The Hartford Financial Services Group Inc. thought it was off the hook when in July 2006 a district court in Connecticut granted the company’s request to dismiss a securities fraud case a class of investors filed against it.
The investors, who filed suit in October 2004, accused the investment and insurance firm of inflating its stock price by concealing kickbacks, bid-rigging and price manipulation schemes by insurers and brokers.
“As a result of Hartford paying tens of millions of dollars in kickbacks, they created an image that the company was a success, but a lot of that was merely temporary,” says David Scott, who represents the plaintiffs in the case and is a partner at Scott & Scott.
The district court ruled that the statute of limitations to file such a suit against Hartford had expired. In its rulings, the court took notice of a number of reports in the media, some of which dated back to 1999, regarding bid-rigging and kickback schemes among investment firms. Some of these stories were in niche trade publications while others were in well-known consumer outlets including The New York Times. According to the district court, the plaintiffs should have been on inquiry notice several years prior to filing their suit. Inquiry notice means there is enough information publicly available to alert ordinary investors of problems, such as fraudulent activity, at a company. Once on inquiry notice, investors have two years to file suit.
The court ruled that the plaintiffs were on inquiry notice since 2001 due to a similar suit filed in California, and thus the statute of limitations had expired. It promptly dismissed the case.
On appeal, however, the 2nd Circuit disagreed. It overturned the lower court’s order to dismiss and reinstated the case, remanding it to the lower court. In addition, the justices tackled the contentious issue of what constitutes a “storm warning,” the information that leads to an inquiry notice.
“This was a relatively liberal decision for the plaintiffs,” says Jonathan Dickey, co-chair of the securities litigation practice group at Gibson, Dunn & Crutcher. “It gives them wider latitude to bring claims that will not be time-barred. Correspondingly it is not as favorable
of a decision for defendants who are trying to enforce the relative statute
At issue in Staehr v. The Hartford Financial Services Group Inc. was the nature of the media reports the defense relied on to build its case that the plaintiffs should have been on inquiry notice in 2001. The Hartford presented 17 news reports, 13 of which were from trade publications and the remaining four from the mainstream press.
Out of the 13 trade pieces, only one mentioned The Hartford by name, as did only one of the four mainstream stories. According to Judge Colleen McMahon, who wrote the appellate opinion, the articles were not enough to constitute a duty to inquire because an ordinary investor would not “have inferred that The Hartford was involved at all.”
“To trigger an inquiry notice, there have to be sufficient storm warnings that are specific enough, disseminated enough and contain information that would suggest to an investor of ordinary intelligence the probability that he or she had been defrauded,” says Daniel Pirolo, a senior associate at Fulbright & Jaworski.
In addition, the court took issue with The Hartford’s regulatory filings, which detailed the contingent commissions insurers paid to garner business from brokers. The court stated that the filings did not implicate The Hartford in fraudulent actions but rather were “seemingly benign.”
Quite possibly the most damaging piece of evidence against the plaintiffs was the filing of a similar lawsuit in California Superior Court against The Hartford’s subsidiaries. However, the company did not discuss the 2001 suit in any of its public filings.
“Based on the exhibits submitted by the defendants, the only way this could have come to the attention of the public was if someone stumbled upon it,” Scott says.
The court agreed, noting that information about the California lawsuit was not disseminated widely enough to be seen by an ordinary investor and thus did not constitute inquiry notice.
The court’s decision to reinstitute Staehr builds on a 2nd Circuit decision in Lentell v. Merrill Lynch & Co., which also briefly dealt with the issue of whether generic articles constitute storm warnings (see “Notice Triggers”). Staehr further clarifies the threshold for what is considered too vague or not widely disseminated. However, in making this significant ruling, the court may have raised more questions.
According to Dickey, Staehr may conflict with another judicial doctrine known as the “fraud on the market” theory. This theory, which arose from a decades-old Supreme Court decision, established that every public statement a public company makes regarding the company is presumed to absorb into the stock price.
“Therefore investors don’t have to prove any reliance on the company statement,” Dickey says. “The stock market acts as their proxy because it is assumed that stock professionals will read that information.”
Whereas Staehr says that some lawsuits and news articles are not disseminated enough for the average investor to take notice, the fraud on the market theory says this point is moot because investors should be able to rely on the market itself, based on the information market professionals have on hand including such niche articles and court cases.
“There is a need here for some uniform standards and for the Supreme Court to harmonize these different legal doctrines,” Dickey says.