1 darryl p. rains (ca sbn 104802) eugene illovsky (ca...

Case3:08-cv-01510-WHA Document442 Filed03/04/10 Page1 of 17

1 DARRYL P. RAINS (CA SBN 104802)EUGENE ILLOVSKY (CA SBN 117892)

2 MORRISON & FOERSTER LLP

755 Page Mill Road3 Palo Alto, California 94304-1018

Telephone: 650.813.56004 Facsimile: 650.494.0792

Email: [email protected]

CRAIG D. MARTIN (CA SBN 168195)6 DOROTHY L. FERNANDEZ (CA SBN 184266)

MORRISON & FOERSTER LLP

7 425 Market StreetSan Francisco, California 94105-2482

8 Telephone: 415.268.7000Facsimile: 415.268.7522

9Attorneys for defendants The Charles Schwab Corporation,

10 Charles Schwab & Co., Inc., Charles Schwab InvestmentManagement, Inc., Schwab Investments, Charles R. Schwab,

11 Evelyn Dilsaver, Randall W. Merk, George Pereira, MatthewHastings, Mariann Byerwalter, Donald F. Dorward, William A.

12 Hasler, Robert G. Holmes, Gerald B. Smith, Donald R.Stephens, and Michael W. Wilsey

13

14 UNITED STATES DISTRICT COURT

15 NORTHERN DISTRICT OF CALIFORNIA

16 SAN FRANCISCO DIVISION

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18 IN RE CHARLES SCHWAB CORP. Master File No. C-08-01510-WHASECURITIES LITIGATION

19 CLASS ACTION

20 SCHWAB’S OPPOSITION TOMOTION TO EXCLUDE

21 CHRISTOPHER M. JAMES

22 Date: March 25, 2010Time: 8:00 a.m.

23 Judge: Hon. William H. Alsup

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SCHWAB ’ S OPPOSITION TO MOTION TO EXCLUDE CHRISTOPHER M. JAMESMASTER FILE NO . C-08-01510-WHAdn-157498


1 STATEMENT OF ISSUES

2 (Local Rule 7-4)

3 Whether the Court should deny plaintiffs’ motion to exclude the expert testimony of

4 Professor James where his testimony is based on rigorous analysis of mountains of data regarding

5 price movements of the YieldPlus fund’s securities, using well-recognized methodologies and

6 accepted economic principles, and is relevant to show that the misrepresentations alleged by

7 plaintiffs did not cause the fund’s price declines?

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SCHWAB ’ S OPPOSITION TO MOTION TO EXCLUDE CHRISTOPHER M. JAMES iMASTER FILE NO . C-08-01510-WHAdn-157498


1 TABLE OF CONTENTS

2 Page

3 STATEMENT OF ISSUES i

4 TABLE OF AUTHORITIES iii

5 INTRODUCTION 1

6 ARGUMENT 2

7 I. PROFESSOR JAMES IS A QUALIFIED EXPERT ON LOSS CAUSATION. 2

8 II. PROFESSOR JAMES EMPLOYED THE CORRECT LEGAL STANDARDFOR NEGATIVE LOSS CAUSATION 3

9III. PLAINTIFFS’ ATTEMPTS TO DISCREDIT PROFESSOR JAMES ARE

10 MISLEADING. 4

11 IV. PROFESSOR JAMES APPLIED RELIABLE PRINCIPLES ANDMETHODOLOGIES. 5

12V. PLAINTIFFS’ RECYCLED ARGUMENTS ARE INAPPLICABLE HERE. 8

13VI. PROFESSOR JAMES’S TESTIMONY IS NOT CONTRADICTED BY THE

14 EVIDENCE 10

15 CONCLUSION 12

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SCHWAB ’ S OPPOSITION TO MOTION TO EXCLUDE CHRISTOPHER M. JAMES iiMASTER FILE NO . C-08-01510-WHAdn-157498


1 TABLE OF AUTHORITIES

2 Page(s)

3 CASES

4 California Fed. Bank v. United States,54 Fed. Cl. 704 (Ct. Fed. Cl. 2002) 4

5Clark v. Nevis Capital Mgmt., LLC,

6 No. 04 Civ. 2702, 2005 WL 488641 (S.D.N.Y. Mar. 2, 2005) 9

7 Daubert v. Merrell DowPharm., Inc.,

8 509 U.S. 579 (1993) passim

9 Dorn v. Burlington Northern Santa Fe R.R. Co.,397 F.3d 1183 (9th Cir. 2005) 5, 8

10Dura Pharms., Inc. v. Broudo,

11 544 U.S. 336 (2005) 10, 11

12 In re Britannia Bulk Holdings Inc. Sec. Litig.,

13No. 08 Civ. 9554(DLC), 2009 WL 3353045 (S.D.N.Y. Oct. 19, 2009) 4

14 In re Metropolitan Sec. Litig.,

2:04cv00025-FVS, slip op. (E.D. Wash. Feb. 18, 2010) 1015

Kumho Tire Co. v. Carmichael,16 526 U.S. 137 (1999) 2, 5, 8

17 Maiz v. Virani,253 F.3d 641 (11th Cir. 2001) 8

18McKowan Lowe & Co. v. Jasmine,

19 No. Civ. 94-5522 (RBK), Civ. 96-2318 (RBK),

20 2005 WL 1541062 (D.N.J. June 30, 2005) 4

21 RMED Int’l, Inc. v. Sloan’s Supermarkets, Inc.,No. 94 Civ. 5587, 2000 WL 310352 (S.D.N.Y. Mar. 24, 2000) 9

22Smith v. Pac Bell Tel. Co.,

23 649 F. Supp. 2d 1073 (E.D. Cal. 2009) 11

24 Sterling Savings Ass’n v. United States,

25 80 Fed. Cl. 497 (Ct. Fed. Cl. 2008) 4

26 Textron Inc. v. Barber-Colman Co.,903 F. Supp. 1546 (W.D.N.C. 1995) 11

27Ulico Casualty Co. v. Clover Capital Mgmt.,

28 217 F. Supp. 2d 311 (N.D.N.Y. 2002) 8

SCHWAB ’ S OPPOSITION TO MOTION TO EXCLUDE CHRISTOPHER M. JAMES iiiMASTER FILE NO . C-08-01510-WHAdn-157498


1 United States v. Diaz,

2CR 05-000167 WHA, 2006 WL 2699042 (N.D. Cal. Sept. 19, 2006) 5

3 United States v. Ferguson,

584 F. Supp. 2d 447 (D. Conn. 2008) 9

4United States v. Sandoval-Mendoza,

5 472 F.3d 645 (9th Cir. 2006) 4

6 Yu v. State Street Corp.,

7No. 08 Civ. 8235 (RJH), 2010 U.S. Dist. LEXIS 17147 (S.D.N.Y. Feb. 25, 2010) 11

8

9 STATUTES AND RULES

10 15 U.S.C.§ 77k(e) 3, 4

11 § 77l(b) 3

12 Fed. R. of Evid.

13Rule 702 2,11

14

15 OTHER AUTHORITIES

16 A. Craig MacKinlay, Event Studies in Economics and Finance,35 J. Econ. Lit. 13 (Mar. 1997) 9

17Jeffrey M. Netter, The Role of Financial Economics in Securities Fraud Cases,

18 49 Bus. Law. 545 (Feb. 1994) 9

19 Kent Daniel et al., Measuring Mutual Fund Performance with Characteristic-Based

20Benchmarks,52 J. Fin. 1035 (July 1997) 6

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SCHWAB ’ S OPPOSITION TO MOTION TO EXCLUDE CHRISTOPHER M. JAMES ivMASTER FILE NO . C-08-01510-WHAdn-157498


1 INTRODUCTION

2 The Court should deny plaintiffs’ motion to exclude Professor James’s testimony. Their

3 motion is riddled with unsupported generalities, irrelevant claims, and misleading arguments.

4 Christopher M. James is an eminently qualified professor of finance with special

5 expertise in loss causation. Professor James’s opinions that alleged misstatements did not cause

6 investors’ losses are based on principles and methodologies that are fully consistent with

7 Daubert. He did a rigorous analysis of market and fund data in ways accepted by courts and

8 other professionals. He used benchmarks and model portfolios to test the effect of the alleged

9 misrepresentations. And he applied his specialized knowledge of accepted financial and

10 economic principles in evaluating to what extent each alleged misrepresentation or omission

11 caused losses.

12 Plaintiffs say Professor James used the wrong “negative loss causation” legal standard.

13 But it is plaintiffs who have the law wrong. As we show in our opposition to plaintiffs’ motion

14 for summary judgment on negative loss causation, they apply the wrong legal standard while

15 Professor James applies the correct one. Schwab has no obligation — through Professor

16 James’s testimony or otherwise — to “affirmatively prove that other contemporaneous events

17 wholly unrelated to Plaintiffs’ allegations caused the decline,” as plaintiffs claim; Schwab need

18 show only that “any portion or all” of plaintiffs’ losses was not caused by an alleged

19 misstatement.

20 Plaintiffs make general assertions that Professor James’s testimony is “unsupported

21 speculation” and “totally devoid of technical analysis.” But they ignore Professor James’s

22 benchmark methodology and the extensive analysis of market and fund data that he does

23 throughout his reports to support his opinions. In fact, they don’t question the reliability of any

24 specific methodology he uses.

25 Finally, plaintiffs say Professor James “completely ignores” “critical record facts.” That

26 argument is wrong, but, in any event, goes only to the weight of Professor James’s opinions, not

27 their admissibility. Moreover, the evidence plaintiffs cite is irrelevant to loss causation. It is

28 unremarkable testimony confirming that the value of the fund’s securities, including its

SCHWAB ’ S OPPOSITION TO MOTION TO EXCLUDE CHRISTOPHER M. JAMES 1MASTER FILE NO . C-08-01510-WHAdn-157498


1 mortgage-backed securities, declined during the credit crisis. None of the testimony causally

2 links the losses to an alleged misrepresentation. In fact, witnesses testified that economic

3 circumstances changed dramatically in late 2007 and early 2008. Losses caused by changed

4 economic circumstances are not recoverable. The evidence plaintiffs cite shows that there was a

5 loss — a decline in the fund’s NAV because of the decline of the value of its holdings — but

6 does not show loss causation.

7 ARGUMENT

8 Federal Rule of Evidence 702 allows a witness “qualified as an expert by knowledge,

9 skill, experience, training, or education,” to testify in the form of an opinion. Fed. R. Evid. 702.

10 That expert opinion, to be admissible, must be reliable and relevant. Daubert v. Merrell Dow

11 Pharm., Inc., 509 U.S. 579, 597 (1993). The test of reliability is flexible, and depends on “the

12 nature of the issue, the expert’s particular expertise, and the subject of [the] testimony.” Kumho

13 Tire Co. v. Carmichael, 526 U.S. 137, 150 (1999). It focuses solely on principles and

14 methodology, and not on the conclusions generated. Daubert, 509 U.S. at 595. The expert must

15 “employ[] in the courtroom the same level of intellectual rigor that characterizes the practice of

16 an expert in the relevant field.” Kumho, 526 U.S. at 152. The relevance prong of Daubert asks

17 whether the testimony will “assist the trier of fact to understand the evidence or determine a fact

18 in issue.” Daubert, 509 U.S. at 591.

19 Professor James has more than ample qualifications to testify on loss causation, his

20 methodologies are reliable, and his testimony is relevant.

21 I. PROFESSOR JAMES IS A QUALIFIED EXPERT ON LOSS CAUSATION.

22 Plaintiffs do not challenge Professor James’s qualifications to testify as an expert in the

23 area of loss causation. Nor could they: Professor James has a PhD in Finance from the

24 University of Michigan, and has more than thirty years of experience in the finance field,

25 lecturing on topics including loss causation under the securities laws. (Berman Decl. Exh. A

26 (James Report) at Exh. 1; Fernandez Decl. Exh. A (James Depo.) at 15:14–20.) He is currently

27 the William H. Dial/SunBank Eminent Scholar in Finance and Economics, and Professor of

28 Finance at the University of Florida. (Berman Decl. Exh. A at 1 . ) In addition to being a finance



1 professor, he has held positions at the Federal Reserve Bank of San Francisco, the Federal

2 Deposit Insurance Corp., and the Treasury Department. He has authored nearly 70 publications,

3 addressing issues relating to corporate finance, interest rate management, mutual fund

4 performance and how information is incorporated into securities prices. ( Id. at 1 and Exh. 1.) 1

5 He has also served on the editorial boards of four scholarly journals, including the Journal of

6 Financial Economics. (Berman Decl. Exh. A at 1.) Professor James’s education, knowledge

7 and experience are more than sufficient to qualify him as an expert, and plaintiffs do not

8 contend otherwise. 2

9 II. PROFESSOR JAMES EMPLOYED THE CORRECT LEGAL STANDARDFOR NEGATIVE LOSS CAUSATION.

10

11 Plaintiffs assert that Professor James’s analysis is based on the wrong legal standard

12 because he analyzed “to what extent investor’s losses resulted from the alleged

13 misrepresentation.” (Open. Br. 4.) They say Professor James should have investigated what

14 other, “wholly unrelated” events caused the decline in value. ( Id. 3–4.) But it is plaintiffs, not

15 Professor James, who use the wrong legal standard. We show this in detail in our opposition to

16 plaintiffs’ motion for summary judgment on loss causation.

17 Both section 11 and section 12 allow Schwab to prove its negative causation defense by

18 showing “that any portion or all of” plaintiffs’ losses “represents other than” a decline in the

19 fund’s NAV “resulting from” a misrepresentation in a prospectus or registration statement.

20 15 U.S.C. §§ 77k(e), 77l(b). Under the plain and common-sense meaning of the statutory text, a

21 showing that plaintiffs’ loss could not have been caused by the alleged misrepresentations

22 necessarily proves that plaintiffs’ loss was caused by something “other than” those alleged

23 misrepresentations.

24 1 Particularly relevant here, Professor James has authored peer reviewed papers on

25 (i) pricing and performance of mortgage-backed securities; (ii) how portfolio holdings impactreturns; and (iii) academic tools used in evaluating loss causation. (Fernandez Decl. Exh. A at

26 12:6–22, 13:10–11, 15:9–12.)

27 2 Plaintiffs do not challenge Professor James’s opinions on damages on any ground.(Open. Br. 1, n.1.)

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SCHWAB ’ S OPPOSITION TO MOTION TO EXCLUDE CHRISTOPHER M. JAMES 3MASTER FILE NO. C-08-01510-WHAdn-157498


1 Likewise, the cases say that “once a defendant shows that the alleged misrepresentation

2 was not the cause of the plaintiffs’ losses, its burden is met” and the defendant does not need to

3 show “what other factors” caused the loss. See, e.g., McKowan Lowe & Co. v. Jasmine, No.

4 Civ. 94-5522 (RBK), Civ. 96-2318 (RBK), 2005 WL 1541062, at *12 n.12 (D.N.J. June 30,

5 2005); accord In re Britannia Bulk Holdings Inc. Sec. Litig., No. 08 Civ. 9554(DLC), 2009 WL

6 3353045, at *13 (S.D.N.Y. Oct. 19, 2009) (defendants may sustain a negative causation defense

7 “by proving that the allegedly misleading misrepresentations did not cause the depreciation in

8 the stock’s value”).

9 Accordingly, Professor James’s analysis properly considered “to what extent investor’s

10 losses resulted from the alleged misstatements.” (Berman Decl. Exh. A at 6–7.) 3 Because

11 Schwab may establish its affirmative defense to claims under sections 11 and 12(a)(2) by

12 showing that “any portion” of plaintiffs’ losses was caused by anything other than the

13 misstatement or omission, see 15 U.S.C. §§ 77k(e), 77l(b), Professor James’s testimony is

14 relevant and helpful to the trier of fact. See, e.g., United States v. Sandoval-Mendoza, 472 F.3d

15 645, 654 (9th Cir. 2006) (expert testimony relevant where underlying knowledge has “valid . . .

16 connection to the pertinent inquiry”).

17 III. PLAINTIFFS’ ATTEMPTS TO DISCREDIT PROFESSOR JAMES AREMISLEADING.

18

19 Plaintiffs say two other courts considered Professor James’s expert testimony and

20 “refused to allow it to be presented to a jury.” (Open. Br. 7.) They are misleading this Court in

21 an effort to discredit Professor James. The two cases plaintiffs cite were bench trials — neither

22 case involved a Daubert challenge, and it is simply false to say those courts refused to allow his

23 testimony to go “to a jury.” See California Fed. Bank v. United States, 54 Fed. Cl. 704 (Ct. Fed.

24 Cl. 2002); Sterling Savings Ass’n v. United States, 80 Fed. Cl. 497 (Ct. Fed. Cl. 2008). The

25

26 3 By contrast, plaintiffs’ experts, Candace Preston and Gifford Fong, made no attempt tocausally link the depreciation in the value of YieldPlus shares to the alleged misrepresentations.

27 (See Fernandez Decl. Exh. B (James Rebuttal Report) at 6.) Schwab intends to move to excludethose, and other, opinions under Daubert.

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1 Court of Federal Claims doesn’t have jury trials. And it is highly disingenuous for plaintiffs to

2 cite these cases in their Daubert motion without mentioning the entirely different standard that

3 applies to a judge’s weighing of competing experts’ testimony when sitting as the trier of fact.

4 See Dorn v. Burlington Northern Santa Fe R.R. Co., 397 F.3d 1183, 1196 (9th Cir. 2005)

5 (“authority to determine the victor in ... a battle of expert witnesses” rests with trier of fact).

6 IV. PROFESSOR JAMES APPLIED RELIABLE PRINCIPLES ANDMETHODOLOGIES.

7

8 Plaintiffs do not challenge the reliability of any specific methodology; they instead make

9 generalized objections that Professor James’s testimony is “unscientific,” “unsupported

10 speculation” and “totally devoid of . . . technical analysis.” (Open. Br. 4, 7–8.) 4 Plaintiffs

11 ignore the mountains of data and detailed analyses that Professor James uses, which more than

12 adequately reflect the “intellectual rigor that characterizes the practices of an expert” in his field.

13 Professor James’s expert report identified eleven categories of alleged

14 misrepresentations from plaintiffs’ complaint. In stating each of his conclusions, Professor

15 James considered models, benchmarks, and/or other objective data — and applied his

16 specialized knowledge concerning financial principles and how mutual fund prices are

17 calculated — to explain why each alleged misrepresentation was not the cause of YieldPlus’s

18 losses. In each instance, Professor James’s methodologies are clearly explained.

19 For example, Professor James concluded that the depreciation in the value of YieldPlus

20 shares did not result from the alleged misstatements of material fact regarding interest rate risk,

21 because interest rates actually declined during the relevant period. (Berman Decl. Exh. A at 12.)

22 Far from “unsupported speculation,” this conclusion is based on:

23 • Rigorous analysis of data from the U.S. Treasury Department showing that

24interest rates for all horizons declined during the entire relevant period,

25 4 Plaintiffs also reflexively repeat Daubert’s illustrative list of factors (Open. Br. 7),ignoring the flexible nature of Daubert’s inquiry, and Kumho’s instruction that the Daubert

26 factors may or may not be pertinent in assessing reliability. Kumho, 526 U.S. at 151. Factorssuch as potential error rate are not always applicable to particular expert testimony, and

27 reliability may depend heavily on the knowledge and experience of the expert. United States v.Diaz, No. CR 05-000167 WHA, 2006 WL 2699042, at *3 (N.D. Cal. Sept. 19, 2006).

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1 including between July 31, 2007, and March 18, 2008, the period whenYieldPlus experienced most of its losses ( id. at 13 and Exhs. 5.1 and 5.2);

2• Professor James’s experience-based knowledge that “[i]nvestors in bonds or

3 other fixed income securities can experience losses if interest rates increasebecause the prices of these securities tend to fall in rising interest rate

4 environments” ( id. at 12); and

5 • Professor James’s examination of the performance of indices of governmentbonds and agency mortgage-backed securities from 2006 to 2008 (these

6 securities are exposed to interest rate risk without significant exposure to creditrisk), showing that when interest rates went down, prices went up (and prices of

7 higher duration bonds went up by more than lower duration bonds) ( id. at 13–14and Exhs. 6.1 and 6.2).

8

9 Indeed, plaintiffs’ expert, H. Gifford Fong, agreed with the fundamental financial principles

10 upon which Professor James relies. (Fernandez Decl. Exh. C (Fong Depo.) at 98:13–99:19

11 (nominal interest rates declined in 2007 and 2008; bond prices usually rise as interest rates

12 fall)). Plaintiffs’ motion to exclude Professor James’s testimony offers no explanation as to why

13 his principles and methodology are unreliable.

14 Likewise, Professor James’s opinion that the depreciation in the value of YieldPlus

15 shares did not result from the fund’s allegedly excessive allocation to non-agency mortgage-

16 backed securities is based on objective data and accepted methodology. (Berman Decl. Exh. A

17 at 25.) Specifically, Professor James compared the fund’s performance to several benchmarks.

18 This is a well-recognized method of analysis by academics studying mutual funds. See, e.g.,

19 Kent Daniel et al., Measuring Mutual Fund Performance with Characteristic-Based

20 Benchmarks, 52 J. Fin. 1035, 1040, 1043 (July 1997). Professor James constructed his

21 benchmarks using a massive amount of data about the fund, including over 205,000

22 observations of daily price movements of the fund’s securities. (Berman Decl. Ex. A at 38–39.)

23 He used this data to map out the market value-weighted average of the returns of the hundreds

24 of individual securities that the fund owned. ( Id. at 39.) His methodology then proportionately

25 reallocated some of the fund’s investments in non-agency mortgage-backed securities to other

26 assets held by the fund, while setting investments in non-agency mortgage-backed securities at

27 various thresholds — e.g., 25%, 20%, 15%, 10% and 5% of total assets. (Id. at 38–39.) He then

28 compared the performance of the actual portfolio to each of these benchmarks. ( Id. at 25 &



1 Exh. 12.) Professor James’s rigorous, empirical analysis showed that YieldPlus performed

2 comparably to or slightly better than each of the benchmarks that had a lower allocation to non-

3 agency mortgage-backed securities. (Id.)

4 Professor James used a similar methodology to test whether an alleged excess of illiquid

5 securities caused plaintiffs’ losses. He examined the securities that plaintiffs’ complaint alleges

6 were illiquid (non-agency mortgage-backed securities and asset-backed securities that are

7 “home equity loans”). (Sec. Am. Compl. [Dkt. No. 250] ¶¶ 92–97.) His methodology then

8 reallocated some of the fund’s investments in those securities to other assets held by the fund,

9 while setting investments in the allegedly illiquid securities at various thresholds — e.g., 15%,

10 10% and 5% of total assets. (Berman Decl. Exh. A at 28.) Professor James’s rigorous,

11 empirical analysis showed that YieldPlus performed comparably to or slightly better than each

12 of the benchmarks with a lower allocation to allegedly illiquid securities. ( Id. at 28 and

13 Exhs. 13 and 14.)

14 Appendices to Professor James’s report detail at length the data and methodology used

15 in constructing the benchmarks created to compare YieldPlus’s actual performance to what its

16 performance would have been with alternative portfolio weightings. (Id. at 38.) Specifically,

17 Professor James obtained daily reports on the assets of the YieldPlus fund, including asset ID,

18 sector classification, price, par amount, and market value and a list of each purchase or sale of

19 assets by the fund. (Id. at 38–39.) Professor James used this data and his financial expertise to

20 calculate the market value-weighted average return on individual assets in the fund. ( Id.) He

21 next calculated the market value-weighted average price return of two groups of assets: non-

22 agency mortgage-backed securities and “other assets.” (Id. at 40.) By capping the weight of the

23 mortgage-backed securities in the portfolio at certain targets — and reallocating any excess

24 weight beyond the target to the “other assets” portion of the portfolio — Professor James was

25 able to test the effect of the fund’s allegedly excessive allocation to mortgage-backed securities.

26 (Id.) For example, if the target weight of the mortgage-backed securities in the portfolio is

27 25 percent of total assets, and the actual weight was 27 percent in a particular period, then

28 Professor James would reduce the mortgage-backed securities weight to 25 percent, and



1 increase the weight of the “other assets” portion of the portfolio from 73 percent to 75 percent.

2 (Id.)

3 Plaintiffs do not mention Professor James’s methodology, nor do they offer any specific

4 argument as to why his rigorous benchmark methodology is unreliable. Plaintiffs’ expert, in

5 fact, used a similar benchmark methodology in an opposition report. (Fernandez Decl. Exh. D

6 (Fong Opp. Report) § 2.7) (using modified version of Professor James’s benchmark

7 methodology with different assumptions). 5 And, in a variety of different contexts, courts

8 frequently admit expert testimony based on similar benchmark methodologies. See, e.g.,

9 Maiz v. Virani, 253 F.3d 641, 664–66 (11th Cir. 2001) (affirming admission of expert testimony

10 using comparative benchmark for gauging lost profits).

11 At bottom, Professor James’s opinions — which are based on objective facts, his

12 expertise, and explained principles and methodologies — are more than sufficient to satisfy

13 Daubert. See Ulico Casualty Co. v. Clover Capital Mgmt., 217 F. Supp. 2d 311, 317 (N.D.N.Y.

14 2002) (expert testimony reliable where it has a “traceable, analytical basis in objective fact”);

15 see generally Kumho, 526 U.S. at 156 (“no one denies that an expert might draw a conclusion

16 from a set of observations based on extensive and specialized experience”).

17 V. PLAINTIFFS’ RECYCLED ARGUMENTS ARE INAPPLICABLE HERE.

18 Plaintiffs recycle two arguments from a filing their counsel made in an unrelated case —

19 apparently without evaluating their applicability to Professor James’s report here. First,

20 plaintiffs state, “Professor James elected to simply look at a very minimal and obviously biased

21 set of events over a few days, provide a general storytelling, unscientific approach and call it

22 good.” (Open. Br. 7.) This argument is nonsensical here, as even a cursory review of his report

23 shows it is not based on a “set of events over a few days.” For example, Professor James’s

24 benchmarks and supporting exhibits show he analyzed the prices of every security that the fund

25

26 5 To the extent that plaintiffs’ expert disagreed with Professor James’s assumptions inconstructing the benchmark, such a challenge goes to weight, not admissibility. Dorn, 397 F.3d

27 at 1196 (reasonableness of assumptions underlying expert analysis and criticisms of expert’smethod of calculation are matters for jury’s consideration in weighing evidence).

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1 owned (along with several other important variables) on every day in the entire class period.

2 (See Berman Decl. Exh. A, Exhs. 5.1, 6.1, 11, 12, 13, and 14.)

3 Second, plaintiffs assert that Professor James’s report is unreliable because it does not

4 include an event study. (Open. Br. 7.) They are wrong, for the simple reason that “[e]vent

5 study methodology has its foundation in the efficient market hypothesis.” Jeffrey M. Netter,

6 The Role of Financial Economics in Securities Fraud Cases, 49 Bus. Law. 545, 557 (Feb.

7 1994); A. Craig MacKinlay, Event Studies in Economics and Finance, 35 J. Econ. Lit. 13, 13

8 (Mar. 1997) (event study useful where effects of event “will be reflected immediately in security

9 prices”). Specifically, “[a]n event study is an examination of the association between news

10 about a company (good, bad, neutral) and stock price movements. The researcher is examining

11 whether the association between news and share price movements is strong enough to support

12 an inference of, among other things, causation . . . .” United States v. Ferguson, 584 F. Supp. 2d

13 447, 449 n.3 (D. Conn. 2008) (citation omitted).

14 But this is not a public market case that involves a security whose value fluctuates based

15 on news about the issuer of the security. As Professor James explains in his report, and as we

16 explain in our motion for summary judgment on loss causation, the NAV of mutual funds does

17 not respond to news about the fund itself. (Berman Decl. Exh. A at 9.) See Clark v. Nevis

18 Capital Mgmt., LLC, No. 04 Civ. 2702, 2005 WL 488641, at *18 (S.D.N.Y. Mar. 2, 2005) (price

19 of a mutual fund is not affected by alleged misrepresentations and omissions concerning fund

20 itself). Schwab is not aware of a single ‘33 Act case involving a mutual fund in which an event

21 study was used, and plaintiffs do not cite even one.

22 Moreover, plaintiffs don’t identify any “events” in their complaint (e.g., alleged

23 corrective disclosures), from which to conduct an event study. Courts recognize that an event

24 study is not practical in all circumstances. See, e.g., RMED Int’l, Inc. v. Sloan’s Supermarkets,

25 Inc., No. 94 Civ. 5587, 2000 WL 310352, at *8 (S.D.N.Y. Mar. 24, 2000) (event study may not

26 be practical where there is no control period or where the “alleged misrepresentations and

27 omissions were not revealed to the market in a single clean announcement”). Neither of

28



1 plaintiffs’ experts, Gifford Fong and Candace Preston, performed an event study. 6

2 Plaintiffs will likely rely on In re Metropolitan Securities Litigation, 2:04cv00025-FVS, slip op.

3 (E.D. Wash. Feb. 18, 2010), in which the court excluded a portion of Professor James’s testimony

4 for failure to conduct an event study. But that case (i) did not involve a mutual fund; and

5 (ii) involved testimony about five specific events that caused the decline in the value of the

6 securities. Because this case involves a mutual fund, and does not involve specific, identifiable

7 events, the In re Metropolitan Securities Litigation decision is irrelevant. Notably, this unique

8 decision is the only time any part of Professor James’s testimony has ever been excluded under

9 Daubert. (See Fernandez Decl. Exh. A at 19:11–16.) We are informed that, during his 25 years

10 as a testifying expert, parties in well over 50 cases have sought to exclude Professor James

11 without success.

12 VI. PROFESSOR JAMES’S TESTIMONY IS NOT CONTRADICTED BY THEEVIDENCE.

13

14 Finally, plaintiffs accuse Professor James of “completely ignor[ing]” “critical record

15 facts” that “flatly contradict[]” his opinions. (Open. Br. 5.) They are wrong — and they do not

16 point to one “record fact” that contradicts Professor James’s loss causation opinion. In their

17 motion for summary judgment, plaintiffs cite only unremarkable testimony confirming that the

18 value of the fund’s securities, including its mortgage-backed securities, declined. (Dkt. No. 418

19 at 6–10.) As explained in our opposition to plaintiffs’ motion for summary judgment on loss

20 causation, none of the testimony causally links the losses to an alleged misrepresentation back in

21 2006. In fact, witnesses testified that economic circumstances changed dramatically in late

22 2007 and early 2008. Losses caused by changed economic circumstances are not recoverable.

23 Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 342–43 (2005). The evidence plaintiffs cite shows

24 that there was a loss — a decline in the fund’s NAV because of the decline of the value of its

25 holdings. But it does not show loss causation — that is, a showing that the fund’s NAV decline

26

27 6 Ms. Preston did a make-weight regression, which adds nothing to her analysis and willbe a subject of Schwab’s anticipated Daubert motion.

28



1 happened because of a misrepresentation. Id. at 345 (securities laws not meant “to provide

2 investors with broad insurance against market losses, but to protect them against economic

3 losses that misrepresentations actually cause”). As one court recently put it, in dismissing

4 section 11 and section 12 claims arising from another ultra-short bond fund’s investments in

5 mortgage-backed securities, “[a] backward looking assessment of the infirmities of mortgage-

6 related securities . . . cannot help plaintiffs’ case.” Yu v. State Street Corp., No. 08 Civ. 8235

7 (RJH), 2010 U.S. Dist. LEXIS 17147, at *22 (S.D.N.Y. Feb. 25, 2010).

8 Professor James’s report carefully discusses each of the alleged misrepresentations and

9 explains why depreciation in the value of the fund did not result from the alleged

10 misrepresentations. As discussed throughout, Professor James’s opinions are based on a

11 massive amount of objective data, including over 205,000 observations of daily price

12 movements of the fund’s securities, along with a close analysis of the Second Amended

13 Complaint’s allegations and Schwab’s disclosures in SEC filings. (Berman Decl. Ex. A at 10–

14 11 and Exh. 3.) Plaintiffs do not — and cannot — explain how testimony that the value of the

15 fund’s securities declined undermines the reliability of Professor James’s principles and

16 methodology.

17 In any event, a district court’s gatekeeper role under Daubert should not displace the

18 adversary system and role of the jury. “Vigorous cross-examination, presentation of contrary

19 evidence, and careful instruction on the burden of proof are the traditional and appropriate

20 means of attacking” admissible expert testimony. Daubert, 509 U.S. at 596. Where, as here,

21 Professor James’s testimony is based on mountains of data and detailed analysis, and is reliable

22 and relevant, plaintiffs’ allegations of “contradictory” facts goes to weight, not admissibility. 7

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25 7 The cases plaintiffs cite are irrelevant. See, e.g., Smith v. Pac Bell Tel. Co., 649 F.Supp. 2d 1073, 1097 (E.D. Cal. 2009) (expert had no evidence to support his alternative

26 timeline); Textron Inc. v. Barber-Colman Co., 903 F. Supp. 1546, 1556 (W.D.N.C. 1995)(expert witness speculated about possible hazardous wastes present at facility in 1975 and 1976

27 from scant evidence years earlier and general practices in the industry, rather than any scientificmethodology).

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SCHWAB ’ S OPPOSITION TO MOTION TO EXCLUDE CHRISTOPHER M. JAMES 1 1MASTER FILE NO. C-08-01510-WHAdn-157498


1 CONCLUSION

2 Professor James’s testimony is admissible under rule 702 because it is both relevant and,

3 since it is based on rigorous empirical analysis, reliable. Plaintiffs’ general, unsupported

4 assertions show nothing to the contrary. The Court should deny plaintiffs’ motion. In the event

5 the Court has any questions regarding Professor James’s methodologies, Schwab respectfully

6 requests a Daubert hearing on this motion.

7

8 Dated: March 4, 2010 DARRYL P. RAINSEUGENE ILLOVSKY

9 CRAIG D. MARTINDOROTHY L. FERNANDEZ


11 By: /s/ Darryl P. Rains Darryl P. Rains

12Attorneys for defendants The Charles

13 Schwab Corporation, Charles Schwab &Co., Inc., Charles Schwab Investment

14 Management, Inc., Schwab Investments,Charles R. Schwab, Evelyn Dilsaver,

15 Randall W. Merk, George Pereira,Matthew Hastings, Mariann Byerwalter,

16 Donald F. Dorward, William A. Hasler,Robert G. Holmes, Gerald B. Smith,

17 Donald R. Stephens, andMichael W. Wilsey

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Case3:08-cv-01510-WHA Document442-1 Filed03/04/10 Page1 of 2

1 DARRYL P. RAINS (CA SBN 104802)EUGENE ILLOVSKY (CA SBN 117892)


755 Page Mill Road3 Palo Alto, California 94304-1018

Telephone: 650.813.56004 Facsimile: 650.494.0792

Email: [email protected]

CRAIG D. MARTIN (CA SBN 168195)6 DOROTHY L. FERNANDEZ (CA SBN 184266)

MORRISON & FOERSTER LLP

7 425 Market StreetSan Francisco, California 94105-2482

8 Telephone: 415.268.7000Facsimile: 415.268.7522

9

10 Attorneys for defendants The Charles Schwab Corporation,Charles Schwab & Co., Inc., Charles Schwab Investment

11 Management, Inc., Schwab Investments, Charles R. Schwab,Evelyn Dilsaver, Randall W. Merk, George Pereira, Matthew

12 Hastings, Mariann Byerwalter, Donald F. Dorward, William A.Hasler, Robert G. Holmes, Gerald B. Smith, Donald R.

13 Stephens, and Michael W. Wilsey

14

15 UNITED STATES DISTRICT COURT

16 NORTHERN DISTRICT OF CALIFORNIA

17 SAN FRANCISCO DIVISION

18

19 IN RE CHARLES SCHWAB CORP. Master File No. C-08-01510-WHASECURITIES LITIGATION

20 CLASS ACTION

21[PROPOSED] ORDER DENYING

22 PLAINTIFFS’ MOTION TO EXCLUDEDEFENDANTS’ EXPERT

23 CHRISTOPHER M. JAMES

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[PROPOSED] ORDER DENYING PLAINTIFFS’ MOTION TO EXCLUDE EXPERT CHRISTOPHER M. JAMESMASTER FILE NO .: C-08-01510-WHAsf-2811150

Case3:08-cv-01510-WHA Document442-1 Filed03/04/10 Page2 of 2

1 Plaintiffs moved the Court for an order excluding defendants’ expert, Christopher M.

2 James, from testifying pursuant to Federal Rule of Evidence 702 and Local Rule 7-2. Defendants

3 opposed plaintiffs’ motion.

4 The matter came for hearing on March 25, 2010 at 8:00 a.m. Having considered all the

5 papers filed by the parties in connection with plaintiffs’ motion to exclude testimony from

6 defendants’ expert Christopher M. James, the parties’ arguments at the hearing on this matter, and

7 other materials of which the Court may properly take judicial notice, the Court hereby DENIES

8 plaintiffs’ motion to exclude the testimony of Christopher M. James.

9 IT IS SO ORDERED.

10

11Dated: , 2010

12HON. WILLIAM H. ALSUP

13 UNITED STATES DISTRICT JUDGE

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[PROPOSED] ORDER DENYING PLAINTIFFS’ MOTION TO EXCLUDE EXPERT CHRISTOPHER M. JAMES 1MASTER FILE NO .: C-08-01510-WHAsf-2811150

1 darryl p. rains (ca sbn 104802) eugene illovsky (ca...

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