The 10b-5 Daily

On Tuesday, the U.S. Supreme Court heard oral argument in the Cyan, Inc. v. Beaver County Employees Retirement Fund case, which addresses the preemptive scope of the Securities Litigation Uniform Standards Act of 1998 (SLUSA).   At issue in the case is whether SLUSA divests 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).

The question before the Court is closely tied to Congress’s intent in enacting SLUSA.  In 1995, Congress passed the Private Securities Litigation Reform Act (PSLRA) to protect corporate defendants from meritless securities class actions.   The PSLRA, however, only applied to federal cases.  To evade the PSLRA’s impact, plaintiffs began filing securities class actions in state court, usually based on state law causes of action.

Congress passed SLUSA to close this loophole.  Due to unclear drafting, however, there has been confusion in the lower courts over whether SLUSA also makes federal court the sole venue for class actions alleging Securities Act claims (which historically enjoyed concurrent jurisdiction in state or federal court).  In Cyan, the parties have put forward three competing interpretations of SLUSA.  The Petitioners (Defendants) contend that SLUSA divests state courts of jurisdiction over class actions asserting Securities Act claims, thereby insuring that those cases must be litigated in federal court.  The Solicitor General maintains that SLUSA permits the removal of class actions asserting Securities Act claims, thereby also allowing those cases to be heard in federal court.  Finally, the Respondents (Plaintiffs) contend that SLUSA did not address class actions asserting Securities Act claims at all, meaning that once in state court they are not removable to federal court.

The parties’ textual arguments require having SLUSA in one hand and a yellow highlighter in the other.  In the end, however, the text of the statute might not end up having much sway over the Court.  The justices expressed varying degrees of frustration in trying to parse through the specific statutory language to reach a result, with Justice Alito, in particular, repeatedly referring to the relevant provisions as “gibberish” and noting that “all the readings that everybody has given to all of these provisions are a stretch.”

Petitioners and the Solicitor General appeared to have more success on the issue of Congressional intent.  Petitioners’ counsel drew an analogy to building a house, suggesting that it was nonsensical to believe that Congress would have barred the front door against the bringing of securities class actions in state court asserting state law claims, while simultaneously leaving the back door open for plaintiffs to bring securities class actions in state court asserting federal law claims.  Moreover, if securities class actions asserting federal law claims go forward in state court, they are not subject to the PSLRA’s procedural protections, a result that Congress presumably wanted to avoid.

Several justices picked up on this theme, with Justice Ginsburg asking Respondents’ counsel “why would Congress want to do that” given that you end up with “the federal claim in state court, and none of those [PSLRA] restrictions apply”?  Similarly, Justice Alito expressed incredulity that Congress would 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].”  Respondents’ counsel answered that if Congress was concerned about the “evasion of the PSLRA” in securities class actions alleging Securities Act claims, there were “10 different easier ways and more clear ways” that it could have removed the existence of concurrent jurisdiction for those cases (but it did not).  Justices Kagan and Sotomayor appeared sympathetic to that position, with Justice Kagan noting that “Congress did everything it wanted with respect to actions [under the Securities Exchange Act of 1934], which are the lion’s share of securities lawsuits.”

A decision is expected sometime early next year.

In its Omnicare decision, 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.  A key open question, however, is whether Omnicare’s reasoning extends to securities fraud claims brought under Section 10(b) of the Securities Exchange Act of 1934.

While some district courts have held that Omnicare is limited to Section 11 claims, the appellate trend is going the other way.  In City of Dearborn Heights Act 345 Police & Fire Retirement System v. Align Technology, Inc., et al., No. 14-16814 (9th Cir. May 5, 2017), the court agreed with a recent Second Circuit decision and found that Omnicare should apply to Section 10(b) claims as well.  The court reasoned that both Section 11 and Section 10(b) claims are based on untrue statements of fact and, as a result, the same falsity analysis is warranted.

Holding: Dismissal affirmed.

Is paying someone else to make a misstatement to investors the same as making the misstatement yourself for purposes of securities fraud liability?  Two recent appellate decisions address this question and come to different conclusions based on the specific type of liability alleged.

In In re Galectin Therapeutics, Inc. Sec. Litig., 843 F.3d 1257 (11th Cir. 2016), the corporate defendants retained promoters to “recommend or tout” the company’s stock by writing favorable articles.  These articles allegedly contained misstatements that misled the company’s investors.  While the defendants “worked in conjunction with the stock promoters,” there were no allegations showing that any defendant told the stock promoters what to say.  Under the Supreme Court’s Janus decision, a defendant is only subject to primary securities fraud liability if it has “ultimate authority” over the alleged misstatement.  The Eleventh Circuit concluded that merely paying for the articles did not demonstrate ultimately authority over any alleged misstatements made by the promoters and, as a result, the claims against the defendants based on those alleged misstatements must be dismissed.

In West Virginia Pipe Trades Health & Welfare Fund v. Medtronic, 845 F.3d 384 (8th Cir. 2016), the corporate defendants subsidized a number of medical journal articles that allegedly overstated the efficacy and safety of a treatment sold by the company.  Rather than assert primary liability for these alleged misstatements, the plaintiffs argued that the corporate defendants were liable as participants in a scheme to mislead investors.  Under the Supreme Court’s Stoneridge decision, a plaintiff cannot bring a scheme liability claim based on deceptive conduct that makes its way to investors through a third party’s statements because investors cannot demonstrate that they relied on any acts taken by the company.

Nevertheless, the Eighth Circuit found that the scheme liability claims against Medtronic were adequately plead because, among other reasons, the company had “instructed” the authors of the articles to make the alleged misstatements.  According to the court, the plaintiffs would be able to demonstrate that investors had relied upon statements – even though they were made by third parties – because a “company cannot instruct individuals to take a certain action, pay to induce them to do it, and then claim that any casual connection is too remote when they follow through.”

The Galectin and Medtronic decisions are difficult to reconcile.  The Supreme Court has made it clear that it wants to severely restrict the ability of private plaintiffs to bring what amounts to aiding and abetting claims for securities fraud.  So if the alleged facts are insufficient to establish that the corporate defendant is the maker of the third party statements, should plaintiffs be allowed to use scheme liability to circumvent that restriction?  Stay tuned.