Adverse Interests

Is it possible for a securities class action based on alleged misrepresentations in a company’s public filings to proceed against an individual officer, but not the company (presuming the company is not otherwise immune from suit)?  The answer is yes, but the circumstances will be unusual.

In Nathanson v. Polycom, et al., 2015 WL 1517777 (N.D. Cal. April 3, 2015), the plaintiffs alleged that as the result of the former CEO’s improperly claimed personal expenses, the company misstated its operating expenses and failed to disclose that the CEO would be subject to termination.  The court found that the plaintiffs had adequately alleged the existence of material misstatements and, as to the CEO, a strong inference of scienter.

Normally, a CEO’s scienter can be imputed to the company based on the law of agency, but that rule is subject to an “adverse interest exception” in cases where the officer acted purely out of self-interest and his conduct did not benefit the company.  The improper claiming of personal expenses did not benefit Polycom.  Accordingly, the court concluded that the adverse interest exception applied, the CEO’s scienter could not be imputed to Polycom, and, as a result, the case could not proceed against the company.

Holding: Motion to dismiss granted in part (Polycom and other individual defendants) and denied in part (former CEO).

Leave a comment

Filed under Motion To Dismiss Monitor

Not Congress’s Concern

The Securities Litigation Uniform Standards Act (“SLUSA) is designed to limit the ability of plaintiffs to avoid the heightened pleading standards (and other procedural and substantive protections) applicable to federal securities class actions by pleading their cases as violations of state law.  Accordingly, the statute precludes certain class actions based upon state law that allege a misrepresentation or deceptive conduct in connection with the purchase or sale of nationally traded securities.  Although SLUSA was enacted in 1998, the exact scope of its preclusive effect continues to be a hot topic, with a recent Supreme Court decision addressing the “in connection with” requirement.

In In re Kingate Management Ltd. Litigation, 2015 WL 1839874 (2d Cir. April 23, 2015), the court considered a different interpretive question: what does SLUSA mean when it proscribes the “main[tenance]” of a covered class action “alleging . . . [false conduct] in connection with the purchase or sale of a covered security”?  The Second Circuit concluded that “alleging” must be interpreted narrowly to only cover “conduct by the defendant falling within SLUSA’s specifications of conduct prohibited by the anti-falsity provisions” of the federal securities laws.  A broader application – e.g., to claims where the requisite falsity is a “necessary predicate of the plaintiffs’ claim” but “the falsity is not chargeable to the defendant and the claim could not have been brought against the defendants under the federal securities laws” – would improperly “bar state law claims in a manner unrelated to SLUSA’s purposes.”

The Second Circuit, however, did add some important caveats to its holding.  First, plaintiffs cannot engage in artful pleading to avoid SLUSA preclusion.  Any time “the success of a class action claim depends on a showing that the defendants committed false conduct conforming to SLUSA’s specifications, the claims will be subject to SLUSA,” even if the plaintiffs choose to invoke a state law theory that does not include false conduct as an element.  Second, consistent with the Supreme Court’s Dabit decision, SLUSA preclusion may apply even if the alleged conduct could not lead to a private claim (as opposed to an enforcement action by the SEC).  Finally, even if the plaintiffs do not specifically allege that the requisite false conduct was in connection with the purchase or sale of nationally traded securities, “the court may nonetheless ascertain those facts independently of the plaintiffs’ allegations and apply SLUSA.”

Holding: District court’s dismissal of complaint vacated; case remanded to district court for claim-by-claim assessment of whether SLUSA preclusion applies.

Quote of note: “Interpreting SLUSA to apply more broadly to state law claims that are altogether outside the prohibitions of the federal securities laws, and could not be subject to the PSLRA, would . . . construe ambiguous provisions of SLUSA in a highly improbable manner – as prohibiting state law claims involving matters that were not Congress’s concern in passing SLUSA, that have never been a subject of congressional concern, and that in a number of instances might even lie outside the powers of Congress.”

Leave a comment

Filed under Appellate Monitor

Creating Your Own Losses

Under the PSLRA, the presumptive lead plaintiff in a securities class action is the applicant with the “largest financial interest in the relief sought by the class.”  The largest financial interest is measured by assessing the approximate losses suffered, with courts generally holding that losses suffered as the result of “in-and-out” stock transactions that took place before any misconduct was revealed do not count.

With this background in mind, the court in Topping v. Deloitte Touche Tohmatsu, 2015 WL 1427317 (S.D.N.Y. March 27, 2015) faced a novel procedural twist in assessing competing lead plaintiff applications.  The applicant with the largest claimed losses actually sold all of its holdings before the corrective public disclosure alleged in the original complaint was made.  While that would normally be disqualifying, shortly after the lead plaintiff deadline, the applicant’s counsel filed a “Corrected Complaint” adding allegations about an earlier, partial disclosure that occurred prior to the applicant’s sales.  In its lead plaintiff briefing, the applicant argued that based on the Corrected Complaint, it was not an in-and-out trader and should be appointed.

The court rejected this argument on two grounds.  First, the court found that it could not look to allegations in a corrected or amended complaint filed after the lead plaintiff application deadline in assessing which applicant has the largest claimed losses.  Not only would doing so undermine the timeliness of the lead plaintiff process by inviting additional briefing, but it would prejudice other class members who had relied on the original complaint in determining whether and how to make their lead plaintiff applications.   Second, even if the court were to consider the Corrected Complaint, the alleged partial disclosure did not reveal anything about the alleged fraud and could not be used to demonstrate loss causation.

Holding: Appointed applicant with second-largest claimed losses as lead plaintiff.

 

Leave a comment

Filed under Lead Plaintiff/Lead Counsel

Omnicare Decided

The U.S. Supreme Court has issued a decision in the Omnicare case holding that opinions presented in registration statements can be subject to Section 11 liability if either (a) the opinion was not genuinely held, or (b) the registration statement omitted material facts about the issuer’s inquiry into, or knowledge concerning, the opinion.  It is a 9-0 decision authored by Justice Kagan, although Justices Scalia and Thomas filed separate concurring opinions that effectively function as dissents.

The decision addresses an existing split in the circuit courts.  While the Second, Third, and Ninth Circuits had held that the plaintiff must allege the opinion was both objectively and subjectively false – requiring allegations that the speaker’s actual opinion was different from the one expressed – in Omnicare, the Sixth Circuit found that if a defendant “discloses information that includes a material misstatement [even if it is an opinion], that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity.”  The Supreme Court rejected both positions and, as was extensively discussed at the oral argument, endorsed a middle ground approach.

In Omnicare, the relevant opinions related to the company’s compliance with applicable law.  The plaintiffs failed to allege that the company did not believe it was legally compliant or that the opinions contained some false statement of underlying fact.  As a result, the Court held, the first prong of its liability analysis was inapplicable.

That said, the plaintiffs also alleged that Omnicare omitted to state facts that necessary to make its opinions on legal compliance not misleading.  The Court held that this was a potentially viable claim, because a reasonable investor “expects not just that the issuer believes the opinion (however irrationally), but that it fairly aligns with the information in the issuer’s possession at the time.” While it is not enough that some fact cuts against the stated opinion, if the investor can “identify particular (and material) facts going to the basis for the issuer’s opinion – facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have – whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context,” there can be Section 11 liability.  In the case of a legal opinion, for example, “if the issuer made the statement in the face of its lawyers’ contrary advice, or with the knowledge that the Federal Government was taking the opposite view,” the investor has “cause to complain.”

The Omnicare plaintiffs claimed the company received some contrary advice from an attorney about the legal risks associated with a particular contract.  The Court remanded the case for the lower court to determine whether (a) the excluded fact would have been material to a reasonable investor and (b) in light of the overall context, including other disclosures that Omnicare made about its legal compliance and risks, “the excluded fact shows that Omnicare lacked the basis for making those statements that a reasonable investor would expect.”

Holding: Judgment vacated and remanded for further proceedings.

Quote of note: “Section 11’s omissions clause, as applied to statements of both opinion and fact, necessarily brings the reasonable person into the analysis, and asks what she would naturally understand a statement to convey beyond its literal meaning.  And for expressions of opinion, that means considering the foundation she would expect an issuer to have before making the statement.  All that, however, is a feature, not a bug, of the omissions provision.”

Notes on the Decision

(1) The Court concluded that it will be “no small task for an investor” to adequately demonstrate that an omission has rendered an opinion misleading.  At the same time, it also found that to avoid exposure to liability “an issuer need only divulge an opinion’s basis, or else make clear the real tentativeness of its belief.”  Whether this judicial advice will change how opinions are presented in registration statements remains to be seen.

(2) As perhaps to be expected when the Court adopts a middle ground approach, both the plaintiffs and defense bars will have reason to be satisfied with the decision.  While the Court struck down the Sixth Circuit’s purely objective standard, it also arguably provided a new basis for opinion liability in the Second, Third, and Ninth Circuits (and those circuits are where the majority of securities class actions are filed).

(3) Justice Scalia’s concurrence took issue with the majority’s omissions analysis, arguing that “[t]he objective test proposed by the Court – inconsistent with the common law and common intuitions about statements of opinion – invites roundabout attacks upon expressions of opinion.”

Leave a comment

Filed under Appellate Monitor

The Streak Is Over

Plaintiffs in securities class actions often point to insider trades as evidence that the individual defendants had a pecuniary motive to commit fraud.   But if the plaintiffs do not make any allegations related to insider trades, can defendants conversely use SEC filings to show, at the motion to dismiss stage, that there was no suspicious trading (and, accordingly, no pecuniary motive)?

In Zak v. Chelsea Therapeutics Int’l, Ltd., 2015 WL 1137142 (4th Cir. March 16, 2015), the district court took judicial notice of certain SEC filings concerning insider sales and the individual defendants’ stock holdings.  It then “concluded that the defendants’ purported failure to sell Chelsea stock during the class period ‘tip[ped] the scales’ of the competing inferences of scienter” in favor of the defendants.  The Fourth Circuit held that this analysis was improper.  First, the district court should not have considered the SEC filings because they “were not explicitly referenced in, or an integral part of, the plaintiff’s complaint,” which did not contain any allegations related to insider trades.   Second, the SEC filings the district court considered did not conclusively establish that none of the individual defendants sold any Chelsea stock during the class period.

Holding: Dismissal vacated.

Addition:  One of the panel members dissented from the decision, but stated that he agreed with the majority’s “determination that the district court misused the challenged SEC documents.”  Interestingly, the dissent notes that prior to the instant case, the Fourth Circuit had never overturned, in the post-PSLRA era, a district court decision holding that the plaintiffs had failed to plead facts supporting a strong inference of scienter (eight total cases).

Leave a comment

Filed under Appellate Monitor

Core Workout

The core operations theory, as developed in the Ninth Circuit, holds that it may be possible to infer a strong inference of scienter in situations where the nature of the alleged fraud “is of such prominence that it would be ‘absurd’ to suggest that the management was without knowledge of the matter.”   The theory has come under criticism from other courts and there are relatively few reported decisions where it has been successfully invoked.

In Patel v. Axesstel, Inc., 2015 WL 631525 (S.D. Cal. Feb. 13, 2015), however, the court found the alleged facts supported the application of the core operations theory.  As the court summarized the situation: “it would be absurd to think that the CEO and CFO of a company with just thirty-five employees, or whom only ten are involved in sales, general or administration, would be unaware of the lack of written agreements or definitive payment terms with the five new customers in Africa that represented the company’s first sales of a significant new product that constituted between twenty and forty percent of Axesstel’s overall revenue.”  Moreover, the individual defendants made “numerous statements . . . indicating that they were directly involved in sales and knew the details of Axesstel’s dealings with its African customers.”  Accordingly, the court held that the plaintiffs had adequately plead a strong inference of scienter.

Holding: Motion to dismiss denied.

Quote of note: “[The individual defendants’] roles in Axesstel are magnified by the exceedingly small size of the company.  Axesstel is not to be confused with Apple.  The individual defendants here are not officers in a large company who may be removed from the details of a specific business line or remote business activity.”

Leave a comment

Filed under Motion To Dismiss Monitor

Give and Take

To what extent does a company have to anticipate that its actions could result in a negative regulatory outcome?  In Fire and Police Pension Association of Colorado v. Abiomed, Inc., 2015 WL 500748 (1st Cir. Feb. 6, 2015), the plaintiffs asserted that the company’s alleged off-label drug marketing rendered false or misleading its (a) financial statements, and (b) disclosures about its interaction with the Food and Drug Administration (FDA) on the issue of marketing.  On appeal, the court held that the plaintiffs had failed to plead the requisite “strong inference” of scienter as to any of the defendants.

The court found that it was not clear that the alleged off-label drug marketing had materially impacted Abiomed’s financial results, which “weighs against an argument that defendants here possessed the requisite scienter.”  Moreover, the company promptly disclosed when the FDA sent it a “warning letter” about its marketing and explicitly told investors that the FDA might conclude that it had engaged in improper marketing.  Abiomed also took corrective actions and the FDA “eventually closed out its investigation of Abiomed without taking any action adverse to the company.”  Finally, the alleged insider trading “was neither unusual nor suspicious.”  Indeed, one of the individual defendants actually increased his holdings of Abiomed stock during the class period.

Holding: Dismissal affirmed.

Quote of note: “Under plaintiffs’ theory of the case, Abiomed should have affirmatively admitted widespread wrongdoing rather than stating that the outcome of its regulatory back-and-forth with the FDA was uncertain.  That would be a perverse result; such an admission would have been misleading, since the off-label marketing issues had the potential to be resolved with no adverse action from the FDA. . . . There must be some room for give and take between a regulated entity and its regulator.”

Leave a comment

Filed under Appellate Monitor