Category Archives: Uncategorized

Specific Issues

It is common for a securities class action to follow an announcement that a company has engaged in Foreign Corrupt Practices Act (FCPA) violations.  Plaintiffs typically allege that the company’s statements about its legal compliance, internal controls, and/or financial results were rendered false or misleading by the failure to disclose that certain revenues were obtained through corruption.

In Doshi v. General Cable Corp., 2019 WL 1965159 (E.D. Ky. April 30, 2019), General Cable entered into settlements with the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) over FCPA violations.  As part of a non-prosecution agreement with the DOJ, the company admitted that it knew about certain corrupt payments and “knowingly and willfully failed to implement and maintain an adequate system of internal accounting controls designed to detect and prevent corruption or other illegal payments by its agents.”  The court’s motion to dismiss ruling contains three interesting holdings.

First, there is a two-year statute of limitations for federal securities fraud claims, which begins to run when the “plaintiff did discover or a reasonably diligent plaintiff would have discovered the the facts constituting the violation.”  Although the complaint was filed more than two years after General Cable first disclosed the possibility of FCPA violations, the court held that the claims were not barred by the statute of limitations because there was no available evidence of scienter (i.e., fraudulent intent) until the company entered into the government settlements.

Second, the court found that the only actionable misstatements made by General Cable related to its statements concerning the effectiveness of its internal controls over financial reporting (including SOX certifications).  The company’s disclosure that it had a FCPA compliance program was not rendered false or misleading by the fact that the program was not effective.  The company also had no obligation to disclose a theoretical risk that its overseas operations might fail if it could not rely on corrupt business practices.

Finally, despite its holdings regarding the statute of limitations and the existence of actionable misstatements, the court concluded that the plaintiffs had failed to adequately plead scienter.  The company’s settlements with the government established that “GC knew it did not have controls that provided a sufficient framework for dealing with third-parties in the identified subsidiaries and GC knew that this allowed it to violate the FCPA in particular countries.”  However, the court held, “this does not mean that GC knew its overall internal controls over financial reporting were not effective, nor does it mean that GC knew its SOX certifications – which do not specifically relate to the FCPA – were false.”  In other words, the court found that the “most plausible inference” was that GC believed that its overall financial reporting system was “sound despite a specific FCPA-related issue.”

Holding: Motion to dismiss granted.

Leave a comment

Filed under Motion To Dismiss Monitor, Uncategorized

Slim To None (And Slim Just Left Town)

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.

Leave a comment

Filed under Motion To Dismiss Monitor, Uncategorized

Emulex Dismissed

On Tuesday, the U.S. Supreme Court dismissed the writ of certiorari in the Emulex case as “improvidently granted.”

The author of The 10b-5 Daily has an op-ed on Law360 discussing the ramifications of the decision (which also can be viewed here).

Leave a comment

Filed under Appellate Monitor, Uncategorized

Emulex Argued

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).

Leave a comment

Filed under Appellate Monitor, Uncategorized

Lorenzo Decided

The U.S. Supreme Court has issued a decision in the Lorenzo v. SEC case holding that an individual who disseminates false statements to investors (even if the statements were made by someone else) can be primarily liable for securities fraud under Section 10(b) of the Exchange Act and SEC Rule 10b-5.  It is a 6-2 decision authored by Justice Breyer.

In Lorenzo, the court addressed an action by the Securities and Exchange Commission (SEC) against the director of investment banking at a brokerage.  Lorenzo sent e-mails to investors, the contents of which were provided to him by his boss, that he knew falsely touted a potential investment.  In an administrative action, the SEC found that Lorenzo had violated Section 10(b) and Rule 10b-5 and, on appeal, the D.C. Circuit affirmed that ruling.

Before the Court, Lorenzo argued that his case should be governed by subsection (b) of Rule 10b-5, which specifically addresses misstatements.  The Court – in its 2011 decision in Janus – had held that an individual who does not have “ultimate authority” over a misstatement is not its “maker” and cannot be primarily liable under subsection (b).  Given that Lorenzo’s boss was the maker of the misstatements (which the SEC did not contest), Lorenzo concluded that he should not have faced primary liability for his actions.

Rule 10b-5, however, contains two other subsections.  By their plain language, subsections (a) and (c) cover a wide range of potential conduct, including “employing” a “device,” “scheme,” or “artifice to defraud” and “engaging in any act, practice, or course of business” that “operates . . . as a fraud or deceit.”  The Court found it “obvious” that “the words in these provisions are, as ordinarily used, sufficiently broad to include within their scope the dissemination of false or misleading information with the intent to defraud.”  As to whether applying these subsections in a misstatements case would render subsection (b) “superfluous,” the Court concluded that the subsections are not mutually exclusive and any other conclusion “would mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether.”

In a vigorous dissent, Justice Thomas (joined by Justice Gorsuch)), argued that the majority decision “eviscerates” the Janus distinction between primary and secondary liability.  Justice Thomas noted that this will have a wide impact on the enforcement of the securities laws, because “virtually any person who assists with the making of a fraudulent misstatement will be primarily liable and thereby subject not only to SEC enforcement, but private lawsuits.”  Moreover, this potential liability could extend widely to anyone who participates in the dissemination of misstatements, including administrative employees (secretaries, mail clerks, etc.).

Held: Judgment affirmed.

Quote of note: “Coupled with the Rule’s expansive language, which readily embraces the conduct before us, this considerable overlap suggests we should not hesitate to hold that Lorenzo’s conduct ran afoul of subsections (a) and (c), as well as the related statutory provisions.  Our conviction is strengthened by the fact that we here confront behavior that, though plainly fraudulent, might otherwise fall outside the scope of the Rule. Lorenzo’s view that subsection (b), the making-false-statements provision, exclusively regulates conduct involving false or misleading statements would mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether. But using false representations to induce the purchase of securities would seem a paradigmatic example of securities fraud.  We do not know why Congress or the Commission would have wanted to disarm enforcement in this way.”

Note: The absence of aider and abettor liability in private actions alleging violations of Section 10(b) and Rule 10b-5 means that who can be subject to primary liability is a crucial question.  Just as Janus resulted in significant litigation over who is a “maker” of corporate statements, Lorenzo is likely to lead to significant litigation over who is a “distributor” of corporate statements.  Stay tuned.

Disclaimer: The author of The 10b-5 Daily assisted with the submission of an amicus brief by a group of law professors in support of the petitioner.

Leave a comment

Filed under Uncategorized

Voila!

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.”

Leave a comment

Filed under Appellate Monitor, Uncategorized

Compare and Contrast

NERA Economic Consulting and Cornerstone Research have released their respective 2018 annual reports on federal securities class action filings.  As usual, the different methodologies employed by the two organizations have led to different numbers, although they both identify the same general trends.

The findings for 2018 include:

(1) The reports agree that filings continue to be at near-record levels, driven by a steady growth in “standard” filings alleging violations of Rule 10b-5, Section 11, and/or Section 12 and the continued shift to federal court of M&A-related cases.  NERA finds that there were 441 filings (compared with 434 filings in 2017), while Cornerstone finds that there were 403 filings (compared with 412 filings in 2017).

(2) Both NERA and Cornerstone report that approximately 8% of publicly-listed companies were subject to securities class actions in 2018.  While that is an all-time high, it also is a function of the fact that the overall number of publicly-listed companies has declined substantially over the last 25 years (the result of a combination of fewer IPOs and M&A activity).

(3) Filings against foreign issuers had steadily increased from 2013-2017, with these companies facing a disproportionate (as compared to their percentage of listings) risk of securities class action litigation.  In 2018, however, both NERA and Cornerstone find a decrease in these filings, although the overall number of filings against foreign issuers (Cornerstone – 47; NERA – 43) remains high as compared to the historical average.

(4) NERA reports that, in 2013, 24% of filings alleging violations of Rule 10b-5 contained insider trading allegations.  That percentage has dropped precipitously since 2013, with only 5% of last year’s filings containing insider trading allegations.  NERA attributes the decline to the regulatory crackdown on insider trading and the increased corporate use of Rule 10b5-1 trading plans.

(5) NERA finds that the average settlement value for standard cases (excluding settlements over $1 billion) increased from $25 million (2017) to $30 million (2018). Meanwhile, the median settlement value for these cases increased from $6 million (2017) to $13 million (2018).

The NERA report can be found here.  The Cornerstone report can be found here.

Leave a comment

Filed under Lies, Damn Lies, And Statistics, Uncategorized