On a personal note, Lyle Roberts (the author of The 10b-5 Daily) has joined the Washington, DC office of Shearman & Sterling LLP. The firm’s press release can be found here. Posting has been correspondingly light, but something new should be up soon!
The U.S. Supreme Court has issued a decision in the Cyan v. Beaver County Employees Retirement Fund case holding that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) does not divest state courts of jurisdiction over class actions asserting claims arising under the Securities Act of 1933 (e.g., claims alleging a material misstatement in a registration statement). It is a unanimous decision authored by Justice Kagan.
Cases alleging 1933 Act claims historically have enjoyed concurrent jurisdiction in state or federal court. In Cyan, the court considered whether SLUSA’s text and legislative purpose mandated that these cases – if brought as class actions – must be heard in federal court. There was good reason to believe that Congress may have intended that outcome. The overall purpose of SLUSA was to prohibit plaintiffs from bringing securities class actions based on state law. As Justice Alito suggested at the Cyan oral argument, why would Congress want to bar “a claim in state court under a state cause of action that mirrors the ’33 Act” but then allow “the state court to be able to entertain the real thing, an actual ’33 Act [claim].”
In the Cyan decision, however, the Court concluded that the “recalcitrant statutory language” did not allow it to conclude that SLUSA had divested state courts of jurisdiction. SLUSA modified the concurrent jurisdiction provision in the 1933 Act by adding an except clause – “except as provided in section 77p of this title with respect to covered class actions.” Defendants argued that the except clause’s reference to “covered class actions” was intended to direct the reader to the definition of “covered class actions” in section 77p(f)(2), which defines that term to mean any suit (whether based on state or federal law) seeking damages on behalf of more than 50 persons. In other words, SLUSA made concurrent jurisdiction unavailable for class actions.
The Court disagreed. First, the Court noted that Congress could have expressly pointed to the “covered class action” definition in its except clause, but instead referred generally to section 77p. Given that section 77p makes no specific reference to securities class actions based on federal law, there is no reason to think that Congress intended its except clause to be read to alter the existence of state court jurisdiction for those cases. Second, the Court found that “the definitional paragraph on which Cyan relies cannot be read to ‘provide’ an ‘except[ion]’ to the rule of concurrent jurisdiction” because a “definition does not provide an exception, but instead gives meaning to a term—and Congress well knows the difference between those two functions.” To find otherwise would be to conclude that Congress decided to make a radical change to the securities laws through a conforming statutory amendment and Congress does not “hide elephants in mouseholes.”
The Court also held that leaving concurrent jurisdiction intact does not undermine SLUSA’s objectives. SLUSA’s primary purpose of barring state-law securities class actions “does not depend on stripping state courts of jurisdiction over 1933 Act class suits.” Moreover, SLUSA still ensures that “the bulk of securities class actions [will] proceed in federal court – because the 1934 Act regulates all trading of securities whereas the 1933 Act addresses only securities offerings.” While the Court conceded that its reading of the except clause leaves open the question of why Congress included that clause at all (although there are possible explanations), it found that this “does not matter” because “we have no sound basis for giving the except clause a broader reading than its language can bear.”
Holding: Judgement below affirmed. (The Court also rejected a compromise position put forward by federal government.)
Quote of note: “[T]his Court has no license to disregard clear language based on an intuition that Congress must have intended something broader. SLUSA did quite a bit to ‘make good on the promise of the Reform Act’ (as Cyan puts it). If further steps are needed, they are up to Congress.”
As The 10b-5 Daily recently has noted, it is difficult for corporate defendants to avoid securities fraud liability when they fail to disclose hidden wrongdoing at the company. But what if the company’s CEO is engaged in hidden wrongdoing at a different company?
In Fries v. Northern Oil & Gas, Inc., 2018 WL 388915 (S.D.N.Y. Jan. 11, 2018), Northern Oil fired its CEO after the SEC sought to bring an enforcement action against him. The enforcement action was based on the CEO’s activities at an unrelated company, Dakota Plains Transport, which he had founded. When Northern Oil announced the dismissal of its CEO, its stock price dropped and a securities class action was filed. The plaintiffs alleged that Northern Oil had omitted material facts about the CEO’s wrongdoing at Dakota Plains when the company made statements about its Code of Business Conduct and Ethics and the CEO’s value to the business.
The court found that the plaintiffs had failed to adequately plead that Northern Oil made any false statements. A failure to disclose wrongdoing is only actionable if the “non-disclosures render other statements by defendants misleading.” The company did not tout its compliance with its Code of Business Conduct and Ethics and there was nothing inaccurate about the company’s statements concerning its reliance on the CEO’s expertise and industry contacts. Accordingly, the hidden wrongdoing at Dakota Plains did not make those statements actionable.
Holding: Motion to dismiss granted. (The court also found that the plaintiffs failed to adequately plead scienter.)
In Halliburton II, the U.S. Supreme Court held that defendants can rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence of a lack of stock price impact. There are at least two different points, however, when stock price impact might be relevant: (a) the date of the alleged misstatement, and (b) the date of the alleged corrective disclosure. Is it enough for defendants to provide evidence of a lack of stock price impact as of the date of the alleged misstatement?
In In Re Finisar Corp. Sec. Litig., 2017 WL 6026244 (N.D. Cal. Dec. 5, 2017), the plaintiffs alleged that a December 2010 statement misled investors as to the nature of Finisar’s growth by denying that the company’s revenue increase was the result of an unsustainable inventory build-up by customers. The complaint also stated that Finisar’s stock price increased after the statement was issued.
At class certification, the defendants presented an expert report demonstrating that any increase in Finisar’s stock price following the alleged misstatement was not statistically significant “when the price is adjusted for general market and industry trading.” Among other objections, the plaintiffs asserted that the expert report was “flawed insofar as it fails to consider Finisar’s stock price change following the allegedly corrective disclosure” that occurred several months later. The court acknowledged that for purposes of price impact analysis, many courts have focused on the corrective disclosure date, especially where there may have been offsetting disclosures about the company on the date of the alleged misstatement or the plaintiffs had alleged that the misstatement maintained the stock price at an artificially-inflated level. (For more on the “price maintenance theory,” see here and here.)
In the instant case, however, the court found that neither of those rationales for focusing on the corrective disclosure date were applicable. There was no evidence that other information about Finisar had offset any price inflation caused by the alleged misstatement and the plaintiffs were not proceeding on a price maintenance theory. Under these circumstances, the court found no flaw in the expert analysis “simply because it focuses on the date of the alleged misstatement rather than the date of the alleged corrective disclosure.”
Holding: Class certification denied.
Can the filing of a judicial complaint against a company constitute a revelation of the alleged fraud sufficient to establish loss causation? In Norfolk Country Retirement System v. Community Health Systems, Inc., 2017 WL 6347726 (6th Cir. Dec. 13, 2017), the court addressed this question in a case alleging that Community Health Systems failed to disclose that it used a system called the “Blue Book” to improperly increase the number of inpatient services provided at its hospitals and overcharge Medicare. The plaintiffs alleged that this practice was revealed to the market when another healthcare company, Tenet Healthcare, filed a suit against Community. Community’s stock price subsequently fell by 35%.
The district court held that Tenet’s complaint could not have revealed the truth behind Community’s prior alleged misrepresentations because a complaint can only reveal allegations rather than truth. On appeal, the Sixth Circuit disagreed that this should be a “categorical rule.” Instead, each alleged corrective disclosure must be evaluated “individually (and in the context of any other disclosures) to determine whether the market could have perceived it as true.”
In this case, the panel found that “two aspects of the Tenet complaint set it apart from most complaints for purposes of that determination.” First, following the filing of the complaint, Community’s CEO “promptly admitted the truth of one of the complaint’s core allegations, namely that Community had used the Blue Book to guide inpatient admissions.” Second, the Tenet complaint included expert analyses that described “the extent to which the Blue Book inflated revenues and exposed the company to liability.”
While the defendants argued that the existence of the Blue Book and Community’s admissions data were publicly available information, the panel concluded that it “quite plausibly came as news to investors” that Community was inflating its inpatient admissions in ways that were clinically improper. Under these circumstances, the panel found that the plaintiffs had “plausibly alleged corrective disclosures that revealed the defendants’ antecedent fraud to the market and thereby caused the plaintiffs’ economic loss.”
Holding: Dismissal reversed and case remanding for further proceedings.
Quote of note: “As an initial matter, every representation of fact is in a sense an allegation, whether made in a complaint, newspaper report, press release, or under oath in a courtroom. The difference between those representations is that some are more credible than others and thus more likely to be acted upon as truth. Statements made under oath are deemed relatively credible because the speaker typically makes them under penalty of perjury. And a defendant’s own admissions of wrongdoing are credible because they are statements against interest. Mere allegations in a complaint tend to be less credible for the opposite reason, namely that they are made in seeking money damages or other relief. But these are differences of degree, not kind, and even within each type of representation some are more credible than others. Hence we must evaluate each putative disclosure individually (and in the context of any other disclosures) to determine whether the market could have perceived it as true.”
On Tuesday, the U.S. Supreme Court heard oral argument in the Cyan, Inc. v. Beaver County Employees Retirement Fund case, which addresses the preemptive scope of the Securities Litigation Uniform Standards Act of 1998 (SLUSA). At issue in the case is whether SLUSA divests state courts of jurisdiction over class actions asserting claims arising under the Securities Act of 1933 (e.g., claims alleging a material misstatement in a registration statement).
The question before the Court is closely tied to Congress’s intent in enacting SLUSA. In 1995, Congress passed the Private Securities Litigation Reform Act (PSLRA) to protect corporate defendants from meritless securities class actions. The PSLRA, however, only applied to federal cases. To evade the PSLRA’s impact, plaintiffs began filing securities class actions in state court, usually based on state law causes of action.
Congress passed SLUSA to close this loophole. Due to unclear drafting, however, there has been confusion in the lower courts over whether SLUSA also makes federal court the sole venue for class actions alleging Securities Act claims (which historically enjoyed concurrent jurisdiction in state or federal court). In Cyan, the parties have put forward three competing interpretations of SLUSA. The Petitioners (Defendants) contend that SLUSA divests state courts of jurisdiction over class actions asserting Securities Act claims, thereby insuring that those cases must be litigated in federal court. The Solicitor General maintains that SLUSA permits the removal of class actions asserting Securities Act claims, thereby also allowing those cases to be heard in federal court. Finally, the Respondents (Plaintiffs) contend that SLUSA did not address class actions asserting Securities Act claims at all, meaning that once in state court they are not removable to federal court.
The parties’ textual arguments require having SLUSA in one hand and a yellow highlighter in the other. In the end, however, the text of the statute might not end up having much sway over the Court. The justices expressed varying degrees of frustration in trying to parse through the specific statutory language to reach a result, with Justice Alito, in particular, repeatedly referring to the relevant provisions as “gibberish” and noting that “all the readings that everybody has given to all of these provisions are a stretch.”
Petitioners and the Solicitor General appeared to have more success on the issue of Congressional intent. Petitioners’ counsel drew an analogy to building a house, suggesting that it was nonsensical to believe that Congress would have barred the front door against the bringing of securities class actions in state court asserting state law claims, while simultaneously leaving the back door open for plaintiffs to bring securities class actions in state court asserting federal law claims. Moreover, if securities class actions asserting federal law claims go forward in state court, they are not subject to the PSLRA’s procedural protections, a result that Congress presumably wanted to avoid.
Several justices picked up on this theme, with Justice Ginsburg asking Respondents’ counsel “why would Congress want to do that” given that you end up with “the federal claim in state court, and none of those [PSLRA] restrictions apply”? Similarly, Justice Alito expressed incredulity that Congress would want to bar “a claim in state court under a state cause of action that mirrors the ’33 Act” but then allow “the state court to be able to entertain the real thing, an actual ’33 Act [claim].” Respondents’ counsel answered that if Congress was concerned about the “evasion of the PSLRA” in securities class actions alleging Securities Act claims, there were “10 different easier ways and more clear ways” that it could have removed the existence of concurrent jurisdiction for those cases (but it did not). Justices Kagan and Sotomayor appeared sympathetic to that position, with Justice Kagan noting that “Congress did everything it wanted with respect to actions [under the Securities Exchange Act of 1934], which are the lion’s share of securities lawsuits.”
A decision is expected sometime early next year.
When does a company have a duty to disclose hidden wrongdoing? As many courts have noted, disclosure is not a “rite of confession” and a company does not have a general obligation to tell investors whether some (or all) of its gains are ill-gotten. Because of an exception that tends to swallow the rule, however, corporate defendants are often disappointed when they attempt to invoke this principle to defeat securities fraud claims.
In In re VEON Ltd. Sec. Lit., 2017 WL 4162342 (S.D.N.Y. Sept. 19, 2017), the court considered whether VEON’s public filings were rendered false or misleading by its failure to disclose that it had violated the Foreign Corrupt Practices Act (“FCPA”) by making, or attempting to make, “millions of dollars in improper payments to Gulnara Karimova, the eldest daughter of the Uzbekistan’s President, in an effort to achieve favorable treatment in Uzbekistan.” The defendants argued that there was no dispute over the accuracy of VEON’s financial statements (bribery notwithstanding), so the plaintiffs’ claims were “in reality, an improper attempt to enforce the FCPA, which has no private right of action.”
The court agreed that VEON had no general duty to disclose the FCPA violations and that the company’s actual financial reporting was accurate. The court noted, however, that a “duty to disclose may arise when a company puts the topic of the cause of its financial success at issue.” Of course, most companies make disclosures about the causes of their financial success. The court found that VEON’s attribution of its growth in Uzbekistan to things like its “sales and marketing efforts,” without mentioning the bribes, was an actionable misstatement. Moreover, VEON had made a specific disclosure about owners of telecommunications networks in Uzbekistan enjoying “equal protection guaranteed by law,” which the court held was rendered misleading by the fact that VEON had to pay bribes to operate in the country. Finally, the court concluded that the facts admitted in VEON’s deferred prosecution agreement with the DOJ made it clear that the company’s statements about having adequate internal controls were false.
Holding: Motion to dismiss granted in part and denied in part.