Category Archives: Appellate Monitor
The U.S. Supreme Court heard oral argument in the Emulex case this week. The question presented focused on the mental state for securities claims alleging a misstatement in connection with a tender offer under Section 14(e) of the Securities Exchange Act. While most circuits have found that the required mental state is scienter (i.e., fraudulent intent), the Ninth Circuit decision below concluded that a finding of negligence is sufficient.
Much of the commentary, activity, and briefing in the case, however, was directed at a different issue. For many years, lower courts have found that there is an implied private right of action under Section 14(e). But is that correct under more recent Supreme Court precedents that have limited the creation of implied private rights of action?
As highlighted at the oral argument, however, it is not clear that the Court will be willing to take on an issue that was barely raised below and not directly presented to the Court. Five justices expressed skepticism (at least in their questioning) that the issue was properly before the Court, with Justice Sotomayor asking the petitioners whether considering it would be the equivalent of “rewarding you for not raising it adequately below, rewarding you for mentioning it in two sentences in your cert petition and not asking us to take it as a separate question presented?” Justice Alito, in his only question of the day, asked the government (appearing as amicus): “Could you explain why you think it’s appropriate for us to reach the question whether there’s a private right of action? If you were the Respondent here, would you think that that claim was properly before us? Is that the precedent you want us to set?” If the issue were to be decided, however, Chief Justice Roberts and Justice Gorsuch appeared to be the biggest proponents of the position that there is no implied private right of action for Section 14(e) claims.
On the other hand, the questioning suggested that there may be considerable support for a finding that scienter is the required mental state. Justice Sotomayor noted, in a point picked up by other justices, “that since 14(e) borrows the language of 10-5, and we have all along interpreted 10b-5 to require scienter, why shouldn’t we require the same standard here?” There also was discussion of the practicalities of the Court’s potential rulings. For example, Justice Kavanaugh asked the government whether “that’s caused real-world problems, recognizing the private right of action?” and later asked respondents “how would you assess SEC enforcement alone of a negligence standard versus SEC plus private enforcement of a higher mens rea standard?”
A decision should be issued by June 2019. A transcript of the oral argument can be found here.
Disclosure: The author of The 10b-5 Daily assisted the Washington Legal Foundation in the submission of an amicus brief arguing that there should be a uniform scienter standard for violations of Section 14(e) (misstatements in connection with a tender offer) and Section 14(a) (misstatements in connection with a proxy solicitation).
Plaintiffs frequently bring securities class actions arguing that the corporate disclosure of a regulatory issue has rendered earlier statements about regulatory compliance false or misleading. But are general corporate statements concerning regulatory compliance material to investors?
In Singh v. Cigna Corp., 2019 WL 1029597 (2d Cir., March 5, 2019), the Second Circuit addressed this issue. Following an audit by the Centers for Medicare and Medicaid Services (“CMS”), Cigna received a letter stating that it had “substantially failed to comply with CMS requirements regarding coverage determinations, appeals, benefits administration, compliance program effectiveness and similar matters.” After Cigna disclosed the letter and CMS’s proposed sanctions, its stock price declined.
The plaintiffs argued that these compliance issues rendered a number of prior Cigna statements false or misleading. In particular, Cigna had disclosed that it (a) had “established policies and procedures to comply with applicable requirements,” (b) had “a responsibility to act with integrity in all we do, including any and all dealings with government officials,” and (c) “expect[ed] to continue to allocate significant resources” to compliance.
The Second Circuit found that all of Cigna’s statements, however, were immaterial as a matter of law. The statements were “tentative and generic,” and, given that Cigna talked about allocating significant resources to compliance, “seem to reflect Cigna’s uncertainty as to the very possibility of maintaining adequate compliance mechanism in light of complex and shifting government regulations.” Accordingly, the court affirmed the dismissal of the plaintiffs’ claims.
Holding: Dismissal affirmed.
Quote of note: “This case presents us with a creative attempt to recast corporate mismanagement as securities fraud. The attempt relies on a simple equation: first, point to banal and vague corporate statements affirming the importance of regulatory compliance; next, point to significant regulatory violations; and voila, you have alleged a prima facie case of securities fraud! The problem with this equation, however, is that such generic statements do not invite reasonable reliance. They are not, therefore, materially misleading, and so cannot form the basis of a fraud case.”
The Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) precludes any “covered class action” based upon state law that alleges a misrepresentation in connection with the purchase or sale of nationally traded securities. The defendants are permitted to remove the case to federal district court for a determination as to whether the case is precluded by the statute. If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.
SLUSA has a bifurcated definition of “covered class action” for a single lawsuit. The action qualifies as a covered class action when (in relevant part) either (a) damages are sought on behalf of more than 50 persons or prospective class members; or (b) one or more named parties seek to recover damages on a representative basis on behalf of themselves and other unnamed parties similarly situated.
In Nielen-Thomas v. Concorde Investment Services, LLC, 2019 WL 302766 (7th Cir. Jan. 24, 2019), the Seventh Circuit considered whether a putative class action meeting all of the other requirements for SLUSA preclusion, but brought on behalf of “between thirty-five and forty-nine members,” should be allowed to proceed in state court. The plaintiffs argued that the two definitions of “covered class action” were “separate, independent bases for excluding securities class actions from SLUSA’s proscriptions” so that being excluded under one was sufficient, or, alternatively, the fifty-person threshold must apply to both definitions to avoid making the second definition superfluous. The Seventh Circuit disagreed.
The Seventh Circuit found that while there was an overlap between the two definitions, each had a separate meaning. Under the first definition, the action could “be treated as a class action even if all plaintiffs are identified in the complaint and no plaintiff is pursuing claims as a representative on behalf of others, if there are more than fifty such plaintiffs and SLUSA’s other requirements are met.” The second definition, in contrast, “includes any action brought as a putative class action in the traditional Rule 23 meaning of the term.” The Seventh Circuit also found that this interpretation is consistent with SLUSA’s purpose and legislative history, noting that Congress wanted to prevent plaintiffs from circumventing the barriers to federal securities class actions by simply filing them in state court (no matter how large the size of the class). Because the case before the court clearly was a putative class action, it fell within the second definition and was precluded.
Holding: Dismissal affirmed.
Quote of note: “To the extent the identities of any of the other putative class members are known, and these individuals wish to pursue claims on their own behalf in state court under state law, nothing in SLUSA prevents them from doing so (provided there are fewer than fifty such plaintiffs for which common questions of law or fact predominate). What SLUSA does preclude these individuals from doing is continuing to pursue their claims in the form of a class action.”
After fifteen years of publishing The 10b-5 Daily, it was good to take a short sabbatical! But with the new year, this blog is back up and running. So let’s get to it.
On Friday, the U.S. Supreme Court granted certiorari in Emulex Corp. v. Varjabedian, setting up a battle over actions brought under Section 14 of the Securities Exchange Act.
In its petition, Emulex presented the following question:
Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.
The direct question presented is a narrow dispute over the Section 14(e) state of mind requirement – i.e., does a private plaintiff need to show that the defendant acted with negligence or scienter (i.e., fraudulent intent)? That said, there are a few ways the case could have a broader impact.
First, although the question presented refers to a “private right of action,” any determination as to the required state of mind also would apply to actions brought by the government.
Second, there is a related statutory provision – Section 14(a) – that addresses misstatements or omissions made in connection with proxy solicitations. The state of mind requirement for actions brought under Section 14(a) also is the subject of a circuit split and may be impacted by the Court’s decision.
Finally, there is some question as to whether there should be an inferred private right of action under Section 14(e) at all (despite the fact that a number of lower courts have found that one exists). In its amicus brief filed in support of the cert petition, the U.S. Chamber of Commerce argued that the Court should address this threshold issue and find that only the government can bring an action to enforce Section 14(e).
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.”
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.”