Category Archives: Appellate Monitor

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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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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On This Record

On the same day that it issued its “Model V” decision, the Second Circuit issued another opinion in the Vivendi securities litigation addressing whether “value investors” can invoke the fraud-on-the-market presumption of reliance.

In Gamco Investors, Inc. v. Vivendi Universal, S.A., 2016 WL 5389281 (2d Cir. Sept. 27, 2016), the district court held that Vivendi had successfully rebutted the fraud-on-the-market presumption.  In particular, the court found “that, given the facts in the record, Vivendi proved that GAMCO would have purchased Vivendi securities even if it had known of Vivendi’s alleged fraud.”  The district court entered judgment for the defendant.  (Click here for a summary of an earlier decision in the case on this issue).

On appeal, the Second Circuit rejected GAMCO’s contention that the district court had created a blanket rule barring “value investors” from invoking the fraud-on-the-market presumption because those investors do not necessarily consider the market price to be an efficient reflection of the value of the security.  Instead, the panel focused on the evidence and concluded that it was sufficient to establish that “had GAMCO known of Vivendi’s liquidity problems, GAMCO would still have believed, first, that Vivendi’s securities were substantially undervalued by the market and second, that an event was likely to happen in the next few years that would awake the market to that fact.”  Accordingly, “the district court did not clearly err in concluding, on this record, that in this case, and with regard to this particular fraud” that GAMCO could not establish reliance on the alleged misrepresentations.

Holding: Judgment of district court affirmed.

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Don’t Buy a “Model V”

In a typical securities fraud case, where the plaintiff alleges that a misrepresentation artificially inflated the company’s stock price, the defendant may be able to rebut reliance by providing evidence that there was no stock price increase as a result of the misrepresentation. 

At least two circuit courts (Seventh and Eleventh), however, have recognized an alternative “price maintenance theory” of artificial inflation.  Under the price maintenance theory, a misrepresentation can artificially inflate a stock’s price by improperly maintaining the existing price (e.g., by repeating prior falsehoods and preventing the stock’s price from falling to its true value). The Pfizer case decided by the Second Circuit earlier this year caused some speculation as to whether that court might break with its sister circuits on price maintenance, but this week the Second Circuit firmly endorsed the theory.

In In re Vivendi, S.A. Sec. Lit., 2016 WL 5389288 (2d Cir. Sept. 27, 2016), Vivendi argued that the trial court had improperly admitted expert testimony about a series of alleged misrepresentations that had not caused stock price increases.  The Second Circuit found, however, that “[i]t is hardly illogical or inconsistent with precedent to find that a statement may cause inflation not simply by adding it to a stock, but by maintaining it.”  Any other result would allow companies to “eschew securities-fraud liability whenever they actively perpetuate (i.e., through affirmative misstatements) inflation that is already extant in their stock price, as long as they cannot be found liable for whatever originally introduced the inflation.”  Accordingly, the court held that it did “not accept Vivendi’s position that the ‘price impact’ requirement inherent in the reliance element of a private § 10(b) action means that an alleged misstatement must be associated with an increase in inflation to have any effect on a company’s stock price.”

Holding: Partial judgment of trial court affirmed.

Quote of note: “Suppose an automobile manufacturer widely praised for selling the world’s safest cars plans to release a new model (‘Model V’) in the near future. The market believes that Model V, like all of the company’s previous models, is safe, or has no reason to think otherwise. In fact, the automobile manufacturer knows that Model V has failed crash test after crash test; it is, in short, simply unfit to be on the road. To protect its stock price, however, the automobile manufacturer informs the market, as per routine industry practice, that Model V has passed all safety tests. When the truth eventually reaches the market, the automobile manufacturer’s stock price bottoms out. . . . [T]he question of the automobile manufacturer’s liability for securities fraud does not turn on whether inflation moved incrementally upwards when the company represented to the market that the new model passed all safety tests. Nor does it rest on whether the market originally arrived at a misconception about the model’s safety on its own, or whether the company led the market to that misconception in the first place.” 

 

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Scienter Samba

The Sixth Circuit continues to be a source of interesting opinions regarding corporate scienter.  In 2014, the court held in its Omnicare decision that only a limited set of corporate officers (including officers who had either made or approved the alleged misstatements) could have their state of mind imputed to the company.  But what about lower corporate officers who know about undisclosed problems and fail to report them?

In Doshi v. General Cable Corp., 2016 WL 2991006 (6th Cir. 2016), the court addressed a case arising out of General Cable’s financial restatement, which was the result of a “complex theft scheme in Brazil and, to a somewhat lesser extent, accounting errors, primarily in Brazil.”  The plaintiffs alleged that the head of the company’s “Rest of World” (ROW) division, which included Brazil, knew about these issues but failed to report them to the executive management.  Moreover, the plaintiffs argued, his knowledge could be imputed to General Cable because he “furnished information used in General Cable’s false public financial statements.”

The court found that even if the head of the ROW division had acted recklessly,  in the absence of any allegations that he had “drafted, reviewed, or approved” the alleged misstatements, “only his knowledge of the theft and accounting errors – not his state of mind – imputes to General Cable.”  The court then applied its normal “scienter factors” to determine whether the plaintiffs had adequately plead that the company, with that knowledge, had acted with a fraudulent intent.  Ultimately, the court found that the more compelling inference was that “a theft scheme racked General Cable’s operations in Brazil where local managers overrode accounting procedures, which, when coupled with the legitimate freedom afforded ROW to report its financial data, led General Cable to issue materially false public financial statements.”  Accordingly, the plaintiffs’ allegations failed “to create a strong inference that General Cable acted with scienter.”

Holding: Dismissal affirmed.

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Shaky Ground

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.  In a typical case, where the plaintiff alleges that a misrepresentation artificially inflated the company’s stock price, the defendant can satisfy this requirement by providing evidence that there was no stock price increase as a result of the misrepresentation. 

At least two circuit courts (Seventh and Eleventh), however, have recognized an alternative “price maintenance theory” of artificial inflation.  Under the price maintenance theory, a misrepresentation can artificially inflate a stock’s price by improperly maintaining the existing price (e.g., by repeating prior falsehoods and preventing the stock’s price from falling to its true value).  But how does a defendant provide evidence to establish a lack of stock price impact under these circumstances?

Perhaps because of the inherent tension between Halliburton II and the price maintenance theory, two recent circuit court decisions appear to question the theory’s use in securities class actions.

In IBEW Local 98 Pension Fund v. Best Buy Co., Inc., 2016 WL 1425807 (8th Cir. April 12, 2016), the court held that the district court had improperly certified a class based on statements made in an earnings call.  According to experts for both sides, the statements were merely confirmatory and did not cause the company’s stock price to increase.  While the plaintiffs argued that a price increase was not necessary under their price maintenance theory, the court found that the “theory provided no evidence that refuted defendants’ overwhelming evidence of no price impact.”

In In re Pfizer Inc. Sec. Litig., 2016 WL 1426211 (2nd Cir. April 12, 2016), the court addressed the issue more indirectly.  The district court granted summary judgment for the defendants after excluding the plaintiffs’ loss causation and damages expert from testifying.  On appeal, the court found that the plaintiffs were relying on a price maintenance theory and that the expert’s testimony would be helpful to the jury in that context.  As to the theory itself, however, the court went out of its way to note that it was not  deciding whether it was “either legally or factually sustainable” and that it “might be that Plaintiffs’ inflation-maintenance theory is deficient under Rule 10b-5.”

As noted by the dissent in the Best Buy case, “[n]either the Supreme Court nor any circuit court has however discussed the type of showing needed to rebut [] a presumption of reliance in a price maintenance case.”  Until that issue is addressed, the price maintenance theory appears to be on shaky ground.

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