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.”
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).
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!
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.”
As The 10b-5 Daily recently has noted, it is difficult for corporate defendants to avoid securities fraud liability when they fail to disclose hidden wrongdoing at the company. But what if the company’s CEO is engaged in hidden wrongdoing at a different company?
In Fries v. Northern Oil & Gas, Inc., 2018 WL 388915 (S.D.N.Y. Jan. 11, 2018), Northern Oil fired its CEO after the SEC sought to bring an enforcement action against him. The enforcement action was based on the CEO’s activities at an unrelated company, Dakota Plains Transport, which he had founded. When Northern Oil announced the dismissal of its CEO, its stock price dropped and a securities class action was filed. The plaintiffs alleged that Northern Oil had omitted material facts about the CEO’s wrongdoing at Dakota Plains when the company made statements about its Code of Business Conduct and Ethics and the CEO’s value to the business.
The court found that the plaintiffs had failed to adequately plead that Northern Oil made any false statements. A failure to disclose wrongdoing is only actionable if the “non-disclosures render other statements by defendants misleading.” The company did not tout its compliance with its Code of Business Conduct and Ethics and there was nothing inaccurate about the company’s statements concerning its reliance on the CEO’s expertise and industry contacts. Accordingly, the hidden wrongdoing at Dakota Plains did not make those statements actionable.
Holding: Motion to dismiss granted. (The court also found that the plaintiffs failed to adequately plead scienter.)
In Halliburton II, the U.S. Supreme Court held that defendants can rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence of a lack of stock price impact. There are at least two different points, however, when stock price impact might be relevant: (a) the date of the alleged misstatement, and (b) the date of the alleged corrective disclosure. Is it enough for defendants to provide evidence of a lack of stock price impact as of the date of the alleged misstatement?
In In Re Finisar Corp. Sec. Litig., 2017 WL 6026244 (N.D. Cal. Dec. 5, 2017), the plaintiffs alleged that a December 2010 statement misled investors as to the nature of Finisar’s growth by denying that the company’s revenue increase was the result of an unsustainable inventory build-up by customers. The complaint also stated that Finisar’s stock price increased after the statement was issued.
At class certification, the defendants presented an expert report demonstrating that any increase in Finisar’s stock price following the alleged misstatement was not statistically significant “when the price is adjusted for general market and industry trading.” Among other objections, the plaintiffs asserted that the expert report was “flawed insofar as it fails to consider Finisar’s stock price change following the allegedly corrective disclosure” that occurred several months later. The court acknowledged that for purposes of price impact analysis, many courts have focused on the corrective disclosure date, especially where there may have been offsetting disclosures about the company on the date of the alleged misstatement or the plaintiffs had alleged that the misstatement maintained the stock price at an artificially-inflated level. (For more on the “price maintenance theory,” see here and here.)
In the instant case, however, the court found that neither of those rationales for focusing on the corrective disclosure date were applicable. There was no evidence that other information about Finisar had offset any price inflation caused by the alleged misstatement and the plaintiffs were not proceeding on a price maintenance theory. Under these circumstances, the court found no flaw in the expert analysis “simply because it focuses on the date of the alleged misstatement rather than the date of the alleged corrective disclosure.”
Holding: Class certification denied.
Can the filing of a judicial complaint against a company constitute a revelation of the alleged fraud sufficient to establish loss causation? In Norfolk Country Retirement System v. Community Health Systems, Inc., 2017 WL 6347726 (6th Cir. Dec. 13, 2017), the court addressed this question in a case alleging that Community Health Systems failed to disclose that it used a system called the “Blue Book” to improperly increase the number of inpatient services provided at its hospitals and overcharge Medicare. The plaintiffs alleged that this practice was revealed to the market when another healthcare company, Tenet Healthcare, filed a suit against Community. Community’s stock price subsequently fell by 35%.
The district court held that Tenet’s complaint could not have revealed the truth behind Community’s prior alleged misrepresentations because a complaint can only reveal allegations rather than truth. On appeal, the Sixth Circuit disagreed that this should be a “categorical rule.” Instead, each alleged corrective disclosure must be evaluated “individually (and in the context of any other disclosures) to determine whether the market could have perceived it as true.”
In this case, the panel found that “two aspects of the Tenet complaint set it apart from most complaints for purposes of that determination.” First, following the filing of the complaint, Community’s CEO “promptly admitted the truth of one of the complaint’s core allegations, namely that Community had used the Blue Book to guide inpatient admissions.” Second, the Tenet complaint included expert analyses that described “the extent to which the Blue Book inflated revenues and exposed the company to liability.”
While the defendants argued that the existence of the Blue Book and Community’s admissions data were publicly available information, the panel concluded that it “quite plausibly came as news to investors” that Community was inflating its inpatient admissions in ways that were clinically improper. Under these circumstances, the panel found that the plaintiffs had “plausibly alleged corrective disclosures that revealed the defendants’ antecedent fraud to the market and thereby caused the plaintiffs’ economic loss.”
Holding: Dismissal reversed and case remanding for further proceedings.
Quote of note: “As an initial matter, every representation of fact is in a sense an allegation, whether made in a complaint, newspaper report, press release, or under oath in a courtroom. The difference between those representations is that some are more credible than others and thus more likely to be acted upon as truth. Statements made under oath are deemed relatively credible because the speaker typically makes them under penalty of perjury. And a defendant’s own admissions of wrongdoing are credible because they are statements against interest. Mere allegations in a complaint tend to be less credible for the opposite reason, namely that they are made in seeking money damages or other relief. But these are differences of degree, not kind, and even within each type of representation some are more credible than others. Hence we must evaluate each putative disclosure individually (and in the context of any other disclosures) to determine whether the market could have perceived it as true.”