Corporate Governance

Derivatives and Lead Plaintiff Status: In re Crocs Securities Litigation

By Joseph Aguilar

In the class action suit In re Crocs, Inc. Securities Litigation, No. 07-cv-02351-REB-KLM, 2008 U.S. Dist. LEXIS 87524 (Colo. Dist. Ct. Sept. 17, 2008), the United States District Court of Colorado held the presumptive lead plaintiff adequate to represent the class because its “contracts for difference” (“CFD) were “securities” under the Securities Exchange Act.

Plaintiffs filed a complaint against defendants Crocs Inc. (“Crocs”), along with its CEO and CFO, for violations of sections 10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5. Plaintiffs alleged that Crocs issued inaccurate financial statements and forecasts for the second and third quarters of 2007 resulting in a stock price increase from $55.42 to $74 per share. When Crocs corrected the disclsoure, its shares fell to $47.74.

The Sanchez Group sought appointment as lead plaintiff.  The Group had the largest loss but owned CFDs rather than shares.  CFDs are contracts between a buyer and seller, requiring one party to pay the other the difference between the current value of an asset and its value at the contracted time.  They do not require actual ownership of the shares.  As the court described: 

• CFD purchasers acquire the future price movement of the underlying company's common stock (positive or negative) without taking formal ownership of the underlying shares. Unlike calls and puts, which trade in tandem with, but not at the same price as, the underlying publicly traded common stock, the purchase and sale prices of CFDs are alleged to be identical to the prices quoted for shares of the underlying company's common stock on the public securities exchange. In advance of pricing the CFDs, actual matching shares of the underlying common stock are purchased or sold by the broker on the public securities exchange on which the common stock normally trades. The prices paid or received by the broker for those corresponding shares of common stock are the prices set for the CFDs representing those shares and charged to, or paid by, the customer. Because identical matched transactions occur in shares of the actual common stock immediately before the purchase or sale of the CFDs, any influence on the public market price of the underlying securities is also reflected in the price of the CFDs. CFDs [*13]have no fixed expiration date, CFD holders receive the benefit of any dividends paid on the underlying shares, and the CFD may include voting rights on the underlying shares. 

Other putative plaintiffs challenged the appointment of the Sanchez Group as lead plaintiff, alleging that the CFDs were not “securities” but futures contracts.  Additionally, they argued CFDs made the lead plaintiff an atypical plaintiff with special defenses.

The court disagreed with the challengers’ assertions that CFDs were not “securities,” because the term, as envisioned by Securities Exchange Act, is “very broad, encompassing a wide range of financial instruments.”   The opinion contained little direct reasoning, relying mostly on Freudenberg v. E*Trade Financial Corp., 2008 US Dist. Lexis 62767 (SD NY July 16, 2008) which likewise found the instruments to be securities.  The court also dismissed the argument that the Sanchez Group was an atypical plaintiff.  Because the CFDs were classified as securities, the court concluded that there were no unique defenses that precluded the group from serving as lead plaintiff.

Finding all of the challengers’ arguments unpersuasive, the court approved the Sanchez Group and their counsel as lead plaintiff.  The primary materials for this post are available on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on January 29, 2009 (boomark / email).