statements” by management). The determination of inquiry notice is fact-intensive. See, e.g., Alaska Elec. Fund, 554 F.3d at 350 (“The totality of the evidence in the public realm . . . did not indicate a possibility of fraud or even hint at any malfeasance”); Staehr v. Hartford Fin. Servs. Group, Inc., 547 F.3d 406, 435 (9th Cir. 2008) (holding that filing suit did not trigger inquiry notice where reasonable investor of ordinary intelligence would not have known about a lawsuit “filed in an unlikely venue . . . that received no publicity whatever” and did not result in a published or “broadly disseminated” opinion during the relevant time period); In re Merck & Co., Inc. Sec. Deriv. & ERISA Litig., 543 F.3d 150 (3rd Cir. 2008) (appellate court reversed and remanded district court’s dismissal of plaintiffs’ claims, holding that investors were not necessarily put on inquiry notice by the various articles and press releases dealing with the safety and FDA approval of Vioxx); Benak v. Alliance Capital Mgmt., LP, 435 F.3d 396 (3d Cir. 2006) (holding mutual fund investors are held to a lower standard of inquiry notice because they may be unaware of where their investments are placed); La Grasta v. First Union Sec., Inc., 358 F.3d 840, 847, 850 (11th Cir. 2004) (holding that a decline in stock price alone is not enough to put investors on inquiry notice when stock had history of volatility); Caprin v. Simon Transp. Serv., Inc., 99 F. App’x 150, 156-57 (10th Cir. 2004) (stating that plaintiff was on inquiry notice of the company’s fraudulent activity in light of the dramatic decline in stock price and press release projecting loss); Menowitz v. Brown, 991 F.2d 36, 41-42 (2d Cir. 1993) (holding that inquiry notice was provided by SEC filings); Swack v. Credit Suisse First Boston, 383 F. Supp. 2d 223, 234-36 (D. Mass. 2004) (finding that extensive reports about conflicts of interest were not significant enough to trigger the limitations period until the facts were revealed in a government investigation); In re Dynegy, Inc. Sec. Litig., 339 F. Supp. 2d 804 (S.D. Tex. 2004). But see Newman v. Warnaco Group, Inc., 335 F.3d 187 (2d Cir. 2003) (holding that SEC filing of restated earnings did not put the plaintiffs on inquiry notice because the report attributed the restatement to a “benign” accounting change and failed to disclose the presence of serious inventory problems); Domenikos v. Roth, No. 05-CV2080, 2007 WL 221418, at *3 (S.D.N.Y. Jan. 26, 2006) (holding that the similarity of the allegations in another class action case against the same defendants and the proximity of the time periods at issue were sufficient to put the plaintiffs on inquiry notice); Shah v. Stanley, No. 03 CIV. 8761 (RJH), 2004 WL 2346716, at *9-13 (S.D.N.Y. Oct. 19, 2004), aff’d, 435 F.3d 244 (2d Cir. 2006) (finding that suit was time barred because an investor in a security firm had inquiry notice about conflicts of interest when articles critical of the security firm’s practices were published); In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 431 (S.D.N.Y. 2003) (finding that SEC subpoena by itself does not trigger inquiry notice); In re Tyson Foods Consol. S’holder Litig., 919 A.2d 563, 591 (Del. Ch. 2007) (holding even though proxy statements contained the grant date and options price of “spring-loaded” options, investors were not on inquiry notice because investors’ duty to exercise reasonable diligence does not include an obligation to sift through a proxy statement). In 2010, the Supreme Court clarified the meaning of “discovery” for purposes of applying Section 10(b)’s statute of limitations. Merck & Co., Inc. v. Reynolds, 130 S.Ct. 1784. The district court had held that a complaint was time-barred because plaintiffs were on “inquiry notice” no later than 2001 that patients taking Merck’s pharmaceutical Vioxx had a higher incidence of heart attacks than patients taking naproxen. At that time, Merck claimed the difference was due to the positive effect of naproxen in reducing heart attacks, not any negative effect of Vioxx. The Third Circuit reversed, holding that the “storm warnings” in 2001 did not suggest Merck knew that its naproxen explanation was false so as to put plaintiffs on inquiry notice. The Supreme Court affirmed. Noting the circuit split on when “discovery” occurs, the Court rejected the use of an “inquiry notice” standard because the point at which a reasonable investigation would begin is not necessarily the same as the point at which “the facts constituting the violation” would be discovered. Accordingly, the Court held that the statute begins to run only when a plaintiff actually discovers, or when a reasonably diligent plaintiff would have discovered, the “facts constituting the violation,” including the requisite element of scienter. e. Equitable Tolling Under Lampf, the one-year/three-year limitations period was not subject to the doctrine of equitable tolling. The one-year period began after discovery of the facts constituting the violation, which made tolling unnecessary, and the three-year limit was a period of repose that is inconsistent with tolling. Lampf, Pleva,

Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350 (1991). However, courts in Ballard and Wyser-Pratte Management Co., Inc. v. Telxon Corp., 413 F.3d 553 (6th Cir. 2005) held that the legal tolling of the statute of repose period while a class action is pending was permissible under Section 10(b). In Wyser-Pratte, the Sixth Circuit held that class action tolling did not apply to a defendant not named in the class action complaint. 413 F.3d at 566-69. A plaintiff who chooses to file an independent action without waiting for a determination on the class certification issue may not rely on the American Pipe tolling doctrine. There may be equitable tolling under the Sarbanes-Oxley Act under exceptional circumstances. See In re Parmalat Sec. Litig., 493 F. Supp. 2d 723, 730 (S.D.N.Y. 2007). But see In re Mercury Interactive Corp. Sec. Litig., No. C 05-3395 JF, 2007 WL 2209278, at *5 (N.D. Cal. July 30, 2007) (“The five-year period of repose is not subject to tolling.”); In re Ditech Networks, Inc. Derivative Litig., No. 06-5157, 2007 WL 2070300, at *8 (N.D. Cal. July 17, 2007) (noting skepticism of a continuing wrong theory that would revive a time-barred claim based on the filing of a subsequent financial statement that failed to correct a prior statement). The court in Parmalat applied the two-year extended statute of limitations under the Sarbanes-Oxley Act to the plaintiffs’ fraud claims. Id. at 730. To invoke equitable tolling, a plaintiff must show that “(1) it has pursued its rights diligently and (2) some extraordinary circumstance stood in its way.” Id. (citing Pace v. DiGuglielmo, 544 U.S. 408, 418 (2005)). Because a court order prevented the plaintiffs in Parmalat from pursuing relief, the court held that the statute of limitations was equitably tolled. Id. at 731-32. B. Section 11 Of The 1933 Act Section 11(a) of the Securities Act of 1933, 15 U.S.C. § 7k, provides that: In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proven that at the time of such acquisition he knew of such untruth or omission) may, either at law or in equity, in any court of competent jurisdiction, sue [designated persons connected with the registration statement]. 1. Elements Of A Section 11 Claim a. Liability Limited To Registration Statement Or Prospectus The scope of liability under Section 11 applies to alleged misstatements contained in prospectuses or registration statements. Aftermarket statements, which include “roadshow” presentations, analyst reports, and statements to institutional investors during conference calls, are generally outside the reach of Section 11. In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1405 (9th Cir. 1996); Castlerock Mgmt., Ltd. v. Ultralife Batteries, Inc., 68 F. Supp. 2d 480, 484 (D.N.J. 1999); see also In re Levi Strauss & Co. Sec. Litig., 527 F. Supp. 2d 965 (N.D. Cal 2007) (noting that since plaintiffs must establish that they purchased shares “either (1) directly in the public offering for which the misleading registration statement was filed or (2) traceable to that public offering,” Section 11 liability is not available for Rule 144A private offerings.). b. Material Misstatement Or Omission To state a claim under Section 11, the registration statement must contain a misrepresentation of material fact or omit either a fact required by law to be included or a fact necessary to make statements contained in the registration statement not misleading. 15 U.S.C. § 77k. The alleged misstatement must be false or misleading as of the date the registration statement becomes effective. Id.

1) Materiality A plaintiff must allege and prove that the alleged misstatement was of a material fact. Herman & McLean v. Huddleston, 459 U.S. 375, 382 (1983) (“If a plaintiff purchased a security issued pursuant to a registration statement, he need only show a material misstatement or omission to establish his prima facie case”). The Securities and Exchange Commission has defined the term “material” as “those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered.” 17 C.F.R. § 230.405; see Sedighim v. Donaldson, Lufkin & Jenrette, Inc., 167 F. Supp. 2d 639, 647 (S.D.N.Y. 2001). The same standard for materiality applies to both Section 10(b) and Section 11 claims. See In re Global Crossing, Ltd. Sec. Litig., 322 F. Supp. 2d 319, 348 (S.D.N.Y. 2004) (citing Kronfeld v. Trans World Airlines, Inc., 832 F.2d 726, 731 (2d Cir. 1987)). Materiality is a mixed question of law and fact. Therefore, it is “ordinarily an issue left to the factfinder and … not typically a matter for Rule 12(b)(6) dismissal.” In re Adams Golf, Inc. Sec. Litig., 381 F.3d 267, 274 (3d Cir. 2004). To determine whether a misstatement is material, courts consider the certainty of the information, its availability in the public domain, and the need for the information in light of cautionary statements being made. Klein v. Gen. Nutrition Co., 186 F.3d 338, 342 (3d Cir. 1999). Even if a material fact is disclosed, “where the method of presentation obscures or distorts the significance of material facts, a violation of Section 11 will be found.” Greenapple v. Detroit Edison Co., 618 F.2d 198, 205 (2d Cir. 1980). When assessing whether an alleged misstatement or omission is material, a court may not employ hindsight. Instead, a court must consider whether the omission was material on the date the registration statement was issued. In re Unicapital Corp. Sec. Litig., 149 F. Supp. 2d 1353, 1363 (S.D. Fla. 2001). If the alleged omissions are so obviously unimportant to investors that reasonable minds could not differ on the question of materiality, then the court may rule such omissions immaterial as a matter of law. Klein v. Gen. Nutrition Co., 186 F.3d 338, 342-343 (3d Cir. 1999); In re Livent, Inc. Noteholders Sec. Litig., 151 F. Supp. 2d 371, 408 (S.D.N.Y. 2001). Cf. Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 166 (2d Cir. 1980) (noting that information must be “reasonably certain to have a substantial effect on the market price of the security”).

2) Misrepresentation Or Omission The complaint must set forth a misrepresentation of an existing material fact or an omission of an existing material fact necessary in order to make the statements not misleading. See In re Int’l Business Machines Corp. Sec. Litig., 163 F.3d 102, 106-07 (2d Cir. 1998); In re Westinghouse Sec. Litig., 90 F.3d 696 (3d Cir. 1996); In re Trump Casino Sec. Litig., 7 F.3d 357 (3d Cir. 1993). Courts should evaluate an alleged misrepresentation or omission in the complete context in which it was conveyed. See I. Meyer Pincus & Assocs. v. Oppenheimer & Co. Inc., 936 F.2d 759, 763 (2d Cir. 1991). For instance, a particular misrepresentation or omission that is significant to a reasonable investor in one document or circumstance may not influence a reasonable investor in another. Trump, 7 F.3d at 369. Section 11 does not impose liability for the mere omission of a material fact unless that fact is either required by law to be included in the registration statement or must be included in order to make other facts included in the statement not misleading. See, e.g., In re SeaChange Intern., Inc., No. CIV. A. 02-12116-DPW, 2004 WL 240317, at *8 (D. Mass. Feb. 6, 2004) (“While a company that chooses to reveal material information, even though it had no duty to do so, ‘must disclose the whole truth,’ it need not disclose everything it knows; rather, the company is required only to make additional disclosures to keep the information from being materially misleading.”) (quotation omitted); In re Adams Golf, Inc. Sec. Litig., 381 F.3d 267, 279 (3d Cir. 2004) (stating that defendants had no duty to disclose general industry-wide trends easily discernible from available public information); Parnes v. Gateway 2000, Inc., 122 F.3d 539, 546 (8th Cir. 1997) (holding that a failure to disclose information in the public domain is immaterial and does not amount to securities fraud); Cooperman v. Individual, Inc., 171 F.3d 43, 49 (1st Cir. 1999) (“The mere possession of material non-public information does

not create a duty [under Section 11] to disclose it.”).

3) Statements That “Bespeak Caution” “Certain alleged misrepresentations in a stock offering are immaterial as a matter of law because it cannot be said that any reasonable investor would consider them important in light of adequate cautionary language set out in the same offering.” In re Globalstar Sec. Litig., No. 01 CIV. 1748 (SHS), 2003 WL 22953163, at *10 (S.D.N.Y. Dec. 15, 2003) (quoting Halperin v. ebanker USA.com, Inc., 295 F.3d 352, 357 (2d Cir. 2002), aff’d, 40 F. App’x 624 (2d Cir. 2002); additionally, the Reform Act’s safe harbor provision applies to a defendant’s prospectus. Id. at *10). Thus, a registration statement or prospectus will be found to “bespeak caution” when it is “balanced by extensive cautionary language” which is prominent and specific and which “warn[s] investors of exactly the risk plaintiffs claim was not disclosed.” Globalstar, 2003 WL 22953163, at *10 (citation omitted). However, defendants cannot seek protection of the doctrine if they fail to disclose a currently existing fact critical to appreciating the magnitude of the risks described. Id. at *11. There is Second Circuit precedent stating that the “bespeaks caution” doctrine applies only to “forward-looking, prospective” representations or omissions. Rubin v. MF Global, Ltd., 634 F. Supp. 2d 459, 467 (S.D.N.Y., 2009) (citing P. Stolz Family P’ship L.P. v. Daum, 355 F.3d 92, 96-97 (2d. Cir. 2004); Heller v. Goldin Restructuring Fund, L.P., 590 F. Supp. 2d 603, 617 (S.D.N.Y. 2008); Scantek Med., Inc. v. Sabella, 583 F. Supp. 2d 477, 496 (S.D.N.Y. 2008). However, the Rubin court cautioned that plaintiffs could not “evade application of the ‘bespeaks caution’ doctrine through pleading that fixates on present or historical facts” when plaintiff’s claims really amounted to an allegation regarding current facts. Rubin, 634 F. Supp. 2d at 472 (emphasis added). c. Plaintiff’s Standing To Assert Claim To possess standing, a plaintiff must allege and prove the purchase of a security that was issued pursuant to the specific registration statement containing an alleged material misstatement. Herman & MacLean v. Huddleston, 459 U.S. 375, 381-82 (1983); Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1079 (9th Cir. 1999). Section 11 does not apply to previously traded shares or shares that a plaintiff merely alleges were likely issued during the questioned offering. See, e.g., Kirkwood v. Taylor, 590 F. Supp. 1375, 1378-83 (D. Minn. 1984), aff’d, 760 F.2d 272 (8th Cir. 1985). In the context of a merger, Section 11 standing is not limited to those shareholders eligible to vote on the merger, but extends to all shareholders who acquired shares through the merger. In re Cendant Corp. Litig., 60 F. Supp. 2d 354, 365 (D.N.J. 1999). However, as detailed below, a split of authority exists on the issue of aftermarket purchasers.

1) Split Authority Over “Tracing” Tracing Prohibited. The Supreme Court has acknowledged in dicta that Section 11 claims are limited to purchasers who bought their shares in the allegedly defective offering itself. Gustafson v. Alloyd Co. Inc., 513 U.S. 561, 571-72 (1995). Many courts have followed the reasoning of Gustafson and held that a plaintiff’s ability to “trace” his purchase back to the defective offering is insufficient to bring a claim under Section 11. Only investors who purchased shares in a public offering have standing to sue. See, e.g., Brosious v. Children’s Place Retail Stores, 189 F.R.D. 138, 144 (D.N.J. 1999); Lilley v. Charren, 936 F. Supp. 708, 715-16 (N.D. Cal 1996) (stating that shares purchased in the secondary market, even if those shares were registered and first sold in an offering, may not form the basis for liability under Section 11); Stack v. Lobo, 903 F. Supp. 1361, 1375-76 (N.D. Cal. 1995) (“Although Gustafson only addressed the applicability of Section 12(2) to secondary transactions, it applies with equal force to Section 11”).

Tracing Permitted. A recent trend in Section 11 cases permits aftermarket purchasers to trace back to the defective offering. Most courts that have expressly considered the issue have reasoned that the Supreme Court’s holding in Gustafson is limited to Section 12(a)(2) claims, or that Gustafson’s holding did not directly address “traceability” at all. “Tracing may be established either through proof of a direct chain of title from the original offering to the ultimate owner ... or through proof that the owner bought her shares in a market containing only shares issued pursuant to the allegedly defective registration statement.” In re Initial Pub. Offering Sec. Litig., 227 F.R.D. 65, 117-18 (S.D.N.Y. 2004) (citation omitted). However, tracing is difficult to prove. “Even where the open market is predominantly or overwhelmingly composed of registered shares, plaintiffs are not entitled to a presumption of traceability.” Id. The Second, Fifth, Eighth, Ninth, and Tenth Circuits are the only circuits that have addressed the standing of aftermarket purchasers under Section 11. Both Joseph v. Wiles, 223 F.3d 1155 (10th Cir. 2000) and Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999) hold that anyone purchasing a security issued or traceable to a false or misleading registration statement has standing, “regardless of whether he bought in the initial offering, a week later, or a month after that.” Hertzberg, 191 F.3d at 1080. The Eighth Circuit in Lee v. Ernst & Young, LLP held that plaintiffs who are “aftermarket purchasers” can establish standing by tracing. 294 F.3d 969, 974-75 (8th Cir. 2002) (citing both Joseph and Hertzberg). The Fifth Circuit held in Krim v. pcOrder.com, Inc, 402 F.3d 489, 495 (5th Cir. 2005), that “there is no reason to categorically exclude aftermarket purchasers, so long as the security was indeed issued under that registration statement and not another.” The Second Circuit held in DeMaria v. Andersen, 318 F.3d 170 (2d Cir. 2003), that aftermarket purchasers who can trace their shares to an allegedly misleading registration statement have standing to sue. Id. at 178. Although the district courts remain divided, many allow tracing to establish Section 11 standing. See, e.g. Danis v. USN Commc’ns, Inc., 73 F. Supp. 2d 923, 931 (N.D. Ill. 1999) (citing Hertzberg); Cooperman v. Individual, Inc., No. CIV. A. 96-12272-DPW, 1998 WL 953726 (D. Mass. May 27, 1998), aff’d, 171 F.3d 43 (1st Cir. 1999) (acknowledging that district courts “have split” on the issue of Section 11 standing by allowing “tracing” to an IPO).

2) No Privity Requirement A plaintiff need not allege that he was in privity with the defendant in order to state a Section 11 claim. Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1081 (9th Cir. 1999) (distinguishing Section 11 claims from Section 12 claims, in which privity is required). d. Limited Class Of Defendants In addition to the issuer, Section 11(a) limits the class of persons who may be sued under Section 11 to the following: 1) 2) 3) 4) every person who signed the registration statement; every person who was a director, or person performing a similar function, or partner in the issuer at the time of the filing of the part of the registration statement with respect to which his liability is asserted; every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner; every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report or valuation, which purports to have been prepared or certified by him; every underwriter with respect to such security.

5)

e. Reliance Ordinarily, a plaintiff need not allege reliance on the alleged misrepresentation or omission to state a claim under Section 11. Metz v. United Counties Bancorp, 61 F. Supp. 2d 364, 377 (D.N.J. 1999). However, Section 11(a) requires a showing of actual, not presumed, reliance if the stock was purchased after the issuance of a twelve-month earnings statement. Section 11(a) provides that, if plaintiff “acquired the security after the issuer has made generally available to its security holders an earning statement covering a period of at least twelve months beginning after the effective date of the registration statement, then the right of recovery under this subsection shall be conditioned on proof that such person acquired the security relying upon such untrue statement in the registration statement or relying upon the registration statement and not knowing of such omission, but such reliance may be established without proof of the reading of the registration statement by such person.” 15 U.S.C. § 77k(a). The reliance requirement may be satisfied by an allegation of indirect reliance. Rudnick v. Franchard Corp., 237 F. Supp. 871, 873 (S.D.N.Y. 1965). Additionally, in a case where investors bound themselves to an investment before the filing of a registration statement (though one would eventually be filed), the 11th Circuit held that it would be illogical to allow the investors the Section 11 presumption of reliance, as they would be relying on a document that did not exist at the time they made their investment. APA Excelsior III L.P. v. Premiere Techs., 476 F.3d 1261, 1273 (11th Cir. 2007). f. Causation Causation is not an essential element of a prima facie case under Section 11. However, the absence of loss causation is an affirmative defense to a Section 11 claim. See 15 U.S.C. §77k(e); In re Adams Golf, Inc. Sec. Litig., 381 F.3d 267, 277 (3d Cir. 2004); Miller v. Apropos Tech., Inc., No. 01 C 8406, 2003 WL 1733558, at *8 (N.D.Ill. Mar. 31, 2003); In re Worlds of Wonder Sec. Litig., 814 F. Supp. 850, 866-67 (N.D. Cal. 1993) (reasoning that securities declined in value due to market forces and not because defendant’s financial statements may have been in error), aff’d in relevant part, 35 F.3d 1407 (9th Cir. 1994). g. Statute Of Limitations The Sarbanes-Oxley Act left open the question whether Section 11 claims that “sound in fraud” will be subject to the longer statute of limitations period. Section 804 of Sarbanes-Oxley lengthened the statute of limitations for private causes of action alleging securities fraud. SEE 28 U.S.C. § 1658 (“Section 804”). In In re Global Crossing, Ltd. Sec. Litig., 313 F. Supp. 2d 189 (S.D.N.Y. 2003), the court held that a Section 11 cause of action based on negligence is not a claim for “fraud, deceit, manipulation, or contrivance,” thus not subject to the extended statute of limitations. 313 F. Supp. 2d at 196-97. In In re WorldCom, Inc. Sec. Litig., the court also stated that the extended statute of limitations does not apply to Section 11 and 12(a)(2) claims because they do not sound in fraud. 294 F. Supp. 2d 431, 440-44 (S.D.N.Y. 2003). In WorldCom, the plaintiffs tried to seek clarification on whether Section 804 can ever apply to Section 11 or 12(a)(2) claims, but the court refused to render an advisory opinion on this issue. 308 F. Supp. 2d at 233; see also Lawrence E. Jaffe Pension Plan v. Household Int’l, Inc., No. 02 C5 893, 2004 WL 574665, at *13 (N.D. Ill. Mar. 22, 2004) (holding that the extended statute of limitations under the Sarbanes-Oxley Act does not apply to Section 11 claims). 2. Defenses To Liability Under Section 11 a. Plaintiff’s Knowledge Recovery is not permitted under Section 11 if, at the time of the challenged security transaction, plaintiff knew the true facts concerning the alleged misrepresentation or omission. 15 U.S.C. § 77k(a).

b. Due Diligence Defense With the exception of the issuer, defendants may avoid Section 11 liability by demonstrating that they acted reasonably in connection with the portions of the registration statement for which they were responsible. This defense is known as the “due diligence defense.” 15 U.S.C. § 77k(b); Weinberger v. Jackson, No. C-89-2301CAL, 1990 WL 260676 (N.D. Cal. Oct. 11, 1990); In re Software Toolworks, Inc. Sec. Litig., 789 F. Supp. 1489 (N.D. Cal. 1992), aff’d in part, rev’d in part, 38 F.3d 1078 (9th Cir. 1994); Glassman v. Computervision Corp., 90 F.3d 617, 626-28 (1st Cir. 1996); In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d 281 (S.D.N.Y. 2003). The due diligence defense is discussed in further detail below. c. Reliance On Counsel Defense Reliance on counsel can constitute due diligence under circumstances where counsel has properly “expertised” a portion of an offering document or where a client has delegated due diligence to his counsel who has successfully carried it out. Moreover, in some circumstances, reliance on counsel can also constitute an independent defense to charges of securities fraud. The scope of this independent defense is not well defined. d. The Good Faith Or Due Care Defense The defense of reliance on counsel is known as the good faith or due care defense and can negate the elements of scienter and negligence, respectively. Draney v. Wilson, Morton, Assaf & McElligott, 592 F. Supp. 9, 11 (D. Ariz. 1984). A defendant must show that it: (1) made a complete disclosure to counsel; (2) requested advice as to legality of the contemplated action; (3) received advice that the action would be legal; and (4) relied in good faith on that advice. Id.; S.E.C. v. Savoy Indus., Inc., 665 F.2d 1310, 1314 n.28 (D.C. Cir. 1981). Reliance as to factual matters does not sustain the defense. See Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 697 (S.D.N.Y. 1968). Indeed, inappropriate reliance on counsel in nonlegal matters can negate the defense as to legal matters. Draney, 592 F. Supp. at 11 (holding that reliance on counsel regarding economic feasibility destroyed counsel’s independent judgment where counsel was to be paid a percentage of the proceeds). In any event, reliance on counsel’s advice that disclosures in an offering document are complete and legally sufficient is insufficient to sustain a due diligence defense. To hold otherwise would tacitly permit the “expertising” of the entire offering document, a concept rejected in BarChris. Reliance on counsel, however, can be treated as a component of a due diligence defense. Longstreth, Reliance on Counsel as a Defense to Securities Laws Violations, 37 Bus. Law. 1185, 1193 (1982); see also Feit v. Leasco Data Processing Corp., 332 F. Supp. 544, 582-83 (E.D.N.Y. 1971). See generally Hawes & Sherrard, Reliance on Advice of Counsel as a Defense in Corporate and Securities Cases, 62 Va. L. Rev. 1, 110-23 (1976). The reliance on counsel defense also impacts the availability of the attorney-client privilege, which may be held to have been waived as to the advice relied upon and other advice on the same subject matter. See Apex Mun. Fund v. N-Group Sec., 841 F. Supp. 1423, 1431 (S.D. Tex. 1993). e. “Negative Causation” Defense Damages may be reduced if the defendant proves that any portion “represents other than the depreciation in value of such security resulting from [the allegedly untrue] part of the registration statement, with respect to which his liability is asserted.” 15 U.S.C. § 77k(e); Goldkrantz v. Griffin, No. 97 CIV. 9075 (DLC), 1999 WL

191540, at *3 (S.D.N.Y. Apr. 6, 1999), aff’d, 201 F.3d 431 (2d Cir. 1999); Beecher v. Able, 435 F. Supp. 397, 407 (S.D.N.Y. 1975) (holding that a decline in market price resulting from general economic problems cannot be charged to defendants). In In re Metropolitan Sec. Litig., 2010 U.S. Dist. LEXIS 4209 (E.D. Wash. Jan. 20, 2010), the court held in a case against accounting firms that the standards governing loss causation under Section 10(b) are equally applicable to the defense of negative causation under Section 11. If a plaintiff establishes a prima facie case under Section 11, causation is presumed and, pursuant to Section 11(e), defendants have the burden to show that “other factors” caused the decline in the value of the stock for which plaintiff seeks to recover. See In re Adams Golf, Inc. Sec. Litig., 381 F.3d 267, 277 (3d Cir. 2004) (“While a defendant may be able to prove this ‘negative causation’ theory, an affirmative defense may not be used to dismiss a plaintiff’s complaint under Rule 12(b)(6).”); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1421-23 (9th Cir. 1994) (characterizing the defendant’s burden to prove its loss causation defense as a “heavy burden” and reversing the district court’s grant of summary judgment in favor of accountants). In Akerman v. Oryx Commc’ns, Inc., 810 F.2d 336 (2d Cir. 1987), the court held that a Section 11 defendant was not liable for the price decline prior to disclosure of errors in the registration statement. Regarding the post-disclosure price decline, the court held that defendants met their “negative causation” burden because (1) the misstatement was “barely material” and (2) ”the public failed to react adversely” to the disclosure. Id. at 343; see also Collins v. Signetics Corp., 605 F.2d 110, 114-16 (3d Cir. 1979) (allowing the defendants to establish negative causation defense through expert testimony regarding economic and political factors that affected price decline), overruled in part on other grounds in In re Craftmatic Sec. Litig., 890 F.2d 628, 635-36 (3d Cir. 1989); McMahan & Co. v. Wherehouse Ent’mt, Inc., 65 F.3d 1044, 1048 (2d Cir. 1995) (ordering the district court, on remand, to allow defendants the opportunity to prove negative causation); In re Executive Telecard, Ltd. Sec. Litig., 979 F. Supp. 1021, 1025 (S.D.N.Y. 1997) (stating that negative causation principles of Section 11 require elimination of the portion of the price decline resulting from forces unrelated to the wrong). The defendant’s burden is not “insurmountable” and summary judgment has been granted in appropriate cases. In re Fortune Sys. Sec. Litig., 680 F. Supp. 1360, 1364 (N.D. Cal. 1987); see also Madden v. Deloitte & Touche, 118 F. App’x 150 (9th Cir. 2004) (affirming district court’s grant of summary judgment on plaintiffs’ Section 11 claim because undisputed expert testimony established no loss causation); Ross v. Warner, No. 77 CIV. 243 (CHT), 1980 U.S. Dist. LEXIS 15622, at *26 (S.D.N.Y. Dec. 12, 1980) (finding summary judgment on Section 11 claims appropriate in “light of the minimal materiality of [defendant’s] nondisclosure and the market’s failure to react in any discernible way to the revelations”). In Hildes v. Arthur Andersen, 2010 U.S. Dist. LEXIS 72086 (S.D. Cal. July 19, 2010), the court granted a motion to dismiss, holding that the negative causation defense barred a Section 11 claim as a matter of law because plaintiff had entered into a binding commitment to exchange stock in a merger before the false statement was made in a prospectus. 3. Damages Under Section 11 Section 11(e) limits the damages available to a plaintiff. a. Measure Of Damages Damages “shall represent the difference between the amount paid for the security (not exceeding the price at which the security was offered to the public) and (1) the value thereof as of the time such suit was brought, or (2) the price at which such security shall have been disposed of in the market before suit, or (3) the price at which such security shall have been disposed of after suit but before judgment” if less than the difference between the purchase price and the value of the security at the time of suit. 15 U.S.C. § 77k(e). This list of damage theories is exclusive and precludes recovery on other theories. McMahan & Co. v. Wherehouse Ent’mt,

Inc., 65 F.3d 1044, 1048 (2d Cir. 1995); Goldkrantz v. Griffin, No. 97 CIV. 9075 (DLC), 1999 WL 191540, at *3 (S.D.N.Y. Apr. 6, 1999). If a plaintiff disposes of a security at a greater price than the offering price, the plaintiff cannot recover damages. Securities Release No. 33-45, 11 F.R. 10947 (1933), reprinted in 1 Fed. Sec. L. Rep. (CCH) ¶ 4655, at 4089 (1982); see Metz v. United Counties Bancorp, 61 F. Supp. 2d 364, 377-78 (D.N.J. 1999); Grossman v. Waste Mgmt., Inc., 589 F. Supp. 395, 415-17 (N.D. Ill. 1984). If a plaintiff holds her shares, the price of the shares goes up after the suit is filed, and the plaintiff disposes of the shares at the higher price, the defendant gets the benefit of the increase in value after the suit was filed. However, if the market price of the shares goes down, and the plaintiff disposes of the shares after the suit was filed, the plaintiff still only receives the difference between the purchase price and the value of the shares at the time the suit was filed. A defendant is thereby unaffected by post-suit sales in a falling market and benefits from post-suit sales in a rising market. Thus, a plaintiff who wants to ensure being made whole should not hold onto the security after filing suit. L. Loss, Fundamentals of Security Regulations 1039 (1983). 15 U.S.C. § 77k(g) limits the amount a plaintiff may recover to “the price at which the security was offered to the public.” This provision primarily applies to those plaintiffs who purchased shares in the open market rather than in the course of the distribution. Loss, supra, at 1039. In Grossman, Faber & Miller, P.A. v. Cable Funding Corp., No. 4720, 1974 WL 470, at *11 (D. Del. Dec. 16, 1974), the court held that, when a plaintiff states a claim under Section 11, damages are limited by the provisions of Section 11, even though his allegations also state a claim under Section 12. However, the court noted that, when liability is premised on the additional element of intentional deception, or its legal equivalent under Section 10(b), “there would appear to be no reason to restrict a plaintiff’s recovery to the limitations of Section 11.” Id.; accord McMahan & Co. v. Wherehouse Ent’mt, Inc., 65 F.3d 1044 (2d Cir. 1995) (stating that while damages under the Securities Act are expressly limited and therefore preclude benefit of the bargain damages under Section 11, plaintiffs could recover those damages under the Securities Exchange Act). Where multiple Section 11 actions are brought with respect to the same set of facts, the filing date of the first action should control as the date for measuring the value of the securities under Section 11(e). This rule discourages date-shopping in future cases and limits multiplicity of identical suits. Beecher v. Able, 435 F. Supp. 397, 402 (S.D.N.Y. 1975). Courts look at the “value” of the security at the time suit is brought. In re AFC Enters., Inc. Sec. Litig., No. 1:03-CV-817-TWT, 2004 U.S. Dist. LEXIS 26088, at *1380 (N.D. Ga. Dec. 28, 2004) (holding that an amended complaint containing the initial assertions of a Section 11 claim “relates back” to the original complaint for the purpose of determining the date by which Section 11 damages are measured). Section 11(e) uses “value” and not “market price.” Id. In Beecher, the court stated that the realistic value of a security may be something other than the market price where the public is either misinformed or uninformed about important factors relating to the issuer’s well-being. The court in Beecher added 9 1/2 points to the market price as a measure of the “fair value.” 435 F. Supp. at 406; see also Goldkrantz v. Griffin, No. 97 CIV. 9075 (DLC), 1999 WL 191540, at *3 (S.D.N.Y. Apr. 6, 1999), aff’d, 201 F.3d 431 (2d Cir. 1999) (stating that, although stock price is the “usual starting point” for determining value under Section 11(e), the presence or absence of stock price movement immediately after disclosure is not per se dispositive under Section 11(e)). However, a distinction between the market price and the value of a security is “an unusual and rare situation.” In re Fortune Sys. Sec. Litig., 680 F. Supp. 1360, 1370 (N.D. Cal. 1987). b. Underwriter’s Liability Limited An underwriter defendant can be liable only to the extent of “the total price at which the securities underwritten by him and distributed to the public were offered to the public,” unless the underwriter received a special, disproportionate benefit from the offering beyond that received by other underwriters. 15 U.S.C. § 77k(e); see, e.g., In re Itel Sec. Litig., 89 F.R.D. 104, 111 (N.D. Cal. 1981); In re Gap Stores Sec. Litig., 79 F.R.D. 283

(N.D. Cal. 1978); see also Special Situations Fund, III, L.P. v. Cocchiola, Civ. No. 02-3099 (WHW), 2007 WL 2261557, at *10 (D.N.J. Aug. 3, 2007) (holding that “section 11(e) of the Securities Act does not limit the liability of an underwriter to the shares that particular underwriter personally distributed to the public”). c. Outside Director’s Liability Limited The Reform Act limits the liability of outside directors in Section 11 actions to their proportionate liability. 15 U.S.C. § 77k(f)(2)(A). However, as noted by the Southern District of New York, the relevant case law demonstrates a lack of uniform understanding as to precisely who counts as an outside director, an uncertainty unaided by the SEC who has yet to provide a definition. In re WorldCom, Inc. Sec. Litig., No. 02 CIV. 3288DLC, 2005 WL 638268, at *10 (S.D.N.Y. Dec. 15, 2004). d. Attorney’s Fees And Costs A court may award attorney’s fees and costs under Section 11(e) if it finds that the losing party asserted a claim or defense without merit or brought in bad faith. 15 U.S.C. § 77k(e); Aizuss v. Commonwealth Equity Trust, 847 F. Supp. 1482 (E.D. Cal. 1993); Sharp v. I.S., Inc., 685 F. Supp. 688 (S.D. Ill. 1988), abrogated in part on other grounds as recognized by Berson v. Hardiman, No. 97 C 3583, 1999 WL 754703, at *6 n.9 (N.D. Ill. Sept. 13, 1999); Zissu v. Bear, Stearns & Co., 627 F. Supp. 687, 694 (S.D.N.Y. 1986); Johnson v. Yerger, 612 F.2d 953, 959 (5th Cir. 1980). In order for a claim or defense to be without merit under Section 11(e), it must border on frivolity. Layman v. Combs, 994 F.2d 1344 (9th Cir. 1992). A mere failure to present sufficient evidence to support a claim will not in itself warrant a determination of frivolity. Aid Auto Stores, Inc. v. Cannon, 525 F.2d 468, 471 (2d Cir. 1975). Specific Finding Required. Section 11(e) requires the court to make a specific finding of lack of merit before fees may be awarded. 15 U.S.C. § 77k(e). Courts have interpreted the attorney’s fee provisions to provide the court with discretion to award fees in a broader range of cases than it would under general equitable powers. Weil v. Investment/Indicators, Research & Mgmt., Inc., 647 F.2d 18, 22 (9th Cir. 1981); see also Katz v. Amos Treat & Co., 411 F.2d 1046 (2d Cir. 1969); Reube v. Pharmacodynamics, Inc., 348 F. Supp. 900 (E.D. Pa. 1972). Posting of Security. 15 U.S.C. § 77k(e) also authorizes the court to require a party to post security, in advance of trial, sufficient to cover the costs and attorney’s fees of the opposing party. The standard for determining whether a party should be required to post such a security is whether “the defendants [have] show[n] that plaintiff has commenced … suit in bad faith or that . . . [the] claim borders on the frivolous.” Weil, 647 F.2d at 22 (alteration in original) (citations omitted). The decision need not be based on a formal, factual finding that the claim or defense is obviously without merit. Id. e. Interest On Damages Although Section 11 does not discuss a plaintiff’s ability to obtain interest, the court in Beecher v. Able, 435 F. Supp. 397, 410 (S.D.N.Y. 1975), used its discretion to award interest from the time of sale or the time of suit, whichever is earlier. 4. Contribution And Indemnity Indemnity is usually unavailable under the 1933 Act. Laventhol, Krekstein, Horwath & Horwath v. Horwitch, 637 F.2d 672, 676 (9th Cir. 1980). As the court recognized in Laventhol, “[i]n extending liability to underwriters and those who prepared misleading statements, the purpose of the [1933] Act is regulatory rather than compensatory, and permitting indemnity would undermine the statutory purpose of assuring diligent

performance of duty and deterring negligence.” Id. Section 11(f) provides a right of contribution: Except as provided in paragraph (2) [which limits the liability of outside directors] all or any one or more of the persons specified in subsection (a) of this section shall be jointly and severally liable, and every person who becomes liable to make any payment under this section may recover contribution as in cases of contract from any person who, if sued separately, would have been liable to make the same payment, unless the person who has become liable was, and the other was not, guilty of fraudulent misrepresentation. 15 U.S.C. § 77k(f)(1). 5. Applicability Of The Heightened Pleading Requirements Of Rule 9(b) And The Reform Act A split of authority exists on whether 1933 Securities Act claims are subject to the Rule 9(b) heightened pleading standard when grounded in fraud rather than negligence. The majority holds that the particularity requirements of Rule 9(b) apply only to those Section 11 claims that are “grounded in fraud.” See, e.g., Rubke v. Capitol Bancrop Ltd., 551 F.3d 1156 (9th Cir. 2009) (holding that plaintiffs cannot argue that certain facts meet the particularized pleading requirements of Section 10(b) while backing away from those same allegations to argue that Section 11 claims are not based on fraud); Wagner v. First Horizon Pharm. Corp., 464 F.3d 1273, 1277 (11th Cir. 2002) (holding that Rule 9(b) applies when the misrepresentation justifying relief under the Securities Act is also alleged to support a claim for fraud under the Exchange Act and Rule 10(b)-5); Rombach v. Chang, 355 F.3d 164, 171 (2d Cir. 2004) (“while a plaintiff need allege no more than negligence to proceed under Section 11 …, claims that do rely upon averments of fraud are subject to the test of Rule 9(b)”); Shapiro v. UJB Fin. Corp., 964 F.2d 272, 287-89 (3d Cir. 1992); Melder v. Morris, 27 F.3d 1097, 100 n.6 (5th Cir. 1994); Sears v. Likens, 912 F.2d 889, 893 (7th Cir. 1990); In re Daou Sys., Inc., 411 F. 3d 1006, 1027-1028 (9th Cir. 2005); accord Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1223 (1st Cir. 1996) (noting in dicta that the requirements of Rule 9(b) would apply to Section 11 and Section 12 claims where the plaintiff alleges one “unified course of fraudulent conduct”), superseded in part by statute as stated in Greebel v. FTP Software, Inc., 194 F.3d 185, 196-97 (1st Cir. 1999). The Third Circuit determined that Rule 9(b)’s particularity requirements may be triggered by a Section 11 or 12(a)(2) claim grounded in fraud even though either claim may be pled without alleging fraud. See Shapiro, 964 F.2d at 287-89, cited with approval in Schwartz, 124 F.3d at 1251-52. Shapiro held that Rule 9(b) applies if the complaint does not allege negligence. Shapiro, 964 F.2d at 287-89; see also Schwartz v. Celestial Seasonings, Inc., 124 F.3d 1246, 1252 (10th Cir. 1997) (“assuming without deciding” that the approach set out by the Third Circuit in Shapiro applies). The Fifth Circuit held that the district court abused its discretion in dismissing a Section 11 claim with prejudice for failure to satisfy Rule 9(b)’s particularity requirement. See Lone Star Ladies Inv. Club v. Schlotzsky’s Inc., 238 F.3d 363 (5th Cir. 2001) (noting that while Rule 9(b) applies to claims grounded in fraud, failure to comply does not warrant dismissal with prejudice). However, the District Court for Utah found Shapiro inapposite in Spiegel v. Tenfold Corp., 192 F. Supp. 2d 1261, 1267-68 (D. Utah 2002), because the complaint in Speigel did not allege negligence for both the Sections 11 and 12(a) claims. It held that Rule 8 applies to complaints that do assert negligence grounds. Spiegel, 192 F. Supp. 2d at 1268; see also In re Majesco Sec. Litig., No. CIV A 05CV-3557 WL 2846281, at *2 (D.N.J. Sept. 19, 2006) (citing In re Suprema Specialities, Inc. Sec. Litig., 438 F.3d 256 (3d Cir. 2005) in holding that 9(b)’s heightened pleading requirements did not apply to Section 11 claim where negligence allegations in support of the Section 11 claim were pled separately and distinctly from fraud allegations in support of Section 10(b) claim). The Eighth Circuit held that the particularity requirement of Rule 9(b) does not apply because proof of fraud and scienter are not prerequisites to establishing liability under Section 11. See In re NationsMart Corp. Sec.

Litig., 130 F.3d 309, 315 (8th Cir. 1997). A distinct but related question is whether the heightened pleading requirements of the Reform Act apply to Section 11 claims. Most courts that have considered this question have determined that the heightened pleading requirements of 15 U.S.C. § 78u-4(b) do not apply to Section 11 claims. See In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d 281 (S.D.N.Y. 2003) (holding that the language in 15 U.S.C. § 78u-4(b)(1) referring to “any private action arising under this chapter” does not apply to 1933 Act claims) (emphasis in original); Giarraputo v. UNUMProvident Corp., No. CIV. 99-301-PC, 2000 WL 1701294, at *9 (D. Me. Nov. 8, 2000) (“[T]he PSLRA does not place a parallel provision to § 78u-4(b) in the Securities Act.”); In re BankAmerica Corp. Sec. Litig., 78 F. Supp. 2d 976, 1000 (E.D. Mo. 1999) (“The strict pleading requirements for the PSLRA and Rule 9(b) do not apply to claims pursuant to [Sections 11 and 12(a)(2)].”). But see In re Seachange Int’l, Inc., No. CIV. A.02-12116-DPW, 2004 WL 240317, at *3 (D. Mass. Feb. 6, 2004) (“Section 78u-4(b)(1) does away with the need to determine whether a complaint ‘sounds in fraud’ and imposes a heightened pleading requirement on all § 11 and § 12(a)(2) claims arising out of alleged misrepresentations or omissions.”). 6. Due Diligence – Defense Or Duty “Due diligence” represents a variety of related concepts. First, “due diligence” refers to an affirmative defense to various federal securities claims. Second, it refers to an affirmative duty to verify the accuracy of disclosures concerning securities. Finally, “due diligence” refers to the standard investigation conducted in connection with every issuance of securities. All three of these meanings come into play when analyzing a Section 11 claim. Although Sections 11 and 12(2) do not expressly mention “due diligence” and are structured to provide a defense based on reasonable investigation or care, due diligence is sometimes viewed as an affirmative duty. Even if not a legally-imposed duty, the concept of due diligence as a common sense duty arises from the in terrorem effect of Section 11 and Section 12(2) liability. See Douglas and Bates, The Federal Securities Act of 1933, 43 Yale L. J. 171, 173 (1933). a. The Statutes Sections 11 and 12(2) both provide that a defendant who sustains the burden of proof as to his exercise of due diligence shall not be liable. Thus, the statutes structure due diligence as a defense to charges of material misstatements and not as an affirmative duty. b. The SEC’s View The SEC’s view of the “defense versus duty” issue is not clear. In requesting the NASD to establish due diligence standards, the SEC noted that, “[a]lthough there is no express provision in the [1933] Act requiring an underwriter to conduct a due diligence investigation, in order to establish a defense under the civil liability provisions of Section 11 of the Act, an underwriter must exercise reasonable care in verifying the statements in the prospectus.” SEC Release Nos. 33-5275 & 34-9671, Fed. Sec. L. Rep. (CCH) ¶ 4506B at 4054, Special Edition No. 434 (July 26, 1972). Although this statement can be read as recognizing due diligence to be solely a defense rather than a duty, other SEC comments suggest that perhaps the statement simply recognized that no duty was expressly mandated. Fortenbaugh, Underwriter’s Due Diligence, 14 Rev. of Sec. Reg. 799, 802 (1981). For example, the SEC observed that “the primary function of Section 11 may not be the compensation of investors ... rather that section may have been designed by Congress to assure adherence to high standards of conduct through the ‘in terrorem’ nature of the liabilities.” Release No. 33-5275 at 4055. In Charles E. Bailey & Co., the SEC observed that the underwriter “owed a duty to the investing public to exercise a degree of care reasonable under the circumstances to assure the substantial accuracy of representations made in the prospectus and other sales literature.” 35 S.E.C. 33, 41 (1953); see also In re

Rooney, Pace Inc. & Randolph K. Pace, 39 S.E.C. 804 (1987); In re Hamilton Grant & Co. and Mark G. Ross, 38 S.E.C. 1030 (1987); accord Richmond Corp., 41 S.E.C. 398, 406 (1963) (“[A]n underwriter impliedly represents that he has made such an investigation in accordance with professional standards.”). c. The FINRA View Although FINRA does not have an official statement on this issue, most of its members apparently adhere to the “strict interpretation of the Securities Act of 1933, [which] holds that due diligence is only a defense, and not an affirmative obligation.” Macklin and Hensley, “Background and Purpose of Seminars,” NASD Special Report — Due Diligence Seminars at 1. d. Judicial Views Several courts have commented on this issue directly or indirectly. For example, ruling on the typicality of a defendant underwriter class, the court referred to due diligence in dicta as a “responsibility to insure the accuracy of the offering materials.” In re Consumers Power Co. Sec. Litig., 105 F.R.D. 583, 612 (E.D. Mich. 1985). Describing due diligence as a “responsibility” in a discussion of typical defenses highlights the blurring of the line between duty and defense. In Chris-Craft Indus., Inc. v. Piper Aircraft Corp., 480 F.2d 341, 370-71 (2d Cir. 1973), holding that the underwriter violated Section 14(e) of the Exchange Act (material misstatement with regard to an exchange offer), the court explained that the underwriter had an “obligation” and was “duty-bound” to exercise Section 11-type due diligence to verify the accuracy of the registration statement. Thus, the court relied on the view that an investigation was a duty in order to read a due diligence obligation into Section 14(e). In discussing the due diligence standard, the court in In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N.Y. 2004) stated that “Section 11 provides an affirmative defense of ‘due diligence.’” Id. at 659. However, the court also emphasized that “[u]nderwriters must exercise a high degree of care in investigation and independent verification of the company’s representations.” Id. at 662.

7. The Due Diligence Defense For an extensive discussion of the due diligence defense and tips for conducting effective due diligence, see Alderman, “Due Diligence in the Post-Enron Era: A Litigator’s Practical Tips on Mitigating Underwritten Risk, Course Handbook No. B-1746 (PLI 2009). While the diligence that must be exercised to take advantage of this defense generally depends on the totality of the circumstances, the applicability of the due diligence defense varies with the type of defendant, its relationship to the issuer, its access to information, and the type of security and offering. S.E.C. Rule 176, 17 C.F.R. § 230.176. a. No Issuer Defense The due diligence defense is not available to issuers. Section 11 imposes almost absolute liability on issuers because issuers are liable without regard for any action taken to prevent or avoid any material misstatement contained in the registration statement. Herman & MacLean v. Huddleston, 459 U.S. 375, 382 (1983); Krim v. pcOrder.com, Inc., 402 F.3d 489, 495 (2005). b. Due Diligence Defenses For Non-Issuer Defendants Although the phrase “due diligence” does not appear in the Securities Act, two affirmative defenses available under Section 11(b) are collectively known as the “due diligence” defense. In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 662 (S.D.N.Y. 2004). The first relates to “non-expertised” portions of the registration statement and the second to “expertised” portions.

1) “Non-Expertised” Portions For portions of the registration statement not made on the authority of an expert, “a defendant will not be liable upon a showing that he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” WorldCom, 346 F. Supp. 2d at 662 (citing 15 U.S.C. § 77k(b)(3)(A)) (emphasis in original); In re Enron Corp. Sec., Deriv. & “ERISA” Litig., 540 F. Supp. 2d 800, at n. 16 (S. D. Tex. 2007). This is understood as “a negligence standard.” Id. (citation omitted).

2) “Expertised” Portions For “expertised” portions, a non-expert defendant “will not be liable if he demonstrates that he had no reasonable ground to believe and did not believe, at the time such part of the registration statement became effective, that the statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” WorldCom, 346 F. Supp. 2d at 663 (citing 15 U.S.C. § 77k(b)(3)(C)) (emphasis in original). Courts have labeled this the “reliance defense.” Id. At least one court has stated that “just as underwriters’ reliance on audited financial statements may not be blind, directors also may not fend off liability by claiming reliance where ‘red flags’ regarding the reliability of an audited financial statement, or any other expertised statement, emerge.” In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288DLC, 2005 WL 638268, at *8 (S.D.N.Y. Mar. 21, 2005). When a “red flag” emerges, a defendant has an affirmative “obligation to inquire until satisfied as to the integrity of the” underlying expertised statement. Id. at 11. For an expert defendant, “[t]he expert must prove that he had, after reasonable investigation, reasonable

ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” WorldCom, 346 F. Supp. 2d at 663 (citing 15 U.S.C. § 77k(b)(3)(B)). This is known as the “due diligence defense.” Id. Section 11(a)(4) does not clearly define the term “expert,” but rather “lists the professions that give a person authority to make a statement, which on consent can be included in a registration statement.” In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d at 664; see 15 U.S.C. § 77k(a)(4) (making liable “every accountant, engineer, or appraiser or any person whose profession gives authority to a statement made by him” and “who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement . . .” 15 U.S.C. § 77k(a)(4). Accountants are experts with regard to portions of the registration statement they certified in their capacity as independent accountants. McNamara v. Bre-X Minerals Ltd., 197 F. Supp. 2d 622, 695 (E.D. Tex. 2001); Cashman v. Coopers & Lybrand, 877 F. Supp. 425, 434 (N.D. Ill. 1995). The duty to disclose only applies where a representation or certification is given. Pahmer v. Greenberg, 926 F. Supp. 287, 307 (E.D.N.Y. 1996), aff’d sub nom. Shapiro v. Cantor, 123 F.3d 717 (2d Cir. 1997). Unaudited financial statements are not “expertised” for purposes of Section 11. Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 684 (S.D.N.Y. 1968); see also In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288DLC, 2005 WL 638268 (S.D.N.Y. Mar. 21, 2005); 17 C.F.R. §§ 230.436(c)-(d); S.E.C. Rel. No. 33-6173, 1979 WL 170299 (Dec. 28, 1979) (discussing adoption of Sections 230.436(c) & (d), which exclude an accountant from Section 11 liability arising from a report of a review of unaudited interim financial information); S.E.C. Rel. No. 33-6127, 1979 WL 169953 (S.E.C. Rel. No. 33-6127) (Sept. 20, 1979) (discussing rules ultimately adopted by Rel. No. 33-6173). Comfort letters do not “expertise” any portion of the registration statement that is otherwise “non-expertised.” However, a comfort letter can have significant value as a component in establishing that due diligence was exercised. See Phillips v. Kidder, Peabody & Co., 933 F. Supp. 303, 323 (S.D.N.Y. 1996), aff’d, 108 F.3d 1370 (2d Cir. 1997) (finding that due diligence was supported by comfort letter from accountants). However, while a comfort letter will be important in assessing the reasonableness of the underwriters’ investigation, “it is insufficient by itself to establish the defense.” WorldCom, 346 F. Supp. 2d at 683. Lawyers are generally not considered Section 11 “experts” and their participation in, or drafting of, the registration statement does not serve to “expertise” the entire registration statement. In re Flight Transp. Corp. Sec. Litig., 593 F. Supp. 612, 616 (D. Minn. 1984); Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 683 (S.D.N.Y. 1968). However, an attorney may be rendered an expert within the meaning of Section 11(a)(4) if he or she expressly consents to the inclusion of, or reference to, his or her opinion in the registration statement. See, e.g., Schneider v. Traweek, 1990 WL 169856, at *11 (C.D. Cal. 1990) (holding that plaintiffs had stated a Section 11 claim against a law firm that had drafted and signed allegedly misleading tax opinions that were included in a prospectus with the firm’s consent); In re American Continental Corporation, 794 F. Supp. 1424, 1453 (D. Ariz. 1992) (attorney whose opinion letter was filed pursuant to S.E.C. Regulation S-K, Item 601(b) (5) deemed an expert within meaning of Section 11). Moreover, some courts point to a footnote in Herman & MacLean v. Huddleston, 459 U.S. 375, 387 n. 22 (1983), in which the Court refers to lawyers “not acting as ‘experts’” as leaving open the possibility that under narrow circumstances lawyers can be Section 11 “experts.” See, e.g., In re New York City Shoes Sec. Litig, 1988 WL 80125, at *2 (E.D. Pa. July 8, 1988) An expert is relieved of liability if the “expertised” portion reproduced in the prospectus was not a fair copy, extract, or representation of the expert report or valuation submitted. 15 U.S.C. § 77k(b)(3).

3) “Official” Portions

For portions of the registration statement purporting to be a statement of an official or an official public document, a defendant escapes liability if, at the time of effectiveness, “he had no reasonable ground to believe and did not believe” that a material misstatement or omission existed. Any defendant, except the issuer, is relieved of liability with regard to an “official” portion if the “official” portion was not a fair copy or extract of the public official document. 15 U.S.C. § 77k(b)(3)(D). c. Scope of Due Diligence Defenses The essence of the Section 11 due diligence defense is that a defendant must have had (1) a reasonable basis for the truthfulness of statements; (2) an actual belief in the truthfulness of statements made; and (3) the subjective and objective belief must survive reasonable investigation.

1) Section 11(c) For due diligence purposes, the standard of reasonableness is defined in Section 11(c) as: “that required of a prudent man in the management of his own property.” 15 U.S.C. § 77k(c).

2) “Standard Of The Street” Because what is “reasonable” is a matter of degree and judgment and may vary with the circumstances of each case, reasonableness has been described as a “standard of the street.” Escott, 283 F. Supp. at 697. In other words, reasonableness is likely to be determined based on commonly accepted industry or commercial standards of due diligence. Mann, Fleischer, and Sommer, “Legal Aspects of Due Diligence,” Special Report, NASD Due Diligence Seminars, at 6.

3) Financial Industry Regulatory Authority (FINRA) Delineations Of “Reasonableness” FINRA’s predecessor, NASD (National Association of Securities Dealers), had no general rule or policy statement concerning due diligence. It refrained from adopting a list of recommended due diligence steps because this would unduly restrict an exercise that must be flexible to be effective, might result in liability for even reasonable variances, and would transform a litigation defense into an affirmative duty. Since the consolidation of NASD and the NYSE into FINRA in July 2007, it has not directly addressed due diligence related to publicly-traded securities.

4) SEC Rule 176 Rule 176 provides a list of “relevant circumstances” in determining whether a person’s conduct is reasonable under Section 11(c). The list includes the type of issuer, the security, the type of person, the office held if the person is an officer, the presence or absence of another relationship to the issuer if the person is a director, reasonable reliance on others, the role of the underwriter, the type of underwriting arrangement, and whether the person had any responsibility for a document incorporated by reference into the registration statement. 17 C.F.R. § 230.176; S.E.C. Release Nos. 7606A, 40632A, 33-7606A, 34-40632A, IC - 23519A), 1998 WL 792508, at *92 (Nov. 17, 1998).

d. Due Diligence Defense For Underwriters Several courts have emphasized underwriters’ duty to conduct rigorous due diligence if they are to have the benefit of the defense. As the Southern District of New York has observed, “[u]nderwriters function as ‘the first line of defense’ with respect to material misrepresentations and omissions in registration statements.” In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 662 (S.D.N.Y. 2004). Thus, “courts must be particularly scrupulous in examining their conduct.” Id. at 672 (citations omitted). “It is the task of the underwriter to go behind the publicly available information and, using its direct access to the issuing company, to conduct a searching inquiry as to any portions of a registration statement that are not made on the authority of an expert.” In re WorldCom, Inc. Sec. Litig., No. 02 CIV. 3288 (DLC), 2005 WL 408137, at *3 (S.D.N.Y. Feb. 22, 2005) (citing WorldCom, 346 F. Supp. 2d at 677-78). Even for expertised portions, “an underwriter defendant must show that it had no reasonable ground to believe and did not believe that the statements within the registration statement that were made on an expert’s authority were untrue.” Id. (citing WorldCom, 346 F. Supp. 2d at 673). The due diligence defense has been utilized successfully by underwriters to obtain summary judgment in some cases where underwriters “have demonstrated extensive due diligence.” WorldCom, 346 F. Supp. 2d at 676; see, e.g., Weinberger v. Jackson, No. C-89-2301-CAL, 1990 WL 260676 (N.D. Cal. Oct. 11, 1990) (holding underwriters’ due diligence included following-up on “negative or questionable” information); In re Software Toolworks, Inc. Sec. Litig., 789 F. Supp. 1489, 1496 (N.D. Cal. 1992), aff’d in part, rev’d in part, 38 F.3d 1078 (9th Cir. 1994), amended, 50 F.3d 615 (9th Cir. 1995) (underwriters “only need to reasonably attempt to verify and believe the accuracy of the information in the prospectus”); Phillips v. Kidder, Peabody & Co., 933 F. Supp. 303 (S.D.N.Y. 1996), aff’d, 108 F.3d 1370 (2d Cir. 1997); In re Int’l Rectifier Sec. Litig., No. CV 913357-RMT, 1997 WL 529600 (C.D. Cal. Mar. 31, 1997); Picard Chem. Inc. Profit Sharing Plan v. Perrigo Co., No. 1:95-CV-141, 1:95-CV-290, 1998 WL 513091 (W.D. Mich. June 15, 1998); In re Worlds of Wonder Sec. Litig., 814 F. Supp. 850 (N.D. Cal. 1993), aff’d in part, rev’d in part, 35 F. 3d 1407 (9th Cir. 1994), cert. denied, 516 U.S. 858 (1995).

1) Reliance On Management Representations In Escott v. BarChris Construction Corp., the court held that “in order to make the underwriters’ participation in this enterprise of any value to the investors, the underwriters must make some reasonable attempt to verify the data submitted to them. They may not rely solely on the company’s officers or on the company’s counsel. A prudent man in the management of his own property would not rely on them.” 283 F. Supp. 643, 679 (S.D.N.Y. 1968). In Feit v. Leasco Data Processing Equip. Corp., the court similarly concluded that the underwriters “are expected to exercise a high degree of care in investigation and independent verification of the company’s representations. Tacit reliance on management’s assertions is unacceptable; the underwriters must play devil’s advocate.” 332 F. Supp. 544, 582 (E.D.N.Y. 1971). However, in In re Software Toolworks, Inc. Securities Litigation, the court explained that underwriters may rely on management’s representations when doing so is reasonable under the circumstances. 789 F. Supp. 1489, 1496 (N.D. Cal. 1992), aff’d in part, rev’d in part, 38 F.3d 1078 (9th Cir. 1994), amended, 50 F.3d 615 (9th Cir. 1995). “It is not unreasonable . . . to rely on management’s representations with regard to information that is solely in the possession of the issuer and cannot be reasonably verified by third parties. Underwriters cannot be expected to ferret out everything that management knows about the company; they only need to reasonably attempt to verify and believe the accuracy of the information in the prospectus.” Software Toolworks, 789 F. Supp. at 1496. On appeal, the Ninth Circuit affirmed summary judgment on the underwriters’ due diligence defense for statements concerning the company’s sales practices and its description of revenue, but the court reversed summary judgment on the projected quarterly results. Software Toolworks, 38 F.3d at 1078. In reversing that part of the summary judgment ruling, the court held that, because there was evidence that the underwriters participated in drafting a letter to the SEC that purportedly fraudulently stated the company’s anticipated revenue, “[a] reasonable

factfinder could infer that, as members of the drafting group, the Underwriters had access to all information that was available and deliberately chose to conceal the truth.” Id. at 1087.

2) Reliance On Accountant Representations As the WorldCom court held, “reliance on audited financial statements may not be blind.” In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 672 (S.D.N.Y. 2004). Rather, any “information that strips a defendant of his confidence in the accuracy of those portions of a registration statement premised on audited financial statements” should be treated as a “red flag” such that “mere reliance on an audit will not be sufficient to ward off liability.” Id. at 672. Thus, where the issuer’s expense to revenue ratio in its 10-K was significantly lower than that of its two closest competitors in an extremely competitive market, the WorldCom court held that there was a question of fact that the underwriter defendants had a duty to investigate the discrepancy and denied summary judgment. Id. at 679. In Phillips v. Kidder, Peabody & Co., however, the court granted summary judgment on due diligence and cautionary language grounds, holding that the underwriter’s investigations were reasonable in relying on an accountant’s representation that internal accounting controls were adequate and on an analyst report regarding the future growth potential in the company’s industry. 933 F. Supp. 303 (S.D.N.Y. 1996), aff’d, 108 F.3d 1370 (2d Cir. 1997).

3) Factors In Determining “Reasonableness” The court in In re International Rectifier Securities Litigation relied on the following factors in deciding the reasonableness of an underwriter’s due diligence: (1) the underwriter’s familiarity with the issuer’s finances, management, and operations; (2) the underwriter’s knowledge of the issuer’s industry; (3) whether the underwriter interviewed the issuer’s employees; (4) whether the underwriter interviewed or confirmed issuer data with the issuer’s customers or other third parties; and (5) whether the underwriter obtained written verification from the issuer and its accountants that information contained in the prospectus was accurate. No. CV 91-3357-RMT, 1997 WL 529600 (C.D. Cal. Mar. 31, 1997); see also Weinberger v. Jackson, No. C-89-2301-CAL, 1990 WL 260676 (N.D. Cal. Oct. 11, 1990).

4) Considerations For Due Diligence Although no definitive list of due diligence methods or inquiries has been deemed practical, lists of items for consideration have been developed for underwriters and broker/dealers. These lists can act as guides for others as well. See William F. Alderman, Due Diligence In The Securities Litigation Reform Era: Practical Tips From Litigators On The Effective Conduct, Documentation And Defense Of Underwriter Investigation, 1265 PLI/Corp 413 (2001); “Legal Aspects of Due Diligence,” NASD Special Report – Due Diligence Seminars 1214, 44; Competitive Assocs., supra. These include, for instance, the following:

(a) The Issuing Entity Review the partnership agreement or corporate charter, transfer records, by-laws, and minutes.

(b) Business and Industry Review the business’ manner of distribution, its sources of supply, its competitive position, its market or other studies, reports relating to its industry or competitors, and its licenses, patents, and trademarks.

(c) Management, Counsel, and Auditors Conduct personal interviews and independent inquiries concerning the background and competence of management and the experience of counsel and independent auditors.

(d) Financial Statements Review audited and unaudited financial statements, budgets, forecasts, and internal audit controls.

(e) Properties Examine the physical plant and properties, as well as title and title insurance policies.

(f) Material Contracts Review documents evidencing material purchases and commitments, contracts supporting the backlog of orders, documents evidencing transactions with insiders, and corporate minutes to confirm that contracts have been properly authorized. Contact the company’s major customers, suppliers, and distributors. Review relationships with banks, creditors, and suppliers

(g) Employees Examine employment contracts, salaries, and employee benefit plans, and review union contracts and labor disputes.

(h) Litigation and Administrative Proceedings Review pending and possible unasserted claims. An opinion of counsel may be desirable.

(i) Use of Proceeds Determine how the proceeds of the issue will actually be used.

(j) Prior Filings Review filings made with the SEC, state regulatory authorities, and any stock exchanges.

(k) Investigate “Red Flags” If any “red flags” arise in the course of due diligence, discuss immediately with the appropriate person(s), including company management, attorneys, and/or accountants. The court in In re WorldCom, Inc. Sec. Litig., No. 02 Civ. 3288DLC, 2005 WL 638268, at *8 (S.D.N.Y. Mar. 21, 2005) states that what constitutes a “red flag” is a “fact intensive inquiry that depends upon the circumstances surrounding a particular issuer, the alleged misstatements, and the role of the Section 11 defendant.” 5) Non-Managing Underwriters The underwriter’s due diligence is central to the system of self-regulation. “Self-regulation is the mainspring of the federal securities laws. No greater reliance in our self-regulatory system is placed on any single participant in the issuance of securities than upon the underwriter.” Chris-Craft Indus., Inc. v. Piper Aircraft Corp., 480 F.2d 341, 370 (2d Cir. 1973); see also S.E.C. Release No. 33-6335, 1981 WL 31062, (Aug. 6, 1981). All members of the underwriting syndicate are held to the “same high standard of diligence.” In re Consumers Power Co. Sec. Litig., 105 F.R.D. 583 (E.D. Mich. 1985); accord In re Activision Sec. Litig., 621 F. Supp. 415, 434 (N.D. Cal. 1985). “[T]he underwriting syndicate members sink or swim with the lead underwriter in the usual case.” Consumers Power Co., 105 F.R.D. at 612. In BarChris Construction, the court held that syndicate members, not having made a reasonable investigation of their own, were bound by the deficiencies of the lead underwriters’ investigation. 283 F. Supp. at 697. In a footnote, the court stated: “In view of this conclusion, it becomes unnecessary to decide whether the underwriters other than Drexel would have been protected if Drexel had established that as lead underwriter, it made a reasonable investigation.” Id. at 697 n.26. In Competitive Associates, Inc. v. International Health Sciences, Inc., on the other hand, the court held that the lead underwriter’s sufficient due diligence “inured to the benefit of all of the underwriters.” No. 72 CIV. 1848-CLB, 1975 WL 349, at *19 (S.D.N.Y. Jan. 22, 1975). [Fed. Sec. L. Rep. (CCH) ¶ 4506B, at 4053, Special Edition No. 434 (July 26, 1972)] In its Release No. 335275, the SEC sets forth the diligence standard applicable to syndicate members relying on the lead underwriter’s investigation: The [participating underwriter] may appoint the [managing underwriter] as his agent to do the investigation, [but] it is important to understand that the delegation to the manager and the subsequent reliance on his investigation must be reasonable in light of all the circumstances. This means that the participant may relieve himself of the task of actually verifying the representations in the registration statement, but that he must satisfy himself that the managing underwriter makes the kind of investigation

the participant would have performed if he were the manager. He should assure himself that the manager’s program of investigation and actual investigative performance are adequate. The participant’s checks on the manager are vital since they may provide additional assurance of verification of the statements in the registration statement. Id.

6) Counsel For The Underwriters Underwriters often rely to a considerable extent on their counsel to perform due diligence tasks and to build the record that appropriate steps were taken both by the underwriters and their counsel. See generally William F. Alderman, Due Diligence In The Securities Litigation Reform Era: Practical Tips From Litigators On The Effective Conduct, Documentation And Defense Of Underwriter Investigation, 1265 PLI/Corp 416 (2001). e. Officers And Directors Of The Issuer Some officers may be heavily involved in the process of drafting the registration statement or in conducting due diligence. Since a corporation acts only through its personnel, they may face a very strict standard. See S.E.C. Rule 176 (listing as a “relevant circumstance” in determining due diligence the “office held when the person is an officer”). Directors and other officers normally receive at least one reasonably final draft of the prospectus and are asked to comment on it. They are also routinely asked to complete a questionnaire providing information about themselves and stating that they are satisfied with the disclosure in the prospectus. Important considerations include: (1) whether the questionnaire is sufficient to document the review performed by officers and directors; (2) whether, from an evidentiary point of view, a “long-form” questionnaire that goes into detail and covers a broad array of issues is better than a “short-form” version; and (3) whether officers should keep notes of what they were asked and what was said by underwriters and their counsel while performing their own due diligence. In Escott v. BarChris Construction Corp., the court required corporate insiders to verify the facts contained in the registration statement. 283 F. Supp. 643 (S.D.N.Y. 1968). Outside directors may be held to a lower standard than insiders based on their limited access to information. See Weinberger v. Jackson, No. C-89-2301-CAL, 1990 WL 260676 (N.D. Cal. Oct. 11, 1990); Laven v. Flanagan, 695 F. Supp. 800, 812 (D.N.J. 1988); S.E.C. Rule 176(e) (noting the relevance of the “presence or absence of another relationship to the issuer when the person is a director”); Circumstances Affecting the Determination of What Constitutes Reasonable Investigation and Reasonable Grounds for Belief under Section 11 of the Securities Act, S.E.C. Release No. 33-6335, 1981 WL 31062 (Aug. 6, 1981). On proposing Rule 176, the SEC observed that “[t]he case law makes clear that a director who has another relationship with the issuer involving expertise, knowledge or responsibility with respect to any matter giving rise to the omission or misstatement will be held to a higher standard of investigation and belief than an outside director with no special knowledge or additional responsibility.” Id.; see also Feit v. Leasco Data Processing Equip. Corp., 332 F. Supp. 544, 578 (E.D.N.Y. 1971); BarChris Construction, 283 F. Supp. at 688-91. f. Counsel For The Issuer Like the officers who are most heavily involved in preparation of the prospectus, counsel for the issuer is normally central to the process of collecting information and drafting. The amount of due diligence that issuer’s counsel must do for the offering depends on the extent of historical contact with the issuer. If counsel has been recently retained, a major effort will be necessary. Even if counsel has enjoyed a long relationship with the issuer, counsel must update information and make particularized inquiries. Whether joint

representation of inside and outside directors is appropriate when different standards are to be applied to outside directors than to insiders must be addressed on a case-by-case basis depending on the appearance of actual conflicts and other factors. At least one court has recognized that even “independent” directors may be beholden to the defendant directors who appointed them. Id. g. Accountants And Other Experts Clearly, the presence of accountants and other experts helps to discharge or reduce the due diligence responsibilities of the other participants in the transaction. Experts must meet a high standard with respect to the portions of any prospectus or registration statement they are “expertising.” The extent to which they bear responsibility for other aspects of these documents is unclear. For example, what about a patent lawyer who is expertising a portion of the “patents” section? See Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 683-84 (S.D.N.Y. 1968) (noting that a cross-reference in an “expertised” footnote to another portion of the registration statement did not cause that other portion to become “expertised”); accord Seiffer v. Topsy’s Int’l, Inc., 487 F. Supp. 653, 679 (D. Kan. 1980). This subject has received considerable attention in the context of tax opinions given in tax shelter offerings. See ABA Formal Opinion 346 (January 29, 1982) (setting standards for attorneys’ tax shelter opinion letters); 31 C.F.R. § 10.33 (Practice Before the Internal Revenue Service, Tax Shelter Opinions); Daily Tax Report (BNA) at J-10 (Feb. 22, 1984) (setting standards for attorneys’ tax shelter opinion letters)); see also Sax, Lawyer Responsibility in Tax Shelter Opinions, 34 Tax Law. 5 (1980). 8. Documenting Due Diligence Whether due diligence should be documented and to what extent depends on the particular case and should be dictated by how much the documentation will likely help or hurt the ultimate success of the defense. A detailed memorandum or checklist may be helpful in carrying out due diligence, but the risk is great that, with hindsight, a plaintiff may discover an item not on the list, or an item for which the investigation was not carried out, not completed, or insufficiently or inaccurately documented. Thus, the detailed checklist presents the risk that it would be found insufficient (because of an omission) or not complied with (a listed item was neglected, poorly documented, or intentionally ignored). Either way, the detailed plan approach is risky. Moreover, if experienced personnel are performing due diligence, a detailed plan would seem unnecessary and might inhibit the flexibility needed to adjust as discoveries are made during the investigation. See William F. Alderman, Due Diligence In The Securities Litigation Reform Era: Practical Tips From Litigators On The Effective Conduct, Documentation And Defense Of Underwriter Investigation, 1265 PLI/Corp 416 at 446-52 (2001) (discussing due diligence considerations in the emerging technology sector). 9. The Timing Of Due Diligence Traditionally, due diligence is accomplished in the time between the initial discussions between issuer and underwriter and the effective date of the registration statement. In large part, the due diligence investigation is focused on the drafting process and the bulk of the investigation is often completed before the preliminary prospectus is filed with the SEC and disseminated. Due diligence continues, however, during the period of SEC staff comment through the time the registration statement is declared effective by the SEC, and the failure to consider new information up to the effective date can constitute a lack of due diligence. See Glassman v. Computervision Corp., 90 F.3d 617, 629 (1st Cir. 1996). With respect to qualified issuers, timing of due diligence has been affected by the institution of the integrated disclosure system by which some issuers are permitted to incorporate filings required under the Securities Exchange Act of 1934 into their registration statements. The integrated disclosure system can drastically reduce the drafting time and the post-filing waiting period to less than one week. Moreover, market realities sometimes permit only a brief “window” for an offering, which makes speed of the essence. See Nicholas, The Integrated Disclosure System and Its Impact Upon Underwriters’ Due Diligence, 11 Sec. Reg. L. J. 3 (1983);

S.E.C. Release No. 33-6499 (Nov. 17, 1983); Shelf Registration, S.E.C. Release No. 33-6499, 1983 WL 408321 (Nov. 17, 1983). Issues of ongoing due diligence are also presented by the use of “shelf registrations.” See, e.g., Ketels, S.E.C. Rule 415, The New Experimental Procedures for Shelf Registration, 10 Sec. Reg. L. J. 318 (1983). 10. Drafting Offering Documents a. Risk Factors Offering documents should contain a complete disclosure of the particular risks involved in the investment, especially given the availability of the “bespeaks caution” doctrine and statutory Safe Harbor provisions. See In re NationsMart Corp. Sec. Litig., 130 F.3d 309 (8th Cir. 1997); Phillips v. Kidder, Peabody & Co., 933 F. Supp. 303 (S.D.N.Y. 1996), aff’d, 108 F.3d 1370 (2d Cir. 1997) (ruling on summary judgment based in part on cautionary language in Prospectus). See Alderman, “A Litigator’s Perspective on Disclosing Risks and Bad News,” Course Handbook No. B-1767 (PLI 2009). b. Forward-Looking Information The SEC encourages issuers to disclose forward-looking information. See, e.g., Regulation S-K, Item 303(a), Instruction 7, 17 C.F.R. § 229.303(a). Certain forward-looking information must be disclosed because failure to do so would cause the information that is disclosed to be misleading. This point is explicitly covered by Regulation S-K, Item 303(a)(3)(ii), which states that: [i]f the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed. The SEC has indicated an intention to enforce rigorously the disclosure rules for forward-looking information. In In the Matter of Caterpillar, Inc., the SEC instituted proceedings against Caterpillar because its Form 10-K and Form 10-Q allegedly failed to disclose that its 1989 earnings were directly linked to its Brazilian subsidiary, which had exceptionally high earnings due to hyperinflation. Release No. 34-30532, 51 S.E.C. Docket 147 (Mar. 31, 1992). Caterpillar also failed to disclose that its 1990 earnings were very difficult to predict because sweeping economic reforms were to be instituted in Brazil. The SEC found that Caterpillar had failed to discuss in its 10-K “the uncertainties surrounding [the subsidiary’s] earnings and possible material future impact on Caterpillar’s overall financial condition and results of operations....” The Release reiterates a test first set forth in a 1989 MD&A Release to explain when disclosure of prospective information is required: Where a trend, demand, commitment, event or uncertainty is known, management must make two assessments: (1) is the known trend, demand, commitment, event or uncertainty likely to come to fruition? If management determines that it is not reasonably likely to occur, no disclosure is required; (2) if management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur. S.E.C. Release No. 6835, 43 S.E.C. Docket 1330 (May 18, 1989). Plaintiffs will often try to use the language in Caterpillar to impose on defendants a duty to disclose forward-looking information. However, Item 303 does not give rise to a private cause of action and its standard for disclosure differs from

that under Rule 10b-5. See In re Cypress Semiconductor Sec. Litig., No. C-92-2008-RMW, 1992 WL 394927, at *4 (N.D. Cal. Sept. 23, 1992); In re VeriFone Sec. Litig., 784 F. Supp. 1471 (N.D. Cal. 1992), aff’d, 11 F.3d 865 (9th Cir. 1993); Alfus v. Pyramid Tech. Corp., 764 F. Supp. 598, 608 (N.D. Cal. 1991). c. Safe Harbor Registrants that disclose forward-looking information can, in many cases, take advantage of the “safe harbor” provisions contained in Rule 175 under the 1933 Act and Rule 3b-6 under the 1934 Act. Caterpillar makes the SEC’s Safe Harbor rules especially crucial. See, e.g., Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1121 (1st Cir. 1996), superseded in part by statute as stated in Greebel v. FTP Software, Inc., 194 F.3d 185, 196-97 (1st Cir. 1999); Roots P’ship v. Lands’ End, Inc., 965 F.2d 1411, 1417 (7th Cir. 1992); Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 514-15 (7th Cir. 1989). In substance, these Safe Harbor rules provide that defined types of forward-looking statements will not be deemed “fraudulent” unless plaintiffs can show that the statements were made or reaffirmed without a reasonable basis or other than in good faith. Safe Harbor Rule for Projections, S.E.C. Release No. 33-6084, 1979 WL 181199 (June 25, 1979) (commenting upon adopting Rule 175). See generally Marx v. Computer Scis. Corp., 507 F.2d 485 (9th Cir. 1974) (holding forward-looking statements made with reasonable basis are not actionable). In Release No. 33-6084, the SEC announced its authority for promulgating Rule 175 as follows: The Commission is adopting the rules pursuant to its authority under Section 19(a) of the Securities Act of 1933 [and inter alia] Sections 3(b) and 23(a)(1) of the Securities Exchange Act of 1934 . . . In addition to the definitional authority provided therein, Section 19(a) of the Securities Act [and inter alia] Section 23(a)(1) of the Exchange Act . . . provide that no liability under these acts “shall apply to any act done or omitted in good faith in conformity,” with any rule or regulation of the Commission notwithstanding that such rule or regulation may later be amended, rescinded, or determined invalid. In addition, the Safe Harbor provisions of Section 27A of the Securities Act and Section 21E of the Exchange Act may provide limited protection for certain forward-looking statements. These sections provide that certain issuers, persons acting on their behalf, “outside reviewers,” and underwriters (with respect to information obtained from issuers) shall not be liable with respect to certain forward-looking statements. Forward-looking statements may, for example, fail to support liability if (1) they are accompanied by “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement;” (2) are immaterial; or (3) if plaintiff fails to prove that the statement was made with actual knowledge that it was false or misleading. Id. Despite the protection afforded by the Safe Harbor rules, issuers probably should not include forward-looking information that they are not required to include. Including such information may needlessly expose all participants in a public offering to greater liability risks, as plaintiffs routinely try to use Item 303 to expand 10b-5 liability, albeit unsuccessfully. See, e.g., Oran v. Stafford, 226 F.3d 275, 286 n.6, 288 (3d Cir. 2000); In re VeriFone Sec. Litig., 784 F. Supp. 1471, 1483 (N.D. Cal. 1992), aff’d, 11 F.3d 865 (9th Cir. 1993). 11. Professional Malpractice Professional malpractice claims are sometimes brought together with Section 11 claims. a. Elements Of Cause Of Action For Professional Malpractice Actionable legal or accounting malpractice is composed of the same basic elements as other kinds of actionable negligence: (1) duty; (2) breach of duty; (3) proximate cause; and (4) damage. See generally Howard M. Garfield and Thomas Weathers, A Survey Of Accountant Malpractice: Breach Of Contract Or Tort?, 526 PLI/Lit 271 (1995); Sukoff v Lemkin, 202 Cal. App. 3d 740 (1988).

b. To Whom Is The Duty Owed? Attorneys and accountants who perform work in connection with a public offering usually are retained by the issuer or the underwriters. However, plaintiffs are usually investors who lack privity with these professionals. Therefore, a critical question in malpractice claims raised in public offering litigation is whether a duty of care runs from the professional to persons who foreseeably rely on the professional’s work.

1) Privity Many jurisdictions require that a plaintiff be in privity or in a relationship that is “the practical equivalent of privity” before the plaintiff can state a claim for professional malpractice. See, e.g., Credit Alliance Corp. v. Arthur Andersen & Co., 483 N.E.2d 110, 118-20 (N.Y. 1985), modified on other grounds, 66 N.Y.2d 812 (N.Y. 1985); Bily v. Arthur Young & Co., 3 Cal. 4th 370 (1992); FDIC v. Shraeder & York, 991 F.2d 216, 223 (5th Cir. 1993); Great American Ins. Co. v. Dover, Dixon Horned, PLLC, 456 F.3d 909, 912 (8th Cir. 2006). Other jurisdictions, however, have permitted malpractice actions in the absence of privity. Blu-J, Inc. v. Kemper C.P.A. Group, 916 F.2d 637, 640 (11th Cir. 1990) (explaining Florida adopted Restatement (Second) of Torts § 522 (1976) rule); Lucas v. Hamm, 56 Cal. 2d 583 (1961); Merit Ins. Co. v. Colao, 603 F.2d 654, 659 (7th Cir. 1979) (holding, under Illinois law, malpractice action could be maintained against accountant in the absence of privity). See generally Ronald E. Mallen, Legal Malpractice 156 (1981). However, the trend is to require privity or a similar relationship. Bily, 3 Cal. 4th at 384-389; Credit Alliance v. Arthur Andersen & Co., 483 N.E. 2d 110 (N.Y. Ct. App. 1985), modified on other grounds, 66 N.Y. 2d 812 (1985); Morin v. Trupin, 809 F. Supp. 1081, 1093 (S.D.N.Y. 1993); Pell v. Weinstein, 759 F. Supp. 1107, 1119 (M.D. Pa. 1991), aff’d, 961 F.2d 1568 (3d Cir. 1992).

2) Accountant Liability In Credit Alliance, the New York Court of Appeals announced three prerequisites for accountant liability to noncontracting parties: (1) the accountant must have been aware that the financial reports were to be used for a particular purpose; (2) in the furtherance of which a known party was intended to rely; and (3) there must be conduct on the part of the accountants linking them to that party which evinces the accountant’s understanding of that party’s reliance. 483 N.E. 2d at 118-20; see also Ahmed v. Trupin, 809 F. Supp. 1100 (S.D.N.Y. 1993) (extending Credit Alliance test from accountants to lawyers); First Fed. Sav. & Loan Ass’n of Pittsburg v. Oppenheim, Appel, Dixon & Co., 629 F. Supp. 427, 433 (S.D.N.Y. 1986) (denying motion to dismiss where accountant communicated directly with plaintiff); Equitable Life Assurance Soc. v. Alexander Grant & Co., 627 F. Supp. 1023, 1032 (S.D.N.Y. 1985) (no “unmistakable relationship” was pleaded); Westpac Banking Corp. v. Deschamps, 484 N.E.2d 1351 (1985) (holding plaintiff had not alleged an accountant-third party relationship “approaching privity”). The California Supreme Court has held that an accountant “owes no general duty of care regarding the conduct of an audit to persons other than the client.” Bily, 3 Cal. 4th at 376. Thus, an accountant’s liability for general negligence in the conduct of an audit of its client’s financial statements “is confined to the client, i.e., the person who contracts for or engages the audit services.” Id. at 406. This decision overruled two lower court decisions that made accountants liable to third parties, such as investors and lenders, who reasonably and foreseeably relied on audited financial statements. The Bily court ruled, however, that an accountant could be held liable (1) to nonclients for negligent misrepresentation if the accountant knows that the audit is being prepared for the specific benefit of that party; and (2) to reasonably foreseeable third persons for intentional fraud in the preparation and dissemination of an audit report. Id. at 413; see also B.L.M. v. Sabo & Deitsch, 55 Cal. App. 4th 823, 839 (Cal. Ct. App. 1997) (following Bily, the court declined to extend professional liability under a

negligent misrepresentation theory to individuals who are not clients of the attorney). C. Section 12 Of the 1933 Act 1. Elements Of A Section 12 Claim Section 12 of the Securities Act of 1933, 15 U.S.C. § 771, provides that: Any person who – 1) offers or sells a security in violation of Section 77e of this title; or 2) offers or sells a security (whether or not exempted by the provisions of Section 77c of this title, other than paragraph (2) of subsection of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable . . . to the person purchasing such security from him . . . to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security, or for damages if he no longer owns the security. A plaintiff may bring a Section 12 claim under either Section 12(a)(1) or 12(a)(2). Section 12(a)(1) provides a civil remedy for those who are sold a security without an effective registration statement or prospectus, in violation of Section 5 of the Securities Act, 15 U.S.C. § 77e. Section 12(a)(2) provides a civil remedy for purchasers who are sold a security in a public offering “by means of a prospectus or oral communication” that contained a material misstatement or omission. The elements of a claim under each section are discussed infra. Claims under section 12(a)(1) and 12(a)(2) both require that the transaction involve a “sale” of a “security” and that the defendant is a “seller.” a. Definition Of Security The challenged transaction must involve a “security” as defined by Section 2(a)(1), formerly 2(1), of the 1933 Act. What exactly fits into this definition has often been debated. See Landreth Timber Co. v. Landreth, 471 U.S. 681 (1985) (finding that 100 percent of stock represented a security as defined under Section 2(a)(1) -distinguishing “sale of business” doctrine -- because “when an instrument is both called stock and bears common stocks’ usual characteristics, a purchaser may justifiably assume that the federal securities laws apply”); United Housing Found., Inc. v. Forman, 421 U.S. 837 (1975) (“In searching for the meaning and scope of the word ‘security’ in the [Acts], form should be disregarded for substance and the emphasis should be on economic reality.”); Tcherepnin v. Knight, 389 U.S. 332, 336 (1967). Cf. Reves v. Ernst & Young, 494 U.S. 56 (1990), aff’d, 507 U.S. 170 (1993) (“Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called”). Thus, there is no liability if the transaction did not involve a security. In Developer’s Mortgage Co. v. TransOhio Savings Bank, 706 F. Supp. 570, 574-76 (S.D. Ohio 1989), the court held that the mere fact that the instrument in question bears a label which is listed in the definition of security in Section 2(1) of the 1933 Act does not, ipso facto, make the instrument a security within the meaning of the Act. The critical determination is whether the instrument possesses the characteristics typically associated with securities. Id. at 574. b. Definition Of “Sale” Of Securities Section 12(a)(3) of the Securities Act defines “sale” or “sell” to include “every contract of sale or disposition of

a security . . . for value,” and the terms “offer to sell,” “offer for sale,” or “offer” to include “every attempt or offer to dispose of, or solicitation of an offer to buy, a security . . . for value.” Pinter v. Dahl, 486 U.S. 622, 643 (1988) (citing 15 U.S.C. § 77(b)(3) (emphasis added)). Both the SEC and federal courts have held that, for a “sale” or “solicitation” of securities “for value” to occur under the Securities Act, a plaintiff must part with some “tangible and definable consideration” in return for an interest in the security. Int’l Bhd. of Teamsters v. Daniel, 439 U.S. 551, 560 (1979).

1) Stock And Stock Options Courts, commentators and the SEC agree that grants of stock and stock options under employee benefits plans typically do not involve a purchase or sale of a security subject to the Securities Act’s registration requirements. See Bauman v. Bish, 571 F. Supp. 1054, 1064 (N.D. W. Va. 1983) (finding no offer, sale, or purchase of securities absent the “furnishing of ‘value’ by participating employees”); Employee Benefits Plans, Securities Act Release No. 33-6188, 19 S.E.C. Docket 465, 1980 WL 29482, at *15 (Feb. 1, 1980) (“S.E.C. Release No. 6188”) (“[T]here is no ‘sale’ in the 1933 Act sense to employees, since such persons do not individually bargain to contribute cash or other tangible or definable consideration to such plans.”); Childers v. Nw. Airlines, Inc., 688 F. Supp. 1357, 1363 (D. Minn. 1988) (finding no “‘purchase’ of a security since participating employees did not furnish value”). An employee’s “labor” does not qualify as “value” for purposes of the Securities Act. Int’l Bhd. of Teamsters, 439 U.S. at 560.

2) Affirmative Investment Decision Similarly, there can be no liability for a “sale” or “solicitation” under the Securities Act absent an “affirmative investment decision” by a plaintiff to invest in a security. See Bauman, 571 F. Supp. at 1064 (“It is the opinion of the court that no offer, sale or purchase occurs . . . as contemplated by the securities laws . . . [when] there is no affirmative investment decision.”); S.E.C. Release No. 33-6188, 1980 WL 29482, at *2 (“[A] sale . . . occurs where there is both an investment decision and the furnishing of value by participating employees . . . the staff does not believe a sale occurs when an existing plan is converted . . . except where employees are given a choice in the matter and therefore have the opportunity to make an investment decision.”); see also Isquith by Isquith v. Caremark Int’l, Inc., 136 F.3d 531, 532-34 (7th Cir. 1998) (dismissing complaint alleging securities fraud in connection with corporation’s spin-off of a subsidiary because there was “no purchase or sale of securities” absent a voluntary “investment decision” to buy or sell securities); In re Cendant Corp. Sec. Litig., 76 F. Supp. 2d 539, 544-45 (D.N.J. 1999) (affirming dismissal of employee stock option holders’ Section 10(b) claim because “no purchase or sale” had taken place, as the plan was “both compulsory and noncontributory”). c. Defendant Must Be A “Seller” Of Securities Sections 12(a)(1) and 12(a)(2) expressly limit liability to a person who “offers or sells a security.” Plaintiff, therefore, must allege that defendant is a “seller” within the meaning of Sections 12(a)(1) and (2). Dietrich v. Bauer, 76 F. Supp. 2d 312, 330 (S.D.N.Y. 1999) (“[I]t is not enough . . . simply to allege that [one] acquired securities through [the] defendant, or that [the] defendant made [the] sale of securities possible; . . . defendant [must be the] title-holder of [the] securities prior to sale, or . . . acting as agent, [must have] successfully solicited [the] plaintiff’s purchase . . . from [the] title-holder.”). As discussed below, despite the seemingly clear language of Section 12 and the rescissory measure of damages prescribed by the statute, many courts have expanded the universe of possible Section 12 defendants beyond persons in privity with plaintiff. Although the courts generally apply the same analysis to determine whether a defendant is a seller under both Sections 12(a)(1) and 12(a)(2), (for example, Hill York Corp. v. American International Franchises, Inc., 448

F.2d 680, 692 n.17 (5th Cir. 1971), disagreed with on other grounds in Pinter v. Dahl, 486 U.S. 622, 649 n.25 (1988)), some courts have questioned whether the concept of “seller” under Section 12(a)(2) should be broader than under Section 12(a)(1) because Section 12(a)(1) does not provide a reasonable care defense. See, e.g., Pharo v. Smith, 621 F.2d 656, 665-66, aff’d in part, 625 F.2d 1226 (5th Cir. 1980), disagreed with on other grounds in Pinter, 486 U.S. at 649-50. d. Supreme Court Definition of “Seller” In Pinter v. Dahl, 486 U.S. 622 (1988), the Supreme Court held that the term “seller” as used in Section 12 includes any person who solicits the sale of securities. It is not limited to the person who passes title. A nonowner of securities must solicit the purchaser, motivated at least in part by a desire to serve his own financial interests or those of the securities owner, in order to qualify as a “seller.” Id. at 647. Only if the soliciting person is motivated by such financial interests can it be fully said that the buyer purchased the security from him such that he can be aligned with the owner in a rescission action.

1) Privity Pinter v. Dahl, 486 U.S. 622 (1988), expressly rejected the doctrine of strict privity in a Section 12(a)(1) action. Although the Supreme Court did not take a position on the scope of “seller” for the purposes of a Section 12(a)(2) action, most circuits now hold that the Pinter definition of “seller” applies to Section 12(a)(2). The Second Circuit, in holding that the language of Sections 12(a)(1) and 12(a)(2) is identical in meaning, applied the Supreme Court’s analysis in Pinter and held that the term “seller” must “include the person who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner.” Capri v. Murphy, 856 F.2d 473, 478 (2d Cir. 1988) (citing Pinter v. Dahl, 486 U.S. 622 (1988)); see also Moore v. Kayport Package Exp., Inc., 885 F.2d 531, 537 (9th Cir. 1989) (holding that Pinter provides the standard for determining liability as a “seller” under Section 12(a)(2) as well as under Section 12(a)(1)); Maher v. Durango Metals, Inc., 144 F.3d 1302 (10th Cir. 1998). The Capri court found defendants, who prepared and circulated the allegedly misleading prospectus, liable even though they did not directly communicate with the plaintiffs. Other courts, however, have required that the “soliciting seller” have “direct” or “personal” contact with a plaintiff. See Craftmatic Sec. Litig. v. Kraftsow, 890 F.2d 628, 636 (3d Cir. 1989) (“The purchaser must demonstrate direct and active participation in the solicitation of the immediate sale to hold the issuer liable as a Section 12[(a)](2) seller.”); In re Newbridge Networks Sec. Litig., 767 F. Supp. 275, 281 (D.D.C. 1991) (dismissing Section 12(a)(2) claim because “absent any allegation of direct contact of any kind between defendants and plaintiff-purchasers . . . defendants are not statutory sellers”); Cent. Laborers Pension Fund v. Merix Corp., No. CV04-826-MD, 2005 WL 2244072, at *8 (D. Or. Sept. 15, 2005) (holding the signing of a prospectus by itself does not qualify as soliciting a sale of securities sufficient to render an individual a seller for purposes of Section 12(a)(2)). In Wilson v. Saintine Exploration & Drilling Corp., 872 F.2d 1124 (2d Cir. 1989), the court held that a law firm that prepared and distributed a private placement memorandum containing a material misstatement was not liable under Section 12(a)(2) or Pinter v. Dahl because the law firm did not actively solicit an offer or sale motivated by financial gain. Id. at 1127; see also Commercial Union Assurance Co. v. Milken, 17 F.3d 608, 616 (2d Cir. 1994) (“Since appellants did not purchase the interests directly from [defendants], defendants will be liable under Section 12[(a)](2) only if they ‘solicited’ the sale.”); Moore v. Kayport Package Express, Inc., 885 F.2d 531, 537 (9th Cir. 1989) (holding that allegations that accountant and lawyer defendants merely provided professional services were insufficient to impose Section 12(a)(2) liability); Shaw v. Digital Equip. Corp., 82 F.3d 1194, 1215-16 (1st Cir. 1996) (finding Section 12(a)(2) liability improper in a public offering conducted pursuant to a firm commitment underwriting where plaintiff made “bald and factually unsupported” statements that defendants “solicited” purchasers of securities by preparing the registration statement and

prospectus, and participating in other “activities necessary to effect the sale of the . . . securities to the investing public”), superseded in part by statute as stated in Greebel v. FTP Software, Inc., 194 F.3d 185, 196-97 (1st Cir. 1999); In re Stratosphere Corp. Sec. Litig., 1 F. Supp. 2d 1096 (D. Nev. 1998) (holding that mere involvement in the preparation of a registration statement is insufficient to state a claim under Section 12).

2) Supreme Court Rejects “Substantial Factor” Test The Court in Pinter rejected the “substantial factor test,” which provides that a nontransferor seller is one whose participation in the buy-sell transaction is a substantial factor in causing the transaction to take place, as the appropriate standard for assessing Section 12(a)(1) liability. The Court found that Congress did not intend to impose rescission based on strict liability on a person only remotely related to the transaction. Id. Rather than properly focusing on the defendant’s relationship with the plaintiff-purchaser, as urged by the “purchase from” requirement of Section 12, the “substantial factor test” focused on the defendant’s degree of involvement in the transaction and surrounding circumstances. Id.

3) In Pari Delicto The Pinter Court also extended the in pari delicto defense to a Section 12(a)(1) private rescission action following Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299 (1985), which applied the defense under Section 10(b) and Rule 10b-5. Dahl, an investor in oil leases owned by Pinter, an oil and gas driller, urged eleven other individuals, including friends and relatives, to invest in the same deal. The eleven individuals relied entirely on Dahl’s representations in deciding whether to invest. However, Dahl did not receive any commissions or other compensation for his role. After the leases turned out to be worthless, Dahl and the other investors sued Pinter. Pinter counterclaimed that Dahl had fraudulently misrepresented his own and the other investors’ investment experience and sophistication. Based on this and other alleged involvement on the part of Dahl, Pinter argued that he and Dahl were in pari delicto. Because the district court’s findings were inadequate to determine whether Dahl should be subjected to the in pari delicto defense, the case was remanded for adjudication of that question. The Court provided guidance, however, that the in pari delicto defense applies where: (1) as a direct result of the plaintiff’s own action, the plaintiff “bears at least substantially equal responsibility for the underlying illegality” and (2) the “plaintiff’s role in the offering or sale of nonexempted, unregistered securities is more as a promoter rather than as an investor.” See Pinter, 486 U.S. at 635-36, 639; see also Silva Run Worldwide, Ltd v. Gaming Lottery Corp., No. 96 CIV 3231, 1998 WL 167330, at *10 (S.D.N.Y. Apr. 8, 1998). The first prong of the test is satisfied if the plaintiff is at least equally responsible for the actions that render the sale of the unregistered securities illegal. However, a purchaser’s knowledge that the securities are unregistered cannot by itself constitute equal culpability. One relevant consideration is the extent to which the plaintiff and the defendant cooperated in developing and implementing the distribution scheme. A plaintiff found to have induced the issuer not to register should be precluded from obtaining Section 12(a)(1) rescission. The second prong of the test, whether a plaintiff is primarily an investor or primarily a promoter, depends upon many factors. These factors include, but are not limited to: (1) the extent of the plaintiff’s financial involvement compared to that of third parties solicited by the plaintiff; (2) the incidental nature of the plaintiff’s promotional activities; (3) the benefits received by the plaintiff from his promotional activities; and (4) the extent of the plaintiff’s involvement in the planning stages of the offering. Pinter, 486 U.S. at 639. For post-Pinter cases in the Section 12(a)(1) context, see M. K. Stull, Who May Be Liable in Civil Actions, Under § 12(a)(1) of the Securities Act of 1933 (15 U.S.C.A. §77l(a)(1)) for Selling or Offering Securities for Sale in Violation of Registration or Prospectus Provisions of the Act – Post-Pinter Cases, 105 ALR Fed. 725, 729 (1991).

e. Officers And Directors Of A Corporate Seller Officers and directors of a corporate seller are not “sellers” for purposes of Section 12(a)(1) solely by virtue of their positions within the company. See Royal Am. Managers, Inc. v. IRC Holding Corp., 885 F.2d 1011, 1017 (2d Cir. 1989). 2. Section 12(a)(1) a. Elements Of A Section 12(a)(1) Claim To state a claim under Section 12(a)(1), plaintiff must plead: (1) a sale or offer to sell securities by the defendant; (2) the absence of a registration statement; and (3) the use of the mails or facilities of interstate commerce in connection with the sale or offer. See Ellison v. Am. Image Motor Co., Inc., 36 F. Supp. 2d 628, 638 (S.D.N.Y. 1999). b. Exempt Security One defense to a Section 12(a)(1) claim exists when the challenged transaction involves a security that was exempt from the registration provisions of Section 5 or under the subsections of Section 3(a) of the 1933 Act, 15 U.S.C. § 77c. See S.E.C. v. Life Partners Inc., 87 F.3d 536, 538 (D.C. Cir. 1996) (holding that, if viatical settlements are insurance contracts, they are altogether exempt from coverage under the federal securities laws). Such a security is always exempt from registration, both when issued and later when traded. c. Exempt Transaction Another Section 12(a)(1) defense exists when the challenged transaction is exempted under Section 4 of the 1933 Act, 15 U.S.C. Section 77d. These exemptions include: (1) transactions that do not involve an issuer, underwriter, or dealer under Section 4(1); (2) private offerings under Section 4(2); (3) certain dealer or broker transactions under Sections 4(3) and 4(4); and (4) restricted issuer transactions to accredited investors under Section 4(6). See Baldwin v. Kulch Assoc., Inc., 39 F. Supp. 2d 111, 115 (D.N.H. 1998) (“[D]efendants may avoid the broad registration requirements of Section 5 by proving the affirmative defense that the securities were exempt under 15 U.S.C. Section 77d.”). A defendant bears the burden of proving that a challenged transaction is exempt under Section 4. Western Fed. Corp. v. Erickson, 739 F.2d 1439, 1442-43 (9th Cir. 1984); Butler v. Phlo Corp., No. 00 CIV 1607, 2001 WL 863426, at *5 (S.D.N.Y. July 31, 2001). Failure to carry this burden means the exemption is lost and defendant will be liable under Section 12(a)(1) strict liability. d. No Due Diligence Defense Unlike Sections 11 and 12(a)(2), Section 12(a)(1) does not provide for a “reasonable investigation” or “reasonable care” defense, i.e., a due diligence defense. e. Measure Of Damages Under Section 12(a)(1) Upon tender of the security, a plaintiff may sue to recover actual damages measured by the amount paid for a security, plus interest, less any income received. See 15 U.S.C. § 77(a)(2). If the plaintiff no longer owns the

security, the plaintiff may recover actual damages or any real economic loss suffered. See Smith v. Comm’r, 67 T.C. 570, 575 (1976) (“The measure of damages in a section 12(1) action is the actual or real loss suffered by either a party who buys unregistered stock . . . and suffers an economic loss on its resale or a party who is left holding a worthless security.”). Any damages are rescissory in nature, and any “income received” includes amounts that the plaintiff received from the sale of the security. See Randall v. Loftsgaarden, 478 U.S. 647, 656 (1986). 3. Section 12(a)(2) a. Elements Of A Section 12(a)(2) Claim To state a cause of action under Section 12(a)(2) of the 1933 Act, a plaintiff must allege: (1) an offer or sale of a security; (2) by the use of any means of interstate commerce; (3) through a prospectus or oral communication; (4) which includes an untrue statement of a material fact or omits to state a material fact; and (5) that plaintiff “did not know of the untrue statements or omissions when purchas[ing] the securities.” In re Itel Sec. Litig., 89 F.R.D. 104, 115 (N.D. Cal. 1981); see also In re NationsMart Corp. Sec. Litig., 130 F.3d 309, 318 (8th Cir. 1997).

1) No Reliance A plaintiff need not allege reliance on the misrepresentation or omission. Sanders v. John Nuveen & Co., Inc., 619 F.2d 1222, 1225-26 (7th Cir. 1980); Hines v. ESC Strategic Funds, Inc., No. 3:99-0530, 1999 WL 1705503, at *7 (M.D. Tenn. Sept. 17, 1999). Some courts have required that the misinformation be instrumental in the sale. See Davis v. Avco Fin. Servs., Inc., 739 F.2d 1057, 1068 (6th Cir. 1984) (finding impact of defendant’s activities on plaintiff purchaser relevant to determining whether defendant was a “seller” subject to Section 12(a)(2) liability). However, Davis employed a “proximate cause--substantial factor” test to determine whether the defendant was a Section 12(a)(2) “seller,” an approach that was rejected by the Supreme Court four years later in Pinter, at least in the 12(a)(1) context. Pinter v. Dahl, 486 U.S. 622, 649-50 (1988). In any event, instrumentality may be shown by demonstrating that the market in the purchased securities was bolstered by the misinformation. See Sanders, 619 F.2d at 1227 (finding a sufficient link, even though some plaintiffs did not know of defendant’s representations because the market would have collapsed had the truth been divulged).

2) No Scienter Scienter is not a requirement for alleging a 12(a)(2) claim. Miller v. Thane International, Inc., 519 F.3d 879 (9th Cir. 2008) (citing In re Convergent Tech. Sec. Litig., 948 F.2d 507, 512 (9th Cir. 1991) (“Section 12(a)(2) is a virtually absolute liability provision that does not require an allegation that defendants possessed scienter.”)

3) No Causation Courts have held that plaintiffs asserting a 12(a)(2) claim need not prove causation, i.e., that the sale would not have occurred absent the material misrepresentation or omission. See, e.g., Hill York Corp. v. Am. Int’l Franchises Inc., 448 F.2d 680, 696 (5th Cir. 1971), disagreed with on other grounds in Pinter v. Dahl, 486 U.S. 622, 649 n.25 (1988). Other courts have imposed at least a minimal causation requirement. See Metromedia Co. v. Fugazy, 983 F.2d 350 (2d Cir. 1992) (noting that Section 12(a)(2) requires “some” causal connection

between the alleged communication and the sale); Jackson v. Oppenheim, 533 F.2d 826, 830 n.8 (2d Cir. 1976) (holding that misleading communication must have been intended or perceived as instrumental in effecting the sale). With the passage of the PSLRA, Congress created a defense to Section 12(a)(2) claims to the extent that a defendant can establish the absence of loss causation. Section 12(b) of the Securities Act provides: In an action described in subsection (a)(2) of this section, if the person who offered and sold such security proves that any portion or all of the amount recoverable under subsection (a)(2) of this section represents other than the depreciation in value of the subject security resulting from such part of the prospectus or oral communication with respect to which the liability of that person is asserted, not being true or omitting to state a material fact required to be stated therein or necessary to make the statement not misleading, then such portion or amount, as the case may be, shall not be recoverable. 15 U.S.C. § 77(b); see also In re Salomon Smith Barney Mutual Fund Litig., 441 F. Supp. 2d 579, 588 (S.D.N.Y. 2006) (noting that the Reform Act added express loss causation provision to §12).

4) Limited To Initial Offering Or Sale – No Tracing A plaintiff must have purchased the security directly from the issuer of the prospectus. See Pinter, 486 U.S. at 644, n. 21 (“[A] buyer cannot recover against his seller’s seller.”); Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1081 (9th Cir. 1999). Tracing shares purchased in the secondary market back to the initial offering is not sufficient. Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 577-78 (1995) (stating that only investors who purchased shares in an offering have standing to sue under Section 12(a)(2)); see also Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682, 693 (3d Cir. 1991) (“Section 12[(a)](2) applies only to initial offerings and not to aftermarket trading.”). Cf. Gannon v. Cont’l Ins. Co., 920 F. Supp. 566, 575 (D.N.J. 1996) (explaining that shares redeemed after merger were not issued “pursuant to an initial offering;” hence no Section 12(a)(2) liability); Flake v. Hoskins, 55 F. Supp. 2d 1196, 1228 (D. Kan. 1999) (“To have standing under Section 12, a plaintiff must allege a ‘public offering’ of securities.”). But see Feiner v. SS&C Techs Inc., 47 F. Supp. 2d 250, 253 (D. Conn. 1999) (“Section 12(a)(2) extends to aftermarket trading of a publicly offered security so long as that aftermarket trading occurs ‘by means of a prospectus or oral communication.’”).

5) Scope Of Investors’ Duty Under Section 12(a)(2), statements made in a prospectus that are “literally true on their face may nonetheless be misleading when considered in context,” but investors are not required to look beyond a document to discover what in the document is true. Miller v. Thane International, Inc., 519 F.3d 879, 886 (9th Cir. 2008). In Miller, the Ninth Circuit found that the district court was in error for imputing knowledge of the contents of drafts of the Prospectus to shareholders who received the final Prospectus. Id. at 887. b. “Seller” Status Issues Under 12(a)(2) In addition to traditional privity based claims, Section 12(a)(2) claims against sellers arise in a variety of contexts.

1) Defendants In Public Offering Litigation Plaintiffs in public offering litigation often assert Section 12(a)(2) claims against an issuer, its officers and

directors, and underwriters.

2) Firm Commitment Indemnity In a firm commitment underwriting, where the underwriting syndicate purchases the issuer’s shares and resells to the public, the underwriters are not the “agents” of the issuer or its officers and directors and, thus, there is no privity between the issuer, the officers and directors, and the investor. In re Fortune Sys. Sec. Litig., 604 F. Supp. 150, 159-60 (N.D. Cal. 1984); Lone Star Ladies Inv. Club v. Schlotzsky’s Inc., 238 F.3d 363, 370 (5th Cir. 2001). But see Degulis v. LXR Biotechnology, Inc., No. 95 Civ. 4204 (RWS), 1997 WL 20832, at *6 (S.D.N.Y. Jan. 21, 1997) (“[N]o authority cited stands for the proposition that signatories of a registration statement cannot be considered statutory ‘sellers’ under Section 12(a)(2) merely because there was a firm commitment underwriting of the offering.”).

3) Actual Participation Courts generally hold that the issuer and its officers and directors are not liable under Section 12(a)(2) merely because they were involved in planning the offering, drafting the prospectus, and negotiating the stock price because such acts are typically part of any public offering. “Seller” status must be predicated on “actual participation” in the selling process to the named plaintiffs. In re Craftmatic Sec. Litig., 890 F.2d 628, 636 (3d Cir. 1989) (“The purchaser must demonstrate direct and active participation in the solicitation of the immediate sale to hold the issuer liable as a Section 12[(a)](2) seller.”); Steed Fin. LDC v. Nomura Sec. Int’l, Inc., No. 00 CIV. 8058 (NRB), 2001 WL 1111508, at *7 (S.D.N.Y. Sept. 20, 2001); In re Wicat Sec. Litig., 600 F. Supp. 1236, 1242 (D. Utah 1984). But see Degulis, 1997 WL 20832, at *6 (finding allegation that issuer signed the registration statement is not “conclusory” and survives a motion to dismiss at the pleadings stage); Schaffer v. Evolving Sys., Inc., 29 F. Supp. 2d 1213 (D. Colo. 1998) (finding allegations that underwriters signed the registration statement and sold stock sufficient to allege solicitation of sale and pecuniary gain). The Second Circuit affirmed summary judgment in favor of an issuer in Akerman v. Oryx Commc’ns, Inc., 810 F.2d 336 (2d Cir. 1987), holding that (1) the issuer was not in privity with plaintiffs because the stock was sold in a firm commitment underwriting; and (2) no “participant” liability could attach unless scienter was proven. Similarly, an underwriter cannot incur participant liability to investors who did not purchase from it by performing typical duties as a lead underwriter. Klein v. Computer Devices, Inc., 602 F. Supp. 837, 840 (S.D.N.Y. 1985).

4) Section 12 Claims Against Professionals The judicial expansion of Section 12 “seller” status to persons other than the direct seller (or offeror) of a security has transformed Section 12 into a weapon frequently used against professionals because Sections 12(a) (1) and 12(a)(2), unlike Rule 10b-5, usually do not require proof of scienter.

5) Professionals As Sellers Before Pinter v. Dahl, many courts rejected Section 12 claims against professionals under a “proximate cause” analysis. In Croy v. Campbell, 624 F.2d 709 (5th Cir. 1980), for example, the Fifth Circuit affirmed a directed verdict in favor of an attorney who had arranged a meeting between plaintiffs and a real estate limited partnership developer, recommended the tax shelter project, gave plaintiffs a brochure from the developer, made potential tax liability estimates for plaintiffs, and was paid for his services by the developer. The court

held that his participation in the sale of a security to plaintiffs was not a substantial factor in the transaction. See Stokes v. Lokken, 644 F.2d 779 (8th Cir. 1981) (attorneys); Westlake v. Abrams, 504 F. Supp. 337 (N.D. Ga. 1980) (attorneys); McFarland v. Memorex Corp., 493 F. Supp. 631, 648-49 (N.D. Cal. 1980) (accountants); Canizaro v. Kohlmeyer & Co., 370 F. Supp. 282, 287 (E.D. La. 1974) (“[W]hen the broker represents the buyer alone and executes a purely unsolicited order, it is difficult to see how he could be considered one who ‘sells’ even within the meaning of the Securities Act.”), aff’d, 512 F.2d 484 (5th Cir. 1975). After Pinter, some courts held that a professional can be liable under Section 12(a)(2), though the trend is to find a professional not liable. The following cases have held that a professional defendant may be liable as a seller: Lee v. Spicola, No. 86-1808 CIV-T-10, 1988 WL 152013, at *2 (M.D. Fla. Dec. 9, 1988) (accountant); In re Prof. Fin. Mgmt., Ltd., 692 F. Supp. 1057 (D. Minn. 1988) (attorneys). In the following cases, the professional was not subject to liability as a seller: Wilson v. Saintine Exploration & Drilling Corp., 872 F.2d 1124 (2d Cir. 1989) (law firm); Bank of Denver v. Se. Capital Group, Inc., 763 F. Supp. 1552 (D. Colo. 1991) (attorneys); Dawe v. Main Street Mgmt. Co., 738 F. Supp. 36, 37 (D. Mass. 1990) (accountants merely “collateral participants” in sale of security); Med Safe Nw. Inc. v. Medvial, Inc., No. 981375, 2001 WL 13259, at *6 (10th Cir. Jan. 5, 2001).

6) No Secondary Liability Prior to Pinter v. Dahl, several courts had indicated that a plaintiff could state a cause of action for secondary liability under Section 12. See, e.g., Kilmartin v. H.C. Wainwright & Co., 637 F. Supp. 938 (D. Mass. 1986); In re Itel Sec. Litig., 89 F.R.D. 104, 115 (N.D. Cal. 1981). Although Pinter did not expressly resolve whether secondary liability could exist under Section 12(a)(1), most courts have held that a plaintiff may not state a claim for secondary liability under Section 12(a)(2). See, e.g., Ackerman v. Schwartz, 947 F.2d 841 (7th Cir. 1991); In re Am. Bank Note Holographics Inc., Sec. Litig., 93 F. Supp. 2d 424, 438 (S.D.N.Y. 2000); Craftmatic Sec. Litig. v. Kraftsow, 890 F.2d 628 (3d Cir. 1989) (holding that persons who fail to qualify as “sellers” under the Pinter test may not be held liable under Section 12(a)(2) on an aiding and abetting theory of liability). But see Dawe v. Main Street Mgmt. Co., 738 F. Supp. 36 (D. Mass 1990); In re Worlds of Wonder Sec. Litig., 721 F. Supp. 1140, 1148 (N.D. Cal. 1989). c. Measure Of Damages Under Section 12(a)(2) 1) Rescission Section 12(a)(2) provides express statutory authority for rescission. Randall v. Loftsgaarden, 478 U.S. 647, 655 (1986); Mathews v. Kidder Peabody & Co., Inc., 260 F.3d 239, 249 (3d Cir. 2001). A Section 12 plaintiff may not recover rescissionary damages after disposing of the stock, however. In re MetLife Demutualization Litig., 156 F. Supp. 2d 254, 269 (E.D.N.Y. 2001). The legislative purpose of rescission was deterrence, not compensation. Globus v. Law Research Serv., Inc., 418 F.2d 1276, 1288 (2d Cir. 1969); Feit v. Leasco Data Processing Equip. Corp., 332 F. Supp. 544, 567 (E.D.N.Y. 1971). In order to rescind the transaction under Section 12(a)(2), a purchaser must tender the security to the seller. A plaintiff, therefore, “cannot rescind the transaction under Section 12[(a)](2) and at the same time retain his status as a security holder in order to sue for damages under Section 11.” In re Gap Stores Sec. Litig., 79 F.R.D. 283, 307 (N.D. Cal. 1978). However, “it is reasonable to assume that the plaintiff may pursue both remedies to judgment, electing his choice at the last possible moment.” Id. Courts are divided on the issue of the specificity with which a plea for rescission must be recited in the complaint to constitute a sufficient offer to tender under Section 12. Compare Metz v. United Counties

Bancorp, 61 F. Supp. 2d 364, 379 (D.N.J. 1999) (holding a complaint’s recital that plaintiffs are “entitled either to rescind their [stock] purchases . . . or to receive payment from [the defendants] for damages sustained” insufficient to constitute proper offer to tender under Section 12), with Wigand v. Flo-Tek, Inc., 609 F.2d 1028, 1035 (2d Cir. 1979) (finding a demand for rescission containing an implicit offer to tender sufficient to satisfy the statute).

2) Damages As with Section 12(a)(1), a plaintiff unable to rescind, e.g., having sold or unable to tender the securities, may obtain damages. 15 U.S.C. § 771(2). Goldkrantz v. Griffin, No. 97 CIV. 9075, 1999 WL 191540, at *6 (S.D.N.Y. Apr. 6, 1999), aff’d, 201 F.3d 431 (2d Cir. 1999). The statute does not specify the measure of damages recoverable. When a Section 12(a)(2) plaintiff no longer owns shares and seeks damages, those damages are to be measured so that the result is the substantial equivalent of rescission: namely, the difference between the purchase price and plaintiff’s resale price, plus interest, less any income or return of capital (with interest) that the plaintiff received on the security. L. Loss, Fundamentals of Security Regulations 1025 (1983); see also Randall v. Loftsgaarden, 478 U.S. 647, 656 (1986) (quoting Loss). “Income received” includes “payments in cash or property received by virtue of ownership of a security, such as distributions or dividends on stock, interest on bonds, or a limited partner’s distributive share of the partnership’s capital gains or profits.” Id. at 657. However, “income received” excludes tax benefits. Id.

3) Reform Act Limitation The Reform Act bars recovery of any loss that the defendant proves is attributable to any factor other than depreciation in value resulting from a material misstatement or omission in a prospectus or oral communication. 15 U.S.C. § 77l(b).

4) Attorney’s Fees Although Section 12 does not specifically provide for the recovery of attorney’s fees, Section 11, 15 U.S.C. § 77k(e), provides that “[i]n any suit under this or any other section of this title . . .,” the prevailing party may be awarded attorney’s fees if the court finds that a claim or defense asserted by the losing party is without merit (emphasis added).

5) Punitive Damages Punitive damages are not available under Section 12(a)(2). Hill York Corp. v. Am. Int’l Franchises, Inc., 448 F.2d 680 (5th Cir. 1971), disagreed with on other grounds in Pinter v. Dahl, 486 U.S. 622, 649 n.25 (1988). d. Not Applicable To Private Offerings Although Section 12(a)(2) had been repeatedly applied to private as well as public offerings of securities, see for example Metromedia Co. v. Fugazy, 983 F.2d 350 (2d Cir. 1992) (and cases cited therein), the U.S. Supreme Court in Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 584 (1995), held that Section 12(a)(2) does not extend to a private sale contract, since a contract and its recitations that are not held out to the public are not a

“prospectus” as the term is used in the 1933 Act. See also In re WorldCom, Inc. Sec. Litig., 294 F. Supp. 2d 431, 453-56 (S.D.N.Y. 2003) (holding no Section 12 liability because explicit restrictions of the offering memorandum indicate offering was not a public offering even though bonds were offered to hundreds of investors); Am. High-Income Trust v. AlliedSignal, 329 F. Supp. 2d 534, 543 (S.D.N.Y. 2004) (holding offering memorandum issued as part of private placement and exchange offering is not a prospectus). e. Defenses Available Under Section 12(a)(2) 1) Plaintiff’s Knowledge The fact that the plaintiff knew the truth of the misrepresented or omitted material fact is a defense to a Section 12(a)(2) claim. Section 12(a)(2); In re Itel Sec. Litig., 89 F.R.D. 104, 115 (N.D. Cal. 1981); Ames v. Uranus, Inc., No. 92-2170-JWL, 1994 WL 482626, n.16 (D. Kan. Aug. 24, 1994). In bringing a motion to dismiss for failure to state a Section 12(a)(2) claim, defendants are entitled to raise all information or documents of which plaintiff had “actual notice” and upon which plaintiff must have relied in drafting the complaint. Cortec Indus., Inc. v. Sum Holding, L.P., 949 F.2d 42 (2d Cir. 1991).

2) Reasonable Care/Due Diligence Another defense may be made out if the Defendant did not know and, through the exercise of reasonable care, could not have known of the misrepresentation or omission of material fact. 15 U.S.C. § 771(a)(2); Sanders v. John Nuveen & Co., Inc., 619 F.2d 1222, 1229 (7th Cir. 1980); In re BankAmerica Corp. Sec. Litig., 78 F. Supp. 2d 976, 992 (E.D. Mo. 1999).

3) Materiality There is no liability if the misrepresented or omitted fact was not material. Section 12(a)(2); Parnes v. Gateway 2000, Inc., 122 F.3d 539, 546 (8th Cir. 1997) (“information of common knowledge, insignificant data, or vague statements are examples of immaterial information” that is not actionable under Section 11 or 12(a)(2)); see also In re BankAmerica Corp. Sec. Litig., 78 F. Supp. 2d at 991-92; In re WebSecure, Inc. Sec. Litig., 182 F.R.D. 364 (D. Mass. 1998).

4) Statute Of Limitations Section 13 of the 1933 Act, 15 U.S.C. § 77m, provides that: [n]o action shall be maintained to enforce any liability created under Section 77k or 77l(2) of this title unless brought within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence, or, if the action is to enforce a liability created under Section 771(1) of this title, unless brought within one year after the violation upon which it is based. In no event shall any such action be brought to enforce a liability created under Sections 77k or 771(1) of this title more than three years after the security was bona fide offered to the public, or under Section 771(2) of this title more than three years after the sale. Plaintiff must plead in the complaint compliance with Section 13’s statute of limitations to state a claim under Sections 12(a)(1) or 12(a)(2). Toombs v. Leone, 777 F.2d 465, 468 (9th Cir. 1985); Meadows v. Pacific Inland

Sec. Corp., 36 F. Supp. 2d 1240, 1249 (S.D. Cal. 1999). In interpreting Section 13, “the vast majority of courts... have impliedly or expressly found that the three-year period begins when the security is first bona fide offered.” P. Stoltz Family P’ship L.P. v. Daum, 355 F.3d 92, 100 (2d Cir. 2004) (collecting cases) (emphasis in original). But see In re Bestline Prods. Sec. & Antitrust Litig., No. MDL 162-CIV-JLK, 1975 WL 386, at *1-2 (S.D. Fla. Mar. 21, 1975) (holding that the three year repose period begins after the security was last offered to the public); Bradford v. Moench, 809 F. Supp. 1473, 1485-90 (D. Utah 1992) (same); Hudson v. Capital Mgmt, Int’l Inc., No. C-81-1737, 1982 WL 1384, at *3 n.3 (N.D. Cal. Jan. 6, 1982) (same). Inquiry notice triggers an investor’s duty to exercise reasonable diligence in discovering a material misstatement or omission. See Grubka v. WebAccess Int’l, 445 F. Supp. 2d 1259, 1266 (D. Colo. 2006) (holding standard of diligence is whether reasonably diligent investor would have discovered the relevant facts); see also DeBenedictis v. Merrill Lynch & Co., 492 F.3d 209, 217-18 (3d Cir. 2007) (finding inquiry notice from widespread publication of articles concerning plaintiff’s situation). Several plaintiffs have attempted to argue that the extended statute of limitations under Sarbanes-Oxley applies to Section 12 claims, but courts that have considered the issue have rejected the application of the extended statute of limitations for claims involving “fraud, deceit, manipulation, or contrivance” to non-fraud claims brought under the 1933 Act. See, e.g., Ato Ram, II, Ltd. v. SMC Multimedia Corp., No. 03 CIV. 5569 HB, 2004 WL 744792, at *5 (S.D.N.Y. Apr. 7, 2004); Lawrence E. Jaffe Pension Plan v. Household Int’l, Inc., No. 02C5893, 2004 WL 574665, at *13 (N.D. Ill. Mar. 22, 2004).

5) Equitable Tolling The one-year limit on Section 12(a)(1) may be subject to equitable tolling. Katz v. Amos Treat & Co., 411 F.2d 1046, 1055 (2d Cir. 1969). But see Cook v. Avien, Inc., 573 F.2d 685, 691 (1st Cir. 1978); Blatt v. Merrill Lynch, Pierce, Fenner & Smith, Inc, 916 F. Supp. 1343, 1354 (D.N.J. 1996) (finding that the one year limitation applicable to Section 12(a)(1) claims is absolute); Pell v. Weinstein, 759 F. Supp. 1107, 1111 (M.D. Pa. 1991) aff’d without opinion, 961 F.2d 1568 (3d Cir. 1992) (“[V]ast majority of cases have concluded that the limitations period runs from the date of the violation regardless of whether the plaintiff knew of the violation.”). While there is disagreement with respect to Section 12(a)(1), it is more widely recognized that the one-year limit on Section 12(a)(2) claims is subject to equitable tolling, such as for acts of fraudulent concealment by the defendant. Cook, 573 F.2d at 691; Hudson, 1982 WL 1384, at *3. The three-year statute of repose for Sections 12(a)(1) and 12(a)(2) claims is absolute and is not subject to equitable tolling. Engl v. Berg, 511 F. Supp. 1146, 1151 (E.D. Pa. 1981); Jackson Nat’l Life Ins. v. Merrill Lynch & Co., Inc., 32 F.3d 697, 704 (2d Cir. 1994) (“The three-year period is an absolute limitation which applies whether or not the investor could have discovered the violation.”); Jensen v. Allison-Williams Co., No. 98-CV-2229 TW, 1999 U.S. Dist. LEXIS 22170, at *10 (S.D. Cal. Aug. 23, 1999).

6) Rule 9(b) Although Rule 9(b) applies only to averments sounding in fraud and thus has been held inapplicable to claims under Section 12 (see, for example, Roskos v. Shearson/Am. Express, Inc., 589 F. Supp. 627, 631 (E.D. Wis. 1984); Somerville v. Major Exploration, Inc., 576 F. Supp. 902, 909 n.9 (S.D.N.Y. 1983)), some courts have suggested that a Rule 9(b) motion may be appropriate where a 1933 Act claim “sounds essentially in fraud.” In re Westinghouse Sec. Litig., 90 F.3d 696, 716 (3d Cir. 1996); see also Rombach v. Chang, 355 F. 3d 164, 171 (2d Cir. 2004) (holding Rule 9(b)’s pleading standard applies to 12(a)(2) claim premised on allegations of fraud, even though plaintiff needed only to allege negligence under 12(a)(2)); Melder v. Morris, 27 F.3d 1097

(5th Cir. 1994); In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1404-05 (9th Cir. 1996); Ellison v. Am. Image Motor Co., 36 F. Supp. 2d 628, 639 (S.D.N.Y. 1999).

7) Not Applicable To Aftermarket Transactions The Supreme Court has confirmed that Section 12(a)(2) applies only to sales by a prospectus of newly issued stock in a public offering and not to secondary trading in aftermarket transactions in Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 1064, 1073-74 (1995), as discussed supra. See also Stack v. Lobo, 903 F. Supp. 1361, 1375 (N.D. Cal. 1995) (“The Supreme Court held that Section 12[(a)](2) applies only to initial public offerings.”); Komanoff v. Mabon, Nugent & Co., 884 F. Supp. 848, 857 (S.D.N.Y. 1995) (same); Endo v. Albertine, No. 88 C 1815, 1995 WL 170030, at *n. 3 (N.D. Ill. Apr. 7, 1995) (finding that Gustafson “limits recovery under Section 12[(a)](2) to only those class members who purchased securities in a public offering”). 4. Comparison Of Due Diligence Defense Under Sections 11 And 12(a)(2) a. Different Standards Section 11 requires a reasonable investigation and reasonable grounds for belief that statements made are not misleading. Section 12(a)(2) requires the exercise of reasonable care. The distinction between the Section 11 “reasonable investigation/reasonable grounds” standard and the Section 12(a)(2) “reasonable care” standard is an open question.

1) The Section 11 Standard As More Stringent The Southern District of New York has expressed the view that the standards for the defense under Section 11 are somewhat stricter. In re Worldcom, Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N.Y. 2004). Most commentators agree that the “reasonable investigation” requirement is more stringent than the “reasonable care” requirement. See, e.g., Epstein, “Reasonable Care” in Section 12(a)(2) of the Securities Act of 1933, 48 U. CHI. L. REV. 372, 388 (1982). Justice Powell has noted that “‘[i]nvestigation’ commands a greater undertaking than ‘care’” and argues that the SEC shares his view. John Nuveen & Co., Inc. v. Sanders, 450 U.S. 1005, 1009 (1981) (dissenting).

2) The Sections 11 And 12(a)(2) Standards As Equivalent In Sanders v. John Nuveen & Co., Inc., 619 F.2d 1222, 1228 (7th Cir. 1980), the court held that, under the circumstances of that case, the difference in the language of the Section 11 and 12(a)(2) standards, as applied to an underwriter, was not significant. See also Folk, Civil Liabilities Under the Federal Securities Acts: The BarChris Case, 55 VA. L. REV. 199, 207-16 (1969); In re Software Toolworks, Inc. Sec. Litig., 50 F.3d 615, 621 (9th Cir. 1994) (finding that the two articulations of due diligence are “similar” if not identical).

3) The Section 12(a)(2) Standard As More Stringent The proposition that the Section 12(a)(2) standard is more stringent than the Section 11 standard has some support. See Kaminsky, An Analysis of Securities Litigation Under Section 12(a)(2) and How It Compares with Rule 10b-5, 13 HOUS. L. REV. 231 (1976). Moreover, the Seventh Circuit’s decision in John Nuveen & Co. v.

Sanders, 619 F.2d 1222, 1228 (7th Cir. 1980), can be read as requiring an investigation under Section 12(a)(2) in a situation where Section 11 would not require one: a non-expert sued with regard to “expertised” material. Thus, although the Court said the standards were not significantly different, the Seventh Circuit instead may have imposed a greater burden under Section 12(a)(2). See John Nuveen & Co., 450 U.S. at 1010 (Powell, J., dissenting from denial of certiorari in Sanders). In any event, the standards are not equivalent for all purposes. Regardless of how Sanders is read, the decision does not support the proposition that the Section 12(a)(2) standard is identical to the Section 11 standard for all Section 12(a)(2) “sellers.” The Seventh Circuit was careful to limit its discussion to underwriters. Sanders v. John Nuveen & Co., Inc., 619 F.2d 1222, 1228 (7th Cir. 1980). For other “sellers” who are more distant from the offering materials and have more limited access to the issuer, imposing the due diligence standard that is imposed on the specific persons made liable by Section 11 would not make sense. D. Section 14 Of The 1934 Act 1. Section 14(a) And SEC Rule 14a-9 a. Section 14(a) Section 14(a) prohibits the solicitation of any proxy in a manner that violates rules promulgated by the SEC The provision states, in relevant part, that “[i]t shall be unlawful for any person, by use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe . . . to solicit . . . any proxy . . . in respect of any security (other than an exempted security) registered pursuant to Section 12 of this title.” 15 U.S.C. § 78n(a). b. Rule 14(a)‑9 S.E.C. Rule 14a-9, which was promulgated under Section 14(a), specifically prohibits solicitation of proxies by means of proxy statements that contain false or misleading statements concerning any material fact or omissions of material facts that make any part of the statement misleading. The rule states, in relevant part, “[n]o solicitation subject to this regulation shall be made by means of any proxy statement . . . containing any statement which . . . is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading.” 17 C.F.R. § 240.14a-9. c. Elements Of A Section 14(a) And Rule 14(a)(9) Violation Plaintiffs establish a violation of Section 14(a) and Rule 14a-9 by demonstrating that: (1) the proxy statement contains a material misrepresentation or omission; (2) the defendants are chargeable with some degree of culpability or fault; and (3) the proxy caused an injury to plaintiffs (i.e., the proxy was an essential link in the challenged transaction). See Rudolph v. UTStarcom, 2008 WL 4002855, at *7 (N.D. Cal. Aug.21, 2008) (dismissing 14(a) claim for failing to allege misleading statements or omissions were an “essential link” in the transaction); Bender v. Jordan, 439 F. Supp. 2d 139, 163 (D.D.C. 2006); In re BankAmerica Corp. Sec. Litig., 78 F. Supp. 2d 976, 988-89 (E.D. Mo. 1999); Mendell v. Greenberg, 612 F. Supp. 1543, 1548 (S.D.N.Y. 1985), aff’d, 927 F.2d 667 (2d Cir. 1990); National Home Prods., Inc. v. Gray, 416 F. Supp. 1293, 1312 (D. Del. 1976). The Third Circuit has abandoned the culpability requirement in favor of a standard closer to strict liability. Under these cases, establishing a violation of Section 14(a) and Rule 14a-9 requires plaintiffs to show that (1)

the proxy statement contained a material misrepresentation or omission; (2) which caused the plaintiff injury; and (3) the proxy solicitation was an essential link in effecting the proposed corporate action. Tracinda Corp. v. DaimlerChrysler AG, 364 F. Supp. 2d 362, 388 (D. Del. 2005) (explaining defendant may be liable under Section 14(a) for merely allowing his name to be used in a manner substantially connected to a proxy solicitation); Gen. Elec. Co. v. Cathcart, 980 F.2d 927, 932 (3d Cir. 1992). An omitted fact or misrepresentation in a proxy statement is material when there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. See TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438 (1976); Charal Inv. Co., Inc. v. Rockefeller, 131 F. Supp. 2d 593, 603 (D. Del. 2001), aff’d, 311 F.3d 198 (3d Cir. 2002). However, compliance with SEC rules may act as a shield to liability. Seinfeld v. Gray, 404 F.3d 645, 649 (2d Cir. 2005) (denying claim of material omission because defendant complied with Rule 14a-101). d. Breach Of Fiduciary Duty Breach of a fiduciary duty does not give rise to a securities law claim under Section 14(a) and Rule 14e-9, which relate only to disclosure obligations. See Bond Opportunity Fund v. Unilab Corp., No. 99-CIV. 11074, 2003 WL 21058251 (S.D.N.Y. May 9, 2003), aff’d, 2004 WL 249583 (2d Cir. Feb. 10, 2004). e. Applicability Of The Reform Act Some district courts have held that the Reform Act applies to even those Section 14(a) claims not involving fraud and contains no exception for a lack of scienter. See In re JP Morgan Chase & Co. Sec. Litig., No. 06 C 4675, 2007 WL 4531794, at *7 (N.D. Ill. Dec. 18, 2007); Beck v. Dobrowski, No. 06 C 6411, 2007 WL 3407132 (N.D. Ill. Nov. 14, 2007) (finding the Reform Act applicable regardless of whether fraud is pled); New Jersey v. Sprint Corp., No. 03 2071 JWL, 2008 WL 191780 (D. Kan. Jan 23, 2008) (noting that the Tellabs “strong inference” pleading requirement applies to section 14(a) negligence claims and is not limited to claims requiring scienter). f. Statute Of Limitations Because a Section 14(a) claim does not “sound in fraud,” the extended statute of limitations under the SarbanesOxley Act does not apply to claims under Section 14(a). See Rudolph v. UTStarcom, 560 F. Supp. 2d 880, 892 (N.D. Cal. 2008); In re Ditech Networks, Inc. Derivative Litig., No. 06-5157, 2007 WL 2070300, at *9 (N.D. Cal. July 16, 2007); In re Zoran Corp. Derivative Litig., 511 F. Supp. 2d 986, 1016-17 (N.D. Cal. 2007). The statute of limitations expires one year after the discovery of facts constituting the violation, and in no event more than three years following publication of the false statement. 2. Section 14(d) And SEC Rule 14d-10 a. Best Price Provision Section 14(d)(7) is commonly known as the “best-price” provision of the Williams Act, which regulates tender offers. The provision states, in relevant part, that “[w]here any person varies the terms of a tender offer . . . before the expiration thereof by increasing the consideration offered to holders of such securities, such person shall pay the increased consideration to each security holder whose securities are taken up and paid for pursuant to the tender offer.” 15 U.S.C. § 78n(d)(7). The purpose of Section 14(d)(7) is to “prevent a tender offeror from discriminating in price among tendering

shareholders.” Field v. Trump, 850 F.2d 938, 942 (2d Cir. 1988); S.E.C. Release No. 34-22198, 1985 WL 551642, at *3 (July 01, 1985); see also Karlin v. Alcatel, No. SA CV 00-0214, 2001 WL 1301216, at *1-2 (C.D. Cal. Aug. 13, 2001). b. SEC Rule 14d-10 S.E.C. Rule 14d-10 was promulgated under Section 14(d)(7) and, like Section 14(d)(7), Rule 14d-10 regulates tender offers. Paragraph (a)(2) of Rule 14d-10 reads “[n]o bidder shall make a tender offer unless . . . [t]he consideration paid to any security holder pursuant to the tender offer is the highest security paid to any other security holder during such tender offer.” 17 C.F.R. § 240.14d-10. Rule 14d-10 codifies the SEC’s interpretation of Section 14(d)(7), which is that Section 14(d)(7) requires “a bidder [to] pay a security holder in a tender offer . . . the highest consideration offered to any other security holder of the same class at any time during such tender offer.” S.E.C. Release No. 34-22198, 1985 WL 551642, at *1-3; see also Field, 850 F.2d at 942-43; Millionerrors Inv. Club v. Gen. Elec. Co., No. CIV. A. 99-781, 2000 WL 1288333, at *3 (W.D. Pa. Mar. 21, 2000). Several courts have recognized a private right of action under Section 14(d)(7) and Rule 14d-10. See, e.g., Epstein v. MCA, Inc., 50 F.3d 644 (9th Cir. 1995), rev’d on other grounds, 516 U.S. 367 (1996); Alidina v. Penton Media, Inc., No. 98 Civ. 8474(JES), 2000 WL 98025 (S.D.N.Y. Jan. 26, 2000); Gerber v. Computer Assocs. Int’l, Inc., 812 F. Supp. 361 (E.D.N.Y. 1993). c. Elements Of A Rule 14d-10 (a)(2) Violation In order to establish a violation of the “best price” rule, a plaintiff “must allege and prove . . . four elements: (1) that the bidder; (2) during the pendency of the bidder’s tender offer; (3) purchased a security that is the subject of the tender offer; (4) for more consideration than the bidder paid to other shareholders pursuant to the tender offer.” See, e.g., Kahn v. Va. Ret. Sys., 783 F. Supp. 266, 269 (E.D. Va. 1992), aff’d, 13 F.3d 110 (4th Cir. 1993); Walker v. Shield Acquisition Corp., 145 F. Supp. 2d 1360, 1374 (N.D. Ga. 2001). Currently, there is a split of authority regarding the meaning of the elements “during pendency of the . . . tender offer” and “pursuant to the tender offer.” See generally Lerro v. Quaker Oats Co., 84 F.3d 239 (7th Cir. 1996); Epstein v. MCA, Inc., 50 F.3d 644 (9th Cir. 1995), rev’d on other grounds, 516 U.S. 367 (1996); Millionerrors Inv. Club, 2000 WL 1288333, at *4-5 (adopting the reasoning of Epstein); In re Digital Island Sec. Litig., 357 F.3d 322 (3d Cir. 2004) (synthesizing the Lerro and Epstein approaches).

1) During Pendency Of The Tender Offer

(a) Formal Test Transactions entered into before or after a tender offer are outside the scope of Section 14(d)(7) and Rule 14d-10. See Lerro, 84 F.3d 239 (holding that a distributor agreement between a bidder and a stockholder did not occur “during the pendency of a tender offer” because the agreement was entered into before the tender offer had officially begun).

(b) Possible Exception For Successive Tender Offers

In Field v. Trump, 850 F.2d 938 (2d Cir. 1988), the defendant bidders announced a tender offer but then withdrew the offer four days later. The bidders then purchased a block of shares from a group of directors of the target corporation who opposed the tender offer and subsequent merger. Shortly thereafter, the bidders announced a new tender offer. The price paid for the directors’ shares exceeded the amount offered under either tender offer. The issue in the case was whether the payment for the directors’ shares could be considered “during” the tender offer in light of the fact that it occurred after a withdrawal of one tender offer and before the announcement of the new one. The Second Circuit stated that, “[u]nless successive tender offers interrupted by withdrawals can, in appropriate circumstances, be viewed as a single tender offer for purposes of the Williams Act, the ‘best-price’ rule is meaningless.” Field, 850 F.2d at 944. The Court held that if the purpose of bidder’s withdrawal was merely to escape application of the Williams Act, the withdrawal is ineffective and successive tender offers will be considered a single tender offer. As a result, transactions occurring between a withdrawal and the announcement of a new tender offer can be considered to have occurred “during” the tender offer.

(c) Functional Test If the challenged transaction was an “integral” part of the tender offer, the transaction occurs “during the pendency of the tender offer.” The focus of the inquiry is on what the purpose of the challenged transaction was, rather than on when the bidder entered into the transaction. See Epstein v. MCA, Inc., 50 F.3d 644 (9th Cir. 1995), rev’d on other grounds, 516 U.S. 367 (1996). “[A] transaction is integral to the tender offer . . . [when it] is ‘conditioned on the tender offer’s success,’ or if the transaction and tender offer are interdependent.” Padilla v. MedPartners, Inc., No. CV 98-1092-RSWL (SHx), 1998 WL 34073629, at *10 (C.D. Cal. July 27, 1998) (quoting Epstein, 50 F.3d 644); see also Epstein, 50 F.3d at 656 (holding that a transaction entered into prior to, and finalized after completion of, a tender offer was “integral” to the tender offer because the transaction was conditioned on the success of the tender offer and the redemption value of the stock the shareholder received as payment for his tender incorporated the tender offer price). The Epstein decision was reversed by the United States Supreme Court on grounds unrelated to the Ninth Circuit’s interpretation of Rule 14(d)(7). See Matsushita Elec. Indus. Co., Ltd. v. Epstein, 516 U.S. 367 (1996) (concluding that the Ninth Circuit never should have reached the merits of the case because of a prior settlement of class litigation in Delaware). Nevertheless, several federal district courts have followed and upheld the reasoning of Epstein. See Millionerrors Inv. Club, 2000 WL 1288333, at *4-5; Padilla v. MedPartners, Inc., No. CV98-1092-RSWL, 1998 WL 34073629, at *10 (C.D. Cal. July 27, 1998); Dr. Perera v. Chiron Corp., No. C-95 20725, 1996 WL 251936, at *3-4 (N.D. Cal. May 8, 1996). However, at least one Circuit has stated that the case “lacks precedential value.” Lerro v. Quaker Oats Co., 84 F.3d 239 (7th Cir. 1996).

(d) The Third Circuit’s Approach The Third Circuit has attempted to reconcile the formal test of Lerro with the functional test of Epstein. See In re Digital Island Sec. Litig., 357 F.3d 322 (3d Cir. 2004). In Digital Island, the Third Circuit held that a merger agreement executed before the tender offer that agreed to cash out the stock options and restricted stock held by the target’s directors and provided a “lucrative” employment contract to the target’s CEO did not violate Section 14(e) or Rule 14d-10. In analyzing whether the alleged additional compensation to the directors violated the Best Price Rule, the court held that the formal test of Lerro – that transactions outside the tender offer period are not violations of Rule 14d-10 – generally controls, but there is an exception pursuant to Epstein

for transactions designed to evade the requirements of the Williams Act. 357 F.3d at 333-34. However, the Third Circuit held that the “exception to the general rule is a narrow one” and only when transactions outside the offer period constitute a fraudulent attempt to circumvent the Best Price Rule will the outside transaction be considered a violation of Rule 14d-10. Id. “Accordingly, when reviewing a complaint alleging a violation of Rule 14d-10 based on a transaction executed prior to the commencement of a tender offer, the trial court should determine whether the plaintiff has met the heightened pleading requirements of Rule 9(b) and the PSLRA.” Id. at 337. In Digital Island, because the court had already rejected the plaintiffs’ Section 14(e) claim, the court held that there was no adequately pled fraud exception to the general rule that transactions outside the tender offer period are not violations of Rule 14d-10.

2) Pursuant To The Tender Offer A tender offer followed by a second-step merger is not a single, continuous, integrated transaction. Instead, tender offers and mergers are separate transactions, governed by different rules of law. Consequently, if bidders make payments to shareholders pursuant to a merger agreement, rather than pursuant to a tender offer agreement, the payments are made pursuant to the merger and not “pursuant to the tender offer.” Therefore, Section 14(d)(7) and Rule 14d-10, which apply only to tender offers, are inapplicable to second-step mergers. See Kramer v. Time Warner, Inc., 937 F.2d 767 (2d Cir. 1991). The ruling in Kramer does not have an impact on the formal test for “during the pendency of the tender offer.” If a challenged transaction occurs pursuant to or during a follow-up merger, the transaction is, by definition, not during the preceding tender offer. In addition, any transaction occurring during or pursuant to a merger is not “pursuant to the tender offer.” The Court in Lerro cited Kramer with approval and stated that tender offers and follow-up mergers are “different transactions, under different bodies of law (federal law regulates the tender offer and state law the merger).” Lerro v. Quaker Oats Co., 84 F.3d 239 (7th Cir. 1996) (holding that a distributor agreement between a bidder and a stockholder, which became effective with a second-step merger, did not occur pursuant to the tender offer because a follow-up merger should not be integrated with a tender offer). How courts applying the functional test established in Epstein will incorporate the ruling in Kramer is unclear. The functional test collapses the “during” and “pursuant to” elements of a Section 14(d)(7) and Rule 14d-10 claim into one inquiry: whether the transaction in question was an integral part of the tender offer. However, whether a court applying the functional test would consider the possibility that a transaction occurring during or pursuant to a follow-up merger could be an “integral” part of a preceding tender offer is unclear. The Ninth Circuit did not actually address this issue in Epstein. Instead, in a footnote, the Epstein court discussed the ruling in Kramer and then stated that Kramer was distinguishable on the facts. Kramer involved a tender offer and a second-step statutory merger whereas in Epstein, only a tender offer was involved. Consequently, the Court found that the outcome in Epstein was not dictated by the ruling in Kramer. See Epstein v. MCA, Inc., 50 F.3d 644, 659, n.21 (9th Cir. 1995). At least one court has held that payments made pursuant to a second-step merger could still be considered an “integral” part of a tender offer. See Millionerrors Inv. Club, 2000 WL 1288333, at *5. In Millionerrors Investment Club, plaintiffs alleged that prior to the commencement of a pending tender offer (that was to be followed by a merger), the board of directors of Fore Systems, Inc. provided several of its executives with stock options. General Electric Co. (“the bidder”) agreed that, pursuant to the tender offer, GE would pay all shareholders $35.00 a share and, pursuant to the merger agreement, would purchase all outstanding stock options from the executives. Plaintiffs alleged that payment for the stock options constituted a premium for the executives’ shares in Fore Systems, Inc. and that the bidder agreed to purchase the stock options in order to receive approval of the tender offer from the executives. This action, according to plaintiffs, violated the “best price” rule.

Defendants filed a motion to dismiss on the grounds that the transaction between the bidder and the executives was not “during” the tender offer. The transaction was entered into before the tender offer, and payment was not made until after the tender offer was complete. Relying on the Epstein decision, the court denied the defendants’ motion to dismiss. The court did not find that the Epstein analysis was affected by the fact that the payments in question in Millionerrors Investment Club were made pursuant to a merger, rather than a tender offer. See generally id. d. Other Important Provisions In Rule 14d-10 1) The “All-Holders” Rule Rule 14d-10 (a)(1) states that “[n]o bidder shall make a tender offer unless . . . [t]he tender offer is open to all security holders of the class of securities subject to the tender offer.” 17 C.F.R. § 240.14d-10. The purpose of this section is to “make explicit that a bidder’s tender offer must be open to all holders of the class of securities subject to the tender offer.” Proposed Amendments to Tender Offer Rules, S.E.C. Release No. 34-22198, 1985 WL 551642, at *1 (July 1, 1985).

2) Offering More Than One Type Of Consideration In A Tender Offer Paragraph (c) of Rule 14d-10 states that 14d-10 paragraph (a)(2) “shall not prohibit the offer of more than one type of consideration in a tender offer.” 17 C.F.R. § 240.14d-10. So long as “[s]ecurity holders are afforded equal right to elect among each of the types of consideration offered” and “[t]he highest consideration of each type paid to any security holder is paid to any other security holder receiving that type of consideration,” the tender offeror may offer more than one type of consideration. Id. Where a tender offer does not “make the type of consideration offered to some security holders available to all, a court may presume “that the selectivelyoffered consideration was ‘higher consideration’ for purposes of Section (a)(2).” Epstein, 50 F.3d at 654. e. Applicability Of The Reform Act To Section 14(d) Claims The Reform Act imposes strict pleading requirements on any claim in which a plaintiff alleges that a defendant “made an untrue statement of material fact . . . or omitted to state a material fact necessary in order to make the statements made, in light of the circumstances in which they were made, not misleading.” 15 U.S.C. § 78u-4(b)(1). No cases applying the heightened pleading standards of the Reform Act to a plaintiff’s claims for violations of Section 14(d)(7) and Rule 14d-10 exist. In fact, one court has held that the Reform Act’s heightened pleading standard does not apply to a claim for violation of Section 14(d)(7). See Maxick v. Cadence Design Sys., Inc., No. C-00-0658-PJH, 2000 WL 33174386, at *1 (N.D. Cal. Sept. 21, 2000). 3. Section 14(e) a. Purpose Section 14(e), like section 14(d), is a portion of the Williams Act regulating tender offers. The section reads, in relevant part, that “[i]t shall be unlawful for any person to make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made . . . not misleading . . . in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to

or in favor of any such offer, request, or invitation.” 15 U.S.C. § 78n(e). The provision is “designed to insure that shareholders confronted with a tender offer have adequate and accurate information on which to base the decision whether or not to tender their shares.” In re ValueVision Int’l Inc. Sec. Litig., 896 F. Supp. 434, 448 (E.D. Pa. 1995). b. Private Cause Of Action Section 14(e) does not expressly provide for a private cause of action and some dispute exists as to whether Section 14(e) implicitly authorizes such actions. The Supreme Court of the United States has held that, because the purpose of the Williams Act is to protect individual shareholders, a tender offeror does not have standing to sue under Section 14(e) if the offeror is suing in its capacity as a takeover bidder. See Piper v. Chris-Craft Indus., Inc., 430 U.S. 1, 42 n.28 (1977). Furthermore, at least one federal circuit has held that an issuer does not have standing to sue for violations of Section 14(e). See Liberty National Ins. Holding Co. v. Charter Co., 734 F.2d 545, 547 (11th Cir. 1984). However, the Ninth Circuit has held that Section 14(e) implicitly authorizes shareholder-offerees, whether or not they have tendered their shares, to bring private causes of action for violations of Section 14(e). See Plaine v. McCabe, 797 F.2d 713, 717-18 (9th Cir. 1986); see also Sedighim v. Donaldson, Lufkin & Jenrette, Inc., 167 F. Supp. 2d 639. c. Elements Of A Section 14(e) Claim For Misstatements Or Omissions In order to state a claim for a violation of Section 14(e), a plaintiff “must allege that: (1) the defendant made misstatements or omissions of material fact; (2) with scienter; (3) in connection with a tender offer; (4) upon which plaintiff relied; and (5) that plaintiff’s reliance was the proximate cause of their injury.” In re ValueVision, 896 F. Supp. at 448. Instead of damages, a plaintiff may seek a permanent injunction as relief for a violation of Section 14(e) by demonstrating that: (1) the defendant made misstatements or omissions of material fact; (2) with scienter; (3) in connection with a tender offer. See Clearfield Bank & Trust Co. v. Omega Fin. Corp., 65 F. Supp. 2d 325, 340 (W.D. Pa. 1999).

1) Materiality “A misstatement or omission is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding whether to accept the tender offer.” Polar Int’l Brokerage Corp. v. Reeve, 108 F. Supp. 2d 225, 236 (S.D.N.Y. 2000) (citations omitted); see also TSC Indus., Inc. v. Northway Inc., 426 U.S. 438, 439 (1976) (“An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”).

2) Scienter “The language of the Williams Act clearly demonstrates that Congress envisioned scienter to be an element of [Section] 14(e).” Adams v. Standard Knitting Mills, Inc., 623 F.2d 422, 431 (6th Cir. 198`0); see also Clearfield Bank & Trust Co., 65 F. Supp. 2d at 343; In re Digital Island Sec. Litig., 357 F.3d 322, 328 (3d Cir. 2004). As a result, in order to state a valid claim under Section 14(e), a plaintiff must plead intent to defraud, knowledge of falsity, or a reckless disregard for the truth. See Conn. Nat. Bank v. Fluor Corp., 808 F.2d, 957, 961 (2d Cir. 1987); Sogevalor, SA v. Penn. Cent. Corp., 771 F. Supp. 890, 895 (S.D. Ohio 1991).

3) In Connection With A Tender Offer The Williams Act does not define “tender offer.” See Beaumont v. Am. Can Co., 621 F. Supp. 484, 499-500 (S.D.N.Y. 1985), aff’d, 797 F.2d 79 (2d Cir. 1986). As a result, the courts have developed various tests for differentiating between a tender offer and a private transaction. See id.; see also Gorman v. Coogan, No. 03173-P-H, 2004 WL 60271, at *18-20 (D. Me. Jan. 13, 2004); Gas Natural v. E.ON AG, 468 F. Supp. 2d 595, 611 (S.D.N.Y. 2006) (holding that prior to the commencement of a tender offer as defined by Rule 14d-2, a potential offerer has no duty to disclose the material, non-public information that is required to be disclosed once a tender offer commences).

4) Reliance/Causation

(a) Permanent Injunctions If plaintiff seeks a permanent injunction as relief for a violation of Section 14(e), plaintiff is not required to plead and prove reliance and/or causation. See Clearfield Bank & Trust Co., 65 F. Supp. 2d at 340.

(b) Omissions In cases where a plaintiff alleges that a defendant made a material omission (as opposed to a misstatement), once the plaintiff proves that material facts were withheld, the reliance and causation elements of a Section 14(e) claim are established. See Berman v. Gerber Prods., Co., 454 F. Supp. 1310, 1324 (W.D. Mich. 1978) (citations omitted). “[P]laintiffs need only demonstrate that the omission created a material misimpression regarding the facts at issue.” Feinman v. Dean Witter Reynolds, Inc., No. 94 CIV. 7798, 1995 WL 562177, at *3 (S.D.N.Y. Sept. 21, 1995), aff’d, 84 F.3d 539 (2d Cir. 1996).

(c) Misstatements General Rule. Ordinarily, in a suit for damages for a violation of Section 14(e), if a plaintiff alleges that the violation occurred because a defendant made a material misstatement, that plaintiff must plead and prove that she relied on that misstatement and suffered harm as a result. See Atchley v. Qonaar Corp., 704 F.2d 355, 360 (7th Cir. 1983) (stating that if plaintiffs did not rely on the misstatements defendant allegedly made, then plaintiffs’ Section 14(e) claim should be dismissed); Berman, 454 F. Supp. at 1324 (“In general, a plaintiff must demonstrate . . . reliance in securities fraud cases.”); Waldrop v. Amway Asia Pac. Ltd., No. 99 Civ. 12093 (DC), 2001 U.S. Dist. LEXIS 2857, at *14-15 (S.D.N.Y. Mar. 19, 2001). Exception. There have been cases where a plaintiff has established that a defendant made material misstatements in connection with a tender offer; however, the defendant was then able to demonstrate that the plaintiff did not rely on the misstatements. In these cases, the defendant has moved to dismiss plaintiff’s claim on the grounds that the plaintiff lacks standing. Courts facing this issue have held that, if a plaintiff can prove that other persons relied on the defendants’ misstatements and that the plaintiff suffered harm as a result, the plaintiff has standing to bring the claim. See, e.g., In re PHLCORP Sec. Tender Offer Litig ., 700 F. Supp. 1265, 1276 (S.D.N.Y. 1988) (“In the context of Section 14 of the Exchange Act, ‘the reliance of the individual

plaintiff is irrelevant where the plaintiff may have been damaged by the reliance of others.’”) (quoting Jones v. National Distillers & Chem. Corp., 484 F. Supp. 679, 684 (S.D.N.Y. 1979)). In Plaine v. McCabe, a shareholder of an acquired corporation alleged that the acquiror had made misstatements in the tender offer for the shares of the target corporation. 797 F.2d 713 (9th Cir. 1986). The plaintiffshareholder had not tendered her shares in the tender offer because of the misstatements, but the vast majority of the other shareholders had tendered their shares. As a result, the merger was consummated and the plaintiff was forced to sell shares at (what she felt was) an inadequate price. The plaintiff then brought a claim against the acquiror for violation of Section 14(e). Defendant moved to dismiss the complaint on the grounds that the plaintiff could not establish the element of reliance. However, the Ninth Circuit held that, if other shareholders had relied on defendant’s misstatements and that plaintiff suffered injury as a result, the plaintiff could maintain her claim. See generally id. d. Section 14(e)’s Prohibition Of “Fraudulent, Deceptive, Or Manipulative” Practices Section 14(e) also contains language making it unlawful for any person to engage in “any fraudulent, deceptive, or manipulative acts or practices . . . in connection with a tender offer.” 15 U.S.C. § 78n(e). The section gives the SEC the authority to create rules and regulations that “define, and prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative.” Id. Thus, the SEC possesses the power to prohibit any particular conduct that is, at some point, deemed fraudulent. e. Applicability Of The Reform Act The Reform Act imposes strict pleading requirements on any claim in which a plaintiff alleges that a defendant “made an untrue statement of material fact . . . or omitted to state a material fact necessary in order to make the statements made . . . not misleading.” 15 U.S.C. § 78u-4(b)(1). In addition, the Reform Act imposes similar pleading requirements on claims where a plaintiff can recover money damages “only on proof that the defendant acted with a particular state of mind.” 15 U.S.C. § 78u-4(b)(2). As a result, the Reform Act appears on its face to apply to claims brought under Section 14(e). See 15 U.S.C. § 78n(e). Federal court decisions have applied the requirements of the Reform Act to claims brought under Section 14(e). See Rombach v. Chang, 355 F.3d 164, 171 (2d Cir. 2004); In re Digital Island Sec. Litig., 357 F.3d 322, 328-31 (3d Cir. 2004); Brody v. Transitional Hosp. Corp., 280 F.3d 997, 1006 (9th Cir. 2002); Conn. Nat’l Bank v. Flour Corp., 808 F.2d 957, 962 (2d Cir. 1987); Rubke v. Capital Bancorp, No. 05-4800PJH, 2006 WL 1699569, at *16-17 (N.D. Cal. June 16, 2006); Gas Natural v. E.ON AG, No. 06-13607(DLC), 2006 WL 3734425, at *8, 18 (S.D.N.Y. Dec. 19, 2006); Polar Int’l Brokerage Corp. v. Reeve, 108 F. Supp. 2d 225, 230-31 (S.D.N.Y. 2000); Clearfield Bank & Trust Co. v. Omega Fin. Corp., 65 F. Supp. 2d 325, 343-44 (W.D. Pa. 1999). E. Section 16 Of The 1934 Act Section 16(b) of the 1934 Act, 15. US.C.A. §78p(b) governs the recovery of “short-swing” profits by insiders. “Short-swing” profits are defined as “profits earned within a six months’ period by the purchase and sale of securities.” Blau v. Lehman, 368 U.S. 403, 405, 82 S.Ct. 451, 7 L.Ed.2d 403 (1962). Specifically, Section 16(b) provides that: For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) or a security-based swap agreement (as defined in Section 206B of the Gramm-Leach-Bliley Act) involving any such equity

security within any period of less than six months, unless such security or security-based swap agreement was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security or security-based swap agreement purchased or of not repurchasing the security or security-based swap agreement sold for a period exceeding six months. 1. Purpose Section 16(b) was designed to prevent corporate insiders “‘from profiteering through short-swing securities transactions on the basis of inside information.’” Roth v. Reyes, 567 F.3d 1077, 1079 (9th Cir. 2009) (citing Foremost-McKesson, Inc. v. Provident Securities Co., 423 U.S. 232, 234 (1976). 2. Strict Liability Section 16(b) is a strict liability rule that “‘requires the statutorily defined inside, short-swing trader to disgorge all profits realized on all ‘purchases’ and ‘sales’ within the specified time period, without proof of actual abuse of insider information, and without proof of intent to profit on the basis of such information.’” Id. 3. Standing An action to recover short-swing profits pursuant to Section 16(b) may be brought by the issuer whose stock was traded or by a stockholder “in behalf of the issuer.” 15 U.S.C. §78p(b). 4. Statute Of Limitations Section 16(b) expressly provides that a 16(b) suit may not be brought “more than two years after the date such [short-swing] profit was realized.” 15 U.S.C. § 78p(b). The Roth court held that this two-year limitation period should not be tolled, even where insiders erroneously claim an exemption from Section 16(a) (which requires certain corporate insiders to file statements disclosing their acquisitions and dispositions of company stock, as well as annual statements of their holdings and transactions). Roth, 567 F. 3d at 1082. F. Section 17 Of The 1933 Act Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q, provides that: It shall be unlawful for any person in the offer or sale of any securities by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly – a) to employ any device, scheme, or artifice to defraud; to obtain money or property by means of any untrue statement of a material fact or any omission 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 b) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.

1. Existence Of A Private Right Of Action Although the Supreme Court has thus far declined to address the issue (See Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 304 n.9 (1985); Herman & MacLean v. Huddleston, 459 U.S. 375, 378 n.2 (1983)), most Circuits have refused to imply a private right of action under Section 17(a). See Maldonado v. Dominguez, 137 F.3d 1 (1st Cir. 1998); Finkel v. Stratton Corp., 962 F.2d 169, 175 (2d Cir. 1992); Newcome v. Esrey, 862 F.2d 1099 (4th Cir. 1988) (en banc); Landry v. All Am. Assurance Co., 688 F.2d 381, 384-91 (5th Cir. 1982) (reasoning that the four tests for implying private rights set forth in Cort v. Ash, 422 U.S. 66 (1975), were not met); Schlifke v. Seafirst Corp., 866 F.2d 935, 942-43 (7th Cir. 1989) (overruling previous Seventh Circuit authority in light of the “decisive majority of recent authorities [which] have refused to imply a right of action under Section 17(a)”); Deviries v. Prudential-Bache Sec., Inc., 805 F.2d 326, 328 (8th Cir. 1986); Brannan v. Eisenstein, 804 F.2d 1041, 1042 n.1 (8th Cir. 1986); In re Wash. Public Power Supply Sys. Sec. Litig., 823 F.2d 1349 (9th Cir. 1987) (en banc) (overruling earlier Ninth Circuit rulings); Bath v. Bushkin, Gaims, Gaines and Jonas, 913 F.2d 817, 819 (10th Cir. 1990) (following “our six sister Circuits”), abrogated in part by Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350, 354 n.1 (1991); Rotella v. Wood, 528 U.S. 549, 553-54 (2000); Currie v. Cayman Res. Corp., 835 F.2d 780 (11th Cir. 1988). District courts, rejecting a private right of action under Section 17(a), usually adopt the Fifth Circuit’s reasoning in Landry, 688 F.2d 381. See, e.g., Abbell Credit Corp. v. Banc of Am. Sec., L.L.C., Inc., No. 01 C2227, 2001 WL 1104601, at *4 (N.D. Ill. Sept. 17, 2001); Dafofin Holdings S.A. v. Hotelworks.com, Inc., No. 00 CIV. 7861, 2001 WL 940632, at *6 (S.D.N.Y. Aug. 17, 2001); Hammerman v. Peacock, 607 F. Supp. 911, 914-15 (D.D.C. 1985); Ethanol Partners Accredited v. Weiner, Zuckerbrot, Weiss & Brecher, 635 F. Supp. 18, 21 (E.D. Pa. 1985). 2. SEC Enforcement Actions At least one court has held that SEC enforcement actions alleging violations of Section 17(a) do not have to comply with the provisions of the Reform Act because it applies only to private actions. S.E.C. v. Dunn, 587 F. Supp. 2d 486, 501 (S.D.N.Y. 2008). G. Section 18 Of The 1934 Act Section 18(a) of the 1934 Act, 15 U.S.C. § 78r(a), addresses fraudulent or misrepresentative statements, and provides that: Any person who shall make or cause to be made any statement in any application, report, or document filed pursuant to this chapter or any rule or regulation thereunder or any undertaking contained in a registration statement as provided in subsection (d) of Section 78o of this title, 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. 1. Elements Of Claim In order to state a claim under Section 18(a), a plaintiff must allege the following elements: a. Purchaser/Seller Plaintiff must have either purchased or sold at a price which was affected by such statement. See Ross v. A.H.

Robins Co., Inc., 607 F.2d 545, 552 (2d Cir. 1979); Stromfeld v. Great Atl. & Pac. Tea Co. Inc., 484 F. Supp. 1264, 1269 (S.D.N.Y.), aff’d, 646 F.2d 563 (2d Cir. 1980); see also In re Adelphia Commc’ns Corp. Sec. & Deriv. Litig., No. 03 MD 1529(LMM). 2007 WL 2615928, at *11 (S.D.N.Y. Sept. 10, 2007) (holding that when the “person who actually decides to purchase, and carries out the purchase of, a security is the same one who read and relied on the misstatement . . . the Section 18 claim may proceed”). b. Specific Reliance Plaintiff must actually rely on the statements in the document to successfully allege an 18(a) claim. See Ross, 607 F.2d at 552; Wachovia Bank & Trust Co., N.A. v. Nat’l Student Mktg. Corp., 461 F. Supp. 999, 1006 (D.D.C. 1978), rev’d on other grounds, 650 F.2d 342 (D.C. Cir. 1980) (ruling that application of Section 18(a) is not justified without actual reliance on specific statements); Berger v. Ludwick, No. C-97-0728-CAL, 1998 U.S. Dist. LEXIS 22734, at *11-12 (N.D. Cal. Sept. 15, 1998) (holding that because reliance for Section 18(a) violations was imposed expressly by Congress and reliance based on the “fraud on the market” theory will not suffice). Some courts have held that a plaintiff must plead actual reliance with particularity. In re Enron Corp. Sec., Derivative & ERISA Litig., 540 F. Supp. 2d 800 (S.D. Tex. 2007) (holding that a plaintiff is required to plead actual reliance with particularity, as opposed to constructive or presumed reliance or reliance based on the fraud-on-the-market theory). However, it is important to note that a plaintiff may assert both a Section 10(b) claim and a Section 18(a) claim. Both claims require that the plaintiff show actual reliance. However, to prove an 18(a) claim the reliance need not be reasonable. See In re Adelphia Commc’ns Corp. Sec. & Derivative Litig., 542 F. Supp. 2d 266, 268 (S.D.N.Y. 2008). Although courts require proof of actual reliance, merely viewing a copy of the document is sufficient. If, however, plaintiff knew that the statement was false or misleading at the time, then plaintiff cannot assert reliance. See Erath v. Xidex Corp., No. CIV-89-198TUCACM, 1991 WL 338322, at *8-9. (D. Ariz. Feb. 7, 1991), aff’d, 963 F.2d 378 (9th Cir. 1992). The false or misleading statement must be made in a document filed with the SEC See In re Digi Int’l Inc. Sec. Litig., 6 F. Supp. 2d 1089, 1103 (D. Minn. 1998), aff’d, 2001 WL 753869 (8th Cir. Jul. 5, 2001); Rankow v. First Chicago Corp., 678 F. Supp. 202, 207-08 (N.D. Ill. 1988), rev’d on other grounds, 870 F.2d 356 (7th Cir. 1989) (plaintiffs must allege that a false statement was filed with SEC); Berger, 1998 U.S. Dist. LEXIS 22734, at *11-12. c. Material Misstatement A material misstatement or omission of fact in connection with a document required to be filed with the SEC is necessary for a violation of Section 18(a). See Kennedy v. Chomerics Inc., 669 F. Supp. 1157, 1164 (D. Mass. 1987); Erath, 1991 WL 338322, at *6. In Deephaven Private Placement Trading, Ltd. v. Grant Thornton & Co., 454 F.3d 1168, 1177 (10th Cir. 2006), the mere certification of financial statements was deemed not a material misstatement under §18(a) sufficient to render an independent auditor liable. 2. Documents To Which Section 18(a) Applies Section 18(a) applies to documents, such as Forms 10-K, that must be filed with the SEC pursuant to Section 15(d) of the 1934 Exchange Act, as well as to the Act’s registration and periodic reporting requirements. Plaintiff must have actual knowledge of the materials filed with the SEC Thus, Section 18(a) does not apply to filings under the 1933 Act or any other securities laws. Similarly, Section 18(a) does not apply to annual reports disseminated to shareholders under the proxy rules. 17 C.F.R. 240.14a-3(b). 3. Liability Under Section 18

Liability under Section 18 extends to “any person who shall make or cause to be made” any misstatement or omission. Liability is not limited to the issuer or other person filing the document and can extend to the company’s officers and directors or to those who sign the filed documents. Because the Supreme Court eliminated aiding and abetting liability under Section 10(b), to the extent plaintiffs can demonstrate actual reliance, the courts may witness an increase in claims brought directly against lawyers and accountants under Section 18(a). In fact, Section 18(a)’s application could be deemed broader than Section 10(b) based upon its distinct language, and thus might encompass actions against lawyers and accountants. 4. Defenses Under Section 18 If the defendant can prove that he “acted in good faith and had no knowledge that such statement was false or misleading,” then liability will not be imposed. Ross, 607 F.2d at 556; Magna Inv. Corp. v. Does, 931 F.2d 38, 39-40 (11th Cir. 1991). 5. Attorneys’ Fees Section 18(a) provides that in addition to court costs, the court in its discretion, may assess reasonable attorney’s fees against either party. 6. Statute Of Limitations Section 18(c) provides that the lawsuit must be brought “within one year after the facts constituting the cause of action and within three years after such cause of action accrued.” 15 U.S.C. § 78r(c). Lindner Dividend Fund Inc. v. Ernst & Young, 880 F. Supp. 49, 53 (D. Mass. 1995); City of Painesville, Ohio v. First Montauk Fin. Corp., 178 F.R.D. 180 (N.D. Ohio 1998). Most courts have held that the lengthened limitations period of the Sarbanes-Oxley Act does not apply to section 18(a) claims. See, e.g., In re Enron Corp. Sec., Derivative, & “ERISA” Litig., 465 F. Supp. 2d 687, 712-13 (S.D. Tex. 2006). H. Insider Trading Claims Under Section 10(b) And Section 20A 1. Statutory Provisions a. Section 10(b) Of The 1934 Act Section 10(b), 15 USC § 78j, pertains to insider trading, and provides that it is unlawful: To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered . . . 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. Rule 10b-5, 17 C.F.R. §240.10b-5, promulgated thereunder 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, (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.

b. Section 20A Of The 1934 Securities Exchange Act Insider trading is also addressed in Section 20A, which provides in part: Any person who violates any provision of this Act or the rules or regulations thereunder by purchasing or selling a security while in possession of material, nonpublic information shall be liable in an action in any court of competent jurisdiction to any person who, contemporaneously with the purchase or sale of securities that is the subject of such violation, has purchased (where such violation is based on a sale of securities) or sold (where such violation is based on a purchase of securities) securities of the same class. 2. Private Right of Action For Insider Trading a. Actions Brought Under Rule 10(b) Rule 10b-5, a broad anti-fraud provision, does not specifically address insider trading, but nonetheless has emerged as the fundamental insider trading provision. Three key cases, Chiarella v. United States, 445 U.S. 222 (1980), Dirks v. S.E.C., 463 U.S. 646 (1983), and United States v. O’Hagan, 117 S. Ct. 2199 (1997), define the scope of insider trading under Rule 10b-5. The central tenet of these cases is that insiders, or those with similar fiduciary duties who possess material nonpublic information, must either abstain from trading or disclose the information. See S.E.C. v. Adler, 137 F.3d 1325, 1333 (11th Cir. 1998).

1) Classical Theory Under the classical theory, a person who buys or sells securities on the basis of material nonpublic information violates Rule 10b-5 if: (1) he owes a fiduciary duty to the other party; (2) he is an insider; or (3) he is a tippee who received information from an insider and knows, or should know, that the insider breached a fiduciary duty in disclosing the information to him. Chiarella, 445 U.S. 222. Under this theory, a tipper is liable only if he garnishes the information with his own benefit in mind. Dirks, 463 U.S. 646. The benefit to the tipper need not be financial, e.g., a reputational benefit may suffice. Id.; see also S.E.C. v Maxwell, 341 F. Supp. 2d 941, 948 (S.D. Ohio 2005) (the reputational benefit must be reasonably calculated to translate into a future advantage for the tipper). The tippee’s duty is an extension of the tipper’s fiduciary duty, and the tippee is not liable unless the tipper breached a duty in disclosing the information. The tipper need not know that his breach of fiduciary duty in revealing the information would lead to the tippee’s trading; rather, the fact that the tipper knows he himself breached a duty is sufficient to establish that he expected the tippee would misuse the information. United States v. Liberia, 989 F.2d 596 (2d Cir. 1993). The Ninth Circuit adopted a contemporaneous trading requirement for insider trading claims brought under Section 10(b) and Rule 10b-5. See Brody v. Transitional Hosp. Corp., 280 F.3d 997, 1001 (9th Cir. 2002) (rejecting argument that O’Hagan does away with contemporaneous trading requirement); see also In re Sec. Litig. BMC Software, Inc., 183 F. Supp. 2d 860, 916 (S.D. Tex. 2001) (stating that the contemporaneous trading requirement applies both to claims brought under 10(b) and 20A).

2) Misappropriation Theory

The misappropriation theory expands liability to trading by corporate outsiders by imposing liability on those with a duty to the source of the insider information, even though the person is a corporate outsider and has no direct duty to the trading shareholders. Under this theory, Rule 10b-5 is violated when a person (1) misappropriates material, nonpublic information, (2) by breaching a duty arising out of a relationship of trust and confidence, and (3) uses that information in a securities transaction, (4) regardless of whether he owed any duty to the shareholders of the traded stock. O’Hagan, 117 S. Ct. at 2207; S.E.C. v. Clark, 915 F.2d 439 (9th Cir. 1990); United States v. Cusimano, 123 F.3d 83 (2d Cir. 1997) (trading by an outsider in possession of material nonpublic information obtained and used in violation of duty owed to source treated as insider trading). In S.E.C. v. Cuban, 634 F. Supp. 2d 713, 725 (N.D. Texas, 2009), the court held that misappropriation liability could arise from a contractual duty by agreement, absent any preexisting fiduciary or fiduciary-like relationship, if the agreement consisted of more than an express or implied promise merely to keep information confidential and imposed on the party who received the information the legal duty to refrain from trading on or otherwise using the information for personal gain. The Eleventh Circuit has ruled that tippers must intend to derive a benefit from the tip for misappropriation liability to attach. See S.E.C. v. Yun, 327 F.3d 1263, 1271 (11th Cir. 2003). Also, because the duty of trust runs from the tippee to the source, the tippee may avoid liability by revealing his intentions to trade to the source. O’Hagan, 117 S. Ct. at 2209. Damages under this theory are disgorgement of all profits and dividends received or credited plus interest. S.E.C. v. Tome, 638 F. Supp. 596 (S.D.N.Y. 1986). b. Actions Under Section 20A Section 20A codified the common law discussed above by articulating a private right of action for contemporaneous traders, i.e., where a plaintiff and insider complete trades at or near the same time. Section 20A provides that any person who violates the Securities Exchange Act by purchasing or selling a security while in possession of material, nonpublic information shall be liable to any person who, contemporaneously with the insider trading, purchased or sold securities of the same class. Section 20A is not exclusive; proper plaintiffs may still seek relief under Section 10(b). See 15 U.S.C. § 78t-1(d).

1) Independent Violation Required Section 20A is not a primary source of insider trading liability. In order to recover under Section 20A, plaintiff must show an independent violation of the securities laws. See In re VeriFone Sec. Litig., 11 F.3d 865, 872 (9th Cir. 1993); Carney v. Cambridge Tech. Partners, Inc., 135 F. Supp. 2d 235, 256 (D. Ma. 2001) (“[C]laims under Section 20(A) are derivative, requiring proof of a separate underlying violation of the Exchange Act.”) (citing In re Advanta Corp. Sec. Litig., 180 F.3d 525, 541-42 (3d Cir. 1999)). However, the expiration of the statute of limitations for the underlying violation does not bar Section 20A claims. See Johnson v. Aljian, 490 F.3d 778 (9th Cir. 2007).

2) Contemporaneous Traders As noted, Section 20A creates a right of action only for contemporaneous traders. See Brody v. Transitional Hosp. Corp., 280 F.3d 997, 1001 (9th Cir. 2002) (rejecting argument that O’Hagan does away with the contemporaneous trading requirement); In re MicroStrategy, Inc. Sec. Litig., 115 F. Supp. 2d 620 (E.D. Va. 2000). See also, Fujisawa Pharm. Co., Ltd. v. Kapoor, 932 F. Supp. 208 (N.D. Ill. 1996), aff’d, 115 F.3d 1332

(7th Cir. 1997) (contemporaneous traders are those who purchase stock anonymously on the open market, not those who purchase directly in face-to-face transactions). A plaintiff need not have traded on the same day as the insider in order for the trades to be “contemporaneous.” Courts applying the contemporaneous trading requirement differ in how strictly they construe it. See, e.g. In re Cypress Semiconductor Sec. Litig., 836 F. Supp. 711, 714 (N.D. Cal. 1993) (trade by investor five days after sale of stock by defendants met contemporaneous requirement); In re MicroStrategy, 115 F. Supp. 2d 620 (purchase of shares not contemporaneous with insider’s sale three days earlier); Chanoff v. U.S. Surgical Corp., 857 F. Supp. 1011 (D. Conn.), aff’d, 33 F.3d 50 (2d Cir. 1994) (purchase of more than one month from any insider trade not contemporaneous); In re Verifone Sec. Litig., 784 F. Supp. 1471 (N.D. Cal. 1992), aff’d, 11 F.3d 865 (9th Cir. 1993) (stock purchase two weeks from insider trade not contemporaneous); Colby v. Hologic, Inc., 817 F. Supp. 204 (D. Mass. 1993) (trade eight days after insider trade not contemporaneous); In re Tyco Int’l, Ltd., MDL No. 02-1335-B, 2007 WL 1703023 (D.N.H. June 11, 2007) (holding that purchases a week before defendant’s sales were not contemporaneous). See Section III.A.7.f above.

3) Same Class Of Securities Congress further limited standing to those who traded in the “same class of securities” as the insider trader. See Fujisawa, 115 F.3d at 1337. For example, a plaintiff who purchased class B securities may not bring an action against an insider who sold class A shares. c. Civil And Criminal Liability Under A Misappropriation Theory In government actions alleging insider trading liability, various circuits have held that the government must meet an informational “use” requirement. S.E.C. v. Alder, 137 F.3d 1325 (11th Cir. 1998); United States v. Smith, 155 F.3d 1051 (9th Cir. 1998). Merely showing that an insider traded while in possession of material nonpublic information is not a per se violation. In the civil context, “[W]hen an insider trades while in possession of material nonpublic information, a strong inference arises that such information was used by the insider in trading.” Alder, 137 F.3d at 1337. The insider can attempt to rebut the inference that a causal connection existed between his possession of information and his trading, but the SEC is still able to make out a prima facie case without having to present more direct evidence of any causal connection. In the criminal context, however, constitutional questions would be present if an evidentiary presumption gave rise to an inference of use of the insider information. Although this makes a prosecution by the government somewhat more difficult, many pieces of circumstantial evidence are relevant to causation. SEC rules that were enacted in November 2000 address this use requirement and identify circumstances where family, personal, or other non-business relationships may give rise to a duty of trust or confidence for purposes of the “misappropriation theory” of insider trading. The rules also establish two affirmative defenses to insider trading charges: (1) under Rule 10b5-1(c), a person will not be viewed as having traded on the basis of material nonpublic information if the trade was made pursuant to a pre-existing contract, instruction or an eligible written plan; and (2) under Rule 10b5-1(c)(2), which applies only to entities, an entity can demonstrate that an investment decision was not made “on the basis of” material non-public information if shown that: (1) the individual making the investment decision was not aware of the information; and (2) the entity had reasonable policies and procedures in place to prevent insider trading. d. Definition Of Insider An insider is defined as a party that (1) has direct or indirect access to information intended to be available for corporate purposes only and not for the personal benefit of any individual and (2) takes advantage of such information knowing it is unavailable to those with whom he is dealing. See In re Cady, Roberts & Co., S.E.C. Release No. 8-3925, 1961 WL 60638 (Nov. 8, 1961) (announcing test); S.E.C. v. Texas Gulf Sulphur Co., 401

F.2d 833 (2d Cir. 1968) (adopting Cady test). Under this test, mere access to inside information is not sufficient. In order to impose liability there must be a “relationship giving access” to such information. Cady, 1961 WL 60638, at *4; see also S.E.C. v. Lund, 570 F. Supp. 1397, 1402 (C.D. Cal. 1983) (holding that insider trading liability is directed at those who are in a special relationship with the company and privy to its internal affairs). The innocent eavesdropper is excluded from liability. In addition to officers, directors, and controlling shareholders, certain other individuals may be considered insiders for purposes of 10(b) and 20A. Myzel v. Fields, 386 F.2d 718 (8th Cir. 1967) (ruling that relatives and friends of traditional insiders may themselves be insiders); S.E.C. v. Cherif, 933 F.2d 403 (7th Cir. 1991) (extending insider liability to certain family members); In re Tacoma Sec., Inc., 30 S.E.C. 1067 (1984) (concluding that broker-dealer and investment company were liable as insiders); Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228 (2d Cir. 1974) (holding that underwriters were considered insiders for purposes of 10(b)); United States v. Marcus Schloss & Co., Inc., 710 F. Supp. 944 (S.D.N.Y. 1989) (ruling that insider trading liability extends to an employee of a law firm who has acquired material, nonpublic information regarding a corporate client). But see U.S. Steel & Carnegie Pension Fund, Inc. v. Orenstein, 557 F.2d 343 (2d Cir. 1977) (stating that because bank stood to receive proceeds from securities offering did not necessarily make it an insider); Feldman v. Simkins Indus., Inc., 679 F.2d 1299 (9th Cir. 1982) (holding that fourteen percent stockholder was not a corporate insider because he had no access to confidential corporate information), receded from on other grounds in In re Wash. Public Power Supply Sys. Sec. Litig., 823 F.2d 1349, 1352 (9th Cir. 1987). e. Materiality Whether the nonpublic information is material is crucial to determining liability. The general test of materiality is whether a substantial likelihood that a reasonable investor would consider the information important in making an investment decision exists. S.E.C. v. Antar, 15 F. Supp. 2d 477 (D.N.J. 1998); see also United States v. Smith, 155 F.3d 1051 (9th Cir. 1998) (holding that “soft” information may be material and may give rise to insider trading liability); United States v. Cusimano, 123 F.3d 83 (2d Cir. 1997) (noting that a statement that “something was happening” was sufficiently material to support a conviction for insider trading). I. Securities-Related RICO Suits In response to congressional concerns that RICO served as a loophole for attorneys to bring stale securities actions, the Reform Act amended the civil RICO statute to eliminate RICO liability for most securities fraud claims, except for those premised on securities violations where criminal convictions have been entered. 18 U.S.C. § 1964(c), as amended by the Reform Act, § 107. The primary mechanism of the amendment was to alter RICO to exclude securities fraud as a predicate act. Accordingly, courts have broadly interpreted the amendment to preclude RICO claims rooted in conduct that could be actionable as securities fraud, regardless of whether the plaintiff presents an actionable securities claim. See Howard v. America Online Inc., 208 F.3d 741, 749-50 (9th Cir. 2000); Fezzani v. Bear, Stearns & Co., Inc., No. 99CIV0793(RCC), 2005 WL 500377 at *5 (S.D.N.Y. Mar. 2, 2005) (holding that the RICO amendment bars reliance on any conduct actionable as securities fraud); Gatz v. Ponsoldt, 297 F. Supp. 2d 719, 730 (D. Del. 2003) (holding the Reform Act bars class action and derivative RICO suits based on securities fraud even if plaintiffs do not allege that they purchased or sold securities). However, the Reform Act does not bar RICO suits when the alleged conduct is not actionable as securities fraud, even if the fraud happens to involve a security. See Petters Co., Inc. v. Stayhealthy, Inc., No. CIV. 03-3210 JRT/FLN, 2004 WL 1465830 (D. Minn. June 1, 2004) (finding the connection between the alleged fraud and the securities transaction too tenuous where plaintiff alleged misrepresentations to secure a loan and creditor received both a promissory note and a separate security agreement providing an option for debtor’s common stock). In In re Prudential Securities Inc. Ltd. Partnership Litigation, 930 F. Supp. 68, 77-81 (S.D.N.Y. 1996), the court held that the Reform Act did not apply retroactively to RICO claims filed prior to the Reform Act’s

enactment. See also Mathews v. Kidder, Peabody & Co., Inc., 161 F.3d 156 (3d Cir. 1998) (holding Reform Act RICO Amendment not retroactive where plaintiff’s only viable claims came under RICO statute); Baker v. Pfeifer, 940 F. Supp. 1168 (S.D. Ohio 1996) (holding that the RICO Amendments do not apply retroactively). But see Krear v. Malek, 961 F. Supp. 1065, 1072 (E.D. Mich. 1997) (holding that provision of the Reform Act eliminating securities fraud as a predicate act for RICO claims applies retroactively); ABF Capital Mgmt. v. Askin Capital Mgmt., L.P., 957 F. Supp. 1308, 1320 (S.D.N.Y. 1997) (same). J. The Investment Company Act Of 1940 Congress passed the Investment Company Act of 1940 as a comprehensive federal regulatory scheme to protect investment company shareholders from self-dealing and other abuses that were perceived to be rampant throughout the mutual fund industry. 15 U.S.C. § 80a-1 (1997) (Findings and Declarations of Policy). Unlike the Securities Act of 1933 and the Securities Exchange Act of 1934, which emphasize disclosure, the 1940 Act emphasizes regulatory and remedial measures, and contains various prohibitions and requirements including that the board of directors of a fund consist of “disinterested” members who are not affiliated with the investment adviser of the fund. 15 U.S.C. § 80a-10(a). The Supreme Court has instructed that these persons serve as “independent watchdogs” who supply “an independent check upon the management.” Burks v. Lasker, 441 U.S. 471, 484 (1979). As mutual funds experienced rapid growth in the 1950’s and 1960’s, investment advisers earned fees that did not necessarily reflect the perceived economies of scale realized in managing larger funds. Securities and Exchange Commission, Public Policy Implications of Investment Company Growth, reprinted in H.R. Rep. No. 2237, 89th Cong., 2d Sess., 10-12 (1966). Congress determined that the unique structure of the mutual fund industry resulted in closer relationships between mutual funds and their investment advisers than those usually existing between other buyers and sellers of investment advisory services. Because of this closeness, “the forces of arm’s length bargaining [did] not work in the mutual fund industry in the same manner as they [did] in other sectors of the American economy.” S. Rep. No. 184, 91st Cong., 1st Sess. 5, reprinted in 1970 U.S. Code Cong. & Ad. News 4897, 4901. In 1970, Congress sought to address the problem by adding Section 36(b) to the Act, 15 U.S.C. § 80a-35(b), thereby imposing a fiduciary duty upon investment advisers in connection with their receipt of compensation. Section 36(b) is the only provision under the entire Act that expressly provides private citizens with a right of action. Many federal courts previously found implied private rights of action under various sections of the 1940 Act and have, in effect, superimposed a layer of judicial scrutiny over the actions of mutual fund advisers and independent directors. More recent decisions, however, have declined to find an implied private right of action under certain sections. Other federal courts have narrowed the scope of claims under the Act and embraced important doctrinal defenses. In the future, cases are likely to focus primarily on two areas: (i) the existence of implied private rights of action under the Act; and (ii) the standard for pleading (as opposed to proving) claims under Section 36(b), the Act’s only express right of action. 1. Section 36(b) Of The Investment Company Act Section 36(b) of the Investment Company Act of 1940, 15 U.S.C. § 80a-35(b), provides: An action may be brought under this subsection by the Commission, or by a security holder of such registered investment company on behalf of such company, against such investment adviser, or any affiliated person of such investment adviser, or any other person enumerated in subsection (a) of this section who has a fiduciary duty concerning such compensation or payments, for breach of fiduciary duty in respect of such compensation or payments paid by such registered investment company or by the security holders thereof to such investment adviser or person. By its terms, Section 36(b) is limited to breaches of fiduciary duty involving an investment adviser’s receipt of

compensation and does not, on its face, give plaintiffs the right to sue for alleged breaches of general fiduciary duties. It does not require that plaintiff prove that a defendant engaged in personal misconduct. 15 U.S.C. § 80a-35(b)(1). Furthermore, fees charged are not inevitably found excessive simply because the defendant has breached a fiduciary duty. Mutchka v. Harris, 373 F. Supp. 2d 1021, 1025 (C.D. Cal. 2005). Section 36(b) gives private litigants a short, one-year limitations period in which to bring suit, in direct contrast with the longer, five-year limitations period given the SEC for enforcement proceedings. Damages under Section 36(b) are limited to fees received by investment advisers within the prior year. 15 U.S.C. § 80a-35(b)(3). Only recipients of advisory compensation or other payments shall be liable for damages under § 36(b). Id. Because Section 36(b) is “equitable” in nature, plaintiffs are not entitled to a jury trial. See Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 487 F. Supp. 999, 1001 (S.D.N.Y. 1980), aff’d sub nom. In re Gartenberg, 636 F.2d 16, 17 (2d Cir. 1980); Kalish v. Franklin Advisers, Inc., 928 F.2d 590, 591 (2d Cir. 1991); Schuyt v. Rowe Price Prime Reserve Fund, Inc., 663 F. Supp. 962 (S.D.N.Y.), aff’d, 835 F.2d 45, 46 (2d Cir. 1987). The demand requirement governing derivative actions brought by shareholders of a corporation does not apply to an action brought by an investment company shareholder under Section 36(b) of the Act. See Daily Income Fund, Inc. v. Fox, 464 U.S. 523 (1984). 2. Initial Litigation – The Excessive Fee Cases In connection with the increased popularity of money market funds in the 1980’s, plaintiffs brought numerous claims under Section 36(b) alleging that investment advisers were charging these funds excessive management fees. Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2d Cir. 1982), was the first case to undertake a comprehensive analysis of the standards courts should apply when evaluating “excessive fee” claims under Section 36(b). The court reviewed the “tortuous” legislative history of Section 36(b) and concluded that, to be guilty of a violation, the fee must be “so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.” Id. at 928; see also In re Salomon Smith Barney Mutual Fund Litig., 441, F. Supp. 2d 579, 599 (S.D.N.Y. 2006) (holding it is insufficient to plead that fees are excessive, a complaint must also plead facts showing that fees are disproportionate to the services rendered). The court identified six factors to be considered in determining whether fees charged by the investment adviser were disproportionate to the services rendered: (1) the nature and quality of the services provided to fund shareholders; (2) the profitability of the fund to the adviser-manager; (3) economies of scale of operating the fund as it grows larger; (4) comparative fee structures; (5) fallout benefits, i.e., indirect profits to the adviser attributable in some way to the existence of the fund; and (6) the independence and conscientiousness of the directors. Id. Subsequent to Gartenberg, plaintiffs have been generally unsuccessful in pursuing “excessive fee” claims under Section 36(b). See, e.g., Krinsk v. Fund Asset Mgmt., Inc., 875 F.2d 404, 409 (2d Cir. 1989); Levy v. Alliance Capital Mgmt., L.P., No. 97 CIV. 4672 (DC), 1998 WL 744005, at *4 (S.D.N.Y. Oct. 26, 1998), aff’d, 189 F. 3d 461 (2d Cir. 1999) (dismissing Section 36(b) claim where plaintiff “fail[ed] to explain how the fees and expenses are excessive in light of the ‘Gartenberg’ factors”); Schuyt, 663 F. Supp. 962. But see Millenco L.P. v. MEVC Advisors, Inc., No. CIV. 02-142-JJF, 2002 WL 31051604, at *3-4 (D. Del. Aug. 21, 2002); Sins v. Janus Capital Mgmt., LLC, No. 04-cv-01647-WDM-MEH, 2006 WL 3746130, at *3-4 (D. Colo. Dec. 15, 2006) (finding, under Gartenberg, allegations that the defendant provided identical services to third parties at lower rates weigh against granting a motion to dismiss). Notably, in affirming dismissal of a 36(b) claim, the Seventh Circuit rejected the Gartenberg analysis altogether, finding that the market for mutual fund fees was a more appropriate predictor of what is “reasonable” than judicially created standards. Jones v. Harris Assocs., 527 F.3d 627, 632 (7th Cir. 2008). Additionally, the Eighth Circuit has supported both the Gartenberg and Jones analysis, holding that while the Gartenberg factors were useful, their flaw was that they could be applied

so as to “create a safe harbor of exorbitance” and “be diluted to a simple and easily satisfiable requirement not to charge a fee that is egregiously out of line with industry norms.” Gallus v. Ameriprise Fin., Inc., 561 F.3d 816, 822-23 (8th Cir. 2009) (finding the proper approach to Section 36(b) would be to look “to both advisers’ conduct during negotiations and the end result”). In 2010, the Supreme Court affirmed the Seventh Circuit decision in Jones, but on a different ground. It disagreed with the Seventh Circuit’s rejection of the Gartenberg standard, holding that it fully expresses the meaning of “fiduciary duty” in Section 36(b) and reflects the section’s “place in the statutory scheme and, in particular, its relationship to the other protections that the Act affords investors.” Jones v. Harris Assoc. L.P., 130 S. Ct. 1418, 1427 (2010). While “all relevant circumstances “must be considered in determining wither a fund manager’s compensation is lawful, the Court reaffirmed that the Act “does not call for judicial secondguessing of informed board decisions, id. at 1430; if disinterested directors consider the relevant factors, “their decision to approve a particular fee agreement is entitled to considerable weight, even if a court might weigh the factors differently.” Id. at 1429. 3. Recent Attempts To Expand The Scope Of Section 36(b) Rather than alleging that an adviser’s fees are “excessive,” plaintiffs now invoke Section 36(b) to challenge corporate transactions involving investment companies. Plaintiffs are now also attacking the structure of the fees themselves as per se violations of Section 36(b), without necessarily alleging that they are excessive or disproportionate to the services rendered. Challenges to fees have also been brought under Section 36(b) on the ground that advisory agreements were not properly approved by disinterested directors, since the directors served on multiple fund boards and received significant remuneration for such services. The Supreme Court’s decision in Jones v. Harris Assocs., by focusing broadly on fiduciary duties, will be an obstacle to many such efforts. a. Mergers In Olesh v. Dreyfus Corp., No. CV-94-1664 (CPS), 1995 WL 500491 (E.D.N.Y. Aug. 8, 1995), plaintiff shareholders in two mutual funds managed by The Dreyfus Corporation alleged that the merger of Dreyfus and Mellon Bank violated Section 36(b). Plaintiffs asserted that Dreyfus breached its fiduciary duties under Section 36(b) by failing to negotiate any reduction in the funds’ advisory fees or protections against future fee increases. The district court dismissed the complaint, holding that the failure to negotiate reduced fees or protection against future fee increases in connection with a merger was not a breach of fiduciary duty under Section 36(b). Applying the Gartenberg standard, the Court noted that plaintiffs had failed to allege that either existing or contemplated future fees bore “no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.” Id. at *19 (quoting Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923, 928 (2d Cir. 1982)). Similarly, in Wexler v. Equitable Capital Management Corp., No. 93 CIV. 3834 (RPP), 1994 WL 48807 (S.D.N.Y. Feb. 17, 1994), the court dismissed a challenge under Section 36(b) to an investment adviser’s sale because plaintiffs failed to support their claims with specific allegations that after the sale the investment advisory fees would be excessive under the Gartenberg standard. b. Rights Offerings In In re Nuveen Fund Litigation, No. 94 C 360, 1996 WL 328006 (N.D. Ill. June 11, 1996), plaintiffs brought a claim under Section 36(b) against an adviser to closed-end mutual funds challenging the issuance of new stock pursuant to a rights offering. Plaintiffs alleged that the adviser issued new shares in the funds to generate additional management fees for itself, regardless of the harmful consequences to the funds. The court held that although Section 36(b) imposes a fiduciary duty with respect to the receipt of compensation or payment for

services, it does not regulate the propriety of underlying transactions (such as the rights offering) upon which additional compensation may be based. Id. at *5. The court opined that “Congress enacted Section 36(b) in order to address a narrow area of concern: the negotiation and enforcement of payment arrangements between the investment adviser and its fund.” Id. at *13. The Court concluded that Section 36(b) should not be applied broadly to govern an investment adviser’s performance, and is not the proper vehicle for challenging an underlying transaction that may, in fact, generate fees for the adviser. Id. Similarly, in Strougo v. Scudder, Stevens & Clark, Inc., 964 F. Supp. 783, 805 (S.D.N.Y. 1997), the court dismissed plaintiffs’ Section 36(b) claim where plaintiffs alleged that the rights offering was done to increase the adviser’s fee. The court held that plaintiffs had failed to support the “conclusory allegation that [the adviser’s] compensation after the Rights Offering was unreasonably disproportionate to the value of [the adviser’s] services” and that allegations that the adviser’s fee “increased substantially as a result of a Rights Offering . . . [did] not, in itself, support an excessive fee claim under Section 36(b).” See also King v. Douglass, 973 F. Supp. 707, 722 (S.D. Tex. 1996) (dismissing a Section 36(b) claim for failing to allege that the fee was not commensurate with services provided or could not have been the product of a disinterested business transaction despite adequately pleading that defendants disproportionately received a large fee relative to other investment companies). c. Leveraged Funds In two very similar cases involving the same plaintiffs, courts granted summary judgment for defendants, holding that potential conflicts of interest in an advisory agreement do not constitute a violation of Section 36(b) unless there is an actual breach of the fiduciary duty imposed by that section. In Green v. Fund Asset Management, L.P., 19 F. Supp. 2d 227 (D.N.J. 1998), shareholders in seven “leveraged” closed-end investment companies alleged that the funds and their adviser violated Sections 8(e), 34(b), 36(a) and 36(b) of the Act and state law by receiving compensation based upon the total assets of the funds, including assets acquired by leveraging through the issuance of preferred stock. Plaintiffs asserted that these compensation arrangements created an improper conflict of interest because the adviser had an incentive to always keep the funds fully leveraged in order to maximize advisory fees, even when economic conditions dictated that the leverage should be reduced. The district court granted defendants’ motion to dismiss the claims under Sections 8(e), 34(d) and 36(a) on the ground they were time-barred, and also because Section 36(b) is the exclusive remedy for allegations concerning excessive advisory fees. The court declined, however, to dismiss the Section 36(b) claim, even though plaintiffs conceded they had not alleged that the advisory compensation was disproportionate to the services rendered. Id. at 235. Instead, the court held that if plaintiff’s claims were valid, “then the fees collected by [the adviser] to date were the result of a breach of fiduciary duty in violation of Section 36(b),” and “[i]t would follow that such fees were excessive and recoverable to the extent permitted under that Section.” Id. The district court subsequently granted defendants’ motion for summary judgment dismissing the Section 36(b) claim, and the United States Court of Appeals for the Third Circuit affirmed that dismissal. Green v. Fund Asset Mgmt., L.P., 147 F. Supp. 2d 318 (D.N.J. 2001), aff’d, 286 F.3d 682 (3d Cir. 2002). The Third Circuit, in affirming, agreed that potential conflicts of interest in an advisory fee agreement “are not per se violations of an investment advisors’ fiduciary duties [under Section 36(b)]: an actual breach must be alleged and proven.” Green, 286 F.3d at 685. Because plaintiffs did not allege that they or the funds had suffered any actual damages during the relevant time period as a result of any improper decision by the adviser, the court concluded that they did not have a cognizable claim under Section 36(b). The district court in Green v. Nuveen Advisory Corp., No. 97 C 5255, 2001 WL 1035652 (N.D. Ill. Sept. 10, 2001), aff’d, 295 F.3d 738 (7th Cir. 2002), brought by the plaintiffs who also brought Green v. Fund Asset Management, likewise granted defendants’ motion for summary judgment, adopting much of the district court’s opinion in Green v. Fund Asset Management. The Seventh Circuit affirmed dismissal of the complaint, noting

that “while an abuse of this inherent conflict may violate § 36(b), its mere existence does not.” Green, 295 F.3d at 742. The court agreed with the district court’s observations that the Investment Advisers Act of 1940 permits such advisory contracts and that the fund’s directors, not the adviser, had made the leveraging decisions. Id. at 743-45. d. Annuity Contracts In Levy v. Alliance Capital Management, L.P., No. 97 CIV. 4672 (DC), 1998 WL 744005 (S.D.N.Y. Oct. 26, 1998), aff’d, 189 F.3d 461 (2d Cir. 1999), plaintiff invested in an annuity contract issued by Equitable Life Assurance, a life insurance company, that combined both insurance and investment features. The investment feature permitted contract holders to allocate annuity contract contributions to an account funded by various mutual funds. Plaintiff alleged that the combined insurance and advisory fees charged by Equitable and Alliance were excessive in violation of Section 36(b). Plaintiff sought to hold Equitable (an affiliate of the Funds’ advisor) liable under Section 36(b), on the theory that the insurance charges were really disguised investment advisory fees. The court, however, held that Equitable could not be held liable under Section 36(b) because it neither provided investment advisory services nor received any compensation for providing such services. As to the investment adviser, the court held that plaintiff had failed to allege that the fees were so disproportionate as to bear no reasonable relationship to the services rendered. e. Multiple Fund Boards A series of cases have indirectly attacked advisory fees by challenging the propriety of directors serving on the boards of multiple funds. These cases are based on the theory that outside directors who (1) serve on boards of multiple funds advised by the same adviser and (2) receive significant compensation for such service are “interested directors” under the Act, and therefore advisory fees are not properly approved under Section 15(c). These cases allege that the improperly approved advisory agreements violate Section 36(b). As seen below, courts have largely rejected this argument. SEC-promulgated regulations now require disclosure of the total number of funds on which a director serves, but there is no prohibition against service on multiple boards. See 17 C.F.R. § 240.14a-101 (2003). For example, in Migdal v. Rowe Price-Fleming International, Inc., No. AMD 98-2162, 2000 WL 350400 (D. Md. Mar. 20, 2000), aff’d, 248 F.3d 321 (4th Cir. 2001), plaintiffs brought suit under Section 36(b) against the investment adviser and five individual directors of the T. Rowe Price International Stock Fund. Two of the five directors were also employees of the investment adviser. Plaintiffs alleged that the three non-employee directors were “interested person(s)” of the adviser because they served on multiple fund boards, for which they received compensation of $81,000. The Fourth Circuit affirmed the District Court’s ruling that a “nonemployee, non-affiliate director, who is statutorily presumed to be disinterested, is not rendered interested or non-independent by virtue of the number of interlocking boards on which she or he serves within a family of funds,” notwithstanding the amount of aggregate income that such a director receives for such service. Id. at *3. The court also pointed out that the SEC did not prohibit the use of interlocking boards within fund complexes and affirmed its position that “a director of a fund who also is a director of another fund managed by the same adviser generally would not be viewed as an interested person of the fund under section 2(a)(19) [of the ICA] solely as a result of this relationship.” 248 F.3d at 330 (citations omitted); see also Krantz v. Prudential Invs. Fund Mgmt. LLC, 77 F. Supp. 2d 559 (D.N.J. 1999), aff’d, 305 F.3d 140 (3d Cir. 2002) (holding that a director’s well-compensated service on boards of multiple funds alone will not support a claim that the director is controlled by the adviser); Strougo v. BEA Assocs., 188 F. Supp. 2d 373, 380-82 (S.D.N.Y. 2002) (granting summary judgment dismissing plaintiff’s claims under Sections 36(a) and 36(b)); Krantz v. Fidelity Mgmt. & Research Co., 98 F. Supp. 2d 150, 157 (D. Mass. 2000) (dismissing allegations that outside

directors who sat on multiple boards and received fees were “interested,” but permitting limited discovery for the Section 36(b) claim). f. Membership Dues To ICI In Rohrbaugh v. Inv. Co. Inst., No. CIV. A. 00-1237, 2002 WL 31100821 (D.D.C. July 2, 2002), two fund shareholders brought Section 36(b) claims against the Investment Company Institute (“ICI”) alleging that the ICI, a trade organization whose membership included approximately 7,700 mutual funds and 500 closed-end funds, collected its membership dues from fund shareholders but was “dominated” by investment advisers who held more than 80% of the seats on the ICI Board of Governors, thus creating an inherent conflict of interest to the detriment of the investment companies. Id. at *3. Plaintiffs conceded that they were challenging membership dues, not advisory fees, but contended that those dues fell within the definition of “payments” under Section 36(b). See 15 U.S.C. § 80a-36b (“[A]n action may be brought . . . against such investment adviser, or any affiliated person of such . . . who has a fiduciary duty concerning such compensation or payments.”); Rohrbaugh, 2002 WL 31100821 at *8. The court disagreed, noting that the legislative history was clear that “payments” covered “situations where an investment adviser would try to evade liability for charging excessive fees by arranging for payments to be made to an affiliated person of the adviser rather than directly to the adviser.” Id. at *9. Thus, the court held that a Section 36(b) claim must either “involve a challenge to excessive advisory fees per se or to conduct that results in excessive advisory fees.” Id. Since plaintiffs admitted that their claim had “absolutely no connection” to excessive advisory fees, the court concluded that they had no cognizable claim under Section 36(b) and granted defendant’s motion to dismiss. Id. 4. Preemption Of State Law Claims In Section 36(b) Action In a case of first impression in the federal courts, the U.S. District Court for the District of New Jersey, in Green v. Fund Asset Management, L.P., 53 F. Supp. 2d 723 (D.N.J. 1999), dismissed plaintiffs’ state law claims for breach of fiduciary duty and deceit on the ground that they were preempted by Section 36(b). The court held that “allowing plaintiffs’ inconsistent state law parallel actions would frustrate the statutory scheme purposefully put into place by Congress in Section 36(b).” Id. at 731. On appeal, the Third Circuit reversed the district court decision and remanded for further proceedings. See Green v. Fund Asset Mgmt., L.P., 245 F.3d 214 (3d Cir. 2001). The Third Circuit was not persuaded by defendants’ argument that various procedural differences between the Section 36(b) action and similar state law claims indicated congressional intent to preempt the plaintiffs’ state law claims; instead, it found such procedural differences evidence of a congressional balancing between a “markedly more ‘plaintiff-friendly’” Section 36(b) and the “‘corporate waste’ standard applied by most state courts prior to 1970.” Id. at 229. 5. Implied Right Of Action Under The 1940 Act a. Legislative History When originally enacted, the 1940 Act did not expressly provide private citizens with any enforcement rights under any provision of the Act. The 1940 Congress did not provide for implied rights because: (1) claims under the 1940 Act could u