Chapter 4 PSLRA – Discovery; Sanctions, Other Class Action Provisions, Contribution and Partial Settlements

Hypothetical 4 – Questions

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We are not going to be able to devote ample time to discovery and sanctions post-PSLRA. The stay of discovery provision is often thought of as absolute, but it is not, at least on the surface. There are two grounds for obtaining discovery (1) to preserve evidence and (2) to avoid "undue" prejudice. Neither hold tremendous promise, although discovery has been allowed in a few instances under the latter. See § 4.01.

QUESTIONS

Assume you have been retained by the shareholders of ABC Corp. that just announced that their auditors were requiring a restatement of their prior year financials because of substantial improper recognition of revenue (sold goods with secret promise to accept return with full credit if not sold within 90 days) that would reduce their earnings per share for the year in question from $0.40 to ($0.10).The announcement led to a 30% drop in the price of their stock. You are in the process of preparing a complaint and, among other things, considering what if anything you may want to attempt in the way of discovery after you file the complaint

(1) Where do you look for the information you need concerning representations that the company and/or officers of the company made during the relevant period that were false or misleading at the time made as a result of the restatement. Include, if possible, in addition to the publication of false financial statements representations made concerning the company and its prospects as impacted by the restatement. See § 4.03.

(2) What investigation are you going to conduct to determine that the company and prospective individual defendants knew or recklessly disregarded the contingent nature of a substantial amount of the goods "sold" and delivered.

(3) Under what circumstances may an SEC investigation provide information that you need? See § 4.03[4]. See Critical Path. Compare Enron-Broadband. What about the Freedom of Information Act? Click HERE for the FOIA exceptions; HERE for the SEC FOIA rules; click HERE for SEC response to request. Recall that Judge Harmon in her In re Enron scheduling order allowed plaintiff access to documents furnished in connection with the bankruptcy proceedings relating to the ERISA phase of the case. See § 1:18. She subsequently expanded the order to include all documents produced in the course of the bankruptcy proceeding that had been furnished to Congressional committees, the SEC and Department of Justice. See In re Enron Corp. Sec. Derivative & "ERISA" Litig.,, 2002 WL 31845114 (S.D.Tex. Aug. 16, 2002) . The Southern District of New York has taken the same tack and required the company in the WorldCom litigation and the AOL litigation to produce, subject to attorney-client privilege and work product doctrine to deliver to plaintiff copies of all documents furnished to Congressional investigators, the SEC, and the Department of Justice. Click HERE.

(4) Does the stay of discovery apply to taking depositions from non-parties? For one view, click HERE.

(5) Does the stay of discovery apply before defendant has filed a motion to dismiss? Click HERE..

(6) Under what circumstances can you obtain an order directed at a party not to destroy any relevant documents? From a person that is not a party, but who (e.g. the company's auditor) had relevant documents? Under what circumstances might the stay of discovery be lifted to allow the taking of depositions relating to the possible destruction of documents? On Jan. 11, 2002, Milberg Weiss in Enron even before its plaintiff had been named lead plaintiff moved for particularized discovery from Arthur Andersen to preserve evidence.. Click HERE. To see what they got from Judge Harmon.on January 23, 2002, click HERE...

(7) What are the possibilities of requiring defendants to make available the disclosures required by Rule 26(a)? See § 4.02. To obtain particularized discovery based on undue prejudice? See § 4.01.

(8) Assume you hired an investigator who obtained a list of former employees recently discharged by the company as a result of a downturn in its business and intend to interview them in the hope of developing information you can use to support allegations included in the complaint. Relying on Novak (see §3.10), you intend to assure them that you will not name them in the complaint. Can you also assure them that they will not be deposed? See Theragenics discussed at § 3.13[2] and for subsequent developments in Theragenics, click HERE.

(9) The pending WorldCom private litigation includes an interesting (but not novel twist) in that certain defendants that have also been indicted requested and received a court order (with the support of the Department of Justice) precluding discovery as to them pending completion of the criminal case. The court also entered an order precluding plaintiffs discovery with respect to certain non-indicted cooperating witnesses in the criminal case. These restrictions were imposed prior to a ruling on a motion to dismiss and while all discovery is stayed pending such ruling. Click HERE. A similar motion has been filed by Arnold Fastow in the pending Enron private litigation and Judge Harmon has not ruled on it or on the motion to dismiss of the individual defendants as of this date (Jan. 5, 2002).

(10) In what respects does plaintiffs' counsel in pleading a securities fraud class action case incur risk that would not otherwise be applicable under Rule 11 of the Federal Rules of Civil Procedure? See § 4.04. See Second Circuit's opinion in Gurary. Click HERE. Recall what Judge Harmon had to say in In re Enron concerning a manipulative scheme as being a distinct violation of Rule 10b-5. Click HERE. The plaintiff in Gurary apparently didn't argue that a purchaser of a security that is being manipulated downward should be able to measure damages on the basis of the difference between what plaintiff paid for the security and the further depressed price resulting from the continuation of the scheme to continue to depress the price of the stock. If that argument had been made would the claim relating to the second purchase have been frivolous? Would the claim be substantial enough to keep the overall complaint from being a substantial violation of Rule 11(b)?

Notwithstanding the relatively extensive information and discovery available to plaintiffs, Judge Harmon on March 12, 2003, dismissed the 10b-5 claims against 16 outside directors, including those on the audit, compensation, or executive committees for failure to create a strong inference of scienter. She concluded that the allegations might be sufficient to create a strong inference of negligence, but not scienter. She, however, refused to dismiss the Section 11 claims against the same outside directors except as to instances in which the named plaintiffs purchased the registered securities more than a year after the company had released 12 month income statements for failure to allege actual reliance. See

In re Enron Corp. Securities, Derivative & ERISA Litigation, --- F.Supp.2d ----, 2003 WL 1089307 (S.D.Tex., Mar 12, 2003) (NO. MD-1446, CIV.A.H-01-3624)

[1] Statement of Managers’ Conference Report to accompany H.R. 1058, H.R. Rep. No. 369, 104th Cong., 1st Sess. (Nov. 28, 1995) (hereinafter Conference Report), , at 141 Cong. Rec. H13701.

[2] Conference Report, supra N. 1

[3] 508 U.S. 286 (1993).

[4] Id. at 293.

[5] Securities Exchange Act § 21D(g)(7)(A) (Pub. L. No. 104-67 § 201(a)).

[6] Securities Exchange Act § 21D(g)(7)(A) (Pub. L. No. 104-67 § 201(a)). This was noted in Local 875 I.B.T. Pension Fund v. Pollack, 999 WL 301394, at *2 (E.D.N.Y. May 11, 1999) (“The judgment reduction provision in the Bar Orders proposed here adequately protects the non-settling defendants because it provides them the “greater of” the pro tanto and the proportionate share methods.”).