Category Archives: Appellate Monitor

Cyan Decided

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.”

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Credible Complaints

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.”

 

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Cyan Argued

On Tuesday, the U.S. Supreme Court heard oral argument in the Cyan, Inc. v. Beaver County Employees Retirement Fund case, which addresses the preemptive scope of the Securities Litigation Uniform Standards Act of 1998 (SLUSA).   At issue in the case is whether SLUSA divests 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).

The question before the Court is closely tied to Congress’s intent in enacting SLUSA.  In 1995, Congress passed the Private Securities Litigation Reform Act (PSLRA) to protect corporate defendants from meritless securities class actions.   The PSLRA, however, only applied to federal cases.  To evade the PSLRA’s impact, plaintiffs began filing securities class actions in state court, usually based on state law causes of action.

Congress passed SLUSA to close this loophole.  Due to unclear drafting, however, there has been confusion in the lower courts over whether SLUSA also makes federal court the sole venue for class actions alleging Securities Act claims (which historically enjoyed concurrent jurisdiction in state or federal court).  In Cyan, the parties have put forward three competing interpretations of SLUSA.  The Petitioners (Defendants) contend that SLUSA divests state courts of jurisdiction over class actions asserting Securities Act claims, thereby insuring that those cases must be litigated in federal court.  The Solicitor General maintains that SLUSA permits the removal of class actions asserting Securities Act claims, thereby also allowing those cases to be heard in federal court.  Finally, the Respondents (Plaintiffs) contend that SLUSA did not address class actions asserting Securities Act claims at all, meaning that once in state court they are not removable to federal court.

The parties’ textual arguments require having SLUSA in one hand and a yellow highlighter in the other.  In the end, however, the text of the statute might not end up having much sway over the Court.  The justices expressed varying degrees of frustration in trying to parse through the specific statutory language to reach a result, with Justice Alito, in particular, repeatedly referring to the relevant provisions as “gibberish” and noting that “all the readings that everybody has given to all of these provisions are a stretch.”

Petitioners and the Solicitor General appeared to have more success on the issue of Congressional intent.  Petitioners’ counsel drew an analogy to building a house, suggesting that it was nonsensical to believe that Congress would have barred the front door against the bringing of securities class actions in state court asserting state law claims, while simultaneously leaving the back door open for plaintiffs to bring securities class actions in state court asserting federal law claims.  Moreover, if securities class actions asserting federal law claims go forward in state court, they are not subject to the PSLRA’s procedural protections, a result that Congress presumably wanted to avoid.

Several justices picked up on this theme, with Justice Ginsburg asking Respondents’ counsel “why would Congress want to do that” given that you end up with “the federal claim in state court, and none of those [PSLRA] restrictions apply”?  Similarly, Justice Alito expressed incredulity that Congress would 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].”  Respondents’ counsel answered that if Congress was concerned about the “evasion of the PSLRA” in securities class actions alleging Securities Act claims, there were “10 different easier ways and more clear ways” that it could have removed the existence of concurrent jurisdiction for those cases (but it did not).  Justices Kagan and Sotomayor appeared sympathetic to that position, with Justice Kagan noting that “Congress did everything it wanted with respect to actions [under the Securities Exchange Act of 1934], which are the lion’s share of securities lawsuits.”

A decision is expected sometime early next year.

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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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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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