Supreme Court Reaffirms Low Threshold For Pleading And Proving “Materiality” In Securities Cases

•  Scott+Scott Settles Shareholder Derivative Action In Puerto Rico

•  Supreme Court Reverses Fifth Circuit Decision In Halliburton – Loss Causation Need Not Be Proven At Class Certification

•  SEC Expects High-Quality Tips To Increase As New Whistleblower Program Goes Into Full Effect

•  U.S.Events

(Flashlit version)

Supreme Court Reaffirms Low Threshold For Pleading And Proving “Materiality” In Securities Cases

In a unanimous, investor-friendly decision, the Supreme Court of the United States in Matrixx Initiatives, Inc. v. Siracusano, 131 S.Ct. 1309, recently reaffirmed the low threshold for pleading and proving “materiality” in securities cases.  Materiality is one of the key elements that must be sufficiently pled and proven in every securities case.

In Matrixx, the Court made it clear that information is material if knowing the information would have “significantly altered the total mix of information made available” to a “reasonable investor.”  This is commonly referred to by securities lawyers as the “reasonable investor” test for materiality.

Court Rejects the Defendants’ Proposed “Bright-Line Test”

The defendants in Matrixx asked the Supreme Court to do away with the reasonable investor test for determining materiality.  They wanted the Court to adopt what they referred to as the “bright-line test.”  Under their proposed test, only statistically significant information could be deemed material to investors.  

Matrixx involved false statements and omissions about one of the defendants’ pharmaceutical products.  Specifically, the plaintiffs alleged that the defendants had received, but did not disclose, information that certain consumers who took the defendants’ core product had lost their senses of smell after taking the product.  The defendants argued that these disclosures could not be material because researchers had found no “statistically significant correlation” between the use of the defendants’ product and the loss of smell.  The defendants argued that this was a bright-line test that would enable companies to determine when information needed to be disclosed—i.e., only where there was a “statistically significant correlation” between the use of a product and an adverse effect, would companies like the defendants be required to disclose.   

Materiality Must Be Assessed on a Case-By-Case Basis

The SupremeCourt rejected the defendants proposed bright-line test, explaining that the proposed test would “artificially exclud[e]” information that “would otherwise be considered significant to [a reasonable investor’s] trading decision.”  Instead of the bright-line test, the Court concluded that materiality should be judged on a case-by-case basis, and that information could be material, even if researchers had not found a “statistically significant correlation” between the use of a product and an adverse effect.

The Court also pointed to its decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), in which it held that the materiality standard for securities cases was satisfied where there was “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.” 

Opinion Reaffirms Low Threshold for Pleading and Proving Materiality

 The Matrixx opinion is the Supreme Court’s most extensive analysis of the materiality standard in securities cases in several years.  Importantly, the Court upheld the low threshold for pleading and proving materiality in securities cases, as well as the use of the reasonable investor test for assessing materiality in securities cases.

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Scott+Scott Settles Shareholder Derivative Action In Puerto Rico

Scott+Scott has agreed, on behalf of the named representative plaintiffs, with counsel for the defendants to settle a case filed in June 2009 in the federal court for the District of Puerto Rico against officers and directors, as well as nominal defendant, Popular, Inc., better known as Banco Popular, a financial services company that has been operating in Puerto Rico for well over 100 years.  The complaint alleged that the defendants engaged in breaches of fiduciary duty, gross mismanagement, and waste of corporate assets, which led to the dissemination of false and misleading statements.  The statements concerned the company’s accounting for  deferred tax assets and, in essence, that the company recorded deferred tax assets, the benefit of which could only be realized if the company experienced sufficient United States-based gains within 20 years. The company should have taken a valuation allowance, which it put off doing.  Once it took such an allowance, the company’s share price fell substantially.  The complaint focused on the claims that the officers and directors of the company allowed this to occur, to the detriment of the company and its shareholders.

After engaging in intense formal mediation with an esteemed retired judge in January 2011, negotiations between Scott+Scott and defense counsel continued for months.  The parties were ultimately able to come to a resolution last month.  In the settlement, the defendants have agreed to undertake substantial corporate governance measures via amendments to the company’s charter, bylaws, and other policies.  Popular has further agreed to maintain those corporate governance measures for a period of three years.  Scott+Scott recognized the expense and time required to prosecute the claims through trial and appeals, and that such time and expense would necessarily distract the company’s officers and directors and drain the company of resources to the detriment of the company and the shareholders.  Thus, Scott+Scott agreed that settlement at this point was in the best interest of the company and its shareholders, and that the settlement put significant remedial measures into place.

The parties have applied to the court for preliminary approval of the settlement, including notice to the shareholders.  Once the court approves the form of the notice, it will be published to shareholders.

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Supreme Court Reverses Fifth Circuit Decision In Halliburton – Loss Causation Need Not Be Proven At Class Certification

On June 6, 2011, the Supreme Court of the United States in Erica P. John Fund, Inc. v. Halliburton Co., No. 09-1403, 2011 WL 2175208 (2011), ruled that plaintiffs in securities fraud lawsuits do not need to prove “loss causation” in order to obtain class certification. This ruling resolved a split of authority between the Fifth Circuit, which had previously held that loss causation was not something that needed to be proved at the class certification stage, and other circuits.


In 2002, the Erica P. John Fund, formerly known as the Archdiocese of Milwaukee Supporting Fund, Inc., initiated an action against Halliburton and certain of its officers and directors.  The action, brought on behalf of investors who purchased Halliburton common stock between June 1999 and December 2001, charged the defendants with violations of the securities laws.  The complaint alleged that the proposed class of investors lost money as the market for Halliburton’s securities declined upon the company’s disclosures correcting false statements made during the class period.  Specifically, the complaint alleged that the named defendants made false statements pertaining to the company’s potential liability in asbestos litigation, its accounting of revenue in its engineering and construction business, and the purported benefits of a merger with now-defunct Dresser Industries Inc.

The Texas district court, in denying class certification, held that none of the corrective disclosures identified by the plaintiffs actually revealed the alleged fraud, and for this reason, the plaintiffs had failed to sufficiently establish loss causation, i.e., whether the revelation of the alleged fraud actually caused the plaintiffs’ loss.

On appeal of the order denying class certification, the Fifth Circuit Court of Appeals affirmed the district court.  The Fifth Circuit held that, in order to meet the requirements for class certification, plaintiffs must establish, by preponderance of the evidence, that they can satisfy the element of loss causation, finding that proof of loss causation is necessary for plaintiffs to avail themselves of the “fraud-on-the-market” presumption of reliance.  Without this presumption, the court reasoned, a securities fraud claim cannot proceed on a class-wide basis because plaintiffs will be unable to prove that all investors in the class relied on an alleged misstatement or omission.

On January 7, 2011, the Supreme Court granted the plaintiffs’ petition for writ of certiorari to hear Halliburton, which presented the Court with the opportunity to settle the question as to the extent to which courts must resolve issues of loss causation at the class certification stage of securities fraud action.


The Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224 (1988), established the fraud-on-the-market theory for demonstrating reliance in securities class actions.  In general, plaintiffs seek class certification of SEC Rule 10b-5 claims under Rule 23(b)(3) of the Federal Rules of Civil Procedure.  Rule 23(b)(3) requires a plaintiff to show, among other things, that “questions of law or fact common to class members predominate over any questions affecting only individual members.”  Reliance, an element of a claim under Rule 10b-5, traditionally requires proof that a particular plaintiff in fact relied on an alleged misrepresentation in purchasing or selling a security.  The Court in Basic, observed that if reliance under Rule 10b-5 is an individual issue, it would follow that common issues do not “predominate” for purposes of Rule 23(b)(3) for the purposes of class certification.

The Supreme Court then established the framework under which plaintiffs in securities class actions could establish reliance through class-wide proof, creating a rebuttable presumption of reliance where a plaintiff shows that the securities at issue traded in an efficient market, i.e., a market that efficiently incorporates all public information about a security into the price of the security.  Under Basic, investors who trade in an efficient market, and who satisfy certain additional requirements, are entitled to a rebuttable presumption of class-wide reliance.  However, the presumption of reliance is “rebuttable,” and can be defeated by “[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade.”

The Fifth Circuit in Halliburton held that, in order to invoke the Basic presumption, a plaintiff is required to prove at the class certification stage that the decline in the price of securities resulted because of a correction to the prior misleading statement, and that the subsequent loss could not be explained by other factors revealed in the market at the time.

            On June 6, 2011, the unanimous Supreme Court found that the Fifth Circuit misread Basic.  “The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory,” wrote Chief Justice John Roberts.  “Loss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory.”

According to the Court, Basic’s fundamental premise is this: “an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction.”  The opinion draws a distinction between “transaction causation,” i.e., whether the plaintiff relied on the alleged misrepresentation in deciding whether or not to engage in the transaction, and “loss causation,” which “by contrast,” requires a plaintiff to show “that a misrepresentation that affected the integrity of the market price also cause a subsequent economic loss.”  Chief Justice Roberts wrote that to require proof of loss causation in order to invoke the rebuttable presumption of reliance under the fraud-on-the market theory contravenes Basic’s fundamental premise:  that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction.  The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation.

            Chief Justice Roberts’ opinion, however, sidestepped many of the issues presented at the oral argument in which the parties debated Basic and how it should be applied, noting that, “we need not, and do not, address any other question about Basic, its presumption, or how and when it may be rebutted.”  Despite Halliburton’s narrow holding, the ruling bodes well for shareholders as it brings the Fifth Circuit, as well as district courts in other circuits relying on Fifth Circuit precedent, in line with the other circuits that have consistently held loss causation need not be shown at the class certification stage.

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SEC Expects High-Quality Tips To Increase As New Whistleblower Program Goes Into Full Effect

On May 25, 2011, the United States Securities and Exchange Commission (“SEC”) adopted rules to implement the whistleblower provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).  Dodd-Frank amended the Securities Exchange Act of 1934 to add Section 21F.  The new section establishes a whistleblower program that requires the SEC to pay an award, subject to certain limitations, to eligible whistleblowers who voluntarily provide the SEC with original information about a violation of the federal securities laws.  The SEC will pay whistleblowers the award when the information provided leads to the successful enforcement of a covered judicial or administrative action resulting in monetary sanctions exceeding $1 million.  The awards will be between 10% and 30% of the total monetary sanctions collected.  The amount of the award may be increased based on quality, significance and timeliness of the information, the level of assistance provided, and the SEC’s interest in the matter.  Amounts can be decreased depending on the culpability of the whistleblower, any delay involved, and any interference by the whistleblower. 

The rules reflect the SEC’s attempt to balance two competing interests: receiving high-quality first-hand information, while also encouraging employee-whistleblowers to first utilize employer internal compliance procedures before turning to the SEC.  While a whistleblower need not report information through an employer’s internal compliance procedures to be eligible for an award, the SEC provides financial incentives to promote the use of internal compliance measures.  Voluntary participation in corporate internal reporting programs can increase the reward, while interference with such reporting programs can decrease the reward. 

Certain categories of individuals—attorneys, auditors, and internal compliance personnel—will be excluded from eligibility for a whistleblower award, although exceptions can apply.  These excluded individuals would still be eligible for an award in one of two circumstances. Excluded individuals will be eligible if there was a reasonable basis to believe that disclosure of the information to the SEC was necessary to prevent conduct likely to cause substantial injury to the financial interest or property of the entity or the investors.  Alternatively, eligibility will arise if there was a reasonable basis to believe that the entity was impeding an investigation of the misconduct.

Anti-retaliation protections have been expanded to cover any whistleblower—even if the whistleblower is ineligible for an award or the resulting action is not successful.  This protection extends even to whistleblowers who also are culpable actors in the claimed fraud.  To be covered, however, the whistleblower must possess a “reasonable belief” that a violation occurred or is about to occur. 

Procedures for reporting through the SEC’s new “Office of the Whistleblower” have been simplified, now requiring only a single form and a certification that the information provided is true, correct, and complete.  Whistleblowers may still report anonymously with certification by counsel.  The SEC said it expects to receive about 30,000 whistleblower tips each year, with experts predicting that about half of those will result in monetary claims.

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U.S. Events

Conferences And Educational Seminars

+July 13-15, 2011

Missouri Association of Public Employee Retirement Systems (MAPERS) Silver Anniversary Conference

Tan-Tar-A Resort

Osage Beach, MO

The Missouri Association of Public Employee Retirement Systems (MAPERS) began in October 1987.  Since that time, the organization has worked to bring together individuals and organizations interested in expanding their knowledge of pension and investment issues.  The purpose of the association is to provide education, information, and ideas to strengthen and protect Missouri's public employee retirement systems.  Plan Sponsor membership is open to trustees and administrators of all public pension funds in the State of Missouri.  Corporate membership is open to commercial financial and investment groups.  Associate membership is open to organizations affiliated with public retirement systems including unions, lobbying groups, etc.  MAPERS holds its annual conference each summer; attended by members from all three membership categories.  The agenda includes nationally known speakers from the financial, legal, and retirement arenas.

+July 18-19, 2011


Hedge Fund Accounting, Auditing, and Administration Forum

The Princeton Club

New York City, NY

The two-day conference will focus on a variety of issues including, “Demystifying Dodd-Frank’s Impact on the Hedge Fund Industry,” specifically looking at how the Dodd-Frank Act will affect various policies and procedures for funds and related corporate governance requirements.

+July18-20, 2011


Public Funds Summit East

Newport Marriott

Newport, RI

Opal Financial Group’s annual public funds “Navigate the Future” conference will address issues that are most critical to the investment success of senior public pension fund officers and trustees.  The Summit will cover legal concerns with fund investment and management policies, as well as the benefits and pitfalls of a wide variety of investment strategies.

+July 24-28, 2011

Pennsylvania State Association of  County Controllers (PSACC) Annual Conference

Heritage Hills Golf Resort & Conference Center

York, PA

The Pennsylvania State Association of County Controllers (PSACC) is an organization of county government finance professionals whose purpose is to encourage the discussion and resolution of issues arising in the discharge of the duties and functions of the office of County Controller.  The organization advances the professional development of its members through a conscientiously applied program of continuing professional education and training.


+July31-August 4, 2011


National Association of State Treasurers 2011 National Institute for Public Finance

Kellogg Center for Nonprofit Management

Chicago, IL

The gathering of NAST membership at conferences is an outstanding opportunity for all members to discuss issues that will enhance the efficiency and effectiveness of state treasuries; inform the public and other decision-makers about the responsibilities of state treasurers; and communicate positions on financial matters pertinent to all states.  Membership is composed of all state treasurers or state finance officials with comparable responsibilities from the United States, its commonwealths, territories, and the District of Columbia, as well as more than a hundred private sector firms through the Corporate Affiliate Program founded in 1986. 


Government Finance Officers’ AssociationConferences


+July 17-19, 2011


North Carolina GFOA Annual Meeting

Wrightsville Beach, NC


+July 27-29, 2011


Arkansas GFOA

Little Rock, AR


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Scott + Scott LLP is a nationally recognized law firm headquartered in Connecticut with offices in New York City, Ohio and California. The firm represents individual as well as institutional investors who have suffered from corporate stock fraud. Scott+Scott has participated in recovering billions of dollars and achieved precedent-setting reforms in corporate governance on behalf of its clients. In addition to being involved in complex shareholder securities and corporate governance actions, Scott+Scott also has a significant national practice in antitrust, ERISA, consumer, civil rights and human rights litigation. Through its efforts, Scott+Scott promotes corporate social responsibility.

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