Federal Securities Class Action Satisfied Rule 23 Requirements for Class Action Treatment but Duration of Class Period must be Limited as Requested by Defense District of Columbia Federal Court Holds
Several federal securities class action lawsuits were filed against various defendants Federal National Mortgage Association (Fannie Mae) and its former accountant KPMG, as well as various officers and directors of Fannie Mae alleging that they “intentionally manipulated earnings and violated Generally Accepted Accounting Principles (‘GAAP’), causing losses to investors.” In re Federal Nat’l Mortgage Ass’n Securities, Derivative, & “ERISA” Litig., 247 F.R.D. 32, 33-34 (D.D.C. 2008) (footnote omitted). The class actions were consolidated, and the consolidated class action complaint alleged accounting discrepancies at Fannie Mae in violation of GAAP and inadequate internal controls, id., at 34-35. The class action cited to an SEC investigation and to the Paul Weiss report, each of which confirmed accounting problems at Fannie Mae. Id., at 35-36. The class action alleged that Fannie Mae was ordered to restate its financial statements, and that concerns with these financial reports caused the stock to drop dramatically. Id., at 35. Plaintiffs moved for certification of the litigation as a class action and for appointment of class counsel, id., at 33. Defense attorneys apparently did not oppose class certification per se, id., at 36, but rather objected to the proposed duration of the class period (April 2001 to September 2005) and the identity of the putative class members, id., at 33-34. The district court granted the motion in part.
In addressing whether to grant class action treatment, the district court noted that “[t]he requirements of Rule 23(a) are so clearly met in this case that the defendants raise no opposition to this requirement being satisfied.” In re Federal Nat’l Mortgage, at 37. Defense attorneys did oppose, however, the relevant class period: The parties (other than KPMG) agreed that the start date was April 17, 2001, but while plaintiff sought an end date of September 27, 2005, the defense (except KPMG) sought an end date of December 22, 2004. Id. The defense argued that after December 22, 2004, “it was unreasonable, as a matter of law, for any investor to rely on Fannie Mae’s financial statements as a basis to allege that they were a victim under a fraud on the market theory.” Id., at 37-38. The defense selected that date because Fannie Mae issued a corrective disclosure warning on December 22, 2004 that disavowed its earlier financial reports; accordingly, the defense argued that “any purchasers who acquired stock after December 22, 2004, cannot rely on that presumption because Fannie Mae’s corrective disclosure cured the fraud on the market and thus rebutted the presumption of reliance, leaving only individual issues of reliance to predominate thereafter.” Id., at 38. The district court agreed.
In rejecting plaintiffs’ arguments, the court observed at page 39 that “this is not a situation where the December twenty-second disclosure merely hinted at the existence of the problems and that the market barely reacted to a half-hearted disclosure” (citations omitted). On the contrary, the court held at pages 39 and 40, “Simply stated, there was nothing equivocal about Fannie Mae’s December twenty-second disavowal of its financial statements. The company explicitly warned investors to discount its prior financial statements and that it anticipated a restatement of around $9 billion as a result of a top-to-bottom review of its books. This announcement put investors on notice that Fannie Mae’s financial future was, at best, uncertain.” The court found support for this conclusion in the market’s immediate and negative reaction to the announcement, id., at 40. Accordingly, the court held that the class action covers the period of April 17, 2001, to December 22, 2004. Id., at 40-41.
The defense next argued that plaintiffs’ definition of the class includes individuals who are not proper members of the class. In re Federal Nat’l Mortgage, at 41. Specifically, the defense argued that “the following types of plaintiffs should be excluded: (1) the so-called ‘in-and-out’ traders who sold their shares before the first corrective disclosure on September 22, 2004; and (2) the purchasers of call options and sellers of put options.” Id. (footnote omitted). Based on Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342 (2005), holding that whether a private plaintiff has adequately plead loss causation depends on whether the “the purchaser [sold] the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss,” Fannie Mae argued that individuals who sold stock before the issuance of the September 2004 governmental regulatory report cannot prove loss causation. In re Federal Nat’l Mortgage, at 41. The district court rejected this argument as premature, stating that additional discovery was needed before the parties or the court could address the Dura Pharmaceuticals issue. Id. Similarly, the federal court held that whether individuals who purchased calls or sold options should be part of the class could not be determined based on the information presently available. Id., at 42-43.