Kaplan v. S.A.C. Capital Advisors, L.P.

Citations: 40 F. Supp. 3d 332; 2014 WL 4088099Docket: Nos. 12-CV-9350 (VM), 13-CV-2459 (VM)

Court: District Court, S.D. New York; August 14, 2014; Federal District Court

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Lead Plaintiffs, David E. Kaplan and others, representing a class of investors in Elan Corporation and the City of Birmingham Retirement and Relief System representing investors in Wyeth, filed a Joint Consolidated Amended Class Action Complaint (CAC) against defendants, including various S.A.C. Capital Advisors entities and individuals Mathew Martoma and Sidney Gilman. The CAC contains three counts: Count One alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5; Count Two alleges violations of Section 20A; and Count Three alleges violations of Section 20(a). The defendants sought to dismiss all counts, leading to a ruling that granted in part and denied in part their motions to dismiss.

The allegations focus on an insider trading scheme resulting in $555 million in profits and avoided losses through illicit trading of Elan and Wyeth securities based on material nonpublic information about the clinical trials of the drug bapineuzumab. Martoma, an employee of S.A.C., established connections with doctors overseeing the trials to obtain confidential information about bapi's safety and efficacy. During the Buying Period from August 2006 to July 18, 2008, Martoma provided positive updates on the drug's prospects to Steven Cohen, S.A.C.'s founder. Consequently, S.A.C. significantly increased its investments in Elan and Wyeth, ultimately profiting approximately $158.3 million from Elan and $21.5 million from Wyeth.

Beginning in July 2008, the bapi trials indicated a negative outlook on the drug's success. Gilman, who was to publicly present the trial results on July 29, accessed the disappointing findings between July 14-18, which revealed inconsistent efficacy signals contrary to market expectations for early FDA approval. On July 17, Gilman informed Martoma about the unfavorable results. During the "Selling Period" from July 19 to July 27, with Martoma's help, Cohen sold SAC's entire long positions in Elan and Wyeth, while also purchasing short options on both companies, betting on a decline in their share prices. These trades were conducted secretly, with even SAC traders unaware of the liquidation. Following Gilman's presentation on July 29, Elan and Wyeth’s stock prices fell sharply, allowing SAC to avoid losses of approximately $194 million on its long positions and to gain about $73 million from its short positions. Market reactions varied regarding the trial results, with some viewing them as strongly negative and others as cautiously positive. Additionally, on July 31, Elan announced that two patients treated with Tysabri had contracted a severe disease, leading to a further 50% drop in Elan's shares by August 1. SAC had already divested from Elan, thereby avoiding an additional loss of $106.9 million due to this decline.

Multiple government enforcement actions have targeted the scheme involving SAC, Martoma, and Gilman, primarily led by the SEC. The SEC initiated an enforcement action, SEC v. CR Intrinsic Investors, LLC, focused on SAC's trading activities from July 17 to July 29, 2008, regarding Wyeth and Elan. Gilman settled with the SEC on November 16, 2012, agreeing to disgorge $186,781 and pay $48,087 in prejudgment interest. On March 15, 2013, SAC settled with the SEC, agreeing to disgorge $275 million and pay $52 million in prejudgment interest, along with a $275 million civil penalty, totaling $602 million. Additionally, the U.S. Attorney filed criminal charges against SAC and initiated civil forfeiture proceedings; SAC pled guilty to wire and securities fraud on November 4, 2013, agreeing to pay $1.184 billion in fines and forfeiture. Martoma faced separate criminal charges and was convicted of securities fraud on February 6, 2014, related to insider trading involving Elan and Wyeth.

The plaintiffs in the current action are divided into two classes: the Elan Investor Class, consisting of those who traded Elan ADRs and options from August 23, 2006, to July 29, 2008, and the Wyeth Investor Class, comprising individuals who traded Wyeth common stock and options during a similar period from January 14, 2008, to July 29, 2008. They allege damages under Section 20A, Section 10(b), and Rule 10b-5 due to trading with SAC, which possessed insider information.

Under Rule 12(b)(6), a complaint must present sufficient factual matter to state a plausible claim for relief. The standard requires that factual allegations must raise a right to relief above a speculative level, allowing the court to infer the defendant's liability. The court’s role is to evaluate the legal feasibility of the complaint, accepting all well-pleaded allegations as true and drawing reasonable inferences in favor of the plaintiffs.

SAC contends that the $275 million disgorgement paid to the SEC in the SEC-SAC Settlement eliminates Plaintiffs’ claims for damages related to the drop in Wyeth and Elan share prices on July 29-30, 2008. Under Section 20A, damages are limited to the profits gained or losses avoided from the insider trading violations, and any damages awarded will be reduced by the disgorgement amount. SAC argues that since Plaintiffs seek $268.4 million, which is less than the disgorgement amount, their claims should be dismissed. However, the court finds this argument unconvincing. Plaintiffs may demonstrate that the SEC settlement was insufficient and recover any difference between actual profits and the disgorged amount.

The court notes that Plaintiffs' estimates of SAC's gains are preliminary and do not conclusively prove that the disgorgement exceeds actual profits. It emphasizes that the damages claimed are not definitive and that the SEC settlement amount, negotiated privately, cannot be deemed absolutely accurate without further evidence. Additionally, the court denies Gilman's motion to dismiss, as Gilman's disgorgement amount of $186,781 plus interest may not fully cover his profits from the insider trading scheme, leaving room for Plaintiffs to challenge the sufficiency of that settlement.

Plaintiffs’ claims for damages related to the drop in Elan’s value after the Tysabri disclosure should not be dismissed, as argued by SAC. Following a significant decline in Wyeth and Elan’s shares due to clinical results announced on July 29, Elan's value further decreased on July 31 and August 1 after revealing issues with Tysabri. SAC contends that it should not be liable for losses linked to this drop since it was not due to any misconduct on its part. However, the court maintains that the determination of damages under Section 20A is based on the insider's profits or losses realized after a reasonable time for the market to assimilate the information. The "reasonable amount of time" for market digestion varies by case and is typically not decided at the motion to dismiss stage, as it requires a factual analysis. SAC's assertion that allowing damages related to an unrelated market event would unfairly benefit Plaintiffs was previously rejected in Elkind v. Liggett, where the court ruled that defendants are liable for losses resulting from their insider trading, even if exacerbated by other market factors. The risk of additional losses from unrelated events is assumed by the insider who trades on the information. Therefore, the court emphasizes the principle that defrauded parties should receive benefits, even if considered windfalls, rather than allowing the fraudulent party to retain unjust gains.

Any uncertainty in calculating disgorgement should be attributed to the wrongdoer responsible for the conduct that created the uncertainty, as established in S.E.C. v. MacDonald. Doubts must be resolved against the party that engaged in fraud. The SAC's attempt to differentiate the current case from Elkind is unsuccessful; it argues that in Elkind, market events occurred after insider trading but before corrective disclosures, while in this instance, the Tysabri drop occurred post-corrective disclosure. However, the timing of the Tysabri drop is irrelevant if it occurred before investors had a reasonable opportunity to react to the July 29 report. The court recognizes that a reasonable period for measuring damages extends beyond the disclosure date, as outlined in MicroStrategy Litigation. Plaintiffs have adequately claimed that the Tysabri drop happened before investors could reasonably respond to the ambiguous July 29 bapi disclosure, creating a factual question that should not be dismissed at the pleading stage. Analysts and reporters have characterized the July 29 disclosure as ambiguous, further complicating the reasonableness of investor reactions within a mere forty-eight hours before the August 1 drop. Legal precedents suggest that a reasonable period for investors to respond can vary, with previous cases acknowledging time frames ranging from nine to twenty days.

SAC contends that many of the Plaintiffs’ claims under Section 20A are time-barred, arguing that these claims are subject to the five-year statute of repose outlined in Section 804 of the Sarbanes-Oxley Act. The Elan Investor Class claims pertain to trades from August 23, 2006, to July 29, 2008, with claims filed on May 13, 2013, while the Wyeth Investor Class’s claims cover January 14, 2008, to July 29, 2008, with claims filed on July 15, 2013. SAC asserts that this statute limits the Elan claims to trades after May 13, 2008, and the Wyeth claims to trades after July 15, 2008. However, an analysis of Section 804 and Section 20A indicates that SAC's interpretation is flawed. Section 804 allows a private right of action for fraud related to securities laws to be brought up to five years after a violation, which is defined as a series of trades rather than single transactions. The total damages under Section 20A cannot exceed the profit gained or loss avoided from the transactions involved in the violation, suggesting that multiple trades can constitute one violation. SAC’s argument that each trade must be a separate violation contradicts the provisions of Section 20A, which indicate that the statute of repose begins on the date of the last transaction related to the violation. Therefore, the statute of repose did not commence until July 29, 2008, the last date of SAC’s insider trading in Elan and Wyeth. Additionally, SAC's claim that criminal charges for each trade imply separate violations is inconsistent with the practice of charging multiple trades as a single violation. The Government’s choice to indict SAC and Martoma collectively for several illegal trades supports that a violation under Section 20A can include multiple transactions.

Plaintiffs’ claims under Section 10(b) and Rule 10b-5 are time-barred if related transactions occurred more than five years prior, as established by the statute of repose in 28 U.S.C. § 1658(b). A violation occurs when the parties commit to the purchase or sale, meaning claims related to transactions before May 13, 2008, for the Elan Investor Class and before July 15, 2008, for the Wyeth Investor Class are dismissed. While SAC asserts that any Section 20A claim is unviable if the underlying Rule 10b-5 violation is time-barred, this interpretation is incorrect; a Section 20A claim only requires an allegation of conduct violating the Exchange Act, regardless of whether such conduct is time-barred. The Second Circuit's ruling in Jackson does not negate this, as it addressed violations of the Securities Act of 1933, not the Exchange Act. Additionally, SAC's argument against double-counting profits and losses from Buying and Selling Claims under Section 20A is rejected. The statute permits recovery for profits gained or losses avoided from separate transactions, even if they involve the same securities, as each transaction constitutes a distinct violation.

SAC seeks to dismiss Plaintiffs' claims for prejudgment interest exceeding the rate established in the SEC-SAC Settlement. SAC's assertion that the SEC's standard rate binds the Court lacks legal support and mirrors a previously rejected argument regarding the binding nature of the disgorgement computation in their settlement. In that settlement, prejudgment interest was set at the IRS rate for tax underpayments, reflecting borrowing costs from the government. Under Section 20A claims, damages are limited to profits gained and losses avoided due to a defendant's unlawful actions, with prejudgment interest necessary to fully capture ill-gotten gains accrued from the wrongdoing until judgment. SAC's claim that the Court must adhere to the agreed-upon rate is unfounded, as the determination of prejudgment interest rates falls within the district court's discretion. There is no federal statute dictating these rates, allowing for various approaches. Plaintiffs argue that the IRS underpayment rate fails to account for the time-value of SAC’s unlawful gains, leaving a factual question unresolved at this stage. Moreover, SAC contends that using investment returns as a prejudgment interest rate violates the principle that profits from reinvestment of wrongful profits are new matters. Plaintiffs counter that these returns reflect the cost SAC incurs to utilize investor funds, representing the time-value of illicit gains. The Court finds that Plaintiffs have sufficiently argued that investment returns are a valid prejudgment interest rate, as courts can consider the interest SAC would pay to borrow withheld funds. Therefore, the Court cannot dismiss Plaintiffs’ claim for prejudgment interest based on investment returns at this stage.

The court has issued an order regarding multiple motions to dismiss in a consolidated class action complaint. The motion filed by S.A.C. Capital Advisors and its affiliates is granted for Count One concerning transactions by the Elan Investor Class before May 13, 2008, and by the Wyeth Investor Class before July 15, 2013, but denied for all other claims. Mathew Martoma's motion to dismiss is denied, as it only reiterates S.A.C.'s arguments without introducing new ones. Sidney Gilman's motion is also denied, as it supports S.A.C.'s position while presenting additional arguments. The court reviewed various filings from both Plaintiffs and Defendants, noting a dispute over whether Section 20A's time bar is a statute of limitations or a statute of repose. The court assumes the Plaintiffs' claims are not barred by Section 804's statute of repose, thus not resolving this dispute. Lastly, since the court finds that the Plaintiffs have adequately stated a claim under Section 20A, S.A.C.'s motion to dismiss claims under Section 20(a) is denied.