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.”
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.”