The Need for New News

To adequately plead loss causation, a plaintiff must establish the existence of a corrective disclosure that reveals to the market the pertinent truth that was previously concealed or obscured by the company’s fraud.  Determining whether an alleged corrective disclosure actually provides “new news” or is merely a restatement of previously-disclosed information, however, has proven difficult for courts.

In Luczak v. National Beverage Corp., 2020 WL 2111947 (11th Cir. May 4, 2020) (per curiam), the plaintiffs alleged that the company (a) made misleading statements regarding two sales metrics the Company purportedly touted as an important measure of growth and sales, and (b) failed to disclose that its CEO had engaged in a pattern of sexual misconduct.

As to the sales metrics statements, the plaintiffs alleged that the truth was revealed to the market by a March 2018 SEC letter questioning the company’s use of the metrics and a subsequent June 2018 media report discussing the issue.  The lower court, however, found that neither of these items were “corrective disclosures” because the SEC letter “merely confirm[ed] the SEC’s already established doubt of the veracity” of the sales metrics and the media report was just a summary of the SEC correspondence.  As to the sexual misconduct claims, the plaintiffs argued that a July 2018 Wall Street Journal article had revealed the misconduct, but the lower court found that the article only repeated allegations that had been made in publicly-filed lawsuits.

On appeal, the Eleventh Circuit rendered a split decision.  The panel found that the lower court had read the March 2018 SEC letter and the June 2018 media report too narrowly.  Although the SEC’s interest in the sales metrics was publicly known, the SEC letter and media report arguably provided “new news” that the company was failing to cooperate with the SEC in its inquiry by not providing additional information about the metrics.  Moreover, the media report could be read to suggest that this conclusion came from sources beyond the SEC correspondence.  As to the sexual misconduct claims, however, the panel agreed that the 2018 Wall Street Journal article did not provide any additional information that could not be found in the lawsuits.

Holding: Affirmed in part, reversed in part, and vacated in part.

Additional note:  The decision points out that the Eleventh Circuit has never decided whether the heightened pleading standards of the PSLRA or FRCP 9(b) apply to the pleading of loss causation.  The panel declined to address the issue, however, holding that its decision would not be affected by which pleading standard was used.

 

 

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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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Specific Issues

It is common for a securities class action to follow an announcement that a company has engaged in Foreign Corrupt Practices Act (FCPA) violations.  Plaintiffs typically allege that the company’s statements about its legal compliance, internal controls, and/or financial results were rendered false or misleading by the failure to disclose that certain revenues were obtained through corruption.

In Doshi v. General Cable Corp., 2019 WL 1965159 (E.D. Ky. April 30, 2019), General Cable entered into settlements with the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) over FCPA violations.  As part of a non-prosecution agreement with the DOJ, the company admitted that it knew about certain corrupt payments and “knowingly and willfully failed to implement and maintain an adequate system of internal accounting controls designed to detect and prevent corruption or other illegal payments by its agents.”  The court’s motion to dismiss ruling contains three interesting holdings.

First, there is a two-year statute of limitations for federal securities fraud claims, which begins to run when the “plaintiff did discover or a reasonably diligent plaintiff would have discovered the the facts constituting the violation.”  Although the complaint was filed more than two years after General Cable first disclosed the possibility of FCPA violations, the court held that the claims were not barred by the statute of limitations because there was no available evidence of scienter (i.e., fraudulent intent) until the company entered into the government settlements.

Second, the court found that the only actionable misstatements made by General Cable related to its statements concerning the effectiveness of its internal controls over financial reporting (including SOX certifications).  The company’s disclosure that it had a FCPA compliance program was not rendered false or misleading by the fact that the program was not effective.  The company also had no obligation to disclose a theoretical risk that its overseas operations might fail if it could not rely on corrupt business practices.

Finally, despite its holdings regarding the statute of limitations and the existence of actionable misstatements, the court concluded that the plaintiffs had failed to adequately plead scienter.  The company’s settlements with the government established that “GC knew it did not have controls that provided a sufficient framework for dealing with third-parties in the identified subsidiaries and GC knew that this allowed it to violate the FCPA in particular countries.”  However, the court held, “this does not mean that GC knew its overall internal controls over financial reporting were not effective, nor does it mean that GC knew its SOX certifications – which do not specifically relate to the FCPA – were false.”  In other words, the court found that the “most plausible inference” was that GC believed that its overall financial reporting system was “sound despite a specific FCPA-related issue.”

Holding: Motion to dismiss granted.

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Slim To None (And Slim Just Left Town)

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.

That said, if a plaintiff is worried about a possible sanction, can it avoid the mandatory review by voluntarily dismissing its claim?  In Rezvani v. Jones, 2019 WL 1100149 (C.D. Cal. March 6, 2019), the plaintiff voluntarily dismissed his case with prejudice after he failed to amend his complaint and the court indicated that it found dismissal with prejudice appropriate.  The court held that for purposes of determining whether the dismissal was a “final adjudication” under the PSLRA, the key factor was that the dismissal was with prejudice (not whether it was voluntary or involuntary).  A dismissal with prejudice – no matter the exact circumstances – closes the district court case file, constitutes a “final adjudication,” and leads to the required sanctions review.

However, the court also found that sanctions against the plaintiff were not warranted.  The securities claim had “little merit,” but the court accepted counsel’s representation that he had researched his client’s claims and the case had been brought in good faith.  In addition, the court credited the plaintiff for dropping his securities claim “once the Court identified its deficiencies.”

Holding: Defendant’s motion for sanctions denied.

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