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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Back In The Saddle

After fifteen years of publishing The 10b-5 Daily, it was good to take a short sabbatical!  But with the new year, this blog is back up and running.  So let’s get to it.

On Friday, the U.S. Supreme Court granted certiorari in Emulex Corp. v. Varjabedian, setting up a battle over actions brought under Section 14 of the Securities Exchange Act.

In its petition, Emulex presented the following question:

Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.

The direct question presented is a narrow dispute over the Section 14(e) state of mind requirement – i.e., does a private plaintiff need to show that the defendant acted with negligence or scienter (i.e., fraudulent intent)?  That said, there are a few ways the case could have a broader impact.

First, although the question presented refers to a “private right of action,” any determination as to the required state of mind also would apply to actions brought by the government.

Second, there is a related statutory provision – Section 14(a) – that addresses misstatements or omissions made in connection with proxy solicitations.  The state of mind requirement for actions brought under Section 14(a) also is the subject of a circuit split and may be impacted by the Court’s decision.

Finally, there is some question as to whether there should be an inferred private right of action under Section 14(e) at all (despite the fact that a number of lower courts have found that one exists).  In its amicus brief filed in support of the cert petition, the U.S. Chamber of Commerce argued that the Court should address this threshold issue and find that only the government can bring an action to enforce Section 14(e).

Stay tuned.

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Mr. Roberts Moves Firms

On a personal note, Lyle Roberts (the author of The 10b-5 Daily) has joined the Washington, DC office of Shearman & Sterling LLP.  The firm’s press release can be found here.  Posting has been correspondingly light, but something new should be up soon!

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Cyan Decided

The U.S. Supreme Court has issued a decision in the Cyan v. Beaver County Employees Retirement Fund case holding that the Securities Litigation Uniform Standards Act of 1998 (SLUSA) does not divest state courts of jurisdiction over class actions asserting claims arising under the Securities Act of 1933 (e.g., claims alleging a material misstatement in a registration statement).  It is a unanimous decision authored by Justice Kagan.

Cases alleging 1933 Act claims historically have enjoyed concurrent jurisdiction in state or federal court.  In Cyan, the court considered whether SLUSA’s text and legislative purpose mandated that these cases – if brought as class actions – must be heard in federal court.  There was good reason to believe that Congress may have intended that outcome.  The overall purpose of SLUSA was to prohibit plaintiffs from bringing securities class actions based on state law.  As Justice Alito suggested at the Cyan oral argument, why would Congress want to bar “a claim in state court under a state cause of action that mirrors the ’33 Act” but then allow “the state court to be able to entertain the real thing, an actual ’33 Act [claim].”

In the Cyan decision, however, the Court concluded that the “recalcitrant statutory language” did not allow it to conclude that SLUSA had divested state courts of jurisdiction.  SLUSA modified the concurrent jurisdiction provision in the 1933 Act by adding an except clause – “except as provided in section 77p of this title with respect to covered class actions.”  Defendants argued that the except clause’s reference to “covered class actions” was intended to direct the reader to the definition of “covered class actions” in section 77p(f)(2), which defines that term to mean any suit (whether based on state or federal law) seeking damages on behalf of more than 50 persons.   In other words, SLUSA made concurrent jurisdiction unavailable for class actions.

The Court disagreed.  First, the Court noted that Congress could have expressly pointed to the “covered class action” definition in its except clause, but instead referred generally to section 77p.  Given that section 77p makes no specific reference to securities class actions based on federal law, there is no reason to think that Congress intended its except clause to be read to alter the existence of state court jurisdiction for those cases.  Second, the Court found that “the definitional paragraph on which Cyan relies cannot be read to ‘provide[]’ an ‘except[ion]’ to the rule of concurrent jurisdiction” because a “definition does not provide an exception, but instead gives meaning to a term—and Congress well knows the difference between those two functions.”  To find otherwise would be to conclude that Congress decided to make a radical change to the securities laws through a conforming statutory amendment and Congress does not “hide elephants in mouseholes.”

The Court also held that leaving concurrent jurisdiction intact does not undermine SLUSA’s objectives.  SLUSA’s primary purpose of barring state-law securities class actions “does not depend on stripping state courts of jurisdiction over 1933 Act class suits.”  Moreover, SLUSA still ensures that “the bulk of securities class actions [will] proceed in federal court – because the 1934 Act regulates all trading of securities whereas the 1933 Act addresses only securities offerings.”   While the Court conceded that its reading of the except clause leaves open the question of why Congress included that clause at all (although there are possible explanations), it found that this “does not matter” because “we have no sound basis for giving the except clause a broader reading than its language can bear.”

Holding: Judgement below affirmed.  (The Court also rejected a compromise position put forward by federal government.)

Quote of note: “[T]his Court has no license to disregard clear language based on an intuition that Congress must have intended something broader.  SLUSA did quite a bit to ‘make good on the promise of the Reform Act’ (as Cyan puts it).  If further steps are needed, they are up to Congress.”

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