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.
As The 10b-5 Daily recently has noted, it is difficult for corporate defendants to avoid securities fraud liability when they fail to disclose hidden wrongdoing at the company. But what if the company’s CEO is engaged in hidden wrongdoing at a different company?
In Fries v. Northern Oil & Gas, Inc., 2018 WL 388915 (S.D.N.Y. Jan. 11, 2018), Northern Oil fired its CEO after the SEC sought to bring an enforcement action against him. The enforcement action was based on the CEO’s activities at an unrelated company, Dakota Plains Transport, which he had founded. When Northern Oil announced the dismissal of its CEO, its stock price dropped and a securities class action was filed. The plaintiffs alleged that Northern Oil had omitted material facts about the CEO’s wrongdoing at Dakota Plains when the company made statements about its Code of Business Conduct and Ethics and the CEO’s value to the business.
The court found that the plaintiffs had failed to adequately plead that Northern Oil made any false statements. A failure to disclose wrongdoing is only actionable if the “non-disclosures render other statements by defendants misleading.” The company did not tout its compliance with its Code of Business Conduct and Ethics and there was nothing inaccurate about the company’s statements concerning its reliance on the CEO’s expertise and industry contacts. Accordingly, the hidden wrongdoing at Dakota Plains did not make those statements actionable.
Holding: Motion to dismiss granted. (The court also found that the plaintiffs failed to adequately plead scienter.)
Is “on track” the most dangerous phrase a corporation can use to describe its business? Over the years, there have been a significant number of securities class actions alleging a company’s statement that a regulatory approval process or financial metric was “on track” constituted securities fraud. Defendants typically argue that “on track” is inherently forward-looking (because one cannot know whether something is actually on track until the final results are obtained) and, therefore, protected from liability by the PSLRA’s safe harbor for forward-looking statements. While some courts have held that “on track” cannot be distinguished from the underlying projection and the safe harbor applies, other courts have concluded that “on track” is a statement of present condition.
Another, more recent legal complication, is whether “on track” should actually be assessed as an alleged false opinion subject to the Omnicare standard. In Omnicare, the Supreme Court held (albeit in the context of a non-fraud Section 11 claim) that an opinion is actionable if either (a) the opinion was not genuinely held, or (b) the holder of the opinion omitted material facts about its inquiry into, or knowledge concerning, the opinion.
In Bielousov v. GoPro, Inc., 2017 WL 3168522 (N.D. Cal. July 26, 2017), the court considered whether the CFO’s statement “We believe we’re still on track to make [GoPro’s financial guidance] as well” was a forward-looking statement covered by the PSLRA’s safe harbor. The court held that because the CFO included the phrase “we believe” in his statement, it was a statement of present opinion about “his and GoPro’s existing state of mind.” Accordingly, the PSLRA’s safe harbor did not apply and the statement should be examined under the Omnicare standard.
Holding: Motion to dismiss denied.
If an individual defendant’s stock trading took place pursuant to a pre-determined Rule 10b5-1 trading plan that was entered into before the outset of the alleged fraud, the use of the trading plan may undermine any inference that the trades were “suspicious” for purposes of assessing scienter (i.e., fraudulent intent). As part of this analysis, however, does a court have to accept that the beginning of the class period constitutes the outset of the alleged fraud?
In Harrington v. Tetraphase Pharma., Inc., 2017 WL 1946305 (D. Mass. May 9, 2017), the plaintiffs claimed that the company “knew that the drug they were testing would fail long before that information was released to the public.” The alleged timeline was that the class period began on March 5, 2015, two of the individual defendants entered into Rule 10b5-1 trading plans on March 13, 2015, and the company became aware of the results of its clinical testing as of late April or early May 2015. In assessing the impact of the Rule 10b5-1 trading plans on its scienter analysis, the court noted that the plans “were executed before even Plaintiffs argue that defendants possessed results from the pivotal portion of the [clinical trial].” Accordingly, the court rejected the idea that it was forced to accept, for purposes of analyzing the impact of the trading plans, that the alleged fraud began at the beginning of the class period. Instead, the court concluded that the “reasonable inference from the alleged facts” was that the fraud began after the two individual defendants entered into their trading plans and, as a result, their subsequent trading was not suspicious.
Holding: Motion to dismiss granted (on the basis that the plaintiffs had failed to establish a strong inference of scienter as to any of the defendants).
Can a company face securities fraud liability for describing a lawsuit brought against it as “meritless” if the plaintiff goes on to win a big verdict? In Grobler v. Neovasc, Inc., 2016 WL 6897760 (D. Mass. Nov. 22, 2016), Neovasc was hit with a $70 million verdict in a case alleging that it stole intellectual property, its stock price declined by 75 percent when the verdict was announced, and investors brought a securities class action. The investors alleged that Neovasc had lied when it repeatedly told them that the intellectual property case was “without merit” and “baseless.”
The district court concluded that the PSLRA’s safe harbor for forward-looking statements applied to Neovasc’s statements. First, the statements “were predictions about the future outcome of the pending litigation, and could only be invalidated by reference to the ultimate outcome of the case.” Second, the statements were accompanied by meaningful cautionary language that “included detailed and specific warnings about the possibility and the consequences of losing” the intellectual property case. Finally, whether Neovasc actually believed that it was likely to lose the intellectual property case was irrelevant because “examining an alleged present belief apart from the forward-looking aspects of the statement requires an inquiry into the state of mind of the defendant—something that the first prong of the safe harbor provision is written to ignore.” Accordingly, the court found that the alleged false statements were inactionable.
Holding: Motion to dismiss granted with prejudice.
In securities class actions, plaintiffs sometimes struggle to establish loss causation where the market does not react consistently to the “revelations of the truth.” An interesting recent example can be found in a decision from the District of Nevada involving a gold mining company.
In In re Allied Nevada Gold Corp. Sec. Litig., 2016 WL 4191017 (D. Nev. August 8, 2016), the plaintiffs alleged that the company had misled investors about its operational difficulties, cash position, and projected financial performance. According to the plaintiffs, these problems were slowly revealed to the market in a series of partial disclosures ending in August 2013. All of the alleged partial disclosures, however, did not result in stock price declines.
The July 2013 partial disclosure, for example, led to a stock price increase. The plaintiffs attributed this anomaly to “surging gold prices.” The problem with that position, however, was that the subsequent August 2013 partial disclosure and stock price decline occurred in the midst of a sharp drop in gold prices. The court found that “[p]laintiffs have not offered an adequate explanation as to why Allied’s stock price was tied to the price of gold after one disclosure but not the other.” Accordingly, the court held that “[p]laintiffs have not adequately alleged that the alleged misrepresentations were a substantial cause in the decline in value of their stock.”
Held: Motion to dismiss granted (plaintiffs also failed to adequately allege falsity and scienter).
A number of years ago, the U. S. Court of Appeals for the Fourth Circuit addressed whether a company’s false statement about its CEO’s educational background was material. The court found that the statement was immaterial as a matter of law, even though the company’s stock price dropped significantly once the truth about the CEO’s lack of an undergraduate economics degree was revealed to the market. But is that true of any false statement in a corporate biography?
In Kelsey v. Textura Corp., 2016 WL 825236 (N.D. Illinois March 2, 2016), the court confronted a similar situation. As part of Textura’s initial public offering, the company issued a prospectus and registration statement containing its CEO’s biography. The biography provided a number of details about the CEO’s prior work history, but failed to disclose that the CEO previously had been the CEO of another company and, in that position, had been accused by an auditor of providing the auditor with false information. Indeed, the auditor later announced that it could no longer rely upon the CEO’s representations.
Textura argued that under the applicable SEC regulation, it was only required to provide investors with the last five years of the CEO’s business experience. During that period of time, the CEO had worked at Textura. The court found, however, that once Textura chose to speak about the CEO’s prior work history, it “had a duty to do so in a manner that was not misleading.” Indeed, the court concluded that the CEO’s prior work history clearly was material because Textura chose to include it even though it was not required to do so. The court therefore denied the defendants’ motion to dismiss as to the alleged omission in the CEO’s biography.
Holding: Denying in part and granting in part the motion to dismiss.
Quote of note: “The court rejects defendants’ argument that they did not ‘tout’ [the CEO’s] prior experience. Having convincingly argued that it was not required to include any of [the CEO’s] prior experience, there could be no other reason from them deciding to do so.”