Litigating in the Wake of Manning

Litigating in the Wake of Manning

The United States Supreme Court preserved a role for state courts in securities litigation in a case involving accusations of ‘naked shorting,’ Merrill Lynch v. Manning, a May 2016 decision. Although the case involved specific state law claims, it also prominently referenced the Securities and Exchange Commission’s Reg SHO in defining the alleged manipulation, and this gave a colorable argument to attorneys for the alleged manipulators, the defendants, that the federal courts had exclusive jurisdiction.

This is important, because twenty years ago, in the wake of Newt Gingrich’s victory in the “contract with America” midterm election of 1994, Congress set out to limit securities fraud lawsuits in the federal courts. The Private Securities Litigation Reform Act of 1995 and subsequent Supreme Court decisions such as Tellabs v. Makor (2007) have made life much more difficult for plaintiffs in the federal forum.

But the Supreme Court helped them out a bit this spring, rejecting the argument for federal exclusivity  in sending the matter back to the New Jersey courts for litigation on the merits of the plaintiffs’ contentions.

Meanwhile, in Georgia

Wes Christian, an attorney of some prominence in the securities-fraud plaintiffs’ bar, is in the thick of another action pursuing naked-short charges at the state level, one that may prove in time more consequential than Manning.  This is the matter of Collentine v. Morgan Stanley, pending now in the Superior Court of Fulton County, Georgia.

The first named plaintiffs, Thomas and Judith Collentine, are Georgia residents and former stockholders in a defunct company called Raser Technologies. The Collentines sold 320,374 shares of Raser into the market allegedly depressed by illegal activity.

There is a parallel case underway in Utah, where Raser had its headquarters in the years leading up to its 2011 bankruptcy filing. Raser was, and its successor entity, Cyrq Energy, now is, a geothermal energy developer.

The gist of the complaints in both states is this: various financial industry defendants, the first named of which is Morgan Stanley, regularly violated the law by (1) misapplying the various exceptions to Reg SHO’s LOCATE requirement, (2) including hard-to-locate securities on an easy to borrow list, (3) allowing favored hedge funds to bypass the Locate requirement, and (4) failing to document and supervise short sales by their employees. All this drove down prices, hurting both the issuer and its equity holders.

On April 25, 2007, for example, the complaint alleges that MS moved 1 million shares of restricted Rule 144 Razer stock into the DTCC to allow it to be used for locates or lending.  The “actual amount of stock to be re-certified per customer instructions was only 5,000 shares,” says the complaint. Thus it was unlawfully increasing the supply of stock, depressing its value.

Victory on Discovery

A recent favorable decision on a contested discovery issue has provided the plaintiffs’ attorneys with a lot of material from the defendant institutions. They are going through it all now. In such matters, Christian says, “The fight is to get all the documents that you can, so you can see and lay out what actually happened. Once that is accomplished, the story is pretty simple.”

In this case, the defendants most central to the story that the plaintiffs want to tell the world are Goldman Sachs and Merrill Lynch: more specifically, an affiliate of the former, Goldman Sachs Execution & Clearing LP, and an affiliate of the latter, Merrill Lynch Professional Clearing Corp.

On April 7, Judge Goger granted the plaintiffs’ motion to compel documents from those affiliates, rejecting defendants arguments that, since the affiliates themselves were not defendants, privacy considerations should prevail.

Plaintiffs’ attorneys indicate that this case, especially in its Georgia incarnation, is a good deal closer to coming to trial than is Manning. In its Utah incarnation, involving the issuer plaintiff, there is an extra procedural hurdle, an arbitration requirement imposed by the statutes there.

As to Georgia and its stockholder plaintiffs, “We’ll be filing an amended complaint in due course,” Christian said, taking account of what they are learning from their scrutiny of the newly available documents.  What they are learning is in general in accord with the theory of the case they held going in, although there are “nuances” in which their conceptions are changing and those nuances will be reflected in the amendments.

In conversation, Christian offered the following concise statement of the sometimes complicated facts and theories involved: “If you do anything to circumvent Reg SHO you have violated Reg SHO.”

 

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