In re DVI, Inc. Securities Litigation

Summarized by Richard Corbi , Otterbourg P.C.
14 years 11 months ago

Citation:

(Mar. 29, 2011 3d Cir.) (precedential)

Tag(s):

3rd Circuit

Ruling:

To certify a class, the proposed class representative must satisfy each of the four requirements in Rule 23(a)—numerosity, commonality, typicality, and adequacy—and the putative class action must meet the requirements of one of the subsections of Rule 23(b). In sum, the District Court weighed efficiency factors involving the markets in which DVI’s common stock and senior Notes traded. Granting weight to the listing of DVI’s stock and Notes on the NYSE, and to the cause-and-effect relationships between news releases and DVI’s securities’ prices, the court concluded that each market was efficient. The legal standards it used to evaluate efficiency were proper, its factual findings were not clearly erroneous, and its weighing of the factors was not an abuse of discretion. Accordingly, the Third Circuit held that the District Court did not abuse its discretion in permitting plaintiffs to invoke the fraud-on-themarket presumption of reliance. The Third Circuit also stated that it did not think plaintiffs must establish loss causation as a prerequisite to invoking the presumption of reliance in the first instance. Thus, the Third Circuit declined to require plaintiffs to demonstrate loss causation at class certification. Once established, the presumption of reliance may be rebutted by “any defense to actual reliance.” The Third Circuit believed rebuttal of the presumption of reliance falls within the ambit of issues that should be addressed by district courts at the class certification stage. The District Court did not err in evaluating Deloitte’s rebuttal arguments. Moreover,the Third Circuit agreed with the Second Circuit that a defendant’s successful rebuttal demonstrating that misleading material statements or corrective disclosures did not affect the market price of the security defeats the presumption of reliance for the entire class, thereby defeating the Rule 23(b) predominance requirement. Here, the Plaintiffs adequately demonstrated the markets for DVI securities were efficient—meaning, they absorbed publicly available information about DVI and reflected it in the securities’ prices. The Defendants did not make an adequate showing that the Plaintiffs relied on anything other than publicly available information obtained through careful research that is commonplace among sophisticated institutional investors.

Procedural context:

Plaintiffs moved to certify a class under Fed. R. Civ. P. 23(b)(3) on behalf of DVI investors who purchased securities during the period in which the company allegedly made misrepresentations. The District Court granted plaintiffs’ motion with respect to all defendants but Clifford Chance. The court analyzed the Rule 23 prerequisites and concluded that each was met. Specifically, it found plaintiffs met Rule 23(b)(3)’s predominance requirement by successfully invoking the fraudon- the-market presumption of reliance. But the court found plaintiffs were not entitled to a presumption of reliance with respect to Clifford Chance because its conduct was not publicly disclosed and it owed no duty of disclosure to DVI’s investors. Therefore, individual issues predominated over common issues and a class could not be certified against Clifford Chance. The court appointed lead plaintiffs as class representatives and defined the class as: "All persons and entities who purchased or otherwise acquired the securities of DVI, Inc.Notes) between August 10, 1999 and August 13, 2003, inclusive and who were thereby damaged. Excluded from the class are Defendants; any entity in which a Defendant has a controlling interest or is a part or subsidiary of, or is controlled by a Defendant; the officers, directors, legal representatives, heirs, predecessors, successors and assigns of any of the Defendants. (including its common stock and 9 7/8% Senior Notes). The only Rule 23 requirement raised on appeal is predominance. Predominance requires that “[i]ssues common to the class . . . predominate over individual issues." The plaintiffs asserted a 10(b) private action which included the following elements “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." (citations omitted). The parties dispute the reliance element of plaintiffs’ claims. Reliance, also known as transaction causation, “establishes that but for the fraudulent misrepresentation, the investor would not have purchased or sold the security.” Newton, 259 F.3d at 172. Reliance may be proven directly, but “[r]equiring proof of individualized reliance from each member of [a] proposed plaintiff class effectively would [prevent plaintiffs] from proceeding with a class action, since individual issues then would . . . overwhelm[] the common ones.” Basic, Inc. v. Levinson, 485 U.S. 224, 242 (1988). If reliance must be individually proven, a proposed class cannot meet the Rule 23(b) predominance requirement.

Facts:

Diagnostic Ventures, Inc., (DVI) was a healthcare finance company that extended loans to medical providers to facilitate the purchase of diagnostic medical equipment and leasehold improvements, and offered lines of credit for working capital secured by healthcare receivables. DVI's common stock began trading on the New York Stock Exchange (NYSE) in 1992. It issued two tranches of 9 7/8% senior notes: the first, issued in 1997, totaled $100 million; the second, issued in 1998, totaled $55 million. The Notes were similar but the 1997 Notes were traded on the NYSE, while the 1998 Notes were traded over the counter. On August 13, 2003, DVI announced it would file for Chapter 11 bankruptcy protection resulting from the public disclosure of alleged misrepresentations or omissions as to the amount and nature of collateral pledged to lenders. On September 23, 2003, three plaintiffs (Plaintiffs) filed a class action lawsuit alleging violations of federal securities laws. In the Complaint, the Plaintiffs asserted claims pursuant § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and the SEC’s Rule 10b-5, 17 C.F.R. § 240.10b-5, against multiple defendants, of which Deloitte & Touche LLP involved in these appeals. Deloitte was DVI’s certified public accountant from 1987 to June 2003. The Complaint alleges that between August 10, 1999, and August 13, 2003, defendants engaged in a scheme designed to artificially inflate the price of DVI securities by: (1) refusing to write down millions of dollars of impaired assets; (2) double-pledging collateral and/or pledging ineligible collateral; (3) refusing to implement internal controls or to comply with those in place; and (4) concealing cash shortages by overstating revenues, assets, and earnings, and understating liabilities and expenses. Specifically, the Plaintiffs contended the Deloitte committed securities fraud by wrongfully issuing unqualified, or “clean,” audit reports for fiscal years 1999 to 2002, hiding DVI’s improper accounting practices, and declining to force the company to disclose its fraudulent acts. Plaintiffs sought certification under Rule 23(b)(3), which requires that (1) “the questions of law or fact common to class members predominate over any questions affecting only individual members,” and (2) “that aefficiently adjudicating the controversy.” Fed. R. Civ. P. 23(b)(3). These two requirements are known as predominance and superiority. Deloitte challenged the District Court’s application of the fraud-on-the-market presumption of reliance and its finding that predominance has been satisfied. Deloitte also contended the District Court’s factual findings on market efficiency were an abuse of discretion and that loss causation—a distinct element of the legal claims—must be established as a prerequisite before invoking the presumption of reliance. Finally, even if lead the Plaintiffs successfully invoked the presumption of reliance, Deloitte contended it has rebutted the presumption by demonstrating individual, as opposed to common, issues of loss causation predominate, and by demonstrating that the Plaintiffs relied on a strategy crafted to exploit market inefficiencies. Market efficiency is the cornerstone of the fraud-on-themarket presumption of reliance. As noted, to invoke the presumption of reliance, the Plaintiffs must show they traded securities in an efficient market and the misrepresentations at issue became public. (citations omitted). Because proof of an efficient market is required to invoke the presumption of reliance, which in turn is necessary to meet the Rule 23(b)(3) predominance requirement, a district court, the Third Circuit noted, should conduct a rigorous market efficiency analysis.

Judge(s):

Sciricia, Ambro and Jones (United Statates District Court judge for the Middle District of Pennsylvania sitting by designation)

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