Securities Law - Wells Notice

A Wells Notice advises a public company or a principal officer of a public company that the Securities & Exchange Commission is considering enforcement action because of some alleged violation of the Securities Laws. The company or individual is given a chance to respond and explain why enforcement action should not be brought. Not all Wells’ Notices lead to enforcement action. The term “Wells Notice” is named after Senator John Wells, who in 1972 chaired a committee to review SEC enforcement procedures.

Goldman Sachs received a Wells Notice in July 2009 in connection with the sale by Goldman Sachs of a synthetic collateralized debt obligation known as Abascus 2007-AC-1. The notice was not disclosed to shareholders or otherwise made public. Corporate lawyers believe that it depends on the facts whether a Wells Notice should be disclosed. Plaintiff’s lawyers generally take the position that such notices should be disclosed because they are material. In other words an SEC investigation has proceeded to the point that the staff is considering proceeding against the company or a principle officer. Two class actions have been filed so far against Goldman Sachs alleging, among other things, that the Wells Notice was concealed from investors.

According to an article in the Wall Street Journal dated April 10, 2010, five Senior Executives of Goldman Sachs Group Inc., including the firm’s co-general counsel, sold $65.3 million worth of stock after the firm received notice of possible fraud charges, which later drove its stock down 13%. There is no suggestion in the article that those executives had any knowledge of the Wells Notice.

The SEC has alleged in the well-publicized case against Goldman Sachs that the firm made misrepresentations and material omissions in the marketing in 2007 of a collateralized debt obligation known Abascus 2007 AC-1.

The public will learn much more about Wells Notices after there is further disclosures by either Goldman Sachs or the SEC.

Ira Schochet, a partner in the New York law firm of LaBaton, Sucharow LLP, responded to the argument that disclosing Wells Notices just repeats unproven allegations.
However, Schochet stated that if there is a substantial defense, issuers can disclose that as well. Schochet is also President of the National Associations of Shareholder and Consumer Attorneys, a group of about 100 law firms that represent investors and consumers.

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Business Debts - The Bankruptcy Court Will Not Discharge A Debt Where The Underlying Loan Was Procured Through Fraud

In Ojeda v. Goldberg, No. 09-2008, the Seventh Circuit affirmed a determination of the District Court (Judge Gottschall) that a debt was not dischargeable because the underlying loan was procured through fraud.

This case is of interest even to those who do not practice in the bankruptcy area as bankruptcy considerations often govern corporate transactions.

Facts:

The Goldbergs were creditors of Ernest and Beverly Ojeda. The parties executed a short-term high-interest-rate loan in August 1998. The Ojedas were unable to pay the principal when the loan came due. However, they obtained numerous extensions of the loan's maturity date until January 2006 when the Ojedas defaulted.

In February 2006, the Ojedas filed for bankruptcy. Gail Goldberg filed an adversary proceeding against the Ojedas seeking a declaration that the $600,000 loan was not dischargeable because it was procured fraudulently.

The Ojedas owned (through corporations) two McDonald's restaurants. The Ojedas later sold the McDonald's franchises.

When the loan came up for renewal, the Ojedas did not disclose to the Goldbergs that they had sold the McDonald's restaurants. The District Court held that the entire debt $600,000 should be exempt from discharge because the Ojedas led Gail Goldberg to believe that they still owned the McDonald's restaurants when they did not. In fact, the district court noted that the Ojedas continued to use the checkbook for the McDonald's restaurants to pay interest long after the restaurants were sold.

The Seventh Circuit, in an opinion by Judge Kanne, affirmed. The legal standard is as follows:

For a creditor to receive an exception from discharge under 11 U.S.C. Section 523(a)(2)(A), the creditor must show that (a) the debtor made a false representation; (b) that the debtor knew was false and was made with intent to deceive; (c) upon which the creditor justifiably relied.

The Seventh Circuit agreed with the Bankruptcy and District Court that the Ojedas had made false representations with the intent to deceive the Goldbergs. The more difficult question was whether Gail Goldberd had justifiably relied on the Ojedas representations that they still owned the McDonald's restaurants. As the Court noted, "justifiable reliance is a less demanding standard than reasonable reliance" and Ms. Goldberg met that standard.

The Court noted that the Ojedas continued to use checks bearing the McDonald's information. Unless the Plaintiff possessed outside information, "there was no conceivable way that [Ronald Goldberg] could have been alerted to the sale (of the restaurants) when the Ojedas continued to give the impression that the sale never occurred." In sum, the Seventh Circuit was satisfied that the sale of the McDonald's restaurants was concealed and that the Goldbergs justifiably relied on the misrepresentations.

The Seventh Circuit further held that "a fraudulently induced forbearance constitutes an extension or renewal of credit for purposes of Section 523." The Goldbergs met their burden of proving that the forbearance was fraudulently induced in that (a) they had valuable collection remedies at the time of the misrepresentation; (b) they did not exercise those remedies based upon the misrepresentation; and (c) the remedies lost value during the extension period." Opinion at page 13.

Comment: Clients often believe that filing bankruptcy will wipe away their debts. However, bankruptcy courts often scrutinize transactions to determine if they were fair to all parties. Here, the debtors' trickery (hiding the fact that two fast food restaurants were sold) proved to be their undoing.


Edward X. Clinton, Jr.

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Securities Law - Statute of Limitations Decision - Merck & Co., v. Reynolds, 08-905

SECTION 10(b)-5 STATUTE OF LIMITATIONS

The U.S. Supreme Court on April 27, 2010 has furnished clarity to the question of when does the statute of limitations begin to run § 10(b)-5 Securities lawsuits. Plaintiffs filed a securities fraud action under § 10(b)-5 on November 6, 2003. The District Court dismissed the complaint on the ground that the filing was not timely because the plaintiff should have been alerted to the possibility of Merck’s misrepresentation prior to November 3, 2001 because of a study (the VIGOR study) showing adverse cardiovascular results when the Merck Drug Vioxx was used. The applicable statues of limitations provides in part “private right of action involving a claim for fraud, deceit, manipulation or contrivance in contravention of a regulatory requirement concerning the securities laws … may be brought not later than the earlier of (1) two years after the discovery of facts constituting the violation; or, (2) 5 years after such violation. 29 U.S.C. § 1658(b)(1).

The Complaint alleged that Merck defrauded investors by promoting the drug Vioxx when it knew of the serious safety issues of Vioxx. In 1998, internal Merck clinical trials showed that serious cardiovascular events occurred six times more frequently in patents given Vioxx. Merck claimed that the plaintiff should have known more than two years before filing the Complaint and the District Court agreed.

The Third Circuit reversed and said that although there were storm warnings about the use of Vioxx, they did not put plaintiff on inquiry. Merck sought review in the United States Supreme Court because of disagreements in the Circuits.

Justice Breyer wrote the opinion of the Supreme Court which unanimously affirmed the decision of the Third Circuit. Judge Breyer in his opinion states that the parties and the Solicitor General agree that § 1658(b)(1)’s word “discovery” refers not only to plaintiff’s actual discovery of certain facts, but also to the facts that a reasonably diligent plaintiff would have discovered. The opinion discusses the use of the word “discovery” by various authors and by the Supreme Court itself. In Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350 (1991), the court said that private sections under 10(b)-5 actions “must be commenced within one year after the discovery of the facts constituting the violation and within three years after such violation.” The opinion went on to state that the word “discovery” as used in the statute encompasses not only those facts the plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known.

The Court then considered and dismissed various arguments suggesting that plaintiffs had knowledge more than two years prior to the filing of its Complaint. The Court concluded that the limitation period in § 1658(b)(1) begins to run once the plaintiff did discover or a reasonably diligent plaintiff would have discovered the facts constituting the violation, whichever comes first.

In determining the time at which ”discovery” of those “facts” occurred, such terms as “inquiry notice,” and “storm warnings” may be useful to the extent they identify time when the facts would have prompted a reasonably diligent plaintiff to begin investigating. But the actual limitation period does not begin to run until the plaintiff thereafter discovers or a reasonably diligent plaintiff would have discovered “the facts constituting the violation,” including scienter, irrespective of whether the actual plaintiffs undertook a reasonably diligent investigation.

Judge Stevens wrote a concurring opinion and Justice Scalia wrote a concurring opinion joined by Justice Thomas.

A big defeat for Merck but important clarity when analyzing the § 10(b)-5 Statute Of Limitations.

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