For Our Teenage Readers

While the Second Circuit and Ninth Circuit hear many securities cases and have a wealth of relevant case law, other circuits are still dealing with common issues that they have not yet had a chance to address.  In Carvelli v. Ocwen Financial Corp., 2019 WL 3819305 (11th Cir. Aug. 15, 2019), the Eleventh Circuit examined two issues of first impression: puffery and Item 303.

Puffery – Puffery is generalized, vague, non-quantifiable statements of corporate optimism.  Courts have found that these types of statements are immaterial as a matter of law and, as a result, cannot form the basis for a securities fraud claim.  In Carvelli, the court noted that while the Eleventh Circuit has not addressed the concept in the context of a securities case, “puffery itself—and in particular its relevance to the law—is nothing new.”  Indeed, it appears in nineteenth-century English case law, where courts found that “some advertisements—’mere puff’— clearly aren’t meant to be taken seriously.”

The Eleventh Circuit had little trouble finding that puffery can be a barrier to a securities fraud claim, but cautioned that it was not merely a matter of the court determining that the particular statement “smacks of puff.”  Instead, a “conclusion that a statement constitutes puffery doesn’t absolve the reviewing court of the duty to consider the possibility—however remote—that in context and in light of the ‘total mix’ of available information, a reasonable investor might nonetheless attach importance to the statement.”  In the instant case, however, “Ocwen’s proclamations that it was devoting ‘substantial resources’ to its problems, with ‘improved results,’ as well as its boasts that it was taking a ‘leading role’ and making ‘progress’ toward compliance are precisely the sorts of statements that our sister circuits have—we think correctly—deemed puffery and found immaterial as a matter of law.”

Item 303 – Item 303 of Regulation S-K requires issuers to disclose known trends or uncertainties “reasonably likely” to have a material effect on operations, capital, and liquidity.  In Carvelli, the plaintiffs argued that the failure to make a disclosure required under Item 303 automatically can lead to Rule 10b-5 liability based on the existence of a material omission.  The Third Circuit and Ninth Circuit (and, to a lesser extent, the Second Circuit) have rejected that argument.  The Eleventh Circuit agreed with those decisions, holding that “Item 303 imposes a more sweeping disclosure obligation than Rule 10b-5, such that a violation of the former does not ipso facto indicate a violation of the latter.”

Holding: Dismissal affirmed.

Quote of note: “As Judge Learned Hand once put it, ‘[t]here are some kinds of talk which no sensible man takes seriously, and if he does he suffers from his credulity.” Vulcan Metals Co. v. Simmons Mfg. Co., 248 F. 853, 856 (2d Cir. 1918).  Think, for example, Disneyland’s claim to be ‘The Happiest Place on Earth.’  Or Avis’s boast, ‘We Just Try Harder.’  Or Dunkin Donuts’s assertion that ‘America runs on Dunkin.’  Or (for our teenage readers) Sony’s statement that its PlayStation 3 ‘Only Does Everything.’  These boasts and others like them are widely regarded as ‘puff’—big claims with little substance.”

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Compare and Contrast – Midyear 2019

NERA Economic Consulting and Cornerstone Research have released their 2019 midyear reports on securities class action filings.  As usual, the different methodologies employed by the two organizations have led to slightly different numbers, although they both identify the same general trends.

The key findings include:

(1) The reports agree that filings continue to be at near-record levels, driven by continued growth in “standard” filings alleging violations of Rule 10b-5, Section 11, and/or Section 12, even while M&A-related cases have declined.  NERA finds that there were 218 filings (compared with 217 filings in 1H 2018), while Cornerstone finds that there were 198 filings (compared with 199 filings in 1H 2018).

(2) Following the Cyan decision by the U.S. Supreme Court, there has been a surge in state court filings alleging Section 11 claims.  Cornerstone finds that this has continued in 1H 2019, with 19 cases brought in state courts (with over a third of these cases being accompanied by a federal filing alleging similar claims).

(3) NERA finds that there has been an increase in accounting-related claims, making up 37% of standard filings and notching the highest first half case count since the first half of 2011.

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

 

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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.

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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.

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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).

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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).

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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.

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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.”

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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.

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Fifty Person Limit

The Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) precludes any “covered class action” based upon state law that alleges a misrepresentation in connection with the purchase or sale of nationally traded securities.  The defendants are permitted to remove the case to federal district court for a determination as to whether the case is precluded by the statute.  If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.

SLUSA has a bifurcated definition of “covered class action” for a single lawsuit.  The action qualifies as a covered class action when (in relevant part) either (a) damages are sought on behalf of more than 50 persons or prospective class members; or (b) one or more named parties seek to recover damages on a representative basis on behalf of themselves and other unnamed parties similarly situated.

In Nielen-Thomas v. Concorde Investment Services, LLC, 2019 WL 302766 (7th Cir. Jan. 24, 2019), the Seventh Circuit considered whether a putative class action meeting all of the other requirements for SLUSA preclusion, but brought on behalf of “between thirty-five and forty-nine members,” should be allowed to proceed in state court.  The plaintiffs argued that the two definitions of “covered class action” were “separate, independent bases for excluding securities class actions from SLUSA’s proscriptions” so that being excluded under one was sufficient, or, alternatively, the fifty-person threshold must apply to both definitions to avoid making the second definition superfluous.  The Seventh Circuit disagreed.

The Seventh Circuit found that while there was an overlap between the two definitions, each had a separate meaning.  Under the first definition, the action could “be treated as a class action even if all plaintiffs are identified in the complaint and no plaintiff is pursuing claims as a representative on behalf of others, if there are more than fifty such plaintiffs and SLUSA’s other requirements are met.”  The second definition, in contrast, “includes any action brought as a putative class action in the traditional Rule 23 meaning of the term.”  The Seventh Circuit also found that this interpretation is consistent with SLUSA’s purpose and legislative history, noting that Congress wanted to prevent plaintiffs from circumventing the barriers to federal securities class actions by simply filing them in state court (no matter how large the size of the class).  Because the case before the court clearly was a putative class action, it fell within the second definition and was precluded.

Holding: Dismissal affirmed.

Quote of note:  “To the extent the identities of any of the other putative class members are known, and these individuals wish to pursue claims on their own behalf in state court under state law, nothing in SLUSA prevents them from doing so (provided there are fewer than fifty such plaintiffs for which common questions of law or fact predominate).  What SLUSA does preclude these individuals from doing is continuing to pursue their claims in the form of a class action.”

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