Not Just For Section 11 Claims

In its Omnicare decision, the U.S. Supreme Court held that opinions presented in registration statements can be subject to liability under Section 11 of the Securities Act of 1933 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.  A key open question, however, is whether Omnicare’s reasoning extends to securities fraud claims brought under Section 10(b) of the Securities Exchange Act of 1934.

While some district courts have held that Omnicare is limited to Section 11 claims, the appellate trend is going the other way.  In City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology, Inc., et al., No. 14-16814 (9th Cir. May 5, 2017), the court agreed with a recent Second Circuit decision and found that Omnicare should apply to Section 10(b) claims as well.  The court reasoned that both Section 11 and Section 10(b) claims are based on untrue statements of fact and, as a result, the same falsity analysis is warranted.

Holding: Dismissal affirmed.

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Frivolity

Among other reforms, the Private Securities Litigation Reform Act of 1995 (“PSLRA”) requires that upon final adjudication of a federal securities action, the court shall include in the record “specific findings regarding compliance” with the federal rule providing that attorneys’ must present accurate and non-frivolous pleadings to the court.  If the court finds the rule has been violated, it must impose sanctions on the offending party or attorney.

The PSLRA’s required sanctions review is more honored in the breach than the observance, with federal judges generally declining to provide the specific findings unless prompted by a party.  In turn, parties rarely make these requests because they believe there is a slim likelihood of sanctions being imposed.  The recent decision in Tai Jan Bao v. Solarcity Corp., 2017 WL 878226 (N.D. Cal. March 6, 2017) illustrates the issue.

In Solarcity, the plaintiffs alleged that the defendants had engaged in an accounting fraud.  The court dismissed the complaint based on a failure to adequately plead scienter (i.e., fraudulent intent), but allowed the plaintiffs to revise their pleading.  Two more versions of the complaint were dismissed on the same basis, the last dismissal with prejudice.  Following the entry of the final judgment, the defendants moved the court to amend its judgment by imposing sanctions, arguing that the complaints lacked any factual basis and the plaintiffs’ counsel had failed to conduct a reasonable inquiry.

The court held that the complaints, although failing to satisfy the PSLRA’s pleading standards, “did not raise the types of objectively baseless and frivolous claims that have been the subject of fee awards.”  Moreover, the court found that the plaintiffs’ counsel, by hiring investigators, conducting interviews of former employees, reviewing public documents, and retaining an expert, undertook a reasonable investigation into the dismissed claims.

Holding: Motion to amend the judgment by imposing sanctions denied.  (The court also denied the plaintiffs’ request that the defendants pay their attorneys’ fees incurred in opposing the sanctions request.)

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Somebody Else Said It

Is paying someone else to make a misstatement to investors the same as making the misstatement yourself for purposes of securities fraud liability?  Two recent appellate decisions address this question and come to different conclusions based on the specific type of liability alleged.

In In re Galectin Therapeutics, Inc. Sec. Litig., 843 F.3d 1257 (11th Cir. 2016), the corporate defendants retained promoters to “recommend or tout” the company’s stock by writing favorable articles.  These articles allegedly contained misstatements that misled the company’s investors.  While the defendants “worked in conjunction with the stock promoters,” there were no allegations showing that any defendant told the stock promoters what to say.  Under the Supreme Court’s Janus decision, a defendant is only subject to primary securities fraud liability if it has “ultimate authority” over the alleged misstatement.  The Eleventh Circuit concluded that merely paying for the articles did not demonstrate ultimately authority over any alleged misstatements made by the promoters and, as a result, the claims against the defendants based on those alleged misstatements must be dismissed.

In West Virginia Pipe Trades Health & Welfare Fund v. Medtronic, 845 F.3d 384 (8th Cir. 2016), the corporate defendants subsidized a number of medical journal articles that allegedly overstated the efficacy and safety of a treatment sold by the company.  Rather than assert primary liability for these alleged misstatements, the plaintiffs argued that the corporate defendants were liable as participants in a scheme to mislead investors.  Under the Supreme Court’s Stoneridge decision, a plaintiff cannot bring a scheme liability claim based on deceptive conduct that makes its way to investors through a third party’s statements because investors cannot demonstrate that they relied on any acts taken by the company.

Nevertheless, the Eighth Circuit found that the scheme liability claims against Medtronic were adequately plead because, among other reasons, the company had “instructed” the authors of the articles to make the alleged misstatements.  According to the court, the plaintiffs would be able to demonstrate that investors had relied upon statements – even though they were made by third parties – because a “company cannot instruct individuals to take a certain action, pay to induce them to do it, and then claim that any casual connection is too remote when they follow through.”

The Galectin and Medtronic decisions are difficult to reconcile.  The Supreme Court has made it clear that it wants to severely restrict the ability of private plaintiffs to bring what amounts to aiding and abetting claims for securities fraud.  So if the alleged facts are insufficient to establish that the corporate defendant is the maker of the third party statements, should plaintiffs be allowed to use scheme liability to circumvent that restriction?  Stay tuned.

 

 

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Compare and Contrast

NERA Economic Consulting and Cornerstone Research have released their respective 2016 annual reports on federal securities class action filings.  As usual, the different methodologies employed by the two organizations have led to different numbers, although they both identify the same general trends.

The findings for 2016 include:

(1) The reports agree that filings are up sharply.  NERA finds that there were 300 filings (compared with 228 filings in 2015), while Cornerstone finds that there were 270 filings (compared with 188 filings in 2015).  NERA usually reports higher filings numbers due to its methodology, which counts cases against the same issuer that are filed in different circuits as separate filings  (at least until they are consolidated).

(2) Both NERA and Cornerstone find that there has been a steady growth in “standard” filings alleging violations of Rule 10b-5, Section 11, and/or Section 12.  Most of the discrepancy between 2015 and 2016, however, is the result of a large increase in M&A-related cases (NERA – 88 filings; Cornerstone – 80 filings).  The increase is likely attributable to the fact that various state courts, most notably in Delaware, have issued recent decisions limiting the viability of “disclosure-only” settlements for this type of case.

(3) The Ninth Circuit led the nation in overall filings.  NERA notes, however, that relatively few M&A-related cases were filed in the Second Circuit.  The Second Circuit had the highest number of “standard” filings.

(4) The pharmaceutical, biotechnology, and healthcare sector easily had the most filings.  NERA and Cornerstone agree that around a third of all cases were brought against companies in this space.

(5) NERA finds that for cases filed and resolved between 2000 and 2016, a motion to dismiss was decided in 79% of the cases.  The outcome of those motions to dismiss was: granted with or without prejudice (44%), granted in part and denied in part (30%), and denied (25%).  Only 15% of cases filed over that same period reached a decision on a motion for class certification.

(6) NERA finds a significant increase in the average settlement amount to $72 million (up from $53 million in 2015, as adjusted for inflation).  However, that number was affected by two settlements of more than $1 billion.  If those settlements are removed, the average actually declined to $43 million.  The median settlement amount held fairly steady, as compared to the last few years, at $9.1 million.

The NERA report can be found here.  The Cornerstone report can be found here.

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Transparently Aspirational

Can shareholders bring a claim for securities fraud when a corporate official violates the company’s code of conduct after publicly touting the business’s high standards for ethics and compliance?  According to the U.S. Court of Appeals for the Ninth Circuit, merely touting the business’s high standards – without having warranted compliance – is not enough to support such a claim.

In Retail Wholesale & Department Store Union Local 338 Retirement Fund v.
Hewlett–Packard Co., et al., 2017 WL 218026 (9th Cir. Jan. 19, 2017), the court considered whether an undisclosed sexual harassment scandal involving the CEO, which admittedly violated the company’s code of conduct, could form the basis for a securities class action.  The court concluded that the defendants had not made any material misstatements or omissions.

First, the defendants did not make any affirmative misstatements because a code of conduct “expresses opinions as to which actions are preferable, as opposed to implying that all staff, directors, and officers always adhere to its aspirations.”  Any other interpretation “is simply untenable, as it could turn all corporate wrongdoing into securities fraud.”

Second, the SEC required the company to have and publish a code of conduct.  Under these circumstances, the code of conduct was not material, as “[i]t simply cannot be that a reasonable investor’s decision would conceivably have been affected by HP’s compliance with SEC regulations requiring publication of ethics standards.”

Finally, the failure to disclose the sexual harassment scandal did not render the code of conduct misleading.  The code of conduct and the company’s statements promoting it “were transparently aspirational” and “did not reasonably suggest that there would be no violations of [the code of conduct] by the CEO or anyone else.”

Holding: Dismissal of claims affirmed.

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Pipe Dream

The federal securities laws have statutes of repose that bar a suit after a fixed number of years from the time the defendant acts in some way.  There is an appellate split, however, over whether the existence of a class action tolls the applicable statute of repose for individual class members.

Under what is known as American Pipe tolling, “the commencement of a class action suspends the applicable statute of limitations as to all asserted members of the class who would have been parties had the suit been permitted to continue as a class action.” American Pipe & Construction Co. v. Utah, 414 U.S. 538, 554 (1974). The Supreme Court found that its rule was “consistent both with the procedures of [Federal Rule of Civil Procedure] 23 and with the proper function of limitations statutes.” Id. at 555. In a later case, however, the Supreme Court also found that federal statutes of repose are not subject to equitable tolling. Lampf, Pleva, Lipkind, Prupis & Pettigrow v. Gilbertson, 501 U.S. 350, 364 (1991).

In attempting to reconcile these two cases, the federal appellate courts have come to different conclusions.  The Tenth Circuit has held that American Pipe tolling is a type of legal tolling and, as a result, Lampf is not applicable.  In contrast, the Second, Sixth, and Eleventh Circuits have held that statutes of repose create a substantive right to be free from liability after a legislatively-determined period of time.  Whether the asserted tolling is equitable or legal, it cannot modify that substantive right.

The Supreme Court has granted cert in California Public Employees’ Retirement v. ANZ Securities, Inc., et al.  (Second Circuit) to address this circuit split.  (In 2014,the Court agreed to hear a case presenting the same question, but ultimately dismissed the writ of cert as improvidently granted.)

The official question presented is: “Does the filing of a putative class action serve, under the American Pipe rule, to satisfy the three-year time limitation in Section 13 of the Securities Act with respect to the claims of putative class members?”

The case should be heard this spring with a decision issued by June 2017.

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Halliburton Settled (Again)

When the district court rejected a $6 million settlement in the Halliburton securities class action back in 2004, the judge probably expected the parties to renegotiate.  Many years later, after a change in plaintiffs’ counsel, three trips to the Fifth Circuit, two Supreme Court decisions, and more than a dozen posts on this blog about the case, a new agreement finally has been reached.

According to an announcement from the company made just before Christmas, the settlement is for $100 million.  Halliburton will pay $54 million, with the rest coming from its insurers.  The Reuters legal blog has an interesting review of the settlement from the plaintiffs’ perspective.

Quote of note: “[S]erious settlement talks with Halliburton began after the inconclusive oral argument at the 5th Circuit. Judge Lynn had allowed discovery and briefing to move ahead while the appeal was under way, so summary judgment motions were pending in the trial court. If the 5th Circuit and Judge Lynn had allowed the case to go to trial, Boies himself would have led the shareholders’ team, which would have claimed damages of between $300 million and $750 million.

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