Seventh Circuit Approves Securities Class Certification in Conseco Case

The United States District Court for the Seventh District of Indiana approved class certification for a class of Conseco Investors. (Later Conseco changed its name to CND Financial Group.) Defendant challenged the granting of class certification to the investor class and appealed to the Seventh Circuit in the case of Schleicher v. Wendt, et al., No. 09-2154 (decided August 20, 2010). The Seventh Circuit affirmed the decision to certify a class.

The Court states that class treatment is appropriate when issues common to class members dominate over those that affect them individually. Fed.R.Civ.P. 23(b)(3). The necessary elements under Rule 23(b)3 are: (1) whether the statements were false; (2) whether the false statements are intentional; (3) whether the stock’s price was affected, and (4) whether the magnitude of such effect shows that the false information was material.

The elements of a claim under §10(b) of the Securities Exchange Act of 1934 and the SEC’s Rule 10b-5 are falsehood in connection with the purchase or sale of securities, scienter, materiality, reliance, causation, and loss. Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005). Reliance usually shows how the false statements caused the loss. Until Basic Inc. v. Levinson, 485 U.S. 224 (1988), defendants tried to resist class certification by contending that each investor was bound to have received different information about the company, and that many investors would not have read the supposedly false statements at all. Thus it was argued that each investor’s fund of information differed from every other investor’s. But Basic concluded that the price of a well-followed and frequently traded stock reflects the public information available about a company.

The opinion discusses the fraud-on-the-market doctrine and states that when a statement that adds to the supply of available information that news passes on to each investor through the price of the stock. As stated, the price transmits the information and causes the change in the stock’s price. The approach supplants “reliance” as an independent element by establishing a more direct method of causation. When a stock trades in an efficient market, the contestable elements of Rule 10(b)(5) reduce to falsehood, scienter, materiality, and loss. Therefore, each investor’s loss can be established mechanically – common questions predominate and class certification is routine.

The Defendants mounted an aggressive and comprehensive defense. For example, the Defendants contend that before certifying a class, the District Court must determine that the contested statements actually caused material changes in stock prices.
Defendants also contended that even if the evidence shows scienter, materiality, causation, and loss, individual damages questions still predominate and prevent class certification.

Judge Easterbrook who wrote the opinion for the Seventh Circuit acknowledged the aggressive efforts of the defendants by stating “a more thoroughgoing challenge to class treatment of securities litigation is hard to imagine.”

In other words, the merits of the case must be proven to obtain class certification. As the Court stated, if the Defendants’ arguments were accepted, it would end the use of class actions in securities cases.

Defendants in effect contended that before certifying a class the district judge must first determine that the contested statements actually caused material changes in
stock prices.

The opinion points out that the fact that the Conseco stock was falling during the class period is irrelevant; fraud could have affected the speed of the fall. That is to say if a firm says it lose one hundred million when it actually lost two hundred million, then the announcement of the two hundred million will cause the price to continue to fall.

The Defendant’s contention that before certifying a class, a court must determine whether false statements materially affected the price, but whether the statements were false or whether the effects were large enough to be called material are questions on the merits. The Court expressly stated that the contention of Defendants that class certification is proper only when the class is sure to prevail on the merits, the opinion concluded that the chances, even the certainty that a class will lose on the merits does not prevent certification of the class.

In the writer’s opinion this case will be followed closely because there is a comprehensive review of the elements necessary for class certification and a rejection of various defensive arguments.

The lawyers for the plaintiffs were The Wagner Firm and the Law Offices of Brian Barry, Glancy Binkow & Goldberg LLP, among others and the lawyers for the defendants were Kirkland & Ellis, LLP, Baker & McKenzie, LLP and Barnes & Thornburg LLP, among others.

Edward X. Clinton, Sr.

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Evidence - Admissibility of Business Records

Obtaining the admission of business records is a often a critical component of any trial. It is a must in any business litigation and can cause problems if it is not carefully considered. Obviously, if you cannot obtain the admission in evidence of business records, such as invoices, you can't win even the most simple collection lawsuit.

Under Rule 803(6) if a document qualifies as a business record, it is not hearsay. The rule applies whether or not the declarant is available as a witness. The Rule presupposes that a business will have strong incentives to keep accurate records. Timberlake Construction Co. v. U.S. Fidelity and Guaranty Co., 71 F.3d 335 (10th Cir. 1995). I will discuss several recent decisions discussing the admission of business records.

I. The Rule

The Rule defines a business record as "a memorandum, report, record, or data compilations, in any form, of acts, events, conditions, opinions, or diagnoses, made at or near the time by, or from information transmitted by, a person with knowledge." Rule 803(6) is not limited to businesses. The Rule specifies that "the term 'business' as used in this paragraph includes business, institution, association, profession, occupation, and calling of every kind, whether or not conducted for profit." Rule 803(6).

A business record is admissible if it is "kept in the course of a regularly conducted business activity, and if it was the regular practice of that business activity to make the [record]." Id. A business record is not admissible where "the source of information or the method of circumstances of preparation indicate lack of trustworthiness." Rule 803(6).

The Ninth Circuit summarizes the Rule's requirements as follows: "a business record is admissible when (1) it is made or based on information transmitted by a person with knowledge at or near the time of the transaction; (2) in the ordinary course of business; and (3) is trustworthy, with neither the source of information nor method or circumstances of preparation indicating a lack of trustworthiness." The Monotype Corporation PLC v. Int'l Typeface Corp., 43 F.3d 443, 449 n.6 (9th Cir. 1994).

II. Regularly Conducted Business Activity

The key foundational inquiry is whether the document was prepared in the course of "a regularly conducted business activity." The document must concern business activity. In Hargett v. National Westminster Bank, 78 F.3d 836 (2d Cir. 1996), plaintiff, an african-american, was terminated from his position as an executive of the defendant bank after he allegedly retained a stripper to perform at an office meeting. Plaintiff alleged that he was terminated by reason of his race. At trial, he sought to introduce a handwritten note allegedly prepared by a co-employee of the defendant bank in which the co-employee admitted that he had procured the services of the stripper. The note was unsigned. The district court denied plaintiff's offer of admission because plaintiff could not establish a foundation for its admissibility as a business record. Indeed, it is hard to imagine that the letter was "a record of regularly conducted activity." Moreover, plaintiff could not offer testimony concerning when and where the handwritten letter was prepared.

The business activity must also be regular. In The Monotype Corporation, the defendant and plaintiff entered into a licensing agreement to allow plaintiff to distribute several of defendant's typefaces. Plaintiff developed several typefaces independently and began selling them to purchasers. Defendant claimed that plaintiff's typefaces were copies of its typefaces. Plaintiff sued to bar defendant from making such claims to plaintiff's customers, including Microsoft. At trial, defendant sought to admit a report prepared by an employee of plaintiff's customer Microsoft concerning the similarities in several typefaces sold by plaintiff and defendant. The report was not a business record because it was not Microsoft's regular practice to prepare such reports. Id. at 449-50 (also excluding an electronic mail message which was a one-time event).

III. The Chain Of Knowledge

The proponent must establish a chain of knowledge. According to Weinstein's Evidence, "Each participant in the chain producing the record -- from the initial observer-reporter to the final entrant -- must be acting in the course of the regularly conducted business." 4 Jack B Weinstein & Margaret A. Berger, Weinstein's Evidence P803(6) [04] (1994). In United States v. Warren, 42 F.3d 647 (D.C. Cir. 1994), the defendant was found in a room containing drugs and a handgun. The defendant sought to introduce a statement from a police report that two other occupants of the apartment were dealing drugs and carried handguns. The police report did not qualify as a business record because the defendant could not show that the report's author had personal knowledge concerning the activity of the other occupants of the apartment or had based the statement on information provided to him by a person with personal knowledge acting in the regular course of business. Id. at 656.

IV. The Custodian's Knowledge

The custodian of business records need not have detailed knowledge concerning who prepared a particular business record. The custodian need only show that he is "sufficiently familiar with the business practice" of the business and show that the record was made pursuant to that practice. Phoenix Associates III v. Stone, 60 F.3d 95 (2d Cir. 1995). In Phoenix Associates, the plaintiffs claimed that they had an oral contract with defendant. At trial, plaintiffs sought to introduce a record of a wire transfer to substantiate the claimed oral contract. Plaintiff's witness, its records custodian, testified that plaintiff's accounting department regularly compiled records of every wire transfer it received or issued. The district court denied plaintiff's offer of the exhibit on the ground that the records custodian worked for both the plaintiff and another company which made the wire transfer. The Court of appeals reversed. The custodian's source of employment was irrelevant "as long as his testimony can supply a sufficient foundation." Id. at 101. Moreover, the custodian was not required to demonstrate personal knowledge of the actual creation of the document. Nor was he required to identify the specific employee who prepared the document. The Rule required only that the proponent prove that the business entity's regular practice was to obtain the information from the person who created the document. Id.

V. Is The Document Trustworthy?

The Rule requires the court to determine whether the source of the information or the method or circumstances of the preparation of a document cast doubt on its trustworthiness. In Hoselton v. Metz Banking Co., 48 F.3d 1056 (8th Cir. 1995), plaintiffs, minority shareholders in defendant's business, claimed that defendants breached their fiduciary duties when they were excluded from a sale of the business to a third party. Notes taken by plaintiffs' accountant were properly admissible because they were prepared in the regular course of the accountant's activity. The notes appeared to be trustworthy because the accountant had professional duties to his clients which would give him strong motivation to make accurate notes. Id. at 1061.
Information provided by the customers of a business can create problems under the Rule because many businesses do not verify information received from customers. Such information may be admissible under Rule 803(6) if the proponent can show that "the business entity has adequate verification or other assurance of accuracy of the information provided by the outside person." United States v. McIntyre, 997 F.2d 687 (10th Cir. 1993), cert. denied, 114 S.Ct. 736 (1994). In McIntyre, the court listed two ways to demonstrate reliability: (1) proof that the business has a policy of verifying patrons' identities by examining their credit cards and other forms of identification; or (2) "proof that the business possesses 'sufficient self-interest in the accuracy of the [record]' to justify an inference of trustworthiness." United States v. Cestnik, 36 F.3d 904, 908 (10th Cir. 1994) (quoting McIntyre, 997 F.2d 687, 700 (10th Cir. 1993). In McIntyre, the court held it was improper to admit a hotel's guest registration cards because it was unclear whether the hotel had procedures to verify the accuracy of the cards. 997 F.2d at 701.

VI. Documents Prepared In Anticipation of Litigation

Documents prepared in anticipation of litigation are usually not admissible because they were not prepared in the regular course of business. Timberlake Construction Co., 71 F.3d 335; Fed. R. Evid. 803(6) Advisory Committee Note. In Timberlake Construction, the plaintiff claimed that the defendant insurer wrongfully denied insurance coverage. At trial, plaintiff introduced several letters written by plaintiff's president and by plaintiff's attorney containing legal conclusions claiming the existence of insurance coverage. The court of appeals reversed on the ground that the letters were written in anticipation of litigation and therefore did not fall within Rule 803(6).

However, an auditor's report prepared in anticipation of litigation may also qualify as a business record. In United States v. Frazier, 53 F.3d 1105 (10th Cir. 1995), the defendant was convicted of falsely describing his use of government funds on official forms. At trial, the Government admitted the report of a government auditor as a business record. The defendant objected that the report was prepared in anticipation of litigation. The court found that the report was trustworthy because the auditor prepared it pursuant to a contract with the government, the auditor had ten years experience in preparing that type of audit report and the auditor was a "neutral party" who had "nothing to gain" from litigation against the defendant. Id. at 1110.

VII. Laying A Foundation

The lawyer seeking to admit the business record must, however, lay a foundation that the record was, in fact a business record. A recent Seventh Circuit case discusses the requirement that a foundation be laid. In United States v. Adrianoros, 578 F.3d 703 (7th Cir. 2009), the Government obtained the admission of a summary of telephone and bank records of the illegal activity. The Government called a policeman to testify that he obtained records by serving a subpoena. The Government sought to admit the records under FRE 1006, which allows a party to present, and enter into evidence, a summary of voluminous writings, recordings or photographs. However, the Seventh Circuit held that the records were improperly admitted because there was no testimony to establish that the records were kept in the course of regularly conducted business activity and there was no certification by the custodian of the records. Thus, no foundation was laid and it was error for the district judge to admit the document in evidence.

A foundation must even be laid in the summary judgment context. The party seeking admission of the business record need not have secured the deposition testimony of the records custodian. The proponent of the document must establish sufficient indicia of reliability. Thanongsinh v. Board of Education, 462 F.3d 762 (7th Cir. 2006).

VIII. Specific Types of Documents

1. Laboratory Reports

It is well established that a laboratory report identifying a substance as a narcotic is admissible as a business record because such reports are routinely prepared by government lab technicians. United States v. Roulette, 75 F.3d 418 (8th Cir. 1996). Additionally, in Roulette, the defendant argued that under the Confrontation Clause, the government should be required to provide proof of the unavailability of the lab technician when admitting the report. The court disagreed reasoning that the exception to the hearsay rule was "firmly rooted." Id. See also Sherman v. Scott, 62 F.3d 136, 140-41 (5th Cir. 1995).

2. Computer Records

Computer business records are admissible if (1) they are kept pursuant to a routine procedure designed to assure their accuracy, (2) they are created for motives that tend to assure accuracy (e.g., not including those prepared for litigation), and (3) they are not themselves mere accumulations of hearsay." United States v. Hernandez, 913 F.2d 1506, 1512 (10th Cir. 1990), cert. denied, 499 U.S. 908 (1991). Computer records are thus treated no differently than other business records.

VIII. Conclusion

The business records exception is commonly used to admit documents which contain hearsay declarations. The rule presupposes that a business has strong incentives to keep accurate records. Thus, it is difficult to resist the admission of a business record, unless the record was prepared in anticipation of litigation or its trustworthiness can be legitimately questioned.

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Securities Law - The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform And Consumer Protection Act (the “Act”) is a massive revision of the way in which financial services are furnished. The Act was signed by President Obama on July 23, 2010.Many of the changes become law on the effective date. However, the Act promulgates various studies which could lead to other changes. Some changes may not go into effect but will become bogged down in contentious disputes. If control of Congress should change in November, some changes may never go into effect. The Act will cause a disruption in the way various issues are perceived.

Mayer Brown has published a complete summary of the Act. It was a massive undertaking. At least eight Mayer Brown lawyers worked on the summary.

The securities section of the Act sets forth a significant number of investor protection measures. Those sections of the Act dealing with Securities Law changes will be referred to as the “Amendments.” The Amendments require the SEC to conduct a six-month study of the need to impose a fiduciary duty on brokers providing personalized investment advice to retail customers. Various factors must be taken into account in determining the effectiveness of existing standards of care.

The Amendments establish within the SEC an Investment Advisory Committee composed of (1) an investor advocate who reports directly to the Chairman of the SEC, (2) a representative of State Securities Commissionaires, (3) a representative of the interest of senior citizens and (4) between ten and twenty additional members appointed by the SEC. The Committee has a responsibility of consulting with the SEC on regulatory priorities, the substance of proposed regulations and initiatives by the SEC to protect investors and promote investor confidence in the market.
The Chairman of the SEC will appoint an Investor Advocate to lead a new office within the SEC. An ombudsman will act as liaison between retail investors and the SEC in resolving issues with the SEC and/or the securities Self-Regulatory Organizations (“SRO”). The Chairman of the SEC is responsible to take action to address deficiencies identified by a report of investigation by the SEC.
The stock exchanges must, as directed by the SEC, enforce requirements in the Amendments for clawing back incentive compensation paid to executives mistakenly paid based on erroneous results later corrected and restated within three years of such payment.

The SEC must hire a consultant to study its operations and the possible need for reform of the agencies and furnish within 150 days a report to the SEC and Congress making legislative regulatory and administrative recommendations for improvement in the SEC.

The Controller General of the United States is to issue rules surrounding employees who leave the SEC for employment with regulated firms in the securities industry and report to the SEC and the House Financial Services Committee (“HFSC”) within one year of enactment of the Act.

The SEC must establish an Investor Protection Fund from revenues from certain sanctions. The Fund to be used among other things to pay whistle-blowers who provide original information in a SEC action.

The SEC will be authorized to make nationwide service of subpoenas of civil actions filed in federal court.

The Amendments change who qualifies as an “accredited investor”. These investors must now have $1 million excluding the value of their primary residence, whereas the old standard was simply a $1 million net worth.

The Amendments also authorize the SEC to limit or prohibit the mandatory predispute arbitration clauses that apply to most brokerage accounts. Such clauses force brokerage customers to take any disputes that may arise with their broker before arbitration panels, which critics claim often favor the brokerage industry, rather than taking their claims to court.

The Anti-Fraud provisions of the Federal Securities Laws were extended to apply to “conduct within the United States that constitute significant steps in the furtherance of a violation even if the securities transactions occur outside of the United States and involve only foreign investors.”

The Government Accountability Office (“GAO”) must report to Congress within one year regarding the potential consequences of authorizing a prior right of action against any person who aids or abets another person in violation of the Federal Securities laws. In other words, the new statute reverses the Stoneridge ruling. Stoneridge Investment Partners, LLC v. Scientific Atlantic, Inc., 522 U.S. 148 (2008). In Stoneridge, the U.S. Supreme Court held that those who aid or abet securities fraud are not liable.

Various changes regarding the regulation of credit rating agencies are prescribed. For example, the SEC must establish an office of credit ratings designed to administer the SEC rules applicable to Nationally Recognized Statistical Rating Organizations (“NRSRO). It can make exceptions for smaller NRSRO’s as it considers appropriate. At least two persons on the Board of Directors of NRSRO’s must be independent directors.
Not later than 270 days after the enactment of the Amendments, the SEC, Federal Reserve Board (“FRB”), Federal Deposit Insurance Corporation (“FDIC”) and (Office of the Comptroller of the Currency (“OCC”) must issue rules requiring a securitizer of an asset backed security (other than a residential mortgage-backed security) to retain at least 5% of the credit risk in any asset that the securitizer transfers or sells to a third party. The rules become effective two years after the final version is published in the Federal Register.

Executive compensation is to be revised as follows:

Effective six months after enactment of the Amendments, publicly traded companies must hold a non-binding vote to approve the compensation of executives who are among those disclosed in public filings pursuant to SEC rules (i.e., say-on-pay votes) at least once every three years, and a separate resolution must be offered at least once every six years for a vote to determine whether say-on-pay votes should occur every one, two or three years. Although a “no vote” is not binding, it would likely cause the Board of Directors to take some action to adjust compensation standards.

The Conference Committee also agreed to require these companies to provide a non-binding vote to approve golden parachutes (effective six months after enactment). Institutional investment managers subject to Section 13(f) of the Exchange Act must annually disclose how they vote on say-on-pay and golden parachute matters unless their votes are otherwise publicly reported under SEC rules. The Amendments place ultimate responsibility for compensation decisions for executives with the respective Compensation Committees, which must be comprised of independent directors and advised by compensation consultants, legal counsel, and other advisers who are independent as well.

The SEC is required to amend item 402 of Regulation S-K under the Securities Act to require companies to disclose the relationship between executive compensation and financial performance and the ratio between the CEO’s compensation and the median compensation of all other employees.

The SEC must issue a rule requiring publicly traded companies to disclose whether executives are permitted to hedge the value of any equity securities granted to such executives as compensation.

The SEC must conduct a study, and report to Congress within two years of enactment, regarding the use by publicly traded companies of compensation consultants.

The FRB, in consultation with the OCC and FDIC, has the responsibility of establishing standards making it an unsafe and unsound practice for the holding companies of depository institutions to pay compensation that is excessive or could lead to material financial loss to the holding companies.

There will be many 3 – 2 notes by the SEC with the Commissioners nominated by the democrats winning the contentious issues but only after delays and many dissents.

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