Playing Chicken

If a securities fraud claim is based on the nondisclosure of an illegal act, what is the plaintiff required to plead about the existence of that act?  In Gamm v. Sanderson Farms, Inc., 2019 WL 6704666 (2d Cir. Dec. 10, 2019), the plaintiffs alleged that Sanderson Farms, a poultry processing company, had failed to disclose an anti-competitive conspiracy to inflate the price of chicken by coordinating supply reductions and manipulating a chicken price index.  After a series of antitrust complaints were filed against Sanderson Farms and other chicken producers, the company’s stock price fell.

The district court dismissed the complaint based on the plaintiffs’ failure to adequately plead the existence of “a chicken supply reduction conspiracy with particularized facts.”  On appeal, the Second Circuit agreed.  To support their contention that Sanderson Farms’ financial disclosures were rendered misleading by the failure to disclose the anti-competitive conduct, the plaintiffs were required “to have alleged the basic elements of an underlying antitrust conspiracy” with particularity.   Those elements included “collusive conduct,” but the securities complaint provided “no facts alleging that Sanderson or its peers actually reduced supply, and that those reductions were the result of an agreement, or were even interrelated.”  Accordingly, the complaint was deficient.

Holding: Dismissal affirmed.

Quote of note: “A stock-issuing company like Sanderson cannot be required, whenever accused of illegal activity, to simultaneously defend itself in an accompanying securities fraud suit based on facts not alleged with the level of particularity required by the statute [PSLRA].  Such a reality would harm the company’s stock and contravene the purpose of the securities laws – to protect shareholders’ interests.”

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Compare and Contrast

NERA Economic Consulting and Cornerstone Research have released their respective 2019 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 2019 include:

(1) The reports agree that there continue to be a record or near-record number of filings, with an increase in “standard” filings alleging violations of Rule 10b-5, Section 11, and/or Section 12 offsetting a decline in M&A-related cases.  NERA finds that there were 433 filings (the same as the 433 filings in 2018), while Cornerstone finds that there were 428 filings (compared with 420 filings in 2018).

(2) Over the last few years, the Second Circuit and Ninth Circuit have had a similar number of standard filings.  In 2019, however, both NERA and Cornerstone report that the number of Second Circuit standard filings was nearly double the number of Ninth Circuit standard filings (NERA – 103 (2d) v. 52 (9th); Cornerstone 108 (2d) v. 56 (9th)).  The Third Circuit had the next highest number of filings (NERA – 28; Cornerstone – 32).

(3) Filings against foreign issuers had steadily increased from 2013-2017, with these companies facing a disproportionate (as compared to their percentage of listings) risk of securities class action litigation.  In 2018, the numbers took a dip, but they have rebounded to a record high.  Cornerstone finds that there were 57 standard filings against foreign issuers in 2019, representing 24.3% of all standard filings.

(4) NERA reports a sharp increase in standard filings based on missed earnings guidance (from an average of 20% of filings over the past four years to 32% of filings in 2019).

(5) NERA finds that the average settlement value ($30 million) held steady and the median ($12.8 million) settlement value increased slightly.  However, the median settlement values in 2018 and 2019 were more than 25% higher than the median settlement values in the previous three years, reflecting a downward trend in the proportion of cases settled for less than $10 million.

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

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Congress At Work

The author of The 10b-5 Daily (Lyle Roberts) had an op-ed in the Wall Street Journal last month on the Insider Trading Prohibition Act.  A link to the op-ed can be found here (no paywall).

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Southern District for the Inquisition

Investors frequently bring securities class actions against drug development companies, typically asserting that the company failed to adequately disclose information about its clinical trials.  In Lehmann v OHR Pharmaceutical, Inc.,  2019 WL 452765 (S.D.N.Y. Sept. 20, 2019), the company was developing a drug for the treatment of a degenerative eye disease called Wet Age-Related Macular Degeneration (“Wet AMD”).  The plaintiffs claimed that OHR, in disclosing the results of its Phase II clinical trial, failed to disclose that its control arm results were inconsistent with previous trials (which allegedly made the Phase II trial appear more successful than it really was).  Ultimately, the company announced disappointing results for its subsequent Phase III clinical trial and the stock price declined 81%.

The court found that OHR’s disclosures were accurate and the company was not required to provide more context around its Phase II trial results.  Indeed, the court questioned the entire premise of the case, noting that “[o]n Plaintiffs’ account, it is unclear whether the Company should have embarked on the phase III study after the success of the phase II study – should the Company have ignored what Plaintiffs say were aberrant results, or should it have investigated further?”  The court came down firmly on the side of further investigation, noting “that the law does not abide attempts at using the judiciary to stifle the risk-taking that undergirds scientific achievement and human progress.”

Holding: Motion to dismiss granted (also based on the plaintiffs’ failure to adequately plead scienter).

Quote of note:  “This Court will not adopt a rule that discourages free scientific inquiry in the name of shielding investors from the risks of failure.  Science is risky.  Science advances through those willing to take those risks and break with consensus.  With science suffering from a replication crisis, this Court is happy to report that the law does not abide attempts to use the judiciary to stifle the risk-taking that undergirds scientific advancement and human progress.  The answer to bad science is more science, not this Court’s acting as the Southern District for the Inquisition.”

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Expert Opinion

To what extent can plaintiffs use allegations from a retained expert in a securities fraud complaint?  In Sgarlata v. Paypal Holdings, Inc., 2019 WL 4479562 (N.D. Cal. Sept. 18, 2019), the plaintiffs claimed that PayPal had failed to adequately disclose a cybersecurity breach.  To bolster their scienter (i.e., fraudulent intent) allegations, the plaintiffs engaged a cybersecurity expert to determine what information about the breach likely was available to the company at the time the breach was discovered and provided the expert’s opinions in the complaint.

In its motion to dismiss decision, the court found that it could consider the expert’s statements, but only if they satisfied the same standard applied to confidential witnesses, i.e., (1) the statements must be described with sufficient particularity to establish the expert’s reliability and personal knowledge; and (2) the statements must themselves be indicative of scienter.  The cybersecurity expert had extensive experience in the field and opined that the company must have known more about the breach than it disclosed.

The court noted, however, that there was no allegation in the complaint that the expert “was familiar with, much less had knowledge of, the specific security architecture of Defendants’ privacy network.”  Moreover, the expert “did not actually talk to employees . . . nor did he review documents that – in and of themselves – demonstrate inconsistencies that were available” to the company at the time of its disclosure.  Even considered holistically with the entire complaint, the court found that the expert’s opinions did not support a finding of scienter.

Holding: Motion to dismiss granted.

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For Our Teenage Readers

While the Second Circuit and Ninth Circuit hear many securities cases and have a wealth of relevant case law, other circuits are still dealing with common issues that they have not yet had a chance to address.  In Carvelli v. Ocwen Financial Corp., 2019 WL 3819305 (11th Cir. Aug. 15, 2019), the Eleventh Circuit examined two issues of first impression: puffery and Item 303.

Puffery – Puffery is generalized, vague, non-quantifiable statements of corporate optimism.  Courts have found that these types of statements are immaterial as a matter of law and, as a result, cannot form the basis for a securities fraud claim.  In Carvelli, the court noted that while the Eleventh Circuit has not addressed the concept in the context of a securities case, “puffery itself—and in particular its relevance to the law—is nothing new.”  Indeed, it appears in nineteenth-century English case law, where courts found that “some advertisements—’mere puff’— clearly aren’t meant to be taken seriously.”

The Eleventh Circuit had little trouble finding that puffery can be a barrier to a securities fraud claim, but cautioned that it was not merely a matter of the court determining that the particular statement “smacks of puff.”  Instead, a “conclusion that a statement constitutes puffery doesn’t absolve the reviewing court of the duty to consider the possibility—however remote—that in context and in light of the ‘total mix’ of available information, a reasonable investor might nonetheless attach importance to the statement.”  In the instant case, however, “Ocwen’s proclamations that it was devoting ‘substantial resources’ to its problems, with ‘improved results,’ as well as its boasts that it was taking a ‘leading role’ and making ‘progress’ toward compliance are precisely the sorts of statements that our sister circuits have—we think correctly—deemed puffery and found immaterial as a matter of law.”

Item 303 – Item 303 of Regulation S-K requires issuers to disclose known trends or uncertainties “reasonably likely” to have a material effect on operations, capital, and liquidity.  In Carvelli, the plaintiffs argued that the failure to make a disclosure required under Item 303 automatically can lead to Rule 10b-5 liability based on the existence of a material omission.  The Third Circuit and Ninth Circuit (and, to a lesser extent, the Second Circuit) have rejected that argument.  The Eleventh Circuit agreed with those decisions, holding that “Item 303 imposes a more sweeping disclosure obligation than Rule 10b-5, such that a violation of the former does not ipso facto indicate a violation of the latter.”

Holding: Dismissal affirmed.

Quote of note: “As Judge Learned Hand once put it, ‘[t]here are some kinds of talk which no sensible man takes seriously, and if he does he suffers from his credulity.” Vulcan Metals Co. v. Simmons Mfg. Co., 248 F. 853, 856 (2d Cir. 1918).  Think, for example, Disneyland’s claim to be ‘The Happiest Place on Earth.’  Or Avis’s boast, ‘We Just Try Harder.’  Or Dunkin Donuts’s assertion that ‘America runs on Dunkin.’  Or (for our teenage readers) Sony’s statement that its PlayStation 3 ‘Only Does Everything.’  These boasts and others like them are widely regarded as ‘puff’—big claims with little substance.”

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Compare and Contrast – Midyear 2019

NERA Economic Consulting and Cornerstone Research have released their 2019 midyear reports on securities class action filings.  As usual, the different methodologies employed by the two organizations have led to slightly different numbers, although they both identify the same general trends.

The key findings include:

(1) The reports agree that filings continue to be at near-record levels, driven by continued growth in “standard” filings alleging violations of Rule 10b-5, Section 11, and/or Section 12, even while M&A-related cases have declined.  NERA finds that there were 218 filings (compared with 217 filings in 1H 2018), while Cornerstone finds that there were 198 filings (compared with 199 filings in 1H 2018).

(2) Following the Cyan decision by the U.S. Supreme Court, there has been a surge in state court filings alleging Section 11 claims.  Cornerstone finds that this has continued in 1H 2019, with 19 cases brought in state courts (with over a third of these cases being accompanied by a federal filing alleging similar claims).

(3) NERA finds that there has been an increase in accounting-related claims, making up 37% of standard filings and notching the highest first half case count since the first half of 2011.

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

 

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