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Remedy is not easy in securities fraud cases

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The dismissal of the federal securities fraud case against Zimmer Holdings, Inc., illustrates the hurdles shareholders must leap to move securities cases forward and stirs the arguments both for and against these kinds of lawsuits.

In 2008, the Plumbers and Pipefitters Local Union 719 Pension Fund of West Virginia filed a complaint against the Warsaw-based orthopedic products maker, alleging the company downplayed the significance of difficulties it was experiencing with the manufacture of the Durom Acetabular Component and delayed revealing quality control problems at the Zimmer plant in Dover, Ohio.

Through the course of 2008, Zimmer lowered its January projections of 10 to 11 percent growth as the problems with the Durom Cup and the Ohio plant were made public. In July 2008, projections were 8.5 to 9 percent growth. The plaintiffs maintain the company committed fraud by not using these lower estimates at the start of the year.

The 7th Circuit Court of Appeals issued its ruling on Plumbers and Pipefitters Local Union 719 Pension Fund and Carpenters Pension Fund of West Virginia v. Zimmer Holdings, Inc; David C. Dvorak; and James T. Crines, No. 11-1471, in May. The court affirmed the ruling by the District Court that the plaintiffs failed to show the defendants knowingly provided false information.
 

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Scott Gilchrist, partner at Cohen & Malad LLP, served on the team representing the pension fund, and Paul Wolfla, partner at Faegre Baker Daniels LLP, was among the attorneys representing Zimmer. Both declined to comment specifically on the Zimmer case, but they did speak about securities fraud cases and the Private Securities Litigation Reform Act of 1995, the federal law designed to stem what are believed to be unwarranted securities lawsuits.

Gilchrist sees the PSLRA as having had some “chilling effect” on this type of class-action litigation but, he noted, these complaints continue to be filed because they are a remedy for shareholders against securities fraud.

“I think the plaintiff is faced with a pretty challenging environment when it comes to finding a remedy for a (fraud) that happens in the marketplace or happens to them as a consumer,” he said.

Wolfla agreed that plaintiffs must meet a high standard to even get to the discovery stage. Specifically, the PSLRA will automatically stay any discovery after the initial complaint is filed until the courts consider a motion to dismiss.

This provision bars plaintiffs from using the traditional tools of discovery like having the company produce documents and records or making corporate representatives available for depositions. In the Zimmer complaint, the union relied on statements made in quarterly earnings calls and at a conference at Deutsche Bank, reports filed with the Securities and Exchange Commission, and the testimony of 14 confidential witnesses.

The idea behind that provision, Wolfla said, was the concern Congress had about the number of “strike suits” which lawyers file immediately after a company announces bad news then look for a reason later.

A central point in many of these types of cases is the stock price. Company stock prices can be artificially inflated when information disclosed to the market is either withheld or misleading. When the true information comes out that is material to the price of the stock, the market will push the price down and shareholders’ stakes in the company will not be worth as much.

Securities fraud cases are very onerous on companies and impose a heavy and costly burden on the courts, Wolfla said.

To survive a motion to dismiss, securities fraud cases must clear what Gilchrist called two tricky areas in court. The first is lost causation (where the plaintiff must show the losses were caused by information that was misrepresented or not disclosed) and the second is scienter.

The scienter provision requires the plaintiff to state the facts that give rise to a “strong inference” as to the defendant’s state of mind. In Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007), the U.S. Supreme Court defined the phrase “strong inference” as being more than plausible or reasonable and, instead, must be “cogent and compelling.”

In Zimmer, the Circuit Court found the plaintiffs’ contention to infer scienter was “too generic to satisfy Tellabs.”

Writing for the majority, Chief Judge Frank Easterbrook stated, “The allegations of this complaint concern the problems Zimmer faced in 2008; in a different year the headaches would have come from a different plant or a different product, but the fact that these particular problems occurred – and the information came out over time, as more news accumulated – does not imply that any manager was lying to investors.”

Reviewing “classic filings,” the Stanford Law School Securities Class Action Clearinghouse found a decline in federal securities class-action filing activity during the first half of 2012. Through the end of June, 88 filings had been made, a decrease of 6 percent from both the first and second halves of 2011.

Stanford projected 2012 will end with 176 filings. This is less than the 1993 to 2011 average of 193 but in line with the 2009 to 2011 average of 177. The drop in total filings was primarily attributed to a “substantial decline” in merger and acquisition filings and in Chinese reverse mergers, where a Chinese-based company will merge with a defunct U.S. company, then use its ticker symbol.

In companion research with Stanford, Cornerstone Research has reported that the number of securities class-action settlements approved in 2011 was the lowest in more than a decade. In 2011, there were 65 court-approved securities class-action settlements involving $1.4 billion in total settlement funds.

Wolfla is also seeing a decline in certain types of securities fraud cases. He speculated the downward trend may be a reflection of publicly traded companies becoming “better disciplined” about disclosing material to shareholders and the public. In addition, a lot of corporate governance reform followed the 2001 Enron scandal which has resulted in companies following better processes and procedures.

In being more disciplined, Wolfla said, companies are giving more thought and care, in particular about financial performance. The result is this makes it more difficult for shareholders to allege fraud has been committed on the basis that material information has been omitted.

Although securities fraud cases may be decreasing, shareholders are still active.


vink-paul-mug Vink

Paul Vink, partner at Bose McKinney & Evans LLP, said within the past decade it has become virtually certain that shareholders will file a complaint in court any time a company makes an announcement of a merger or similar transaction.

Vink traced the increase in these shareholder actions to plaintiff law firms that seek such cases as well as to the economic collapse of 2008.

“The biggest factor is the overall suspicion that most members of the public have of corporate America and Wall Street,” Vink said. “There isn’t a level of trust that there was 20 years ago because of some of the scandals we’ve seen.”

One example is the complaint filed by shareholders against Fortune Industries Inc. in April. Here, shareholders sought to prevent the company from being purchased because, they believed, the share price was too low.

Vink was an attorney representing Fortune in the case.

In August, the shareholders voluntarily dropped their claim because it conflicted with Indiana’s dissenters’ rights statute, Vink said. The statute prevents a minority of shareholders from challenging or enjoining a transaction. •

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  1. From back in the day before secularism got a stranglehold on Hoosier jurists comes this great excerpt via Indiana federal court judge Allan Sharp, dedicated to those many Indiana government attorneys (with whom I have dealt) who count the law as a mere tool, an optional tool that is not to be used when political correctness compels a more acceptable result than merely following the path that the law directs: ALLEN SHARP, District Judge. I. In a scene following a visit by Henry VIII to the home of Sir Thomas More, playwriter Robert Bolt puts the following words into the mouths of his characters: Margaret: Father, that man's bad. MORE: There is no law against that. ROPER: There is! God's law! MORE: Then God can arrest him. ROPER: Sophistication upon sophistication! MORE: No, sheer simplicity. The law, Roper, the law. I know what's legal not what's right. And I'll stick to what's legal. ROPER: Then you set man's law above God's! MORE: No, far below; but let me draw your attention to a fact I'm not God. The currents and eddies of right and wrong, which you find such plain sailing, I can't navigate. I'm no voyager. But in the thickets of law, oh, there I'm a forester. I doubt if there's a man alive who could follow me there, thank God... ALICE: (Exasperated, pointing after Rich) While you talk, he's gone! MORE: And go he should, if he was the Devil himself, until he broke the law! ROPER: So now you'd give the Devil benefit of law! MORE: Yes. What would you do? Cut a great road through the law to get after the Devil? ROPER: I'd cut down every law in England to do that! MORE: (Roused and excited) Oh? (Advances on Roper) And when the last law was down, and the Devil turned round on you where would you hide, Roper, the laws being flat? (He leaves *1257 him) This country's planted thick with laws from coast to coast man's laws, not God's and if you cut them down and you're just the man to do it d'you really think you would stand upright in the winds that would blow then? (Quietly) Yes, I'd give the Devil benefit of law, for my own safety's sake. ROPER: I have long suspected this; this is the golden calf; the law's your god. MORE: (Wearily) Oh, Roper, you're a fool, God's my god... (Rather bitterly) But I find him rather too (Very bitterly) subtle... I don't know where he is nor what he wants. ROPER: My God wants service, to the end and unremitting; nothing else! MORE: (Dryly) Are you sure that's God! He sounds like Moloch. But indeed it may be God And whoever hunts for me, Roper, God or Devil, will find me hiding in the thickets of the law! And I'll hide my daughter with me! Not hoist her up the mainmast of your seagoing principles! They put about too nimbly! (Exit More. They all look after him). Pgs. 65-67, A MAN FOR ALL SEASONS A Play in Two Acts, Robert Bolt, Random House, New York, 1960. Linley E. Pearson, Atty. Gen. of Indiana, Indianapolis, for defendants. Childs v. Duckworth, 509 F. Supp. 1254, 1256 (N.D. Ind. 1981) aff'd, 705 F.2d 915 (7th Cir. 1983)

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  3. The family is the foundation of all human government. That is the Grand Design. Modern governments throw off this Design and make bureaucratic war against the family, as does Hollywood and cultural elitists such as third wave feminists. Since WWII we have been on a ship of fools that way, with both the elite and government and their social engineering hacks relentlessly attacking the very foundation of social order. And their success? See it in the streets of Fergusson, on the food stamp doles (mostly broken families)and in the above article. Reject the Grand Design for true social function, enter the Glorious State to manage social dysfunction. Our Brave New World will be a prison camp, and we will welcome it as the only way to manage given the anarchy without it.

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  5. Some in the Hoosier legal elite consider this prayer recommended by the AG seditious, not to mention the Saint who pledged loyalty to God over King and went to the axe for so doing: "Thomas More, counselor of law and statesman of integrity, merry martyr and most human of saints: Pray that, for the glory of God and in the pursuit of His justice, I may be trustworthy with confidences, keen in study, accurate in analysis, correct in conclusion, able in argument, loyal to clients, honest with all, courteous to adversaries, ever attentive to conscience. Sit with me at my desk and listen with me to my clients' tales. Read with me in my library and stand always beside me so that today I shall not, to win a point, lose my soul. Pray that my family may find in me what yours found in you: friendship and courage, cheerfulness and charity, diligence in duties, counsel in adversity, patience in pain—their good servant, and God's first. Amen."

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