Yelp is an online networking platform that hosts user-generated reviews of local businesses. In a recent securities class action (Curry v. Yelp, Inc., 2015 WL 7454137 (N.D. Cal. Nov. 24, 2015)), the court considered claims that Yelp made misstatements about the authenticity of the reviews hosted on the company’s website and whether the company manipulated reviews in favor of businesses that advertised on the website.
In its original motion to dismiss order, the court held that the disclosure of the existence of FTC complaints in a WSJ article about Yelp could not demonstrate either materiality or loss causation. The company previously had disclosed the existence of media reports and lawsuits about review manipulation, leading the court to conclude that the article did not alter the total mix of information available to the market. Moreover, the article could not support the existence of loss causation because the FTC complaints merely alerted the market to the possibility that further investigations by the FTC could establish at some later time that the company had made false statements.
In their amended complaint, Plaintiffs responded to these holdings by including the results of an event study purporting to show that the decline in Yelp’s stock price on the day of the WSJ article “was statistically significant and the direct result of the new information contained within The Wall Street Journal’s article.” According to the court, however, a key problem with this event study was that the WSJ article had been published after the close of the market that day and itself stated that “Yelp was down 6% . . . in Wednesday afternoon trading in the wake of the [FTC] disclosure.” The WSJ article therefore could not have revealed material information or caused the stock price decline. Moreover, the amended complaint failed to specify when the FTC disclosure was made or whether it did anything other than disclose that the FTC had received a certain number of complaints about Yelp. Under these circumstances, the court also could not find that the FTC disclosure itself demonstrated either materiality or loss causation.
Holding: Motion to dismiss granted with prejudice.
In its Omnicare decision issued earlier this year, 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. In Firefighters Pension & Relief Fund of The City of New Orleans v. Buhlman, 2015 WL 7454598 (E.D. La. Nov. 23, 2015), the court had the opportunity to address two interesting questions about Omnicare‘s scope.
First, does Omnicare‘s reasoning extend to securities fraud claims brought under Section 10(b) of the Securities Exchange Act of 1934? A handful of district courts have found that it does. See., e.g., In re Genworth Fin. Inc. Sec. Litig., 2015 WL 2061989 (E.D. Va. Mar. 1, 2015). The Firefighters Pension court, however, went the other way. In particular, the court concluded that Omnicare‘s creation of “liability for statements of opinions that are genuinely held but misleading to a reasonable investor” could not be reconciled with the scienter requirement for securities fraud. Accordingly, the court held that Omnicare “does not directly apply” to Section 10(b) claims.
Second, does Omnicare apply to forward-looking statements of opinions (e.g., financial projections) and thereby modify the PSLRA’s safe harbor for forward-looking statements? The Firefighters Pension court noted that “the opinion statements at issue in Omnicare centered on the lawfulness of the issuer’s existing contracts” and were not forward-looking. Omnicare therefore did not address or purport to modify the PSLRA’s safe harbor.
Holding: Motion to dismiss granted.
If a securities class action is dismissed prior to class certification, is there anything stopping another investor from bringing the same case again? In Dempsey v. Vieau, et al., 2015 WL 5231339 (S.D.N.Y. Sept. 8, 2015), the defendants (former officers and directors of A123 Systems, Inc.) argued that the case was barred by the doctrine of res judicata because a District of Massachusetts court previously had dismissed a substantially similar case brought by a different plaintiff.
The Supreme Court has held that a proposed class action or a rejected class action cannot bind nonparties. The defendants argued that under the Private Securities Litigation Reform Act, however, the appointed lead plaintiff is charged with representing the class. Accordingly, once the earlier securities class action was dismissed with prejudice, that ruling had a preclusive effect on any putative class member who sought to bring the suit again.
The district court disagreed, finding that there is “nothing in the plain language of the Private Securities Litigation Reform Act (“PSLRA”) that would preclude later litigation by an absent class member of a previously dismissed putative class action prior to certification, so long as the statute of limitations has not run.” In sum, “lead plaintiff designation does not abnegate the necessity of class certification” for purposes of res judicata preclusion.
Holding: Denied motion on res judicata grounds, but dismissed case based on the plaintiffs’ failure to adequately plead their claims.
In re Galena Biopharma, Inc. Sec. Litig., 2015 WL 4643474 (D. Or. Aug. 5, 2015) involves an interesting fact pattern. The defendants are alleged to have “entered into an unlawful promotional scheme” that included the placement of “misleading articles on investor websites touting Galena.” These articles allegedly were written by a stock promotion company hired by the company.
Plaintiffs argued that both Galena and the stock promotion company could be held primarily liable for the alleged misstatements contained in the web articles. Under the Janus decision, however, primary liability is limited to the maker of the statement – i.e., “the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” The court rejected the idea that the individual authors (to whom the statements were attributed) or the stock promotion company (who employed the authors) were the makers of the statements. Instead, the court found that the “lesson of Janus is that where legally distinct entities are involved, only one entity has the final say in what, if anything, is published.” Because the plaintiffs had adequately alleged that Galena and its officers “had the final word regarding approved content and whether the article would be published,” primary liability for the alleged Rule 10b-5(b) violations was limited to those defendants.
Holding: Motion to dismiss denied in part and granted in part. The extensive decision contains a number of other holdings, including on the issues of scienter, scheme liability, the applicability of the fraud-on-the-market presumption of reliance, and loss causation.
Quote of note: “If the Court were to consider the individual authors [who worked for the stock promotion company] as the makers of those statements, then companies could avoid liability under the Exchange Act simply by paying third parties to write and publish false or misleading statements about the company, even when the company retains final decision-making authority over the content. The holding in Janus does not support such a broad reading.”
Is it possible for a securities class action based on alleged misrepresentations in a company’s public filings to proceed against an individual officer, but not the company (presuming the company is not otherwise immune from suit)? The answer is yes, but the circumstances will be unusual.
In Nathanson v. Polycom, et al., 2015 WL 1517777 (N.D. Cal. April 3, 2015), the plaintiffs alleged that as the result of the former CEO’s improperly claimed personal expenses, the company misstated its operating expenses and failed to disclose that the CEO would be subject to termination. The court found that the plaintiffs had adequately alleged the existence of material misstatements and, as to the CEO, a strong inference of scienter.
Normally, a CEO’s scienter can be imputed to the company based on the law of agency, but that rule is subject to an “adverse interest exception” in cases where the officer acted purely out of self-interest and his conduct did not benefit the company. The improper claiming of personal expenses did not benefit Polycom. Accordingly, the court concluded that the adverse interest exception applied, the CEO’s scienter could not be imputed to Polycom, and, as a result, the case could not proceed against the company.
Holding: Motion to dismiss granted in part (Polycom and other individual defendants) and denied in part (former CEO).
The core operations theory, as developed in the Ninth Circuit, holds that it may be possible to infer a strong inference of scienter in situations where the nature of the alleged fraud “is of such prominence that it would be ‘absurd’ to suggest that the management was without knowledge of the matter.” The theory has come under criticism from other courts and there are relatively few reported decisions where it has been successfully invoked.
In Patel v. Axesstel, Inc., 2015 WL 631525 (S.D. Cal. Feb. 13, 2015), however, the court found the alleged facts supported the application of the core operations theory. As the court summarized the situation: “it would be absurd to think that the CEO and CFO of a company with just thirty-five employees, or whom only ten are involved in sales, general or administration, would be unaware of the lack of written agreements or definitive payment terms with the five new customers in Africa that represented the company’s first sales of a significant new product that constituted between twenty and forty percent of Axesstel’s overall revenue.” Moreover, the individual defendants made “numerous statements . . . indicating that they were directly involved in sales and knew the details of Axesstel’s dealings with its African customers.” Accordingly, the court held that the plaintiffs had adequately plead a strong inference of scienter.
Holding: Motion to dismiss denied.
Quote of note: “[The individual defendants’] roles in Axesstel are magnified by the exceedingly small size of the company. Axesstel is not to be confused with Apple. The individual defendants here are not officers in a large company who may be removed from the details of a specific business line or remote business activity.”
The long-running saga of the Boeing securities litigation is apparently coming to a close. In 2011, the district court granted the company’s motion to dismiss (on a motion for reconsideration) after it was determined that the key confidential witness denied being the source of the allegations attributed to him in the complaint, denied having worked for Boeing, and claimed to have never met plaintiffs’ counsel until his deposition.
The plaintiffs appealed this decision to the U.S. Court of Appeals for the Seventh Circuit. Not only did the Seventh Circuit affirm the dismissal, but it also strongly suggested that sanctions were appropriate in the case, noting that the “failure to inquire further [about the supposed evidence from the confidential witness] puts one in mind of ostrich tactics – of failing to inquire for fear that the inquiry might reveal stronger evidence of their scienter regarding the authenticity of the confidential source than the flimsy evidence of scienter they were able to marshal against Boeing.” The appellate court remanded the case to the district court to determine whether sanctions should be imposed.
In City of Livonia Employees’ Retirement System v. The Boeing Company, 2014 WL 4199136 (N.D. Ill. August 21, 2014), the district court examined the conduct at issue. First, the court found that the plaintiffs’ counsel should have interviewed the confidential witness before the filing of the initial complaint and that not doing so constituted “a failure to conduct a reasonable pre-filing investigation as required by the PSLRA.” Second, once the confidential witness had been interviewed by an investigator, the court concluded that it should have been clear to the plaintiffs’ counsel that it “did not have reasonable cause to trust the accuracy of the information obtained by the investigator because the investigator herself noted in her report that some of the information [the confidential witness] provided was unreliable.” Finally, even after the confidential witness told the investigator that “he no longer wished to cooperate with Plaintiffs,” the plaintiffs’ counsel filed a second amended complaint attributing key allegations to the confidential witness and “repeatedly made assurances to the court as to the truth of the allegations.” The court also noted that this was not the first time that the plaintiffs’ counsel had engaged in this type of misconduct. Under these circumstances, the court held that the imposition of sanctions was warranted.
Holding: Imposing Rule 11 sanctions and encouraging the parties to mediate and settle the issue of what constituted “reasonable attorneys’ fees and other expenses incurred in defending the lawsuit.”
Securities class actions brought against China-based companies often allege discrepancies between the company’s Chinese regulatory filings and SEC filings. In that type of case, the plaintiff must allege at least some facts to support that (1) the SEC figures, and not the Chinese figures, are false, and (2) any variation is not attributable to variations in reporting rules or accounting standards.
In In re Silvercorp Metals, Inc. Sec. Lit., 2014 WL 2839440 (S.D.N.Y. June 23, 2014), the court addressed allegations that Silvercorp materially misrepresented three important metrics at its key Chinese mine. As alleged in the complaint, “the metrics reported in the SEC filings were dramatically different from those filed with Chinese authorities under the well-developed legal and regulatory regimes established by the Chiese central government and by Henan province, which are strictly implemented.” The defendants argued that the plaintiffs were comparing “apples and oranges” because the Chinese filing covered only part of the mine’s output.
The court disagreed, finding that whether the Chinese filing “is apple, orange, or lychee, plaintiffs have adequately pleaded that it uses the same denominator as the SEC filings, i.e., the whole of the [Chinese] mine.” Indeed, “the Court may not prematurely determine the truth of plaintiffs’ allegation that the comparison is proper, though it expects to be aided by affidavits from dueling experts in Chinese mining law if summary judgment is sought.”
Holding: Motion to dismiss denied as to corporate defendant.
A complaint that includes damaging statements from a confidential witness who used to carpool with the company’s CEO and CFO seems like it should survive a motion to dismiss, but it may depend on how the plaintiffs frame the allegations. In In re Maxwell Technologies, Inc. Sec. Litig., 2014 WL 1796694 (S.D. Cal. May 5, 2014), the plaintiffs alleged that the company and its senior officers had engaged in a scheme to fraudulently recognize revenue. The court’s decision addressed a couple of interesting pleading issues.
(1) Corporate scienter – The requirements for corporate scienter continue to be an open question in the Ninth Circuit. The court found while a corporation can be held responsible for the actions of its executives, corporate scienter cannot be “based only upon the scienter of a non-defendant who did not make or certify the statements at issue.” Accordingly, the plaintiffs needed to demonstrate that one of the named defendants (the CEO and CFO) had acted with scienter.
(2) Confidential witnesses – The plaintiffs based their scienter allegations largely on statements from confidential witnesses. These witnesses included a senior director for global sales and marketing who (a) was fired for having a role in the revenue recognition issues, and (b) used to carpool with the CEO and CFO and reportedly heard them talking about taking certain actions necessary to “make the numbers.” The court, however, took issue with how the confidential witness statements were plead, noting that it was often difficult to determine what the witnesses had actually said as opposed to the plaintiffs’ characterizations of those statements. With respect to the carpooling senior director, the statements “certainly indicate that CW4 may have heard or seen something from which this Court could infer scienter . . . but many of the statements about the role of [the CEO and CFO] are conclusory and without foundation.”
Holding: Dismissed without prejudice based on the failure to sufficiently allege scienter.
There are two prongs to the PSLRA’s safe harbor for forward-looking statements. First, a defendant is not liable with respect to any forward-looking statement that is identified as forward-looking and is accompanied by “meaningful cautionary statements” alerting investors to the factors that could cause actual results to differ. Second, a defendant is not be liable with respect to any forward-looking statement, even in the absence of meaningful cautionary statements, if the plaintiff cannot establish that the statement was made with “actual knowledge” that it was false or misleading.
Although the circuit courts agree that the two prongs operate separately, they are split as to whether the defendant’s state of mind should be considered in determining whether the cautionary statements are sufficiently “meaningful.” The Sixth, Ninth, and Eleventh Circuits have held that the defendant’s state of mind is irrelevant. The Seventh and Second Circuits, however, have suggested that it might be necessary to inquire into what the defendant knew about the risks facing the company before making that determination.
In In re Harman Int’l Indus., Inc. Sec. Litig., 2014 WL 197919 (D.D.C. Jan. 17, 2014), the district court agreed with the majority position and found that the defendant’s state of mind is irrelevant. First, the plain text and the legislative history of the PSLRA make it clear that the first prong should be considered without reference to the defendant’s state of mind. Second, considering the defendant’s state of mind would improperly collapse the two prongs together, essentially making it impossible for a defendant to invoke the first prong at the pleadings stage of the case.
Holding: Motion to dismiss granted.