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From Securities Regulation Daily, May 8, 2013

Event Study Showed Both Market Efficiency and Damages on Classwide Basis

By Rodney F. Tonkovic, J.D.

A class was certified in a securities action alleging that a food company made false and misleading statements relating to payments made to walnut growers. The court found that the class met the requirements of Rule 23, finding in particular that the company’s stock traded in an efficient market, that damages were susceptible to proof on a classwide basis, and that the lead plaintiff met the typicality and adequacy requirements (In re Diamond Foods, Inc. Securities Litigation, May 6, 2013, Alsup, W.).

The plaintiffs alleged that Diamond Foods, Inc. and certain of its officers deliberately understated the cost of walnuts and improperly accounted for payments made to walnut growers in order to increase apparent profits and maintain high share prices. The investors alleged further that the defendants hoped to inflate share prices because Diamond planned to use its stock to acquire the Pringles brand from its owner, a subsidiary of Proctor & Gamble (P&G).

The principal consideration in the proposed transaction with P&G was Diamond stock, and the defendants allegedly manipulated Diamond’s financial statements by improperly recognizing revenues and costs associated with walnuts in order to inflate the share price. An internal investigation by Diamond’s audit committee discovered this practice, and Diamond announced that the financial statements for the affected fiscal years would have to be restated, causing the stock price to drop and leading to the termination of the Pringles acquisition.

Class certification. The lead plaintiff, the Mississippi Public Employees’ Retirement System (MSPERS), sought certification of a class consisting of purchasers of Diamond’s publicly traded securities from October 5, 2010, through February 8, 2012, and who suffered damages as a result. The defendant argued that MSPERS would be unable to establish that Diamond’s stock traded in an efficient market, that damages would not be susceptible to proof on a classwide basis, and that MSPERS was neither typical of the class nor an adequate representative.

Predominance. Diamond contended that individual questions concerning the element of reliance and the "fraud-on-the-market" presumption predominated over common questions of fact or law. Specifically, Diamond maintained that MSPERS failed to show that the market for Diamond stock was efficient during the relevant period, focusing on the plaintiff's expert's event study and the trading strategy of its investment adviser. The study, Diamond asserted, failed to show a causal connection between unexpected events or financial releases and a response in the stock price.

The court concluded that Diamond’s expert was unable to sufficiently rebut the event study’s conclusion that the market was efficient. Diamond’s expert was unable to show that the study’s methodology was flawed or that common shares traded on the NASDAQ are not traded in an efficient market, the court stated. The plaintiffs were thus entitled to the Basic presumption of reliance.

Continuing, the court observed that neither the Supreme Court nor the 9th Circuit has addressed the question of whether market efficiency is an issue for the jury to determine at trial or is reserved for the judge. According to the court’s review of decisions, a majority of courts treat efficiency as an issue for the finder of fact. For now, the court stated, MSPERS met its burden of showing market efficiency at the certification stage.

Next, the court found that MSPERS’ investment strategy did not refute market efficiency. MSPERS’ decisions on buying and selling Diamond stock were based on the advice of its investment adviser. Diamond argued that because the adviser sought to exploit "market inefficiencies" as its trading strategy, this "refute[d] the premise of the fraud-on-the-market doctrine." The court stated that, while a jury might accept this argument, it was not enough to defeat class certification.

Damages. Citing the Supreme Court's recent decision in Comcast Corporation v. Behrend, Diamond argued that MSPERS failed to proffer evidence establishing that damages could be proven on a classwide basis. Comcast, the court explained, addressed whether class certification had been properly granted where the proffered damages model did not measure damages resulting specifically from the theory of liability that the district court determined as appropriate for class treatment.

The court, however, declined to decide whether Comcast "requires that certification be denied absent affirmative evidence that ‘damages are susceptible of measurement across the entire class.’" Here, the court noted that the recent Amgen decision's holding that Rule 23(b)(3) requires a showing that questions common to the class predominate, not that those questions will be answered on the merits. In this case, both parties’ experts agreed that "recoverable damages in a securities fraud case such as this one should be assessed based on determining the price the security would have been, absent the fraud." The court concluded that the event study was sufficient to show that damages were capable of measurement on a classwide basis.

Typicality and adequacy. Diamond then argued that MSPERS was not typical because it relied on an investment adviser and because it sold all of its holdings before the end of the class period. The court concluded that MSPERS’ reliance on an adviser did not subject it to unique defenses, noting that courts have routinely rejected arguments based on such investment strategies.

The sales during the class period also did not subject MSPERS to a unique defense based on loss causation. Diamond alleged that MSPERS sold its share prior to a single corrective disclosure, but the court found that MSPERS adequately alleged that the truth was revealed to the market through several partial corrective disclosures over time. There was also no conflict of interest caused by the sale. The argument that potential intra-class conflicts related to the times of purchase warrant denial of certification has repeatedly been rejected, the court said.

Adequacy of lead plaintiff. The court then found that MSPERS and its counsel would fairly and adequately protect the interests of the class. Diamond asserted that MSPERS’ counsel was selected through a "pay-to-play" arrangement from a list of firms who made political contributions to Mississippi’s Attorney General. The court noted that it had been concerned that MSPERS was a figurehead and that the Attorney General controlled it and used this case as a reward for campaign contributions. The court however, reviewed the law firm’s submissions regarding their contributions and determined that there was no communication between the firms and the Attorney General’s office concerning contributions. The court accordingly rejected the "pay-to-play" theory.

Class definition. Finally, Diamond contended that the class definition was overbroad because it includes short sellers as well as those who were not damaged by the alleged misrepresentations. Because both parties agreed that short sellers should not be in the class, it modified the class definition to explicitly exclude them.

The case is No. C 11-05386 WHA.

Attorneys: Michael M. Goldberg (Glancy Binkow & Goldberg LLP) for Jorge Salhuana. Darren Jay Robbins (Robbins Geller Rudman & Dowd LLP) for Gary Simon. Mark Punzalan (Punzalan Law, P.C.) and Rosemary M. Rivas (Finkelstein Thompson LLP) for Gary Rall and Marion Rall. Joy Ann Kruse (Lieff Cabraser Heimann & Bernstein, LLP) for Mississippi Public Employees Retirement System. Anthony David Phillips (Berman DeValerio) for Richard Mitchem. Arthur Nash Bailey, Jr. (Hausfeld LLP) for Stewart Woodward. Robert S. Green (Green Welling, P.C.) for Henry MacFarland. Jennifer Corinne Bretan (Fenwick & West LLP) for Diamond Foods, Inc. Sara B. Brody (Sidley Austin LLP) for Michael J. Mendes. Michael J. Shepard (Hogan Lovells US LLP) for Steven M. Neil.

Companies: Diamond Foods, Inc.

MainStory: TopStory CaliforniaNews FraudManipulation

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